Under the Tax Cuts and Jobs Act (TCJA), more community banks are now eligible to use the cash method of accounting for federal tax purposes. This offers greater tax-planning flexibility, allowing some businesses to defer taxable income. Newly eligible businesses should determine whether this method change would be advantageous and, if so, consider switching methods.
What's changed?
Previously, the cash method was unavailable to C Corporation banks whose average annual gross receipts for the previous three tax years exceeded $5 million. For S Corporation banks, they were not subjected to this low limitation and thus many utilized this significant tax deferral opportunity by using the cash method of accounting for tax purposes.
The TCJA raised the threshold to $25 million, beginning with the 2018 tax year. In other words, if your average gross receipts for the previous three tax years are $25 million or less, you generally now will be eligible for the cash method, regardless of how your business is structured.
Cash method advantages
The cash method offers several advantages, including:
Effectively permanent deferral: Typically, a bank’s accrued interest income exceeds its interest and operating expense payables. Thus, this cash method provides a taxable income deferral that most likely sustains itself and only gets bigger as the bank grows.
Tax-planning flexibility: It offers flexibility to control the timing of deductible expenses. For example, it allows the bank to utilize cash to pay down operating expense payables at year-end to shift deductions into the current year by accelerating the payment of expenses.
Cash flow benefits: Since income under the cash method is taxed in the year it is received, this method does a better job of matching the recognition of income with the year the business needs to pay its tax bill.
Should you switch?
If you are eligible to switch to the cash method, you need to determine whether it is the right method for your bank. The IRS has established procedures for obtaining automatic consent to such a change, beginning with the 2018 tax year, by filing Form 3115 with your tax return. This does need filed both with your current year tax return and also with a designated IRS service center. The first year reduction to taxable income can be significant but does add some tax planning complexity. Contact us to discuss if this might make sense for your bank.