Like many large businesses, banks started to feel some of the effects of The Tax Cuts and Jobs Act almost immediately. The impact on the banking industry from a decrease in the value of tax-deferred assets was particularly significant, with the largest banks reporting millions or even billions in fourth-quarter charges. However, following that one-time hit, major tax savings are on the way, and banks are expected to be one of the big winners in tax reform going forward.
Win for large banks: Lower corporate tax rates
The banking industry has historically paid among the highest effective tax rates in the U.S. The slashing of the corporate tax rate from 35% to 21% will be a boon for large banks starting in 2018. Some analysts are expecting many banks to see a double-digit increase in earnings per share, as reported by The Wall Street Journal and others.
Win for small banks: Pass-through income deduction for subchapter S banks
Shareholders of smaller banks that are structured as subchapter S corporations may qualify for a new tax deduction under the Tax Cuts and Jobs Act. Shareholders of eligible Subchapter S corporations may receive a 20% deduction on “qualified business income,” effectively reducing their maximum effective tax rate from 39.6% in 2017 to 29.6% in 2018. Note that while this deduction is available for bank shareholders, the new pass-through income deduction includes an exception for broker-dealers and other alternative investment managers with income above a specified amount.
Some owners of Subchapter S banks may consider changing their business tax structure from a pass-through to a subchapter C corporation as a result of this tax law change. A tax adviser and attorney can advise on the pros and cons of any changes to business structure or tax election status.
Initial hit on tax-deferred assets
Many large banks will report a considerable hit on their 2017 financial statements as many banks’ deferred income tax assets and liabilities will need to be re-measured.
A lot of banks have reserves that have been out there since the financial crisis in 2008-09. If these banks have a net deferred tax asset on their balance sheet, the potential value of their future tax deductions is now worth less than it was prior to 2018. Banks holding these assets have, for the most part, been using a 35% federal income tax rate (before the effect of state income taxes) to value these deferred income tax assets. Under the new tax law, this federal income tax rate will drop to 21%. On the flip side, banks with net deferred income tax liabilities were, in some cases, able to record a gain in the fourth-quarter as a result of the above mentioned income tax rate change.
The changes outlined above will affect the vast majority of banks, but those aren’t the only tax changes to be aware of. Contact your Kaufman Rossin tax adviser to learn more about these and other provisions within the new tax law that could affect your financial institution.