Pub. 2 2013 Issue 8

November 2013 23 l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s BANKING INDUSTRY CHANGES CONTINUE IN 2013/2014 By BrianMall, bmall@bkd.com Pre - H.B. 2117 Post - H.B. 2117 Schedule C Taxable Exempt Sole proprietor & Single-member LLC Schedule E Taxable Exempt S corporations, Partnerships, Trusts, Royalties & Rental Real Estate Schedule F Taxable Exempt Farm Maximum Tax Rate 6.45% 4.90% Being phased down over six years Minimum Tax Rate 3.50% 3.00% Being phased down over six years D OES IT FEEL AS IF THE BANKING industry is in a state of constant flux? With new regulations, Basel III, Dodd-Frank Act and income tax changes, the answer seems to be yes. Here is an overview of some of the significant tax changes that could impact your bank and its shareholders. Basel III Deferred Tax Restrictions On July 2, 2013, the Federal Reserve released the Basel III standards, which modified how and when deferred tax assets can be factored into regulatory capital. In general, Basel III does not go into effect until January 1, 2015, for community banks, and the rules are phased in over a five-year period. Under both the current and the new standards, the starting point is generally accepted accounting principles (GAAP) deferred tax asset (DTA)/deferred tax liability (DTL). However, there are some key distinctions after the starting point. Basel III Treatment of DTAs: • First, allocate DTLs pro-rata to offset DTAs. • Second, any remaining DTAs related to net operating loss carry-forwards and/or credit carry-forwards are backed out of Tier 1 capital. In other words, a bank cannot use future projected taxable income to support these types of DTAs. • Third, DTAs are allowed as long as they can be carried back against taxes paid previously and they do not exceed the new threshold deduction computations: o Individually, less than 10 percent of adjusted Common Equity Tier 1 (CET1). o Collectively, less than 15 percent of CET1. • Finally, there is a 250 percent risk weighting on allowable DTAs. In general, the Basel III standards are much more restrictive and will result in a reduction of DTAs allowed in regulatory capital. Banks should familiarize themselves with these new rules and evaluate planning strategies to help mitigate the effects of the new standards. 2014 Final Repair Regulations In September 2013, the IRS issued final repair regulations and these are effective January 1, 2014. Below is a summary of significant changes in the final regulations: • The regulations implemented a simplified de minimis rule. The safe harbor allows a taxpayer to expense an item as long as the cost does not exceed $5,000 per invoice or per item as substantiated by the invoice. o The aforementioned safe harbor applies only to a taxpayer if the taxpayer has applicable financial statements. o To use this safe harbor, banks must have a written policy to expense this dollar amount for books; the policy must be in place by the end of 2013. • The regulations expand the routine maintenance safe harbor to include buildings and structural components. An item is considered routine if the taxpayer expects to replace it more than once over a 10-year period. “Routine” items can be expensed as incurred by the bank. • The final regulations allow a taxpayer to elect to follow book capital improvement cost accounting, but only if the bank capitalizes the item for books. The IRS anticipates most businesses will need to file various elections to conform to the new regulations. Now that the regulations are final, banks should work with their advisors to implement these new regulations. 2013 Kansas Law Change In 2012, Kansas House Bill 2117 changed the tax landscape for Kansas individuals beginning in 2013. The bill eliminated state income taxes on certain activities and reduced the state tax rates on the rest of the activities. Here is a comparison of the significant changes: In addition to the changes listed above, the standard deductions were increased and itemized deductions were either eliminated or decreased. However, banks still will be required to file the Kansas Privilege Tax Return, Form K-130, and pay the tax accordingly. In addition, the bank’s S corp shareholders will be permitted to deduct holding company losses while excluding the bank income, as tax was already paid at the bank level. The taxation treatment of bank S corp earnings in Kansas will remain consistent with prior years. Conclusion While this article summarizes some of the key 2013/2014 tax changes that will affect your bank and its shareholders, please visit the BKD Thought Center at bkd.com/thought-center for more information. This information was written by qualified, experienced BKD professionals, but applying specific information to your situation requires careful consideration of facts and circumstances. Consult your BKD advisor before acting on any matter covered here. Article reprinted with permission from BKD, LLP, bkd. com. All rights reserved.