Issues of Interest
Issues of Interest is a podcast for the banking and financial services industry from Baker Newman Noyes. Our accounting and advisory professionals discuss assurance, tax, business, and technology topics and trends affecting the industry.
Issues of Interest
Tax planning for your institution: credits, deductions, and multistate considerations
In this episode of Issues of Interest from Baker Newman Noyes, Adam Aucoin and Leanne Scott from BNN's financial institutions industry practice discuss current trends in tax planning for banks and financial institutions. Adam also covers several credits impacting the tax landscape and Leanne summarizes a few multi-state considerations for banks operating across state lines. You can see additional corresponding materials here:
[00:07] Joseph Jalbert: Hello and thank you for tuning in today to Issues of Interest from Baker Newman Noyes where we cover assurance, tax, business advisory, and technology topics and trends affecting the banking and financial services industry. I'm Joe Jalbert and I lead the banking and financial services practice here at BNN. Banks and financial institutions are constantly navigating volatility and change. Here at Issues of Interest, we help you stay current on what's happening in the industry so you can achieve success for your institution. Now let's get into the episode.
[00:43] Leanne Scott: Hi everyone. Thanks for joining us for Issues of Interest, BNN's podcast for the banking and financial services industry. I'm your host today, Leanne Scott, state and local tax principal here at Baker Newman Noise. I'm here with Adam Aucoin, also a tax principal at BNN and one of the leads of our banking industry practice. Hi Adam.
[01:02] Adam Aucoin: Hello Leanne, and hello to everyone listening.
[01:04] Leanne Scott: Adam, before we dive in, can you take a moment to share a bit about your role at BNN?
[01:09] Adam Aucoin: Sure. I've been at BNN for about eleven years. I'm one of the tax principals now, one of the leads in the financial institution services. I do work with individuals and small businesses as well, but the bulk of my time is working with banks. I'm based out of Portland and will travel to the other offices as needed. I'm actually in Portsmouth quite a bit as well, and when I'm not working or trying to avoid work, I'm usually at home chasing down my nine, six, and one year old. And that pretty much keeps me busy for every other hour of the day. How about you, Leanne, a little more in your roles?
[01:41] Leanne Scott: Sure. I lead our state and local tax, or salt as we like to call it, practice here at BNN. This involves working with all types of clients in all industries, in all different tax types across the country. So, you have to be a little crazy and like a lot of variety to work in salt. I am based in Boston, but I work with issues in all of the states and often team up with Adam and his team on salt items for the banking and financial industry clients. When I'm not doing that, I'm usually trying to wrangle my three-year-old son or hoping for the return of college football season. So, I'm excited to be here chatting with you today, Adam, about these issues. It's a great break from meetings about tax returns and planning during busy season and prepping for what seems to be another upcoming busy season.
[02:26] Adam Aucoin: Always prepping for another busy season and said in this current environment, it really doesn't end, never ends for our banking clients in particular with everything going on in that industry. So excited to be talking to you as well.
[02:37] Leanne Scott: Great. So today we're here to talk about the current tax planning landscape for financial institutions and what banks and similar institutions should be monitoring in the coming months in terms of planning and strategy for next year and beyond. To get us started, could you talk a little bit about what you're seeing and hearing about the current earnings and interest rate environment for your clients?
[02:58] Adam Aucoin: Sure. Just to kind of put this in context, just when we talk about the current environment and just in comparison maybe to what we've seen over the last few years, just in general, especially as I go through each quarter estimate, we're kind of seeing earnings start to come back down. And that in large part seems to be due to the interest rate margin getting squeezed. So, you got higher interest rates that you're paying on your deposits, and you're maybe getting a little bit more on your loans, but the margin between the two is really getting squeezed. So, we're seeing earnings come down a little bit in general. Not necessarily everybody, but just kind of in general. And that's a big change, I think, over the last few years where we were in very low interest rate environment, and everybody was seemingly enjoying some increased earnings. Between that and PPP, loan fees and a lot of other things going on, just the real estate market booming in general, lots of loans going back forth, there was lots of refinancing for a while, and it's kind of starting to tip the other way now. So, we almost have to think about how we're going about this a little bit differently. Before, we might have been thinking, earnings aren't going to stop, let's just keep going and going, and now we kind of have to put the brakes on a little bit and go, okay, how do we think about planning going forward if we're not getting quite the same earnings levels? And what are the different considerations at that point? Few different things I like to think about too. If you have lower pretax income, your effective tax rate, there's some considerations there. When you're looking at your effective tax rate, that pretax income is really your denominator when you're comparing different items that affect at the different permanent items. So, if you have a lower denominator, it just makes everything that is a permanent difference. Your income, your tax credits, your meals and entertainment, all those things just have more variation in how they affect your effective tax rate. So, if that's an important consideration, maybe less so for some mutual banks than it is for stock banks. But when you're comparing year over year or quarter over quarter, if earnings are coming down, maybe some of the other things don't move as much. But it does have some impact, and it's usually just an easier way to understand what's happening and why it's happening and be able to explain that. Especially if you have shareholders, it becomes a little bit more important to be able to explain why it's moving. And sometimes that pretax income is part of that few other considerations. Just in this environment. Again, if you're dealing with lower earnings, if that's the case, charitable contribution planning and carry forwards becomes a big part of that. You are limited in general to as a C corporation, which is what most of our banks are, your charitable contribution deduction is usually limited to about 10% of taxable income before the charitable deductions and before dividends received deduction. So, in a lower earnings impact, if you have lower taxable income, it can hamper your ability to give maybe to the same level you have in the past or that you desire to, depending on what your goals are. As a financial institution, we do actually see quite a few of our banks who pledge to give 10% of earnings to charitable contributions, whether that's to their foundation or other 501. So, if that's built right into the way you do business, this becomes a big consideration in terms of where earnings are and your ability to give. And if you've been giving at certain levels, do you need to back off of that? Do you need to realize if I give at the same level, I'm going to create a carry forward and what is my ability to utilize that carry forward? Because you have five years to utilize the charitable contribution carry forward, there just becomes a lot of planning back and forth in terms of making sure that you don't lose a tax benefit, if that's a consideration, or if you're willing to lose a tax benefit, understanding the benefits you might be getting in return for that. So, lots of planning back and forth for that and then timing differences in general become big items. A few other things we think about potentially maybe net operating losses. We have a handful of banks where these slim margins are really impacting them. Maybe they're heavy in the residential or other type of loans and maybe they're looking at decreased earnings for the next year or two that might bring them into a federal or state NOL position and just the ability to utilize those going forward. And what does that mean, other things? Fixed assets, do you take bonus of 179, do you back off of that and backed out of it and depreciate over five years just because you don't need the full deductions? And that goes hand in hand sometimes with the charitable contributions, trying to slow down the depreciation, deduction to allow more taxable income, to allow more charitable contributions to be used. Because again, you have the five year carry forward window on that where depreciation, you don't have carry forward window, you just take it over the life of the asset. And then again, pension and retirement plan contributions, how do you time those up? I was actually just talking with a bank this morning and they had been looking at their 2023 pension contribution and they said they looked at their earnings and they saw that it was going to be down. They're like it's really going to hamper our ability to do the charitable contributions. It's going to bring in income, and we're not sure we're going to get quite the same benefit or maybe even brings us into territory where we're thinking about doing something else because of that. So, they actually went back to and said, we've extended we have until October 15 to do this return up to September 15 to make this contribution. And they decided that they were going to make the contribution for the prior year because they had more earnings than 22, than 23. So, these things come up, and they're coming up pretty frequently right now.
[07:59] Leanne Scott: So, lots to think about.
[08:01] Adam Aucoin: Yeah. Really, the timing of when you want to take deduction versus can you defer or accelerate it? It becomes more important when you realize if you accelerate deduction, you might be hampering your ability to take a different deduction.
[08:14] Leanne Scott: Yeah. How about what are you seeing these days in the tax credit environment? How does that play into this list of things you're thinking through?
[08:22] Adam Aucoin: Another very important topic, and one that I think I've been talking to a few different banks a little bit lately, and then even more so over the last couple of months because it's coming up. Terms of some banks. Do a lot of low-income housing investments or just investments in tax credits in general, whether it be that solar or new markets credits or sometimes rehab credits with loans, you have to have taxable income to use those credits in general. In other words, you created credit carry forward. So, there's some limits in terms of how much credits do you want, how much investments do you want based on how much taxable income you project and how much credit carry forward are you willing to take, if any? Sometimes banks don't really want to have the carry forwards. They want to try to time things out. So, they're only utilizing up to their maximum amount each year. And if you have pre decreased earnings, you have decreased tax due, which usually fantastic, great, I don't want to pay tax. Nobody wants to pay more to the government. But if you have a bunch of tax credits that you're taking, it comes into play in terms of how can I use these and what do I need to do if I can't use them? Do I need to back off investments going forward? Especially in Maine, New Hampshire, Vermont. There's some annual type funds for low income housing investments. And some of these banks join these things every year, and they have been joining them every year over the last few years because they take the tax credits, they see the benefit, they get the CRA credit, and they see all the benefits they're getting. And they haven't been as worried about the capacity level to be able to take those credits. Now, going forward, they might have to consider what's going on with that. Can I actually get the bang for my buck in terms of investment if I do this investment this year, can I get the tax credit in this year? Is it going to get deferred? There's a lot of considerations there and that's usually a long-term planning in terms of how long out do you go? I mean, the low-income housing credit goes pretty equally over ten-year period. So, you have to map these things out and realize sometimes it's a matter of, okay, I only have X amount of credits. Here's where I'm at. This one is in its 10th and final year this year. So, in that same year, maybe I can look to get into this investment instead. Loan housing is over ten years, new markets over a certain period of time. Rehab credit is over five years. Solar credit actually, you get all at once. So, some years you might look at this going, I know what I have for low income housing credits. I want to do solar credits as well. Maybe it's part of my ESG goals or something else like that. And you need to look at your taxable income and go, where am I going to be? What's my ability to use this solar credit? If I do it, would I be able to use it the next year? Maybe income is going to be really high some years, so I can really ratchet up on that solar credit, and then the next year I need to back away or go away completely because I realize I don't have the earnings to sustain this. So, it's just lots of planning and projections, but not necessarily overcomplicated. Just another wrinkle to the consideration before you just jump into a low-income housing investment or some type of other tax credit investment, of course.
[11:10] Leanne Scott: And to further complicate it, there are also credits available in my world at the state and local level that we see banks take advantage of at times. I know. We've seen the interest in mass has the Community Investment Tax Credit Program, New Hampshire has the CDFA. I've seen banks in Massachusetts look into maybe historic rehab depending upon the types of buildings they're in. Transferable credits are something I think we're getting a lot more interest in in recent years. Of course, that assumes you have taxable income to offset, but that's usually when banks are looking to buy credits, usually it's some sort of discount from someone else to use on their own tax returns. Film tax credits are a common option there. The other one I think you and I both see quite a bit is the Work Opportunity Tax Credit, or WOTC. It's one of those that it's technically a federal credit, but I know we state people often get involved because they're often administered by state folks. So that's one that, if you haven't thought about, depending upon the hiring profile of folks that are coming into your organization, can be a good one to consider.
[12:11] Adam Aucoin: Yeah, that's an easily forgotten one because I think people see it just as an HR function and don't realize that there's some tax credits involved. We're not usually talking big dollars here, but if you're hiring the right people anyways, might as well take the tax benefit with it. It's a good point. That's definitely one that gets overseen quite a bit.
[12:28] Leanne Scott: Yeah, definitely.
[12:30] Adam Aucoin: But there are other considerations too and other things going on in the current environment in terms of financial institution taxation. One of the big ones I want to get into now is into state and local tax. I'm just curious as to what you see in this environment right now.
[12:43] Leanne Scott: Sure, probably the top issue we're getting from all of our clients, but I think it impacts this industry specifically a lot is remote workers. So, we're all coming out of the pandemic. I know I'm still working from home most of the time. Most people are doing that a lot more than they ever did. And banks were traditionally an industry where I think most people reported to a branch or a corporate office or something every day for work. And now you're seeing people either working from home or banks are realizing that in order to fill certain positions or get top talent, they might be hiring people in new states that are outside of their geographic footprint to do certain roles. So, we get a lot of questions about the impact of that. And what I mean by impact is these questions usually come in with someone wondering what to do about income tax withholding or unemployment. But then once we start to unpack things and talk more, they also realize this could impact their income franchise tax filing position less so for this industry but can have sales and use tax implications. So really a lot of things to consider and an area that we find in addition to tax, you've got to loop in your HR and legal folks as well with a lot of these things, especially in a regulated industry like though that's probably the top thing that we're seeing these days in terms of salts with the banks. But in general, I think nexus, which is the word we use for when you have enough of a connection in a state to have a tax obligation, that's something that our banks are monitoring in general because as I mentioned earlier in the podcast, state rules. What makes it fun for me or drives some people crazy is that the rules are different and they're always changing. So, you really need someone who's plugged into things to tell you OKAY, all of a sudden if you've got somebody working in Illinois, what could that mean or know? So, keeping on top of that with a lot of our banking clients too, where collateral is for certain underlying for loans can impact their nexus position. And also, the states have moved a lot in recent years to what's called market-based sourcing. Meaning, looking at the receipts that might need to be attributed to a state based on where the market or the customer or the benefit, however the particular state defines the market is meaning that you might now have sales in states that in the past you might have considered Massachusetts or New Hampshire under old cost of performance rules. So just another thing that you really want someone to weigh in on, make sure you're doing things appropriately, managing risk and filing in the right places. This also plays into a lot of states now are moving to where you might not even need to have anything physical, meaning a branch or travel or collateral in a state, you could trigger a filing obligation just based on what's called Brightline presence, meaning enough sales in a state. So, these are the kind of things that Adam and I talk about a lot and watch for a lot of these clients because it can really impact you. And one thing I always like to mention is filing in more than one state is not always a bad thing when you do that. Yes, it might mean increased tax compliance, but you could be sourcing income to a state that has a lower tax rate, so you could be getting things out of a higher tax rate jurisdiction. So just to keep that in mind as you're planning and thinking about states.
[15:58] Adam Aucoin: It's a very good point and we do always think, oh, you have to follow more states must be paying more tax and it's completely dependent on where you are. Actually, some of our New Hampshire based states actually got the benefit recently from the change to single sales apportionment that made at times that really dropped the apportionment and they were paying quite a bit less than tax in some cases. So, it completely dependent on where you live and where your income is. And it's a really good point to keep in mind. I think we usually ask the question quarterly with our banks and annually look into it a lot more in terms of where's your exposure, where's your risk, and it is different. I think everyone would always like to see a whole list of where do I want to do lending, where don't I, where are the state rules? Like really complicated versus not. And it's not as black and white as that. It's 50 different, 51 if you include DC, different jurisdictions. And then you can even get down to the state and local level if you're in the right areas. Thankfully, we're not like Ohio and Maine and New Hampshire where Ohio has every city tax in the world, but it's out there, things to watch out for.
[17:01] Leanne Scott: Yes. And since you mentioned single sales factor, I just put in a plug for if Massachusetts ever gets those changed to single sales factor, we'll have a lot more planning to do as well. So definitely monitoring that, so well, good. Well, Adam, I know we've covered a lot of topics, and just in the interest of time, I'll wrap things up. Is there anything else you want to mention that we might not have touched on or just key points you'd like for listeners to keep in mind for their institution going forward?
[17:29] Adam Aucoin: Yeah, just a couple of other very quick bullet points. One other thing we're keeping an eye on is the Section 174 Research and Development amortization rules, where under Tax Cuts and Jobs Act, you're no longer able to deduct those as incurred, you have to amortize them. We don't have a ton of banks that are doing a lot of research and development. You're not talking losing deduction, but it's a pretty big jump in one year with the switch from deducting as incurred to having to capitalize all at once and then start amortizing. So, it's a timing difference, but it could have a pretty big impact in terms of cash flow and something to think about and plan if you haven't been already. A couple other things we are keeping an eye on where the rates are going if the Feds keeps raising rates and what that might mean in terms of earnings and continuing to work with banks to do some planning against strategic planning in terms of timing of things. And then the last thing I'll do is just mention a lot of these topics too. Were actually just in an article I wrote I think was in the June issue of Interest. This is kind of some of what I did piggybacked off of that. But there are some different considerations in terms of interest, expense and timing of deductions and things there. If you want something to read, if this audio isn't quite doing the same level of knowledge base as reading might do for you, that's out there as well.
[18:43] Leanne Scott: Great. I guess the last technical point I'll mention is Adam mentioned 174. Just keep in mind that while most states are conforming to that, there are some significant ones that are not. So always have to bring an assault angle on things. So anyway, Adam, it was great to chat with you about these topics today. I think we covered a lot and a lot of things to consider for this industry. After what's been a volatile year and unprecedented few years for all of our clients, I think things like this are more important than ever. People are, know, trying to manage a lot of moving pieces. So, thank you for your time.
[19:17] Adam Aucoin: No, thank you for sitting with me, Leanne. And I appreciate you jumping on and working with me to be the guinea pigs on the first episode here of the Issues of Interest podcast. And as always, feel free to reach out whether you're a current client or not. I'm happy to talk and discuss taxes in the financial institution realm.
[19:35] Leanne Scott: Great. And yeah, just overall, our team is always monitoring and sharing updates, resources, and development. So please stay tuned for more articles, podcasts, and resources. Thank you all for your interest and attention. Goodbye.
[19:56] Joseph Jalbert: Thank you for listening to issues of interest from Baker Newman Noise. The BNN banking team thrives on solving complex business challenges and helping institutions meet their goals. You can find more of our industry content and subscribe to our newsletter@bnncpa.com. If you'd like to connect with a member of our team, email info@bnncpa.com.
[20:18] Adam Aucoin: Bye now.
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