It’s that time of the year when tax savvy banks start identifying yearend tax-saving opportunities. Few tax law changes are expected in 2016, making this year the first time in several years that taxpayers can project their tax outcome with some confidence. Combining traditional strategies and “extender” provisions enacted in December 2015 should make year-end tax planning somewhat less complicated this year.
Timing techniques can play a big role in 2016 year-end tax planning. Typically, the goal of year-end tax planning is to identify ways to delay the payment of tax until a later year. However, if the tax rate is expected to be higher next year, a good strategy may be to reverse that thought process by moving taxable income into this year and pushing deductible expenses into next year when the deductions could potentially save additional tax dollars.
The tax accounting method a bank uses determines when income must be recognized for tax purposes and when expenses are deductible. Cash-method taxpayers report income when it is actually or constructively received and generally deduct expenses when payments are actually made. Accrual-method taxpayers report income in the year their right to it becomes fixed and the income amount can be determined with reasonable accuracy.
Deductions are taken when all events have occurred, thus creating the liability, and when the amounts can be determined with reasonable accuracy. For instance, if a bank uses the cash method, a timing strategy to delay tax payments may be to pay expenses before year-end that may otherwise have been paid in January. On the other hand, if a bank uses the accrual method, a 2016 deduction may be available for bonus payments to unrelated employees within 2½ months after year-end as long as the liability to pay the bonuses is both fixed and determinable by the end of the year. (In other words, the amount of bonuses to be paid must be board approved prior to December 31, 2016.)
Another timing strategy that could have an impact on taxable income is related to bad debts. A deduction for bad debts is available for any debt that is wholly or partially “worthless.” This generally follows the net charge-offs booked during the year. A close look at book chargeoffs prior to year-end to ensure that they are maximized (staying within regulatory rules for charge-offs for financial statement reporting purposes) could result in an additional deduction from taxable income in 2016 as opposed to the following year.
In addition to the traditional timing strategies, tax extenders included in the PATH Act of 2015 related to tax depreciation can play a big role in determining taxable income, including bonus depreciation and Section 179.
Under the Section 179 election, a business may expense up to $500,000 of eligible asset purchases in the year they are placed in service as opposed to spreading the deduction of the purchase price over a number of years. The cost of new or used assets purchased, including equipment, certain software, and other non-real estate tangible property, can be deducted to reduce taxable income (some limitations may apply).
Another option to accelerate the tax write-off of the cost of assets purchased is bonus depreciation. This election allows a 50% deduction of the cost of qualifying new assets placed in service in 2016 and, unlike Section 179, can be used to create or increase a net operating loss. The 50% deduction amount applies to assets purchased through 2017; however, it is set to phase down to 40% in 2018 and 30% in 2019.
An additional consideration when purchasing assets is the de minimis expensing provisions of the “repair regulations” that went into effect in 2014. To take advantage of this election, a written policy must be in place prior to the start of the year that states a threshold amount up to $5,000. The threshold amount is applied on a per item basis, as opposed to being applied to the invoice total. For example, a bank that has a written policy with a threshold of $5,000 and purchases 20 computers at $500 each would expense the entire invoice amount for the 20 computers. These asset purchases must be expensed for book purposes according to the written policy in order to qualify for this deduction election.
The “repair regulations” also include provisions that allow for expensing of disposed assets’ costs that may not have been initially segregated as a partial disposal. For example, if a bank replaces its roof and it meets the criteria for capitalization, a deduction could be taken for the undepreciated portion of the original roof, even if the cost was not separately identified from the cost of the building.
Keep in mind that assets must be placed in service by December 31, 2016, to qualify for the Section 179 election and bonus or other depreciation in 2016. Mid-quarter convention should also be considered in year-end tax strategies because it can reduce the amount of the depreciation deduction if more than 40% of the year’s purchases are in the last three months of the year.
Many strategies, including those described above, are effective only if they are implemented before year-end. However, before you take any action, consider consulting with a tax professional to avoid any unintended consequences; the tax laws, though more certain this year, are highly complex, and tax planning strategies should be applied to your specific situation.