The world of tax used to be fairly predictable and major changes didn’t happen often; now it seems that there are multiple law changes annually. Here’s a look at some of the administration’s Fiscal Year 2022 proposals that will impact financial institutions.
While it’s a long way from a proposal to a law, financial institutions should still be prepared. changes along the way.
Corporate tax increase
The proposal would increase the income tax rate for C corporations from 21% to 28%. This would be effective for fiscal years beginning after December 31, 2021. Fiscal years would have an allocated rate based on the portion of the taxable year that occurs in 2022. This is an administratively simple way to raise revenue. There are multiple considerations for tax planning purposes in an increasing rate environment, and banks should consult their tax advisors, including revisiting their accounting methods. In addition, consideration should be given to the impact on your deferred tax calculation and how that will play into regulatory capital.
School infrastructure bonds
The proposal would create Qualified School Infrastructure Bonds (QSIBs) similar to BABs (Build America Bonds). The bonds would be taxable and either pay cash or a tax credit equal to 100 percent of the interest on a QSIB. These bonds would enable education agencies to expand access to high-speed broadband for digital learning among other things. For a bank, these may be worth looking at for your investment portfolio.
Increase the top marginal income rate for high earners
The proposal would increase the top marginal individual income tax rate back to 39.6%. This is proposed to be effective for taxable years beginning after December 31, 2021. For 2022, this rate would apply to taxable income over $509,300 for married individuals filing a joint return and taxable income for unmarried individuals of $452,700. Many banks have elected S corporation status, and this may be a good time to revisit your tax structure with the changes to individual tax rates, and changes to gift and estate rules discussed below.
Reformation of capital income
There currently are preferential rates on long-term capital gains and qualified dividends. These are taxed at graduated rates with 20% generally being the highest rate (23.8% including net investment income tax, if applicable).
The proposal would tax long-term capital gains and qualified dividends of taxpayers with adjusted gross income of more than $1 million at ordinary income tax rates, to the extent that the taxpayer’s income exceeds $1 million, indexed for inflation. For example, if a taxpayer had $800,000 of wage income and $300,000 of capital income, only $100,000 of the capital income would be taxed at the ordinary rates and $200,000 would still be eligible for the preferential capital rates. For banks looking at mergers or acquisitions, this change will have a significant impact on the M&A landscape.
Treatment of transfers of appreciated property by gift or on death as realization events
Currently when someone gifts property, the donee receives the cost basis of the donor and there is no gain recognition. Upon death, appreciated property is transferred to heirs at fair market value and there is no income tax involved. Under the proposal, appreciation in a donor’s assets would be subject to income tax upon gifting or at death. Gain on unrealized appreciation would also be recognized by a trust, partnership or other non-corporate entity that is the owner of property if that property had not been subject to a gain recognition event in the prior 90 years. The testing period would begin on January 1, 1940, so the first possible tax under this would be December 31, 2030.
There are certain exclusions under the proposal as well, including a $1 million per-person exclusion from recognition of unrealized capital gains for assets gifted or at death. This would effectively be $2,000,000 per married couple, with portability rules similar to what is currently in place. The exclusion would be indexed to inflation.
These proposals would be effective for individuals for property gifted or property owned at death by decedents after December 31, 2021. This is a major shift in the treatment of these appreciated assets and is particularly concerning to owners of businesses and farms. Many bank owners are currently evaluating estate and gifts plans in light of these proposals. Your tax advisor can assist with that.
Comprehensive financial account reporting to improve tax compliance
Information reporting for businesses currently covers certain types of revenue (e.g. Forms 1099-MISC, 1099-NEC, and 1099-K); there is no information reporting for deductible expenses. The tax gap for business income (outside of large corporations) is estimated by the IRS at $166 billion per year. It is believed that this gap is driven by a lack of comprehensive information reporting and difficulty in identifying non-compliance, outside of an audit.
The proposal would create a comprehensive financial account information reporting regime. Financial institutions would report data on financial accounts in an information return, including gross inflows and outflows with a breakdown for physical cash, transactions with foreign accounts and transfers to and from another account with the same owner.
The proposal imposes this requirement on all business and personal accounts from financial institutions, including bank, loan, and investment accounts (except for accounts below a low de minimis gross flow threshold of $600 or a fair market value of $600).
Additionally, similar reporting requirements would apply to payment settlement entities and crypto asset exchanges and custodians. The proposal would be effective for tax years beginning after December 31, 2022.
How Wipfli can help
It is important for financial institutions to begin planning for some of these potential changes, but to also keep in mind that these are only proposals which will be negotiated and final legislation, if and when enacted, may not even resemble the above; however, this gives a flavor for what is being considered and provides opportunities to start planning in advance.
Reach out to our financial institutions team to learn more about how we can help with tax compliance, digital solutions and cybersecurity, among other services.