1 30pm community banking update

COMMUNITY BANKING UPDATE

SPEAKERS:

COLLEEN DELGERRANDY CHURCHILLMARK REIS

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CURRENT ISSUES BASEL III MERGER & ACQUISITION CONSIDERATIONS RECENT DEVELOPMENTS

Bad debts: claims for refunds Notice 2013-35 Conformity election Nonaccrual interest Oreo issues S elections and their value

Bad Debts: Claims for Refunds, Moving Ahead◦ Where did we come from? Section 166 Wholly Worthless (Section 166(a)(1)) Partially Worthless (Section 166(a)(2))◦ The 6 Most Common Myths of Bank Tax Bad Debts 1 Tax bad debt charge offs must = F/S ALLL charge

offs 2 Charge offs must be entered by year end 3 The IRS has veto power over your bad debts claimed 4 Selling Costs are not “deductible” for tax until sold 5 Bad Debt Changes = Change in Method of

Accounting 6 The Conformity Election gives audit protection

Bad Debts: Claims for Refunds Notice 2013-35: 7 Conclusive Presumptions◦ 1 Which entities should be covered?◦ 2 Should changes in bank regulations change

treasury regulations?◦ 3 Are accounting rules sufficiently similar to IRC

Sec. 166?◦ 4 One conclusive presumption or more?◦ 5 What process should be required?◦ 6 Should limits be placed on timing of deduction?◦ 7 Impediments to uniform loss standard?

Bad Debts/Claims for Refunds/Notice 2013-35

Conformity Election: Facts and Myths◦ Fact: Some will use Election properly ◦ Fact: The election does NOT provide exam

protection or exclusion from loan files review See FSA 200129003, Rev. Rul. 2001-59, IRM Sec. 4◦ Fact: Revocation of Conformity Election by

regulators may be advantageous◦ Myth: Most banks would benefit from the election◦ Myth: EDLs strengthen bad debt deduction taken

Nonaccrual Interest: The Top 6 Myths◦ 1 The Rev. Rul. 2007-32 Election is a good deal◦ 2 All interest accrued is includible in income Section 451 All Events Test/Rev. Rul. 80-361/Regs.

1.446-2◦ 3 If taxable, no bad debt without payoff/REO/sale◦ 4 Rev. Rul. 80-361 is the primary legal determinant◦ 5 Non accrual interest: a bigger issue in good years◦ 6 The tax issue makes perfect sense to CFOs/CEOs

OREO ISSUES◦ Maximize bad debt advantage over OREO losses◦ IRS Notice “OREO AS INVENTORY”◦ Method Change Requirements◦ What costs are deductible vs capitalized?◦ OREO held for rent

S ELECTIONS AND THEIR VALUE◦ Review of past elections ◦ Current Challenge: New issues may make elections

more problematic ◦ Regulators are limiting the ability of Shareholders to

pay tax ◦ Complexities are looked at in a whole new light

What is it? Why is it important? How does it impact future income tax accrual

issues? What do you do to prepare for it?

WHAT IS IT?◦ The third BASEL accord◦ A global, voluntary regulatory standard for banks

for: Capital Adequacy Stress Testing Market Liquidity Risk◦ The purpose: Strengthen Capital Standards, Help

force decrease in bank leverage

WHY IS IT IMPORTANT?◦ Increased capital, leverage, and liquidity standards

will put a premium on capital levels◦ As ratios are increased, new standards will

effectively limit substantially the current deferred tax assets and related tax attributes on the books of banks.◦ Ratios are increased, new standards will effectively

limit substantially the current deferred tax assets and related tax attributes of banks◦ Timing of effectiveness is key (as well as future

changes in response to criticisms)

How does it affect future income tax accrual issues?◦ Capital required: 4.5% of common equity◦ Leverage ratio: in excess of 3% ◦ 2 liquidity ratios: Liquidity coverage ratio Net stable funding ratio◦ Carrybacks become premium for limits◦ DTL netting and hypothetical carryback

What do you do to prepare for it?◦ Rework deferred and current tax receivable models

for new limits◦ State by state BASEL III computations will be needed

to determine limits applicable◦ What do you do with associates and joint ventures’

results and balance sheet positions as included/(excluded) from capital computations◦ Are DTA’s from unrealized gains/loss included?

Structure Skeletons/issues/exposures Optics Attributes optimization Partnership on deal and transition issues

Financial statement tax issues Asset purchase tax issues Stock purchase tax issues Tracking differences

Structure Skeletons/issues/exposures Optics Attributes optimization Partnership on deal and transition issues

Structure◦ We know what structure is, ◦ Or do we?

Tax impacts: Owners Companies Stakeholders Regulators

Skeletons/issues/exposures◦ S elections/inadvertent terminations◦ Prior change of control date issues◦ DTA/VA issues for loss companies◦ What about 382/recent VA releases?◦ Prior return issues (uncertain tax position

items) ◦ Gains or losses triggered inadvertently◦ Big tax on s corporations: 10 year? 7 year?◦ Others (many more)

Optics◦ Financial statements: gain/loss◦ Regulatory capital◦ Financial reporting positions◦ Tax-free/taxable status of transaction◦ Compensation issues and votes◦ Mix of consideration for shareholders◦ Payments to executives: change of control

Attribute optimization◦ NOL carryovers and limitations◦ Credits and credit carryovers available◦ Income capacity – accretive to earnings?◦ Methods of accounting◦ Section 381: what methods survive?◦ Bad debts: section 585 or large bank?◦ What have we not covered?

Partnership on Deal and Transition Issues◦ Protective language◦ Who issues the tax opinions?◦ Who has final returns responsibilities?◦ What tax decisions are made before close? By whom?◦ How are issues on tax elections and split of

attributes to be made by seller/buyer?◦ What items are we missing or not seeing?

Financial statement tax issues Asset purchase tax issues Stock purchase tax issues Tracking differences

Financial statement tax issues• Understanding book-tax differences• Stock vs. Asset or deemed asset sale• Tax basis on day one• Book values on day one

Asset purchase tax issues◦ Day one – book and tax aligned◦ Transaction costs – permanent differences◦ Goodwill tax amortization – 15 years◦ Goodwill tax amortization creates a deferred tax

liability

Stock purchase tax issues◦ Day one – book and tax differences for fair value

adjustments◦ Transaction costs – permanent differences◦ INTANGIBLES TAX AMORTIZATION (i.e. CDI) – n/a◦ Goodwill tax amortization – n/a

Tracking differences◦ Loans◦ Oreo◦ Understanding section 382 limitations◦ Valuation allowance thoughts◦ Acquired tax credits◦ Projection of taxes paid vs. Tax expense

Final tangible property regulations◦ De Minimis Safe Harbor◦ Materials and Supplies (M&S)◦ Acquisition Costs◦ UOP Improvements◦ Improvement Rules◦ Routine Maintenance Safe Harbor◦ Safe Harbor for Small Taxpayers◦ Dispositions

Final tangible property regulations Focus areas for Community Banks◦ De Minimis Safe Harbor May follow book capitalization policy if: Either have AFS, written policy @beginning of year, and

item/invoice cost is $5,000 or less (less than 12 months) No AFS, have accounting procedures @ beginning of year

and item is $500 or less and less than 12 months life Attach an election statement to return each year Use it for all materials and supplies (non-capitalized)

Final tangible property regulations Focus areas for Community Banks Materials and Supplies (M&S)◦ UOP cost changed to $200 or less and added standy

emergency spare parts to qualified list of expenses◦ When deducted rules stayed the same (Incidental,

when paid or incurred; Nonincidental, when used or consumed; rotable/temporary parts, when disposed (optional method))◦ Election to capitalize rotable, temporary, or standby

emergency spare parts ONLY

Final tangible property regulations Focus areas for Community Banks◦ Acquisition Costs Same as proposed regulations (Facilitative costs

capitalized (11 categories), whether or which test for real property, expense compensation and overhead)

Some clarifications added Contingency fees defined◦ UOP Improvements Same with clarifications for leasehold improvements

Final tangible property regulations Focus areas for Community Banks◦ Improvement Rules Betterment, restoration, adaptation rules retained Clarified betterment and restoration tests Clarified rules for removal costs Modified casualty loss rules Added election to capitalize R&M expenses if

capitalized for financial statements

Final tangible property regulations◦ Routine Maintenance Safe Harbor Same, with some clarifications Building property – use 10-year period rather than

class life◦ Safe Harbor for Small Taxpayers New in final regulations: small taxpayers (receipts of

$10 million or less) MAY ELECT TO EXPENSE MINOR BUILDING REPAIRS ON ELIGIBLE BUILDINGS

◦ Dispositions Elections to recognize gain/loss on partial dispositions

Final cost basis reporting rules, debt instruments/options/future contracts◦ New rules

American taxpayer relief act of 2012:◦ Income tax rates◦ Net investment tax◦ Medicare tax◦ Expensing limits◦ Other developments

Ambase Corp. v. U.S. 112 AFTR 2d 2013-6151◦ NOL – statute of limitations◦ Bad debts: issue of time allowed to claim under

Code Section 6511◦ Ruled for Plaintiffs

CCA 201341017: Allocation of interest expenses for subsidiary and affiliated group

Downey Financial Corp., 112 AFTR 2d 2013-6047: Tax Sharing Agreement methodology

Salem Financial, Inc. v. U.S., 112 AFTR 2d 2013-6168 Bank’s tax avoidance transaction nullified

WFC Holdings Corp., 112 AFTR 2d 2013-5815 (Discussed in earlier sessions)

U.S. v. Stargell, 112 AFTR 2d 2013-Advance Anticipation loans

Other cases, rulings and advance rulings

QUESTIONS?