With tax changes likely on the horizon, the 2024 election has been monitored with considerable attention for the past few years. The driver of that attention was the fact that most provisions of the Tax Cuts and Jobs Act (TCJA), enacted under the first Trump administration in 2017, are scheduled to expire on Dec. 31, 2025. Now that we have a slightly clearer picture after the recent election results, financial institutions will want to focus on potential tax-planning changes along with mixing in some old planning techniques to take advantage of lowering your effective tax rate and ultimately paying less money in taxes.
Sunsetting tax cuts: The potential business impact
The TCJA lowered the effective tax rate on certain pass-through business income through introduction of the qualified business income deduction (QBID) under Section 199A. When fully applied, this deduction-based regime works in conjunction with the lowered individual income tax brackets (top bracket of 37.0%) to impose a top 29.6% effective federal tax rate on qualified business income. Early drafts of the TCJA included a 25% tax on pass-through income, but QBID resulted from congressional negotiations. Currently, the existing version of QBID is scheduled to expire at the end of 2025. That expiration, in conjunction with the expiration of changes to individual tax brackets, would increase the top tax bracket on pass-through business income to 39.6%. While this won’t impact C corporation banks, it would have a significant impact on S corporation bank shareholders.
The TCJA was largely focused on providing tax cuts to businesses and individuals. However, concerns about the overall price tag of that bill required the introduction of revenue-raising tax rules. Importantly, three tax rules, commonly referred to as the trifecta, were enacted with deferred effective dates. Only two of these tax cuts generally impact financial institutions.
- Prior to the TCJA, businesses were able to deduct certain research and experimentation expenses under Section 174. Those rules provided tax incentives to both businesses in the startup phase as well as operating companies. Section 174 also worked in conjunction with the research and development (R&D) tax credit under Section 41. However, the TCJA dramatically changed Section 174 by imposing a capitalization and amortization regime. Beginning in 2022, businesses were required to capitalize their Section 174 costs and amortize them over five years (domestic costs) or 15 years (foreign costs).
- The TCJA also imposed a new limitation on the deductibility of business interest expenses. Initially taking effect in 2018, this limitation caps annual business interest deductions at 30% of adjusted taxable income (ATI). During the first four years of applicability, ATI was defined as taxable income with several adjustments, including the add-back of depreciation, amortization, and depletion deductions. However, beginning in 2022, depreciation, amortization, and depletion was no longer allowed as an add-back. Such change reduced the base on which the 30% limitation was applied, which, in turn, tightened the limitation. The positive piece of this revenue raiser for financial institutions is when doing the computation, it’s net interest expense (you’re allowed to net business interest income against it), and thus typically is not impactful for banks.
- The TCJA provided for 100% bonus depreciation for assets placed in service between late 2017 and the end of 2022. Starting in 2023, bonus depreciation was reduced annually by 20%, with a full phase-out due in 2027.
Corporate tax rate
Any discussion about corporate tax rates is necessarily different from other aspects of business taxation, given that it doesn’t involve expiring rules. One key feature of the TCJA was a significant tax rate cut for C corporations, resulting in the reduction of the top tax rate from 35% down to 21%. The first Trump administration initially requested a 15% corporate tax rate, but legislative negotiations resulted in the 21% rate in effect currently. That rate won’t expire at the end of 2025, so it’s not necessary for Congress to take any further action.
Tax-planning considerations
Inflation Reduction Act energy credits
The new Inflation Reduction Act (IRA) energy tax incentives and the related monetization options create a range of tax-planning and business opportunities for financial institutions. The primary benefit of the IRA tax credits is to direct a dollar-for-dollar offset against a business’s current year tax liability for the production of energy and clean resources for sale to unrelated parties. Financial institutions are generally not in the business of producing energy or clean resources, but a provision in the IRA allows businesses that qualify for these credits to sell them to unrelated parties for cash payment. As a result, financial institutions can purchase credits to offset tax liabilities at a negotiated discount. These credits can only be transferred once and, as a result when purchasing, you need to purchase them with the intention to offset tax, not resell. Looking ahead to 2025, the incoming Trump administration and Republican majorities in Congress are expected to revisit those incentives during debate over a new round of tax legislation.
R&D tax credits
To help potentially offset some of the Section 174 changes discussed earlier, financial institutions should consider analyzing any expenses that may qualify for a R&D tax credit. Many financial institutions invest significantly in software development and/or enhancement. This may include software to stay up to date with current trends and cybersecurity, development of online and mobile banking applications, or software targeted at automating various processes. Financial institutions often develop or customize software to increase productivity/security, develop new functionality, or make other changes in an attempt to improve company operations. If your institution has expenses that may qualify under these categories, consider their applicability to Section 174.
Accelerated depreciation
Accelerated depreciation in the form of Section 179 expense and bonus depreciation have been around for many years. Financial institutions have been able to take advantage of this benefit to lower their tax bill in the year an eligible asset is purchased. Remember, the bonus depreciation percentage will drop to 60% for 2024 (down from 100% in 2022 and 80% in 2023). If your institution has purchased eligible 179 property that’s less than $3,050,000, it can take full advantage of the $1,220,000 expense limitation. The phase-out occurs dollar for dollar over $3,050,000 up to $4,270,000.
