GAIN CONTROL OF YOUR TAX PLANNING

GAIN CONTROL OF YOUR TAX PLANNING June 23, 2014 3:30-4:45pm Presented by: Jeffrey A. Ring, CPA, MST Principal BerryDunn 100 Middle Street Portland, ME 04101 P: 207.541.2318 E: jring@berrydunn.com Your company logo here

ON TRACK WITH YOUR AGENDA Our goal is to share our knowledge and expertise and help you gain more control and understanding of your tax function Tax planning and what it means for you Planning goals Financial statement planning Tax process planning Federal/state transactional planning Documentation Specific planning ideas for banks

WHAT YOU STAND TO GAIN Permanent tax savings Financial statement benefits Temporary tax savings Often permanent use of money No impact on tax expense

DOCUMENT YOUR PLANNING It s pretty simple when you think about it: Documentation serves multiple purposes Document for financial statement support Document for internal controls Document for tax authority support

GAIN A LEG UP SPECIFIC PLANNING IDEAS

TANGIBLE PROPERTY CAPITALIZATION REGULATIONS Materials and supplies Disposition costs Acquisition or production costs Improvement costs

MATERIALS AND SUPPLIES A component used to maintain or improve tangible property Consumables (fuel, water, etc.) w/ useful life <12 months Property with acquisition or production costs < $200

COSTS TO IMPROVE TANGIBLE PROPERTY Identify unit of property Apply improvement standards Routine maintenance safe harbor

DEDUCTION OPTION: DE MINIMIS RULE Applies to property < $5,000 with applicable F/S Applies to property < $500 without applicable F/S

ROUTINE MAINTENANCE SAFE HARBOR Amounts paid for recurring activities expected to be performed to keep the unit of property in its ordinary efficient operating condition are not considered improvements Routine maintenance is an activity that the taxpayer reasonably expects to perform more than once during the class life of the unit of property Does not apply to amounts capitalized as betterments, adaptation, and certain restorations

ALLOWANCE FOR LOAN LOSSES General rules under IRC Section 166 Deduction allowed on any debt that becomes worthless within taxable year Large banks (>500M asset required to use this method) Reserve method for small banks Code Section 585 Recapture rules

GAIN CONTROL WITH A CONFORMITY ELECTION Stay in control of your tax charge-offs with a conformity election Requirements 1. Debt charged off in whole or part for regulatory purposes 2. Specific order of bank s supervisory authority, or 3. Corresponds to bank s classification as loss asset 4. Express determination letter required Benefits 1. Book/tax charge-offs are consistent 2. Lower IRS audit risk and fewer procedures

GAIN CONTROL WITH A CONFORMITY ELECTION Loss Asset is a debt classified as loss asset by bank that corresponds to a class that meets the standards in the Uniform Agreement on Classification of Assets and Appraisal of Securities Held by Banks and Thrifts Election must be made on Form 3115 1. Initial election is an automatic change 2. Subsequent elections are not automatic 3. Express determination letter required prior to election

GAIN ADVANTAGES WITH A CONFORMITY ELECTION Non-accrual interest 1. GAAP: Bank stops accruing interest when loan placed on non-performing status 2. Tax: Accrual method taxpayers must take amounts into income when right to the income is fixed and determinable Tax rule: Interest income considered fixed as it is earned (Rev. Rul. 72-100)

GAIN ADVANTAGES WITH A CONFORMITY ELECTION Non-accrual interest 1. Doubt as to collectability: No need to accrue if no reasonable expectation of payment Example: Collateral securing loan is valued less than loan principal 2. Corn Exchange Bank (1930) Even though on accrual basis no tax unless income good and collectible Injustice to taxpayer to insist on taxation

GAIN ADVANTAGES WITH A CONFORMITY ELECTION Non-accrual interest with conformity 1. Must still accrue interest on NPL 2. Interest deemed accrued and then immediately paid off 3. Possible to claim deduction for previously accrued interest

GAIN ADVANTAGES WITH A CONFORMITY ELECTION Loans not subject to conformity 1. Securitized loans 2. Restructured loans with a gain/loss 3. Loans under principal recovery 4. In-substance foreclosures 5. Purchase impaired loans under SOP 03-3 6. Loans held by non-banks

GAIN ADVANTAGES WITH A CONFORMITY ELECTION NPL tax collections 1. IRS rules provide that payments on a loan are interest to the extend interest has accrued on the loan as of the date payment is due 2. GAAP typically applies payments to principal first 3. This can create a disparity between book/tax accounting

NPL EXAMPLE WITH PAYMENT APPLIED TO INTEREST GAAP Beginning Interest Ending Book Balance Accrued Payments Balance Basis Non accrual interest 5,000 6,000 11,000 - Principal 100,000 - (3,000) 97,000 97,000 108,000 97,000 Apply to principal Tax Beginning Interest Ending Tax Balance Accrued Payments Balance Basis Non accrual interest 5,000 6,000 (3,000) 8,000 - Charge off Principal 100,000 - - 100,000 100,000 Charge off of $3,000 108,000 100,000 Charge off as partially worthless pursuant to Reg 1.166-2(d)(3) Difference (3,000) Payment 3,000 Bad debt recovery - Net tax return impact

CONFORMITY ELECTION & OTTI TAX IMPLICATIONS Bad debt on worthless debt securities 1. GAAP may require a write-down: partially to the P/L and partially through OCI 2. Tax: General rule worthless securities under IRC 165 3. Bank tax: Debt obligations under IRC 166 as a bad debt 4. Significance: IRC 166 permits partial worthlessness without disposal; IRC 165 only applies to total worthlessness

CONFORMITY ELECTION & OTTI TAX IMPLICATIONS Tax loss Demonstrated worthlessness such as default on security, bankruptcy, mounting financial losses, lack of collateral, etc. Conformity election may apply to worthless debt securities (IRC 582(a)) OTTI is covered by the Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts a requirement of the conformity election

IRS NOTICE 2013-35 IRS released the notice in May 2013 asking for comments from practitioners and taxpayers regarding the conformity election Whether changes in bank regulatory standards and processes since adoption of the regs require amendment to the regs Whether the regs are consistent with the principles of Code Section 166

IRS NOTICE 2013-35 - OTTI Other Than Temporary Impairment 1. Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts a. Referred to in the regulations b. 2004 agreement rescinds the 1991 agreement 2. Guidance changed the regulatory reporting a. May result in tax deductions not intended by the original regulations

TROUBLED DEBT RESTRUCTING Debt modification can result in taxable event Significant modification to a debt is a taxable event Change in yield of 25 basis points or 5% of yield Change in timing of payments Change in obligor or security Change in recourse nature

TROUBLED DEBT RESTRUCTING Significance of a modification Old debt considered redeemed New debt replaces old debt Can result in a tax charge-off Fair Market Value of new debt compared with face value of old debt If FMV lower, a charge-off will be recorded Tax treatment of new debt Original Issue Discount (OID) tracking is required over the term of the loan

Other Real Estate Owned (OREO) BEFORE 2013 Tax treatment of carrying costs Many taxpayers deduct Many examiners disallow deduction IRS position Assertion OREO is inventory acquired for resale IRC 263A applies and all carrying costs must be capitalized Taxpayer position OREO is not inventory acquired for resale Character issue as well (gain/loss on sale)

OREO 2013 AND THEREAFTER IRS issued differing guidance in 2012/2013 AM (Advice Memoranda) 2013-001 FAA (Field Attorney Advice) 20123201F FAA 20123201F Issued by Associate Area Counsel (Detroit) Application of 263A to OREO Holding: Direct costs and an allocable share of indirect costs associated with OREO must be capitalized Holding: If OREO placed in service, expense not capitalized

OREO 2013 AND THEREAFTER AM 2013-001 Certain OREO excluded from 263A OREO still considered acquired for resale under IRC 1221(a)(1) However, certain OREO will be considered an extension of the loan origination process under 263A IRS Regulation 1.263A-1(b)(13) states the origination of loans is not considered the acquisition of property for resale This is a fact-specific ruling and may not apply to other taxpayers in a different situation

TRANSACTION COSTS COMPLETE OR PARTIAL PURCHASE/SALE Must capitalize amounts paid to facilitate certain transactions Acquisition of assets that are a trade/business Ownership interest if, immediately after, taxpayer is related Acquisition of an ownership interest in the taxpayer Restructuring, recapitalization, or reorganization Tax-free transfer under 351/721 Formation of disregarded entity Capital raising Stock issuance Borrowing Writing an option

MEANING OF FACILITATE WHAT DOES IT ENCOMPASS Amount paid in the process of investigating or pursuing the transaction Based on all the facts and circumstances Fact that amount would/would not have been paid but for the transaction is important but not determinative There are special rules for certain costs We will not discuss all special rules (There are eight special rules; we highlight a few on next slide.)

SIMPLIFYING CONVENTIONS Employee compensation, overhead, and de minimis costs do not facilitate a transaction Employee comp: salary, bonus, and commission. Annual payments to a director are EE comp. Special meeting fees are not EE comp and may facilitate transaction Overhead does not facilitate De minimis costs only if total costs are < $5,000 Can elect to capitalize some or all per transaction

FACILITATE BRIGHT-LINE TEST The regs provide a bright-line test to determine whether a cost facilitates the transaction Only if amount relates to activities performed on or after: Date on which letter of intent, exclusivity agreement, or similar document is executed by acquirer and target Date on which material terms are authorized or approved by Board of Directors. If no Board, by appropriate governing body. If none, date acquirer and target execute binding written contract reflecting terms

BRIGHT-LINE TEST COSTS EXCEPTED FROM RULE Certain costs must be capitalized even if paid or incurred before bright-line test is satisfied Appraisal, formal written evaluation, or fairness opinion Structuring the transaction, including negotiating and obtaining tax advice on the structure Preparing and reviewing documents that effectuate the transaction (e.g., Purchase & Sale Agreement) Obtaining regulator approval including filings Obtaining shareholder approval (proxy costs, solicitation costs, etc.) Conveying property such as transfer taxes and title registration

SUCCESS-BASED FEES MUST THEY BE CAPITALIZED? Amounts paid, contingent upon a successful closing is an amount paid to facilitate must capitalize Exceptions to the rule Document amounts allocable to other activities such as strategic planning Documentation must include: Activities performed Amount of fee or time allocable to each activity performed Date activity performed, if deemed important Name, address, phone number of service provider

SUCCESS-BASED FEES SAFE HARBOR DEDUCTION Revenue Procedure 2011-29 provides a safe harbor in lieu of maintaining documentation Election can be made to deduct 70% of success-based fee without maintaining documentation. Remaining 30% is capitalized. Election must be made with the tax return Statement attached to return in year fee incurred or paid. Election is irrevocable. Stating electing safe harbor, identifying transaction stating success-based fee amounts deducted and capitalized

MUNICIPAL INVESTMENTS & TEFRA DISALLOWANCE Municipal securities exempt from regular tax TEFRA rules disallow interest expense Rule for bank is a formulaic approach 2009/2010 Municipals Excluded from 100% computation Excluded Munis can be non-bank qualified Still subject to 20% disallowance Bank qualified origination limit is $30M Limitation Up to 2% of net assets Only 2009/2010 originations

MUNICIPAL INVESTMENTS & TEFRA DISALLOWANCE Municipal securities held by non-bank entity TEFRA rules do not apply Direct tracing rule applies If no interest expense at non-bank entity, no disallowance Examples Investment company subsidiary Insurance company subsidiary

MARK-TO-MARKET UNDER IRC 475 Most banks are dealers in securities Threshold is typically the purchase/sale of 60+ securities per year MTM requires all securities be marked to FMV at year-end Special bank rule exemption from MTM Planning opportunities Accelerate deduction Character of gain/loss (equity securities MTM) to avoid capital losses is it possible

UNCERTAIN TAX POSITIONS Recognition, derecognition, and measurement of uncertain tax positions Accounting for interest and penalties Presentation and classification Disclosure requirements

UNCERTAIN TAX POSITIONS Application is a two-step process Evaluate for recognition Measure the benefits for positions that are recognized Recognition More-likely-than-not (MLTN) standard (50%) Technical merits of position Presume position will be examined Based on law at reporting date

UNCERTAIN TAX POSITIONS Measurement Amount of benefit to be recognized Different than valuation allowance Probability matrix Largest amount that has greater than 50% chance of being recognized Requires determination of range of possible settlement amounts

REGULATORY CAPITAL CURRENT RULE The amount of DTAs recognized as good assets for regulatory capital are: Net with DTLs: allowed to extent netted with DTLs Net DTAs are allowed if they can be carried back against previously paid taxes Remaining allowed if they can be absorbed against projected tax liability estimated for 12 months from reporting date

REGULATORY CAPITAL CURRENT RULE DTAs exceeding the limits must be written off for regulatory capital purposes AOCI items are reversed: i.e., gains/losses from AFS debt or equity, actuarial gains/losses on pension and gains/losses on cash flow hedges Option to include or exclude from limitation calculation

REGULATORY CAPITAL CURRENT RULE EXAMPLE Example: ABC Bank has its head office and branches in Maine. It has: $1,000 DTA related to loan losses, $100 tax credit carryover, $100 DTL related to fixed assets Year 1 tax liability of $500, year 2 tax liability of $200, projected 12-month liability of $200 Step 1: net DTAs and DTL ($1,000 + $100 - $100 = $1,000) Step 2: Carryback net DTA (PY tax = $700 excess DTA of $300) Step 3: Next 12 months (DTA of $300 - $200 liability = $100 WO

REGULATORY CAPITAL BASEL III SUMMARY Deferred taxes are categorized differently By jurisdiction DTAs from NOLS and credits DTAs from temporary differences Deferred tax liabilities allocated to DTAs pro rata, must be on jurisdiction basis

REGULATORY CAPITAL BASEL III SUMMARY Threshold deduction Good assets to extent individually less than 10% of common equity tier 1 capital (CET1) Collectively less than 15% of CET1 Applies to: DTAs, MSAs and significant investment in unconsolidated financial institution s common stock

REGULATORY CAPITAL BASEL III SUMMARY NOLs and credits are subtracted from CET1 (net of allocated DTLs) DTAs either realized net of DTLs or gross, before DTL allocation Final rule is silent on whether DTAs/DTLs are assumed to reverse at report date Most component of AOCI must be included. There is an opt-out (one-time election) for non-aa Banks.

JEFFREY A. RING, CPA, MST PRINCIPAL Specializing in: Tax compliance Tax planning ASC 740 (tax accrual & related) Financial products taxation Transaction planning Multi-state taxation Mergers, acquisitions & divestitures Consolidated corporate tax returns Stock compensation Bank tax matters