United States

Accounting and tax issues banks should track in 2017

CECL, stock compensation, tax reform head the list

FINANCIAL INSTITUTIONS INSIGHTS  | 

2017 will be the start of significant accounting and tax changes for financial institutions. Accounting Standards Update (ASU) 2016-13, issued in June 2016, laid out the final rules implementing Financial Accounting Standards Board’s (FASB’s) current expected credit loss (CECL) model, which is one of the most significant changes in accounting for financial institutions in recent decades. With the incoming Trump administration and the GOP-controlled House and Senate pushing similar visions for tax reform, significant tax changes may be on the way.

Following is a partial overview of certain key accounting and tax issues of upcoming interest. For a more detailed discussion, watch our webcast, Key year-end accounting and tax issues for financial institutions and refer to our Financial Reporting Resource Center.  

Accounting issues

1. ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This update makes key changes to the recognition and measurement of most equity securities and certain financial liabilities as well as significantly affects disclosure requirements. The biggest changes under ASU 2016-01 are:

  • The requirement that most equity securities be measured at fair value through net income, with a practicability exception for certain securities without a readily determinable fair value.

  • Public business entities (PBEs) will be required to disclose the fair value of amortized cost financial instruments (including loan portfolios) according to the requirements of FASB ASC 820—Fair Value Measurement. This will require PBEs to disclose values based on an exit-price value, which will be a more complex undertaking. Entities who are not PBEs will no longer be required to disclose the fair value of financial instruments measured at amortized cost.

ASU 2016-01 is effective for PBEs for fiscal years beginning after Dec. 15, 2017 including interim periods in those years, and is effective for entities who are not PBEs for years beginning after Dec. 15, 2018 and interim periods in the following years.  Certain provisions can be early adopted.  For more information, see Financial instruments: FASB issues standard on recognition and measurement.

2. ASU 2016-13, Financial Instruments—Credit Losses:  Measurement of Credit Losses on Financial Instruments. This update includes FASB’s new CECL rules for financial assets measured at amortized cost, which include:

  • Loans and loan commitments

  • Lease receivables

  • Held-to-maturity debt securities

The major change under CECL is that financial institutions will now be required to forecast all future losses and reflect those in their financial statements. CECL is a principles-based standard, which means good and bad news for financial institutions. The good news is that the standard describes an objective, not a methodology, leaving financial institutions free to develop a methodology that suits their needs. For financial institutions hoping for specific rules to follow, that is also the bad news.

Effective dates for CECL are:

  • For PBEs that are SEC filers, years beginning after Dec. 15, 2019, including interim periods in those years

  • For PBEs that are not SEC filers, years beginning after Dec. 15, 2020, including interim periods in those years

  • For non-PBEs, years beginning after Dec. 15, 2020 and interim periods in the following years.

  • Early adoption is permitted for years beginning after Dec. 15, 2018, including interim periods in those years

Complying with CECL will be a significant effort. Regardless of effective date, financial institutions should be preparing now to be ready. What steps can you take now?

  • Organize a cross functional implementation team

  • Re-evaluate your loan portfolio segmentation

  • Identify the data you have available as well as any data gaps. For data gaps, consider:

    • Can missing data be restored?

    • Can you start retaining necessary data now?

    • Can you make accommodations until the necessary data is available?

  • Consider the various methodologies for CECL compliance that are available

  • Given possible increases in your loan loss reserves, consider the impact CECL will have on capital planning and potential acquisitions

Regulators recognize that the CECL approach a financial institution takes will be significantly affected by its size. Smaller community banks won’t need to follow the same complex models that major national banks will use. The trick will be choosing a methodology appropriate to your size and complexity and understanding that the model will need to evolve over time as you gather more data and build more experience.

For more detailed information on CECL, listen to our webcast, Understanding FASB's new credit impairment model, or download our white paper, Financial instruments: In-depth analysis of new standard on credit losses.

3. Are you a PBE? Whether a financial institution is a PBE can make a significant difference on a number of fronts. For example:

  • PBEs cannot adopt Private Company Council (PCC) standards

  • PBEs  have to comply with most new standards on earlier effective dates than non-PBEs

  • PBEs sometimes face expanded disclosure requirements

Classification as a PBE may turn out to be broader than many anticipated due to varying interpretations of the standard. We anticipate that some clarity and consistency will be forthcoming.

4. ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. This update simplifies and clarifies a variety of accounting rules for share-based compensation programs. Among the areas simplified by ASU 2016-09 are:

  • Minimum statutory withholding requirements

  • Accounting for forfeitures

  • Accounting for income taxes

  • For non-public entities, a practical expedient for expected term of awards and an option for electing to measure liability classified awards at intrinsic value

See our article, Improvements to employee share-based payment accounting for more information.

Tax Issues

Tax issue 1

Possible significant tax reform. Both the incoming Trump administration and the Republican-controlled house have been promoting significant potential changes to the tax code. What’s more, there is significant overlap between their proposed plans. Following is an overview of key potential changes of interest to financial institutions.

For S corporation banks: 

  • Both the Trump and House plans reduce the top personal rate on W-2 wages from 39.6 percent to 33 percent and also reduce the number of tax brackets to three—12 percent, 25 percent and 33 percent.

  • Both plans include a tax on S corporation income received from the entity on the K-1. Under the Trump plan, this income would be taxed at a special tax rate of 15 percent, under the House plan, at 25 percent. In both cases, this would be less than the current or proposed top marginal tax rates.

  • Both Plans would repeal the current 3.8 percent tax on net  investment income

  • The House plan would allow the immediate write-off of investments in both tangible and intangible property

For C corporation banks: 

  • Both plans call for a reduction in the current 35 percent corporate tax rate. The Trump plan would reduce the rate to 15 percent, the House plan would reduce it to 20 percent.

  • Both plans call for the elimination of the corporate alternative minimum tax

  • The House plan would allow the immediate write-off of investments in both tangible and intangible property

  • The House plan would restrict the deduction of net operating losses (NOLs) to 90 percent of net taxable income, but would allow NOLs to be carried forward indefinitely and to increase by a factor reflecting inflation and the real return on capital. NOLs would not be allowed to be carried back.

Given the possibility of significant tax reform in 2017, financial institutions may wish to consider the following:

  • S corporation banks may wish to reconsider whether S status makes sense under the new proposed rates.

  • With the House plan for both S and C corporations allowing the immediate write-off of investments, financial institutions may wish to hold off on major investments

  • How the proposed tax changes would affect financial statements and earnings. (e.g., Would a reduction in C corporation rates affect the value of deferred tax assets? How would no expiration date on NOLs effect current valuation allowances?)

For more detail on possible tax changes, see our article, Election impact on tax policy.

Tax issue 2

IRS LB&I (Large Business & International) Directive 04-1014-008 Related to § 166 Deductions for Eligible Debt and Eligible Debt Securities Some key questions remain about Section 166 deductions under this directive, including:

  • Treatment of non-accrual loans

  • Treatment of cash payments made after loans are put on non-accrual status

  • Cumulative adjustment for accrued but unpaid interest under the directive versus the cut-off approach in the conformity regulations

Financial institutions considering the conformity election under the directive should evaluate the pros and cons. The conformity election does allow a taxable deduction in the same year that any loan loss is recognized for financial statement and regulatory purposes and provides conformity in the regulatory and financial statement treatment of non-accrual loan interest income. However, making the conformity election does limit bad debt planning options.

AUTHORS


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