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  • 1. 47thBANK & CAPITAL MARKETS TAX INST IT U T Eannual B-3: COMMUNITY BANKING UPDATE Fantasia K-N November 8th, 3:45pm – 5:15pm 47th ANNUAL BANK & CAPITAL MARKETS TAX INSTITUTE DISNEY CONTEMPORARY HOTEL Speakers: STEVEN CORRIE JAMES GOELLER DAVE THORNTON 47 BANK I N S T I T U MARKET th annual TA X & CAPITAL TE NOVEMBER 7-9, 2012 E.COM WWW.BANKTAX I N ST I T U T D I S N E Y C O N T E M P O R A RY H OT E L | ORLANDO
  • 2. Community Banking Update David A. Thornton, CPA, Partner Crowe Horwath LLP, New York, NY James D. Goeller, CPA, Partner Crowe Horwath LLP, San Francisco, CA The Unique Alternative to the Big Four®Agenda:  IRS Controversies  §382 Limitation – Application, Developments and Planning  Overview of Issues Arising in FDIC Assisted Acquisitions  Miscellaneous Developments  S-Corporation Issues Heading into 2013Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 2 IRS Controversies 1
  • 3. The Unique Alternative to the Big Four®Bad Debt Deduction for Worthless Loans  The issue centers on the timing of the deduction for worthless debt obligations under §166 and when a loan is considered to be wholly or partially worthless  The financial statement impact of the issue is often limited to the balance sheet (current/deferred taxes) with some potential exposure for interest  However, for banks with a valuation allowance recorded against their net deferred tax asset, the effect of lost deductions could directly impact income tax expense (with a corresponding reduction to regulatory capital)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 4 The Unique Alternative to the Big Four®Bad Debt Deduction for Worthless Loans  The bad debt conformity election found in Regulation §1.166-2(d)(3) offers banks a safe harbor for deducting worthless loans  If elected, the bank must conform its bad debt deduction to loans classified as loss assets for regulatory purposes  In order to elect the safe harbor, the bank must secure an “Express Determination Letter” from its primary federal regulator and must continue to do so for each subsequent examination cycleAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 5 The Unique Alternative to the Big Four®Bad Debt Deduction for Worthless Loans  While most banks would benefit from the IRS audit protection secured under the election, there may be circumstances under which banks do not want to conform their tax deductions to regulatory charge-offs  These circumstances typically involve scenarios where the bank would prefer to defer the deduction until later years [can easily be done for partial charge-offs – see §166(a)(2)]  significant or expiring NOL / credit carryforwards  §382 built-in loss limitation, so attempting to defer bad debt deductions until after the one year presumed built-in loss period (see IRS Notice 2003-65)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 6 2
  • 4. The Unique Alternative to the Big Four®OREO Foreclosure Issues  Foreclosed property is required to be taken into possession with a tax basis equal to its FMV [see Reg. §1.166-6(b)]  Once OREO is taken into possession, subsequent write-downs to FMV are not deductible for tax purposes until the property is sold  Under examination, there is often disagreement about what the FMV of the OREO was at the foreclosure date based upon the timing of appraisalsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 7 The Unique Alternative to the Big Four®OREO Foreclosure Issues  For post-foreclosure appraisals:  IRS may argue that declines in value occurred after the foreclosure date, rendering the decline a non- deductible post-foreclosure write-down  IRS may argue that an appraised value in excess of the foreclosure date recorded value means the charge-off was overstated (i.e. the increased value was there at the foreclosure date)  Ideally, appraisals dated on, or very close to, the foreclosure date should be used to support the amount of the charge-off claimed upon foreclosureAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 8 The Unique Alternative to the Big Four®OREO Foreclosure Issues  If the value of the property is in dispute, the taxable income or loss determined on the foreclosure date may be an issue under examination  If the taxpayer is under the bad debt conformity election and the bad debt deduction claimed matches the portion of the loan classified as a loss asset for regulatory purposes, should there be any potential examination issue?Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 9 3
  • 5. The Unique Alternative to the Big Four®Non-Performing Loan Interest  The IRS views non-performing loan interest as first being accrued and then measured for worthlessness as a bad debt (must be an accrual basis taxpayer)  Consequently, the same issues and potential arguments apply - timing issue, primarily focused on collectibility, examined as a bad debt under IRC §166  Collectible interest is required to be included in taxable income (there is no 90-day non-performance standard for tax purposes)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 10 The Unique Alternative to the Big Four®Non-Performing Loan Interest  Revenue Ruling 2007-32 extends the safe harbor provided by the bad debt conformity election to cover the presumed charge-off of non-performing loan interest that occurs for book purposes  This protection is significant because it often results in a more beneficial treatment of non-performing loan interest than would otherwise be available outside the scope of the bad debt conformity election  If elected, the bank is still required to pay tax on interest collected while the loan remains in non- performing status (even if this interest is not recorded to book income)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 11 The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  For GAAP purposes, many financial institutions have recorded other than temporary impairment (“OTTI”) against investment securities in order to recognize a permanent reduction in the carrying value due to credit quality and other issues  For tax purposes, the more restrictive limitations placed upon loss deductions under IRC §166 essentially guarantee some amount of book-tax difference for many OTTI securities  The tax deduction may be delayed until a later year when the more restrictive requirements for a bad debt deduction have been satisfiedAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 12 4
  • 6. The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  What are the tax rules?  A loss deduction is always allowed in the year a security becomes wholly worthless (i.e. worth zero with little or no chance of recovery) - §165(g) general rule  However, §582(a) permits a bank to apply the bad debt rules of §166 to debt securities (i.e. bonds, trust preferred securities, mortgage-backed obligations, etc.), thereby expanding the deduction possibilities  Thus, a bank is allowed to claim a loss deduction for a partially worthless debt security - §166(a)(2)  Non-bank taxpayers, including the non-bank members of a bank affiliated group, are not permitted to claim a loss deduction for a partially worthless securityAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 13 The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  What is a loss / impairment?  GAAP – excess of the current carrying value over the net present value of all anticipated future payments resulting from an other than temporary impairment  Shortfalls in principal payments will result in a loss  But so will late principal payments, deferred / late interest payments, missing interest payments, etc.  Tax – a bad debt as determined under §166  Often results from an event that negatively impacts the borrowers ability to repay the principal  Value of collateral is significant in the determination  If full principal is likely to be recovered, there is no loss (interest is considered as part of the principal only if it has been recognized in taxable income)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 14 The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  The timing of the bad debt deduction is a frequent source of disagreement with the IRS because:  1) The deductions are often large  2) The tax deduction is often based upon subjective determinations and analysis (except for obvious cases of completely worthless securities)  3) The criteria supporting the GAAP OTTI loss does not necessarily support the tax deduction due to the disparity in the book and tax rules for determining the loss  The bad debt conformity election is limited to loans, so there is no safe harbor election available to protect the bad debt losses claimed on worthless securitiesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 15 5
  • 7. The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  In July 2012, the IRS issued a directive for the insurance industry (LB&I-4-0712-009) titled “LB&I Directive Related to Partial Worthlessness Deduction for Eligible Securities Reported by Insurance Companies”  Instructs the IRS not to challenge an insurance company’s deduction for charge-offs of credit-related impairment of eligible securities reported on its regulatory filings because doing so “imposes a significant burden” on both taxpayers and the IRS  Eligible securities for this purpose include loan-backed and structured securities within the scope of Statement of Statutory Accounting Principle 43RAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 16 The Unique Alternative to the Big Four®Losses on Worthless Debt Securities  Can the mark-to-market rules of §475 be used to achieve a tax deduction equal to the book FMV adjustment of securities that have been written down for OTTI (assuming the bank is a dealer in securities)?  Yes, but…  cannot be applied retroactively – MTM identification must be in place before the decline in FMV occurs  does not change the character of the resulting loss from the MTM adjustment [but this will be ordinary for a bank anyway if the security is a debt obligation - §582(c)]  the application of MTM cannot be changed or removed and will continue to apply until the security is sold or maturesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 17 The Unique Alternative to the Big Four®Deducting Success-Based Fees in M&A Transactions  In 2011, the IRS issued Revenue Procedure 2011-29 which provides an elective safe harbor to deduct 70% of any success-based fee associated with most merger and acquisition transactions occurring in taxable years ending on or after April 8, 2011  This protection is substantial, as it eliminates what is likely a significant tax uncertainty regarding the deductible portion of these fees  Requires a formal election in the tax return  IRS also indicated they will generally allow pre-2011 deductions under audit if they did not exceed 70% (LB&I-04-0511-012)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 18 6
  • 8. The Unique Alternative to the Big Four®Deducting Success-Based Fees in M&A Transactions  In July 2012, the IRS ruled (CCA 201234027) that non- refundable “milestone payments” that are due under a service agreement cannot qualify as success-based fees for purposes of the 70% deduction election in Revenue Procedure 2011-29  Even if these fees can be credited against the success- based fee charged for the successful completion of the transaction, the fact that they are non-refundable if the transaction fails to close renders them a fixed (rather than contingent) fee  The excess of the contingent portion of the fee over these amounts will qualify for the 70% electionAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 19 The Unique Alternative to the Big Four®Deducting Accrued Bonuses  In 2011, the IRS issued Revenue Ruling 2011-29 to clarify that, in order for accrued bonuses to be deductible in the year of accrual, the amount of the bonus must be fixed and determinable as of the close of the tax year and paid within 2 ½ months of year end  Accrued amounts are not deductible until the year of payment if the plan:  Requires the bonus recipient to remain employed up through the date of payment; AND  Allows the accrued bonus to revert back to the employer if this employment condition is not satisfiedAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 20 The Unique Alternative to the Big Four®Deducting Accrued Bonuses  The ruling makes it clear that an accrued but otherwise unallocated bonus pool is fixed and determinable, even if the plan requires the recipients to remain employed up through the payment date, provided:  The amount of the overall bonus pool is fixed at year end; AND  100% of the fixed bonus pool will be paid out to those participants who remain employed on the payment date (i.e. the overall bonus pool amount is not impacted by employee departures prior to the payment date)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 21 7
  • 9. The Unique Alternative to the Big Four®Deducting OREO Carrying Costs  There have been a growing number of examinations in which the IRS has sought the capitalization of OREO carrying costs on non-income producing property  The IRS argument is based upon an assertion that the OREO property is “inventory” acquired for resale and, consequently, §263A requires all carrying costs to be capitalized to the basis of the individual properties (which would permit them to be deducted upon disposal of the applicable properties)  The IRS position is highly coordinatedAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 22 The Unique Alternative to the Big Four®Deducting OREO Carrying Costs  The argument in support of deducting these costs as they are incurred is based upon an assertion that the OREO properties are not, in fact, “inventory”  Instead, the properties are acquired in the ordinary course of the loan relationship in order to mitigate further losses on a loan transaction gone bad  Such an argument would support the deduction of the OREO carrying costs as an ordinary and necessary business deduction under IRC§162Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 23 The Unique Alternative to the Big Four®Deducting OREO Carrying Costs  The IRS is unwilling to concede this issue  IRS Appeals-level pleas have largely been unsuccessful  Thus, unless a taxpayer is willing to litigate the issue, it will likely have to be conceded under examination  Will the IRS issue a formal pronouncement offering an automatic accounting method change?  Planning point – holding OREO out for rental income production avails the taxpayer of current deductions under §162 for carrying on a trade or businessAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 24 8
  • 10. §382 Limitation – Application, Developments and Planning The Unique Alternative to the Big Four®Section 382 Ownership Changes  The following transactions most commonly contribute to or result in an ownership change:  A merger, stock purchase or other corporate acquisition  A significant capital infusion (over a 36 month period)  A large-block stock purchase (over a 36 month period)  For purposes of measuring whether the ownership of 5% shareholders increases by >50%, all <5% shareholders are aggregated and viewed as a single shareholder, but different groups and sub-groups are segregated based upon discrete transactions and events  The measurement rules are numerous and complex  Recently-issued proposed regulations under §1.382-3 would offer improvements to segregation rulesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 26 The Unique Alternative to the Big Four®Section 382 Primer Look at 5% shareholders and see if any shareholders collectively increased ownership by more than 50% in the 3-year look-back period. First, who is a 5% shareholder?  ‘Look through’ to the ultimate shareholder or not?  In defining an ‘entity’ to determine who is the shareholder for Section 382 testing, Reg.§1.382-3(a)(1)(i): An entity is any corporation, estate, trust, association, company, partnership or similar organization. An entity includes a group of persons who have a formal or informal understanding among themselves to make a coordinated acquisition of stockAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 27 9
  • 11. The Unique Alternative to the Big Four®Section 382 Primer – Section 13(d) SEC Filings  Section 13(d) of the Securities Act of 1934 requires any person who beneficially owns 5% or more of a class of equity securities of a publicly traded company to file a report with the SEC within 10 days of reaching the 5% ownership threshold.  When determining beneficial ownership, a registered investment advisor needs to consider two criteria to determine if it is a beneficial owner over securities held in client accounts. A registered investment advisor may be considered a beneficial owner if it has or shares either of the following:  1) the power to vote or direct the voting of the shares, and  2) the power to dispose or direct the disposition of the security.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 28 The Unique Alternative to the Big Four®Section 382 Primer – Section 13(g)  SEC Filings  There is an alternative to the Schedule D filing requirement if a fund manager falls within certain categories they can file the less onerous Schedule 13G.  Section 13(g) is very similar to Section 13(d). However, the requirements of Section 13(g) are less burdensome because Section 13(g) is designed to require reporting by qualified institutional investors and passive investors which do not raise the types of concerns underlying Section 13(d). Under this section, reporting entities must file Schedule 13G, which is very similar to Schedule 13D but requires less information and, in most cases, must only be updated on an annual basis.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 29 The Unique Alternative to the Big Four®Section 382 Primer – Section 13(f) SEC Filings  An institutional investment manager who exercises investment discretion over $100 million or more in Section 13(f) securities must report its holdings on Form 13F with the Securities and Exchange Commission (SEC). Form 13F is required to be filed within 45 days of the end of a calendar quarter.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 30 10
  • 12. The Unique Alternative to the Big Four®Section 382 Primer – 5% Shareholder Series of PLRs in 2006 and 2007  200605003 - Multiple Funds managed by one Fund Manager are not aggregated into an ‘entity’  200713015 – Look Through  The Loss Company reviewed SEC Schedules 13D and 13G and could rely on the existence or absence of Schedule 13D or 13G to identify all persons who directly own 5 percent or more of Company common stock. [§1.382-2T(k)(1)(i)].  The advisor had the power, on behalf of its clients. to vote and/or dispose of Company common stock but since it did not have the right to the dividends and the right to the proceeds from the sale of stock (“Economic Ownership”) the advisor was not the owner of the stock for purposes of §382.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 31 The Unique Alternative to the Big Four®Section 382 Primer – 5% Shareholder CCA 201215007  Loss Company was owned by 6 private investment funds which had varying amounts of overlapping beneficial ownership, and which were managed by a common group of individuals who acted through several entities and LLCs, which the group of individuals owns.  For the purposes of testing the acquisition and ownership of Loss Company, the Funds were found to be treated as an “entity” within the meaning of §1.382-3(a)(1).Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 32 The Unique Alternative to the Big Four®Capital Raising Issues in this Environment  The more that is raised, the more the Bank needs to be aware of:  The 5% owners and how many shares can be issued to a >% shareholder and how many shares can be issued to a group of < 5% shareholders before there would be a Section 382 problem; and  Whether any prior offerings would be treated as subject to the “anti-stuffing” provisions with respect to valuation of the entity.  The impact of sales of the federal government’s TARP instruments on the Section 382 position.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 33 11
  • 13. The Unique Alternative to the Big Four®TARP Rules  In the Treasury Departments authority granted by the Housing and Economic Recovery Act of 2008 ( P.L. 110-289) it was announced that Regulations under §382 would be issued.  The Emergency Economic Stabilization Act of 2008 ( P.L. 110-343) authorized the Treasury Secretary to establish the Troubled Asset Relief Program (TARP)  Notice 2008-76  Notice 2008-84  Notice 2009-14/Notice 2009-38/Notice 2010-2Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 34 The Unique Alternative to the Big Four®TARP Rules  Stock acquired by Treasury will not be considered to have triggered any of the Section 382 loss limitation rules.  Any preferred stock will be treated as Code Sec. 1504(a)(4) stock. Such instrument will not be treated as stock for purposes of Code Sec. 382 while held by the Treasury or by other holders, except that preferred stock will be treated as stock for purposes of determining the old loss corporations value under Code Sec. 382(e)(1).  Any warrant to purchase stock acquired by the Treasury pursuant to the Public CPP, TARP TIP, and TARP Auto will be treated as an option (not as stock) and will not be deemed exercised under Reg. §1.382-4(d)(2) while held by the Treasury.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 35 The Unique Alternative to the Big Four®Section 382 Change with no “Buyer”  No purchase accounting to mark assets to market  There are limits on NOLs and other deferred tax assets; and  Section 56(g)(4) (G):  56(g)(4)(G) Treatment of certain ownership changes — If—  56(g)(4)(G)(i) there is an ownership change (within the meaning of section 382) in a taxable year beginning after 1989 with respect to any corporation, and  56(g)(4)(G)(ii) there is a net unrealized built-in loss (within the meaning of section 382(h)) with respect to such corporation, then the adjusted basis of each asset of such corporation (immediately after the ownership change) shall be its proportionate share (determined on the basis of respective fair market values) of the fair market value of the assets of such corporation (determined under section 382(h)) immediately before the ownership change.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 36 12
  • 14. Overview of Issues Arising in FDIC Assisted Acquisitions The Unique Alternative to the Big Four®Acquisition of a Failed Bank From the FDIC  Continues to pose significant tax purchase accounting challenges in the marketplace  In a typical transaction involving a loss share agreement, the tax purchase price allocations can vary significantly from the GAAP allocations  This is due primarily to the application of IRC §597, which generally requires a much higher allocation of purchase price to covered loans than is allocated for GAAP purposes (not less than maximum guaranteed value)  This sometimes leaves little or no purchase price to be allocated to fixed assets, core deposit intangibles and other miscellaneous assetsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 38 The Unique Alternative to the Big Four®Acquisition of a Failed Bank From the FDIC  A tax bargain purchase gain can result from the acquisition, but is likely to differ from the FAS 141R gain (if any) recognized for GAAP purposes  Any tax bargain purchase gain is recognized evenly over 6 years, beginning with the year of acquisition per §597  The difference in book and tax acquisition date purchase price allocations result in substantial deferred tax accounting entries  However, the real challenge is tracking the changes in the book and tax basis of acquired assets going forwardAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 39 13
  • 15. The Unique Alternative to the Big Four®Tracking Issues Going Forward – the “Day-2 Dilemma”  For book purposes, any interest accrued is likely being calculated on the recorded balance of the loan, not on the contractual loan terms as required for tax purposes  In some cases, the rate used to accrue interest on the discounted loan for GAAP purposes may not comport with the loan’s stated interest rate  In addition, there will be differences in the amount and methodology employed to calculate the accretion of the loan purchase discount because this amount is calculated on a different loan basis for book and tax purposes and may not be accreted on some loans for book purposesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 40 The Unique Alternative to the Big Four®How Are the Tracking Issues Being Addressed?  A variety of approaches are being used in the marketplace  Specialized software  Benefits:  Precision  Automatic calculations  Detailed support for the schedule M adjustments  Drawbacks:  Price  Output is only as good / reliable as data inputAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 41 The Unique Alternative to the Big Four®How Are the Tracking Issues Being Addressed?  A variety of approaches are being used in the marketplace  Manual calculations (i.e. spreadsheets)  Benefits:  No additional software to purchase  Complete control over the calculations / assumptions  Drawbacks:  Time consuming  Calculations are complex  May not be possible if there are too many loans to trackAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 42 14
  • 16. The Unique Alternative to the Big Four®How Are the Tracking Issues Being Addressed?  A variety of approaches are being used in the marketplace  Deferred Tax Asset / Liability Approach  Benefits:  No additional software to purchase  Typically focuses on calculating the year end tax basis of loans (under the MTM method or otherwise) and comparing that tax basis to book basis to arrive at the ending book-tax basis difference  The M adjustment is measured as simply the change in the beginning and ending book-tax basis difference  Specific interest, market discount, charge-off, and gain/loss adjustments are presumed to fall into placeAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 43 The Unique Alternative to the Big Four®How Are the Tracking Issues Being Addressed?  A variety of approaches are being used in the marketplace  Deferred Tax Asset / Liability Approach  Drawbacks:  Precision may be lower than with other methods  Often lacks detailed support for specific schedule M calculations because the M is driven from proof of the balance sheet position. However, this is often done for other types of M adjustments – i.e. deferred loan fees, loan servicing, etc.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 44 The Unique Alternative to the Big Four®Miscellaneous Day 2 Issues  Market Discount on Deeply Discounted Loans  Loan default causing all amounts to be due and the impact on the accretion rules of Section 1278  Interest applied to principal on deeply discounted loans  No Bad Debt Conformity Election  With a Bad Debt Conformity Election  Triggering Issues under the Section 1001 Rules  Adding collateral to a loan  Loan consolidation (taking multiple loans and consolidating them into one)  SOP 03-3 valuation versus M-T-M under Section 475  Low Income Housing Investments assigned a -0- basis in purchase accounting and the At-Risk rulesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 45 15
  • 17. Miscellaneous Developments The Unique Alternative to the Big Four®Tangible Asset Regulations  In December 2011, the IRS issued much-anticipated temporary regulations governing the tax treatment of costs associated with acquiring, producing and improving tangible property  The regulations are expansive and complex and cover many different applications, including:  Deductible repairs v. capitalized improvements  Costs associated with acquiring fixed assets  De minimis fixed asset capitalization policies  Treatment of supplies inventory  Treatment of component disposalsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 47 The Unique Alternative to the Big Four®Tangible Asset Regulations  Taxpayers may be able to retroactively deduct repairs that were incorrectly capitalized to fixed assets (as determined under the new regulations) by filing an IRS form 3115  Taxpayers may be able to keep their existing de minimis fixed asset expensing policies in place, provided the deduction does not exceed the greater of 0.1% of tax gross receipts or 2% of book depreciation  Clarification is provided on the deductibility of component disposals and the potential to identify unclaimed deductions in this areaAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 48 16
  • 18. The Unique Alternative to the Big Four®Tangible Asset Regulations – 3115s for Banks  The IRS issued Rev. Proc. 2012-20 to cover all automatic accounting method changes associated with the MACRS regulations.  Rev. Proc. 2012-19 covers automatic changes relating to the regulations dealing with capitalization issues.  An automatic change in accounting method procedure may be used to adopt the de minimis expensing method. The change is applied on a cut-off basis (Rev. Proc. 2012-19, adding Section 3.17 to the Appendix of Rev. Proc. 2011-14).Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 49 The Unique Alternative to the Big Four®Tangible Asset Regulations - Timing  The temporary regulations in effect are generally effective for years beginning on or after January 1, 2012.  Today, the Regulations are still Temporary, and while Treasury does not want major changes to the regulations, they will likely not be finalized until 2013.  The Regulations are, in effect, retroactive insofar as an accounting method change is filed in many cases.  In March 2012, the IRS instructed its examiners to "stand down" on audits of capitalization issues for pre- 2012 tax years (LB&I Field Directive 4-0312-004). The stand-down is for a two-year period.Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 50 The Unique Alternative to the Big Four®Limitations on Prepaid Expense Deductions  The IRS issued Revenue Ruling 2012-1 to clarify which short-term prepaid expenses qualify for the advance deduction under Reg. §1.263(a)-4(f)  The clarifications limit the application of the “recurring item exception” for prepaids that are capitalized for book purposes and prevent the advance deduction for prepaid service contracts that represent routine service agreements as opposed to services to be provided under “unique and irregular circumstances” (i.e. disaster recovery, unexpected breakdowns, etc.)  Prepaid insurance and regulatory assessments are still valid deductions under these rulesAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 51 17
  • 19. The Unique Alternative to the Big Four®Foreign Account Tax Compliance Act – “FATCA”  Enacted in 2010 as part of the Hiring Incentives to Restore Employment (“HIRE”) Act  Seeks to address U.S. tax evasion through the use of foreign bank accounts and other foreign financial interests  Generally applicable to payments made by U.S. taxpayers to foreign financial institutions  Imposes a 30% withholding requirement on payments of interest, dividends, rents, royalties and other non- business income unless the recipient certifies compliance with U.S. requirements to identify U.S. account holdersAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 52 The Unique Alternative to the Big Four®Foreign Account Tax Compliance Act – “FATCA”  Generally applicable to withholdable payments made after 12/31/2013 (IRS Notice 2011-53)  However, no withholding is required for payments on any obligation outstanding on 3/18/2012  The payor has the obligation to identify applicable payments to foreign financial institutions (certification will be available)  Model agreement for government-to-government exchange of information issued recently  Operational issues, criticisms and the need for guidance abound  IRS has been issuing a steady stream of guidanceAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 53 The Unique Alternative to the Big Four®Reporting U.S. Deposit Interest  On April 17, 2012, Treasury issued final regulations requiring domestic banks to report U.S. deposit interest to nonresident alien individuals on form 1042-S  The regulations apply to interest paid on or after 1/1/2013 to individuals from countries with which the U.S. has an information exchange agreement  Revenue Procedure 2012-24 provides a list of these countries  Currently, reporting is only required for interest paid to nonresident alien individuals who are residents of CanadaAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 54 18
  • 20. The Unique Alternative to the Big Four®Basis Reporting Requirements  Requires the tax basis of certain covered securities that are held in a broker/custodian account to be reported on form 1099-B  Originally applied as follows:  Shares of stock (other than mutual fund and dividend reinvestment plan shares) acquired for cash on or after 1/1/2011  Mutual fund and dividend reinvestment plan shares acquired for cash on or after 1/1/2012  Debt securities acquired for cash on or after 1/1/2013, or such later date determined by the Treasury  Other securities as the Treasury may designate in future yearsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 55 The Unique Alternative to the Big Four®Basis Reporting Requirements - Update  In November 2011, Treasury issued proposed regulations to clarify the application of the basis reporting rules to debt instruments and to expand its application to options acquired or granted on or after 1/1/2013  The IRS later released Notice 2012-34 to delay the application of the basis reporting requirements to debt instruments and options acquired or granted on or after 1/1/2014Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 56 The Unique Alternative to the Big Four®Basis Reporting Requirements - Update  The rules also require securities issuers to report organizational actions that impact the tax basis of their issued securities  Examples:  Mergers and tax-free reorganizations  Stock dividends  Stock splits  Non-dividend distributions  Early this year, the IRS released form 8937 as the means by which securities issuers are to report the tax basis effect of organizational actionsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 57 19
  • 21. S-Corporation Issues Heading into 2013 The Unique Alternative to the Big Four®The Rates  The so-called “Bush-era tax rates” that have generally been in effect since 2001 are set to expire on 12/31/2012  These rates impact taxpayers in all tax brackets, not just upper-income individuals  They also set the top rate on long-term capital gains at 15% and tie the tax rate on dividend income to this long-term capital gains rate  No action is likely by 12/31/2012 due to election year politicsAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 59 The Unique Alternative to the Big Four®Income Tax Rates  Federal income tax rates will rise for all, not just upper- income taxpayers, on 1/1/2013  The top marginal federal tax rate on ordinary taxable income will rise to over 39.6%  (the effective rate will be higher than 39.6% due to the re- emergence of deduction and exemption phase-outs)  The maximum federal tax rate on long-term capital gains will revert back to 20% (18% for certain capital assets held more than 5 years)  The top marginal federal tax rate on dividend income will move from 15% to 43.4%Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 60 20
  • 22. The Unique Alternative to the Big Four®Income Tax Rates – Changing the Face of S vs. C  Top marginal federal tax rate on dividend income: Cumulative Current rate 15% 15% 2013 rate increase 24.6% 39.6% (if not altered by new legislation) 2013 rate increase 3.8% 43.4% (additional FICA tax on unearned income)Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 61 The Unique Alternative to the Big Four®C Corp vs. S Corp Tax Benefit AnalysisDividends taxes at 15% - 2012 C CORP S CORPPre-tax income $ 1,000,000 $ 1,000,000Corporate level income tax $ (340,000) $ N/ATax distribution @35% $ 0 $ (350,000)After-tax income $ 660,000 $ 650,000Capital retention $ (500,000) $ (500,000)Additional dividend $ 160,000 $ 150,000Income tax @15% dividend rate $ (24,000) $ N/ANet cash to shareholders $ 136,000 $ 150,000Benefit from increase in basis $ 0 $ 75,000Total return to shareholders $ 136,000 $ 225,000Net benefit from S election = $89,000 NOTE: Assumes all shareholders are in 35% tax bracket and amounts are rounded to nearest $1,000. The tax benefit of the stock basis adjustment is equal to 15% multiplied by the net basis increase of $500,000 (not discounted for future value).Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 62 The Unique Alternative to the Big Four®C Corp vs. S Corp Tax Benefit AnalysisDividends taxed at 43.4% - 2013 C CORP S CORPPre-tax income $ 1,000,000 $ 1,000,000Corporate level income tax $ (340,000) $ N/ATax distribution @39.6% $ 0 $ (396,000)After-tax income $ 660,000 $ 604,000Capital retention $ (500,000) $ (500,000)Additional dividend $ 160,000 $ 104,000Income tax @43.4% dividend rate $ (69,000) $ N/ANet cash to shareholders $ 91,000 $ 104,000Benefit from increase in basis $ 0 $ 198,000Total return to shareholders $ 91,000 $ 302,000Net benefit from S election = $185,000 NOTE: Assumes all shareholders are in 39.6% tax bracket and amounts are rounded to nearest $1,000. The tax benefit of the stock basis adjustment is equal to 39.9% multiplied by the net basis increase of $500,000 (not discounted for future value).Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 63 21
  • 23. The Unique Alternative to the Big Four® Questions?Audit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 64 The Unique Alternative to the Big Four® Disclaimers The views expressed do not necessarily represent those of Crowe Horwath LLP. This material is for informational purposes only and should not be construed as legal, tax, accounting or other professional advice. Please seek guidance specific to your organization from qualified advisers in your jurisdiction.Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separateand independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or anyother member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International orany other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a memberof Crowe Horwath International. This material is for informational purposes only and should not be construed as financial or legal advice. Please seek guidancespecific to your organization from qualified advisers in your jurisdiction. © 2010 Crowe Horwath LLPAudit | Tax | Advisory | Risk | Performance © 2011 Crowe Horwath LLP 65 22