Three Things to Do Now for Success During Tax Season

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After the holiday season, many people go back to work refreshed and ready to take on a new year. However, for banks and their vendors, January is one of the busiest times of the year.

Tax season kicks off every January. Customers must receive tax documents for reporting income, loan interest payments and other financial data required by the IRS. The process of collecting the proper data, building the documents and sending them to customers can often be stressful, unorganized and prone to mistakes. Banks have the charge of getting their customers the right information, at the right time, designed in a familiar way. This process is crucial to reinforcing the trust institutions actively work to build each day with their customers.

Many banks accept this stressful process as “just the way it is.” However, there are things leaders can do now, before the federal government even releases the annual tax data fields, to prepare for the January rush.

Create a Game Plan
Banks know that the biggest frustration with tax documents is that the IRS typically does not release the current year’s data fields and form requirements until late fall. While the forms do not typically change dramatically year-to-year, there are always some changes that must be mapped from the core into any document generation processes. Banks must then match that form with their individual system.

To begin taking a more proactive approach to tax season, the first step is to treat tax preparations like any other project. Identify what your team can control and what it cannot. What worked well last year, what didn’t? It is important to think critically — remember, the goal of this exercise is to streamline the process.

Work through the process and timeline step by step with your team, including all key employees who work closely on this project. Discuss pain points, things you can control and possible action items that can be taken ahead of time.

Once you have successfully identified all dependencies, fill in your project timeline. It is important to start sooner rather than later. Luckily there are two vital steps you can take right now.

Contact Your Core
Get in contact with your core provider as early as possible to discuss any changes. Discuss timelines and deadlines that can be shared internally and added to your project timeline. If your bank can receive test data from the core to proactively work through the process, that can prove incredibly valuable.

One of the larger obstacles of the tax process is the data matching and correct application of the data on the form. Janine Specht, senior vice president of business applications and innovation officer at Kearny Bancorp in Kearny, New Jersey, makes a point of coordinating with her core as early as possible to avoid these pain points.

“We have experienced missing data and wrong boxes which leads to the files being received by our core processor getting input incorrectly,” says Specht. “Then we realized we weren’t ready to print and send.”

Specht recommends creating a calendar with alerts for when to expect certain steps, so nothing is overlooked.

Contact Your Document Vendor
Once the core data is set and properly mapped, your team should prepare document vendors for a smooth workflow. If possible, coordinate any changes with vendors ahead of time. Securing the test data from your core will help with this; however, there are still steps you can take to prepare with your vendor if you cannot get any test data.

Communicate the deadlines and timelines you received from your core to the vendor, and be sure to get any deadlines or important steps from them to add to the internal project timeline.

Discuss any design issues that need to be solved outside of data fields. It is important to send customers a form that looks like the tax form they will be filling out, since the familiarity makes it easier to figure out what they need to do with the documents and reduce calls to customer service.

Tax season is stressful, but there are steps bankers can take ahead of time to ease some of those pain points. The more bank leaders can work through and plan for, the more prepared their employees will be. As banks are working through the process and create the project timeline, remember to think critically and outside of the box. This proactive mindset will make the New Year start more efficiently and reduce the stress associated with tax season.

Banks Face a New Regulatory Environment: From Overdrafts to Fair Lending

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Regulatory risk for banks is evolving as they emerge from the darkest days of the pandemic and the economy normalizes.

Banks must stay on top of regulatory updates and potential risks, even as they contend with a challenging operating environment of low loan growth and high liquidity. President Joseph Biden continues to make progress in filling in regulatory and agency heads, and financial regulators have begun unveiling their priorities and thoughts in releases and speeches.

Presenters during the first day of Bank Director’s Audit & Risk Committees Conference, held on Oct. 25 to 27 in Chicago, provided insights on crucial regulatory priorities that bank directors and executives must keep in mind. Below are three of the most pressing and controversial issues they discussed at the event.

IRS Reporting Requirement
While politicos in Washington are watching the negotiations around Biden’s proposed budget, bank trade groups have been sounding the alarm around one way to pay for some of it.

The proposal would require financial institutions to report how much money was deposited and withdrawn from a customer’s bank account over the course of the year to the IRS in order to help the agency identify individuals evading taxes or underreporting their income. Initially, the budget proposal would require reporting on total inflows and outflows greater than $600; in subsequent iterations, it was later pushed to $10,000 and would exclude wage income and payments to federal program beneficiaries. It has the support of the U.S. Department of the Treasury but has yet to make its way into any bills.

Like all aspects of the spending bill, the budget proposal is in flux and up for negotiation, said Charles Yi, a partner at the law firm Arnold & Porter, who spoke via video. Already, trade groups have mounted a defense against the proposal, urging Biden to drop it from considerations. And a critical senator needed for passage of a bill, Sen. Joe Manchin (D-W.V.), came out against the proposal; his lack of support may mean Congressional Democrats would be more apt to drop it.

But if adopted, the informational reporting requirement would impact all banks. Banks would have to report a much greater volume of data and contend with potential data security concerns.

“Essentially, you’re turning on a data feed from your bank to the government for these funds and flows,” said Arnold & Porter Partner Michael Mancusi, who also spoke via video.

Overdrafts Under Pressure
Consumer advocates have long criticized overdraft fees, and regulators have brought enforcement actions against banks connected to the marketing or charging of these fees. Most recently, the Consumer Financial Protection Bureau settled with TD Bank, the domestic unit of Canada-based Toronto-Dominion Bank, for $122 million over illegal overdrafts in 2020. And in May, Bank of America’s bank unit settled a class lawsuit brought by customers that had accused it of charging multiple insufficient fund fees on a single transaction for $75 million.

Pressure to lower or eliminate these fees and other account fees is coming not just from regulators but from big banks, as well as fintech and neobank competitors, said David Konrad, managing director and an equity analyst at the investment bank Keefe, Bruyette & Woods. Banks have rolled out features like early direct deposit that can help consumers avoid overdrafts or have started overdraft-free accounts. These institutions have been able to move away from overdraft fees because of technology investments in the retail channel and mobile apps that give consumers greater control.

But insufficient funds fees may be a significant contributor of noninterest income at community banks without diverse business lines, and they may be reticent to give it up. Those banks may still want to consider ways they can make it easier for consumers to avoid the fee — or choose when to incur it — through modifications of their app.

Fair Lending Scrutiny Continues
Many regulatory priorities reflect the administration in the White House and their agency picks. But Rob Azarow, head of the financial services transactions practice at Arnold & Porter, said that regulators have heightened interest in fair lending laws — and some have committed to using powerful tools to impact banks.

Regulators and government agencies, including the Consumer Financial Protection Bureau and the U.S. Department of Housing and Urban Development, have stated that they will restore disparate impact analysis in their considerations when bringing potential enforcement actions. Disparate impact analysis is a legal approach by which institutions engaged in lending can be held liable for practices that have an adverse impact on members of a particular racial, religious or other statutorily protected class, regardless of intent.

Azarow says this approach to ascertain whether a company’s actions are discriminatory wasn’t established in regulation, but instead crafted and adopted by regulators. The result for banks is “regulation by enforcement action,” he said.

Directors should be responsive to this shift in enforcement and encourage their banks to conduct their own analysis before an examiner does. Azarow recommends directors ask their management teams to analyze their deposit and lending footprints, especially in zip codes where ethnic or racial minorities make up a majority of residents. These questions include:

  • What assessments of our banking activities are we doing?
  • How do we evaluate ourselves?
  • How are we reaching out and serving minority and low-to-moderate income communities?
  • What are our peers doing?
  • What is the impact of our branch strategy on these communities?

Will Your Target’s Tax Attributes Survive the Acquisition?

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percentage.jpgSince the advent of the financial crisis, many financial institutions have accumulated significant amounts of tax attributes in the form of net operating loss (NOL) carryforwards, tax credit carryforwards, and other forms of built-in tax losses. While these attributes may be attractive to potential acquirers or investors, the application of Internal Revenue Code (IRC) section 382 may significantly reduce the benefit of these tax attributes.

A thorough analysis of the existing tax attributes and their value going forward under IRC section 382 is an important step in determining the appropriate value for any target institution. This determination is certainly necessary for an outright acquisition of a target institution but is also relevant to those seeking to participate in a significant stock offering by such an institution.

Section 382 in a Nutshell

Section 382 applies when a corporation experiences a significant ownership change while it is a loss corporation. The provision limits a corporation’s, or its successor’s, ability to deduct any realized built-in losses and use tax loss or credit carryforwards. Due to statutory time limits on the carryforward of these items, the limitation imposed under Section 382 can lead to a permanent loss of tax benefits and a negative impact on a bank’s financial statement.

Will Ownership Change?

An acquisition, any form of stock issuance (such as public offering, private placement, or recapitalization), or a shareholder’s purchase of a significant number of shares from other shareholders can trigger an ownership change.

An ownership change generally occurs when the collective ownership of the major shareholders of a loss corporation (specifically those owning 5 percent or more of the stock) increases by more than 50 percentage points over a three-year testing period. The percentage point increase for each major shareholder is computed separately and then aggregated to determine if it is an ownership change of at least 50 percentage points. The corporation is responsible for monitoring the ownership changes among its shareholders, and the rules for determining these ownership changes are numerous and complex.

Is Your Target a Loss Corporation?

A loss corporation is any corporation with a carryforward of net operating loss, capital loss or tax credits or with net unrealized built-in loss (NUBIL)—collectively referred to as “tax attributes”—at the time of an ownership change.

NUBIL is basically the fair market value of a corporation’s assets less its tax basis in those assets, determined immediately before the ownership change. Economic losses not yet recognized for federal income tax purposes can create NUBIL. Examples of NUBIL include loan and receivable loss reserves not yet charged off for tax purposes; and impairments, or unrealized losses, of securities recorded for financial statement purposes but not tax purposes.

The provision does recognize a de minimis exception: If NUBIL does not exceed the lesser of $10 million or 15 percent of the fair market value of total assets, it is disregarded for purposes of determining if an entity is a loss corporation.

Keep in mind that a decline in asset values can create a loss corporation, as built-in losses can result from loan and receivable loss reserves not yet deducted for tax purposes, unrealized securities portfolio losses or impairments, or unrealized losses on other assets that have declined in value.

Computing the Section 382 Limitation

When an institution that qualifies as a loss corporation experiences an ownership change, it must compute its Section 382 limitation by multiplying the fair market value of its stock immediately before the ownership change by the applicable federal long-term tax-exempt rate.

The limitation determines how much of the tax attributes that existed at the date of the ownership change can be used by the institution or its successor annually after the ownership change. If NUBIL exists, any assets with built-in losses that are sold at a loss within five years of an ownership change will be subject to the annual Section 382 limitation on deductibility. Losses exceeding the annual limit may be carried forward and deducted in future years—within the confines of the annual Section 382 limitation—but could end up expiring unused.

Proceed With Caution

Section 382 can substantially limit the use of tax attributes and might be a trap for an acquirer or the unwary institution trying to increase its equity capital. The tax attributes at issue often exist on the target’s balance sheet in the form of deferred tax assets for NOL carryforwards, tax credit carryforwards, or allowance for loan losses (which can represent NUBIL). While these deferred tax assets may be offset to zero with a valuation allowance, they likely have some value. The key is to determine the precise value of these tax attributes to the acquirer to make sure this value is properly considered in determining the purchase price. The same concept holds true for investors seeking to participate in a significant stock offering that would trigger an ownership change for the issuer.