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BOSTON  MANCHESTER  PORTLAND  PORTSMOUTH FOR PRESENTATION PURPOSES ONLY A CCOUNTING AND T AX U PDATES.

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Presentation on theme: "BOSTON  MANCHESTER  PORTLAND  PORTSMOUTH FOR PRESENTATION PURPOSES ONLY A CCOUNTING AND T AX U PDATES."— Presentation transcript:

1 BOSTON  MANCHESTER  PORTLAND  PORTSMOUTH FOR PRESENTATION PURPOSES ONLY A CCOUNTING AND T AX U PDATES

2 B|N|N FOR PRESENTATION PURPOSES ONLY T OPICS Accounting update Carl Chatto, CPA Principal Tax update Proposed tax legislation and updates on current tax issues including developments in bank specific matters Roger Poulin, CPA, MBA Principal Highlights from the Conference Jeff Skaggs, CPA Principal

3 B|N|N FOR PRESENTATION PURPOSES ONLY I NTRODUCTION Jeff Skaggs, CPA Principal Jeff began with Baker Newman Noyes when the firm was founded in 1995 having previously worked at KPMG, one of our predecessor companies since He is a Principal in the firm's Audit Division specializing in financial institutions. Highlights from the 2012 AICPA National Conference

4 B|N|N FOR PRESENTATION PURPOSES ONLY E CONOMY AND TRENDS Improving trends earnings, problem loans and bank failures Negative effects European Union, “fiscal cliff” in the US

5 B|N|N FOR PRESENTATION PURPOSES ONLY E CONOMY AND TRENDS National and global statistics Public opinion GDP Europe China Consumers Housing market 2013 predictions

6 B|N|N FOR PRESENTATION PURPOSES ONLY R EGULATORY Capital ratios Basel III

7 B|N|N FOR PRESENTATION PURPOSES ONLY R EGULATORY Allowance TDR’s OREO HELOC’s Impaired loans and ALL treatment Accounting Issues

8 B|N|N FOR PRESENTATION PURPOSES ONLY R EGULATORY Independence under AICPA, SEC, PCAOB FDICIA audit issues

9 B|N|N FOR PRESENTATION PURPOSES ONLY FASB Convergence with international standards Impairment Expected loss model Classification & Measurement FV-NI FV-OCI Amortized cost Liquidity risk & interest rate risk disclosures FV accounting Leases Private Company Council Non-public banks

10 B|N|N FOR PRESENTATION PURPOSES ONLY U NCERTAINTY

11 B|N|N FOR PRESENTATION PURPOSES ONLY I NTRODUCTION Tax Update Roger D. Poulin, CPA, MBA Principal Roger began at Baker Newman Noyes when the firm was founded in 1995 having previously worked for KPMG, one of the firm’s predecessor companies since He is a Principal in the Tax Division specializing in financial services, corporations, individual taxation and tax advocacy.

12 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” 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 politics

13 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” 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%

14 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Top marginal federal tax rate on dividend income: Current rate: 15%

15 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Top marginal federal tax rate on dividend income: Cumulative Current Rate15% 2013 rate increase (if not altered by new legislation) 24.6%39.6%

16 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Top marginal federal tax rate on dividend income: Cumulative Current Rate15% 2013 rate increase (if not altered by new legislation) 24.6%39.6% 2013 rate increase (additional tax on unearned income) 3.8%43.4%

17 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Top investment tax rates: , if “Bush tax cuts” expire 2013 including ACA increases Percentage increase from 2012 to 2013 Long-term capital gains 15%20%23.8%58.6% Interest35%39.6%43.4%24% Dividends15%39.6%43.4%189% Source: Internal Revenue Code; M.A. Co.

18 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” The Heritage Foundation itemized the tax increases as follows: End of temporary payroll tax cut $125 billion Alternative Minimum Tax patch ends $118 billion Bush middle-class tax cuts end $99 billion Bush “pro-growth” tax cuts end $67 billion Tax increases from Affordable Care Act begin $23 billion Tax cuts from 2009 stimulus end $21 billion Tax extenders lapse $20 billion Estate and gift taxes increase $13 billion 100% expensing of business investment ends $8 billion

19 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Some proposals call for reducing the corporate tax rate from 35% to a lower rate (perhaps 25%) while eliminating certain corporate deductions and tax benefits While a rate reduction would be a welcome benefit for financial institutions, many banks would take a potentially large one-time hit to income (and capital) as the deferred tax asset is adjusted to a rate of 25% from a current level of 35%

20 B|N|N FOR PRESENTATION PURPOSES ONLY I NCOME T AX R ATES – “T AXMAGEDDON ” Example: Bank has deferred assets at year end. Total Assets$5,000,000 Current Tax Rate 35% Deferred Tax Asset$1,750,000 Total Assets$5,000,000 Current Tax Rate 25% Deferred Tax Asset$1,250,000 One-time hit to income and capital = $500,000

21 B|N|N FOR PRESENTATION PURPOSES ONLY B AD D EBTS AND N ON -P ERFORMING L OANS Both areas have historically been the subject of significant disagreement between taxpayers and the IRS The issue centers on the timing of the deduction for worthless loans and worthless accrued interest Thus the issue is a temporary difference that generally only impacts the deferred tax asset

22 B|N|N FOR PRESENTATION PURPOSES ONLY B AD D EBTS AND N ON -P ERFORMING L OANS The “bad debt conformity election” found in Regulation§ (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 cycle

23 B|N|N FOR PRESENTATION PURPOSES ONLY B AD D EBTS AND N ON -P ERFORMING L OANS 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 involved scenarios where the bank would prefer to defer the deduction until later years (can easily be done for partial charge-offs)

24 B|N|N FOR PRESENTATION PURPOSES ONLY B AD D EBTS AND N ON -P ERFORMING L OANS Revenue Ruling extends the safe harbor provided by the bad debt conformity election to cover the exclusion of non- performing loan interest 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)

25 B|N|N FOR PRESENTATION PURPOSES ONLY E XPRESS D ETERMINATION L ETTER To be eligible to use the conformity method, an institution must first file with the IRS to make the conformity election; thereafter, In connection with its most recent examination of the institution’s loan review process, the institution’s primary federal supervisor must expressly determine that the institution maintains and applies loan loss classification standards that are consistent with the supervisor’s regulatory standards Institutions that have made the election are responsible for requesting an “express determination” letter at each federal safety and soundness examination A request made after the completion of an examination will not be honored

26 B|N|N FOR PRESENTATION PURPOSES ONLY L OSSES ON W ORTHLESS D EBT S ECURITIES 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 places upon loss deductions resulting from these impairments essentially guarantee some amount of book-tax difference for many securities In many cases, the tax deduction may be delayed until a later year when the more restrictive requirements for deductibility have been satisfied

27 B|N|N FOR PRESENTATION PURPOSES ONLY L OSS ON W ORTHLESS D EBT S ECURITIES 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) Only a bank is allowed to claim a loss deduction for a partially worthless debt security (i.e. bonds, trust preferred securities, mortgage-backed obligations, etc.) 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 security Banks also are not permitted to claim a loss deduction for a partially worthless equity security (i.e. stocks, mutual funds, partnership interests, etc.)

28 B|N|N FOR PRESENTATION PURPOSES ONLY L OSS ON W ORTHLESS D EBT S ECURITIES What is a loss/impairment? GAAP – excess of the current carrying value over the net present value of all anticipated future payments resulting from on 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 – anticipated shortfall in principal payments that, in all likelihood, will never be received Often results from an event that negatively impacts the borrowers ability to repay the principal Value of collateral is significant in the determination Timing of cash flows is largely irrelevant If full principal is likely to be recovered, there is no loss Interest income need not be accrued if collection of the interest payments is significantly in doubt

29 B|N|N FOR PRESENTATION PURPOSES ONLY L OSSES ON W ORTHLESS D EBT S ECURITIES The timing of the tax deduction is a frequent source of disagreement with the IRS because: The bad debt conformity election is limited to loans, so there is no safe harbor election available to protect the bad debt losses and claimed on worthless securities The deductions are often large The tax deduction is often based upon subjective determinations and analysis (except for obvious cases of completely worthless securities) 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

30 B|N|N FOR PRESENTATION PURPOSES ONLY D EDUCTING OREO C ARRYING C OSTS 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 coordinated

31 B|N|N FOR PRESENTATION PURPOSES ONLY D EDUCTING OREO C ARRYING C OSTS Such an argument would support the deduction of the OREO carrying costs as an ordinary and necessary business deduction under IRC§162 Instead, the properties are acquired in the ordinary course of the loan relationship in order to mitigate the potential loss on the worthless debt obligation, not to be sold at a profit 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”

32 B|N|N FOR PRESENTATION PURPOSES ONLY I NFORMATION R EPORTING Notice 972CG – Notice of Proposed Civil Penalty Mailed to filers submitting information returns with missing, incorrect, or currently unissued Name/TIN combinations. It is a penalty proposal Penalties - Doubled

33 B|N|N FOR PRESENTATION PURPOSES ONLY I NFORMATION R EPORTING Note: The maximum penalty for all failures in a calendar year is $1,500,000, or $500,000 for small businesses, i.e. gross receipts of $5,000,000 average over the last three years. The penalty for intentional disregard of the filing requirements is $250 per occurrence with no maximum amount. Filing on a missing or incorrect name/TIN combination generates a penalty of… $30, if corrected within 30 days of the filing date $60, if corrected more than 30 day after the filing date, but prior to August 1 $100, if uncorrected or corrected after August 1 of the filing year Penalty Amounts

34 B|N|N FOR PRESENTATION PURPOSES ONLY Q UESTIONS ON T AX U PDATE

35 B|N|N FOR PRESENTATION PURPOSES ONLY I NTRODUCTION Carl Chatto, CPA Principal Carl Chatto has been with Baker Newman Noyes since it was formed in 1995, having previously worked with KPMG, one of our predecessor organizations since Carl is a Principal in BNN's Audit Division specializing in financial institutions, higher education, and quasi- governmental agencies. He is certified in Maine, New Hampshire and Vermont. Accounting Update

36 B|N|N FOR PRESENTATION PURPOSES ONLY O THER COMPREHENSIVE INCOME Presentation change in financial statements Effective this calendar year for non-public banks Already adopted by public banks during 2012 No longer an option to show OCI in the statement of changes in equity

37 B|N|N FOR PRESENTATION PURPOSES ONLY OCI CONTINUED New presentation has two options: Single continuous statement with income statement Second statement just after income statement Informal survey: second statement is the preferred approach

38 B|N|N FOR PRESENTATION PURPOSES ONLY OCI CONTINUED ASU deferred presentation requirements for reclassification entries To address implementation issues FASB is still reviewing

39 B|N|N FOR PRESENTATION PURPOSES ONLY L EASES Exposure draft by June 2013 Will affect banks that have leased branches or other assets The main change is to essentially treat all leases as capital leases The idea has some theoretical merit, but… The devil is in the details

40 B|N|N FOR PRESENTATION PURPOSES ONLY L EASES CONTINUED More assets and liabilities will be shown on the balance sheet A “right to use” asset will be booked with an offsetting lease liability This will decrease capital ratios Some questions still open Amortization of the asset Renewable lease— determining the term Treatment of various lease options

41 B|N|N FOR PRESENTATION PURPOSES ONLY L EASES CONTINUED Will also affect your commercial borrowers Loan covenants will need to be revisited What to do now? If you have a lot of significant leases, start an inventory now Otherwise, wait for the revised exposure draft in 2013

42 B|N|N FOR PRESENTATION PURPOSES ONLY A LLOWANCE FOR LOAN LOSSES Current model: provide for incurred losses Proposed model: provide for expected losses CECL: Current Expected Credit Loss This is a big difference! Most GAAP requires accruing probable losses, not expected ones How does “expected” fit into existing model?

43 B|N|N FOR PRESENTATION PURPOSES ONLY ALL CONTINUED Developed in response to financial crisis Without going into details, there are many implementation issues with this approach International accounting is moving towards a “three bucket” approach That is clearly the regulatory expectation CECL should lead to higher loan loss reserves

44 B|N|N FOR PRESENTATION PURPOSES ONLY ALL CONTINUED Also under review at FASB: Nonaccrual loan accounting At this point, no significant changes to practice Possible application of CECL to debt securities Could be a significant change Advantage: only one loss model to apply Significant disclosure changes (of course!) Possible application of CECL to Purchased Credit Impaired (PCI) loans

45 B|N|N FOR PRESENTATION PURPOSES ONLY ALL CONTINUED Stay Tuned!

46 B|N|N FOR PRESENTATION PURPOSES ONLY O THER CHANGES Private company financial reporting A move to simplify accounting and disclosure for non- public companies, including banks Regulators may insist on “full GAAP” for banks More disclosures about interest rate and liquidity Compromise from full fair fair-value accounting Another FASB proposal

47 B|N|N FOR PRESENTATION PURPOSES ONLY O NE MORE CHANGE The standard audit opinion for non- public companies is changing Longer report Much more specific description of responsibilities of the bank and the auditor

48 B|N|N FOR PRESENTATION PURPOSES ONLY Q UESTIONS ON A CCOUNTING U PDATE

49 B|N|N FOR PRESENTATION PURPOSES ONLY C ONTACT I NFORMATION FOR THE P RESENTERS Carl Chatto, CPA Principal / / Jeff Skaggs, CPA Principal / / Roger D. Poulin, CPA, MBA Principal / /


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