Pub. 8 2013-2014 Issue 3

www.nebankers.org 12 Extraordinary Service for Extraordinary Members. A t the end of 1985, there were 453 Nebraska banks. 1 Contrast that with the 212 Nebraska banks in exis- tence at the end of the first quarter of 2013 and the conclusion is obvious: the Nebraska banking world has con- solidated dramatically in a relatively short amount of time. A recent FDIC community-bank study confirmed this trend is national, noting that the num- ber of banks with assets less than $25 million declined by 96 percent since 1985. In fact, the decline in the number of banks with assets less than $100 millionwas large enough to account for the entire net decline in total banking charters over the same period. 2 Nearly half the banks that exited the industry during the study period exited through merger with an unaffiliated bank. Much of this consolidation has been tied to geography and, since the economic and demographic challenges faced by depopulating regions appear likely to continue, the consolidation trend is also likely to continue. 3 Whether an ac- quiring bank or a target bank, whether rural or located in a metropolitan area, consolidation is something banks must consider as part of their long-term planning. Numerous issues come into play in a bank merger or a structure change, including, importantly, the COUNSELOR’S CORNER tax implications of the transaction. Different tax requirements and, in some cases, different tax method options exist for different banks. This month, we briefly introduce the federal tax method rules and regulations applicable to banks of different sizes. Next time, we’ll apply these taxmethod rules—as well as some additional, specific bank-related rules—to bank mergers and acquisitions. Overall Taxation of Banks Banks are taxed largely under rules applicable to other corporations. Generally, taxable income should be computed under the “method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books” unless the method “does not clearly reflect income.” 4 The two major accounting methods for tax purposes are the cash method and the accrual method. Because it contains variations most applicable to the decisions banks make inmerger and acquisition transactions, this article focuses on the federal tax accrual method. 5 Income Generally, under an accrual method, income (for tax purposes) is included for the taxable yearwhen all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy (i.e., the “all events test”). As it pertains to banks, the “all events test,” as it is known, is modified with respect to debts that are subject to risks of uncollectibility. When a debtor becomes insolvent and the interest on the debt is not collectible, interest must be accrued to the date of insolvency but not thereafter, even if the interest accrued during the same taxable year but before the date of insolvency is uncollectible. 6 Banking Mergers & Structure Changes: A Taxing Proposition Jason Maus , Husch Blackwell LLP 1 http://www.nebankers.org/images/files/pdf-public/communications/press-room/bank-statistics/bank-history.pdf (last visited Aug. 27, 2013). 2 http://www.fdic.gov/regulations/resources/cbi/report/cbi-full.pdf (last visited Aug. 27, 2013). 3 The study tended to show that community banks in rural areas performed quite well throughout the study period and continue to perform well; it was their long-term growth potential that ap- peared likely to remain lower than that of banks located in metropolitan areas. 4 I.R.C. § 446(a). 5 Numerous banks have elected S corporation status since 1996 and as such can elect cash method of accounting for tax purposes. However, due to restrictions on the election of S corporation treat- ment, few corporate taxpayers are able to elect S corporation treatment and, although 30 percent of Nebraska banks elect S corporation status, they are less likely to have the option post-merger. As for other corporations’ methods, a C corporation that has at least $5 million in annual gross receipts is prohibited from using the cash method of accounting. See I.R.C. § 448. 6 Rev. Rul. 80-361, 1980-2 C.B. 164. If the accrued interest subsequently becomes uncollectible, the bank may be entitled the bad debt deduction under I.R.C. § 166, discussed later in this article.