Is Your Deferred Tax Asset Safe?
Congress has just passed the Tax Cut and Jobs Act. It reduces the corporate income tax rate of up to 35% to a 21%. The bill will now be sent to the President for his signature, presumably before the end of the year, but the date is unclear at the moment.
Accounting standards require that deferred tax assets or liabilities be valued at the income tax rates at which the asset or liability is expected to be recognized. Community banks generally have deferred tax assets (DTAs) due to timing differences between book and tax accounting for the allowance for loan losses and deferred compensation plans. These assets have generally been valued at 34%, the rate at which most community banks pay federal income taxes.
With the change in the corporate rate to 21%, the deferred tax asset or liability will also need to be revalued at the lower rate at which the deferred taxes will be recognized. For example, if your bank has a net deferred tax asset of $1 million, the change in rates will cause a revaluation of the DTA to $618,000, an expense of $382,000. The change will result in income if the bank holds a net deferred tax liability (DTL).
The timing of the revaluation, however, is significant. As of last week, it appeared that the bill would not be signed into law until 2018 due to the procedural requirements of the House and Senate, meaning that the DTA/DTL revaluation would not occur until 2018. Currently, it is still unclear if the President will sign the bill in 2017 or 2018 due to negotiations surrounding the Continuing Resolution to keep the federal government funded. If this is resolved by Friday, when the government technically runs out of funding, the President has indicated he will sign the bill. If it is not resolved, there is a possibility that the bill won’t become law until 2018. This means that deferred tax assets and liabilities will need to be revalued as of December 31, 2017 if the bill is signed before year-end or in January, 2018 if the signing is delayed.
Offsetting the potential expense of a DTA revaluation, of course, will be the lower rates over the foreseeable future that will certainly more than offset any expense occurred in 2017. In upcoming weeks we will highlight other tax implications of the new act for banks.