Author: Alexis Long

Child care tax credits could expand if a bipartisan bill passes. On July 17, U.S. House members Salud Carbajal (D-CA) and Lori Chavez-DeRemer (R-OR) introduced the Child Care Investment Act. “Skyrocketing costs have left affordable child care out of reach for too many families,” stated Chavez-DeRemer in a press release. If passed, the bill would use a three-pronged approach to reduce child care costs and improve access to assistance for many families. Among other things, the bill would double the credit for employer-provided child care and raise the maximum credit from $150,000 to $500,000 (possibly higher for small businesses). Here’s the press release: https://bit.ly/3Ep8BWR

If you’ve been noticing your neighbors making energy related home improvements lately, such as installing solar panels on the roof, it may be thanks to the expanded home energy tax credits provided by the Inflation Reduction Act.

You can claim either the Energy Efficient Home Improvement Credit or the Residential Clean Energy Credit for the year in which you make qualifying improvements to your primary residence. The former can help cover the costs of replacing windows, doors, and heating and air conditioning systems. The latter may cover the costs of solar, wind, and other sustainable energy projects. For additional details from the IRS on these two credits: https://bit.ly/3QwWr5i

The IRS is making progress on one of its major modernization objectives. The tax agency has announced that taxpayers will have the choice to go fully paperless by 2024’s filing season. It estimates that more than 94% of taxpayers will no longer need to send any form of paper mail to the IRS. And by 2025’s filing season, the IRS will convert all paper returns it receives into digital form.

These and other technological initiatives are made possible by funding from the Inflation Reduction Act. In a fact sheet, the IRS states that digitization will reduce errors and help its customer service employees more quickly and accurately answer questions and resolve problems.

Before long, students will be heading off to college or trade school. Higher education is expensive, but taxpayers who take post-high school coursework in 2023 (or who have dependents taking such courses) may qualify for one of two tax credits that can reduce their tax bills.

The American Opportunity Tax Credit is worth up to $2,500 per eligible student for the first four years at an eligible school. The Lifetime Learning Credit tops out at $2,000 per tax return for any number of years. Income-based limits and additional rules apply. For more information and a link to a tool to find out if you qualify: https://bit.ly/3QoUiJ2

Summertime can mean hiring time for many types of businesses. With legions of working-age kids and college students out of school, and some spouses of business owners looking for part-time or seasonal work, companies may have a much deeper hiring pool to dive into this time of year. If you’re considering hiring your children or spouse, there could be some tax advantages in play. However, you’ll need to be careful about following the IRS rules.

Employing your kids

Children who work for the business of a parent are subject to income tax withholding regardless of age. If the company is a partnership or corporation, children’s wages are also subject to Social Security and Medicare taxes (commonly known as FICA taxes) and Federal Unemployment Tax Act (FUTA) taxes — unless each partner is a parent of the child. However, substantial savings are possible for a business that’s a sole proprietorship or a partnership in which each partner is a parent of the child-employee. In such cases: Children under age 18 aren’t subject to FICA or FUTA taxes, and Children who are 18 to 20 years old are subject to FICA taxes but not FUTA taxes.

As you can see, substantial tax savings may be in the offing depending on your child’s age. Avoiding FICA or FUTA taxes, or both, means more money in your pocket and that of your child. It’s also worth noting that children generally are taxed at lower rates than their parents. Moreover, a child’s income can be offset partially or completely by the child’s standard deduction ($13,850 for single taxpayers in 2023). If your child earns less than the standard deduction, income is tax-free for the child on top of being deductible for the business.

Hiring your spouse

When your spouse goes to work for your business, that individual’s wages are subject to income tax withholding and FICA taxes — but not FUTA taxes. Employers generally must pay 6% of an employee’s first $7,000 in earnings as the FUTA tax, subject to tax credits for state unemployment taxes paid. Thus, you’ll save the money you’d otherwise spend for a non-spouse employee’s FUTA taxes. It’s important that your spouse is treated and compensated as an employee. When spouses run a business together, and they share in profits and losses, the IRS may deem them partners — even in the absence of a formal partnership agreement.

You also may reap some savings from hiring your spouse if you’re a sole proprietor and have a Health Reimbursement Arrangement (HRA). Your family can receive tax-free reimbursement from the business for medical expenses, and the business can deduct the reimbursements — reducing your income and self-employment taxes. HRA reimbursements aren’t subject to FICA taxes and the plan itself is a tax-free fringe benefit for your spouse. Do note, however, that this strategy isn’t available if you have other employees.

Handling it properly

Whether you decide to hire a child or spouse, or both, you’ll need to step carefully. Assign them actual job duties, pay them a reasonable amount, and keep thorough employment records (including timesheets as well as IRS Forms W-4 and I-9). Essentially, treat them as you would any other employee. Our firm can help you handle the situation properly. © 2023

An estimated 190 million Americans have recently been under heat advisory alerts, according to the National Weather Service. That may have spurred you to think about making your home more energy efficient — and there’s a cool tax break that may apply. Thanks to the Inflation Reduction Act of 2022, you may be able to benefit from an enhanced residential energy tax credit to help defray the cost.

Eligibility rules

If you make eligible energy-efficient improvements to your home on or after January 1, 2023, you may qualify for a tax credit up to $3,200. You can claim the credit for improvements made through 2032. The credit equals 30% of certain qualified expenses for energy improvements to a home located in the United States, including: Qualified energy-efficient improvements installed during the year, Residential “energy property” expenses, and Home energy audits.

There are limits on the allowable annual credit and on the amount of credit for certain types of expenses. The maximum credit you can claim each year is: $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600 total) and home energy audits ($150), as well as $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers. In addition to windows and doors, other energy property includes central air conditioners and hot water heaters.

Before the 2022 law was enacted, there was a $500 lifetime credit limit. Now, the credit has no lifetime dollar limit. You can claim the maximum annual amount every year that you make eligible improvements until 2033. For example, you can make some improvements this year and take a $1,200 credit for 2023 — and then make more improvements next year and claim another $1,200 credit for 2024. The credit is claimed in the year in which the installation is completed.

Other limits and rules

In general, the credit is available for your main home, although certain improvements made to second homes may qualify. If a property is used exclusively for business, you can’t claim the credit. If your home is used partly for business, the credit amount varies. For business use up to 20%, you can claim a full credit. But if you use more than 20% of your home for business, you only get a partial credit. Although the credit is available for certain water heating equipment, you can’t claim it for equipment that’s used to heat a swimming pool or hot tub. The credit is nonrefundable. That means you can’t get back more on the credit than you owe in taxes. You can’t apply any excess credit to future tax years. However, there’s no phaseout based on your income, so even high-income taxpayers can claim the credit.

Collecting green for going green

Contact us if you have questions about making energy-efficient improvements or purchasing energy-saving property for your home. The Inflation Reduction Act may have other tax breaks you can benefit from for making clean energy purchases, such as installing solar panels. We can help ensure you get the maximum tax savings for your expenditures. Stay cool! © 2023

 

CFPB targets “junk fees”

In recent guidance, the Consumer Financial Protection Bureau (CFPB) highlighted two “junk fee” practices that, in its view, are likely unlawful:

1. Surprise depositor fees. Banks sometimes charge fees to consumers who deposit checks that bounce. Typically, this happens because check originators have insufficient funds in their accounts, but in some cases, depositors are victims of check fraud. Either way, the CFPB explains, “Charging a fee to the depositor penalizes the person who could not anticipate the check would bounce, while doing nothing to deter the originator from writing bad checks.” According to the CFPB, indiscriminately charging these depositor fees likely violates the Consumer Financial Protection Act. A better approach is for banks to limit these fees to situations in which the depositor should have anticipated the check would bounce — for example, when the depositor has deposited several bad checks from the same originator.
2. Surprise overdraft fees. These fees — which may be imposed when a customer doesn’t reasonably expect their actions to result in an overdraft — also may violate the law. One example is an “authorize positive, settle negative” transaction. This occurs when a consumer has sufficient available balance in the account when a transaction is initiated and authorized by the bank. But because of intervening authorizations, settlements or other complex processes, the financial institution finds the consumer’s balance is insufficient at the time the transaction is settled.

Should you amend your qualified retirement plans?                   

Like many businesses, banks are facing a labor shortage. One way to help attract and retain qualified workers is to offer a competitive employee benefits package. The SECURE 2.0 Act of 2022 provides employers with several options for enhancing their 401(k) or other qualified retirement plans. For example, plans can now permit employees who suffer economic losses from a federally declared disaster to withdraw up to $22,000 penalty-free. Employees also can spread the tax on those withdrawals over three years — or avoid tax completely — by repaying the withdrawal and recontributing the funds to a tax-advantaged retirement account within three years. In addition, plans may increase the maximum loan amount for disaster victims from $50,000 to $100,000.

Starting in 2024, under SECURE 2.0, plans will be permitted to treat qualified student loan payments as elective deferrals for matching purposes. This can be an attractive benefit for employees who otherwise would have to choose between paying down their student debt and deferring salary to a qualified plan to get matching contributions. Other provisions allow employers to offer tax-advantaged emergency savings accounts to rank-and-file employees and to permit employees to receive fully vested employer contributions (including matching contributions) as after-tax Roth contributions.

© 2023

If your bank participates in U.S. Small Business Administration (SBA) lending programs, it must comply with all SBA requirements and standards to ensure that the government will honor its loan guarantees.

SBA lending offers significant benefits for banks. Under the 7(a) program, for example, the SBA guarantees up to 75% of loans to eligible small businesses (85% for loans of $150,000 or less), with a maximum loan amount of $5 million. These loans allow banks to expand customer base, reduce risk, boost lending capacity (the guaranteed portion of these loans doesn’t count toward a bank’s legal lending limit), and improve liquidity (the guaranteed portion can be sold on the secondary market).

Preserve the guarantee

The key to the benefits of SBA lending is the government’s guarantee. If a borrower defaults, the SBA will scrutinize the loan file to ensure that the lender has complied with SBA requirements, as well as SBA loan authorization and prudent lending practices. If the lender doesn’t meet these standards, the SBA may reduce the amount of the guarantee (known as a “repair”) or, in more extreme cases, deny the guarantee altogether.

Here are common reasons for a repair or denial:

Lien or collateral issues. Examples include failure to obtain the required lien position, failure to properly perfect a security interest or failure to fully collateralize the loan at origination when additional collateral was available (usually a repair).

Unauthorized use of proceeds. This involves disbursing proceeds for purposes inconsistent with the loan authorization (denial or repair, depending on the circumstances).

Liquidation deficiencies. These include failure to conduct a site visit, improper safeguarding or disposition of collateral, and misapplication of recoveries to the lender’s loan (usually a repair, but could be a denial if the harm is the full value of the outstanding balance).

Undocumented servicing actions. This includes failing to renew liens when required, releasing or subordinating collateral without a documented business justification, and allowing hazard insurance to lapse on collateral that’s later destroyed (usually a repair).

Early defaults. Typically, early defaults occur within 18 months if there are lender omissions, such as missing or unsupported verification of a required equity injection or missing or unsupported documentation of verification of borrower financial information with the IRS (possible denial if the SBA determines these omissions are the reason for the borrower’s business failure).

SBA loan eligibility issues. These may involve an ineligible franchise, ineligible loan purpose or ineligible loan recipient — for example, a loan to an associate of the lender (usually a denial).

If the SBA denies or reduces a loan guarantee, your bank will have an opportunity to present its case to honor the guarantee. But this time-consuming process will require convincing evidence showing that the bank’s actions were prudent and consistent with SBA requirements and the loan authorization.

Review your program

To preserve the benefits of SBA loan guarantees, review your bank’s SBA lending program. Make sure you have policies, procedures, checklists, controls and properly trained staff in place to ensure that your bank complies with SBA requirements. And be vigilant in monitoring SBA loans to avoid deficiencies that can jeopardize loan guarantees.

© 2023

Many currently problematic loans once looked good on paper — but now, aren’t worth the paper they’re printed on! To ensure your bank doesn’t succumb to the lure of loans that seem to be — and are — too good to be true, it’s important to have a policy of conducting proactive due diligence practices from the start. That way, you’ll help your loan portfolios remain stable and profitable over time.

Steps to consider

Start the due diligence process as an auditor would. That is, before you open a borrower’s financial statements, consider documenting the risks in the industry, applicable economic conditions, and the borrower’s business operations and collateral sources.

This risk assessment identifies what’s most relevant, where your greatest exposure lies, what trends you expect in this year’s financials and which bank products the customer might need. Risk assessments save time because you’re targeting due diligence on high-risk areas.

Financial risk

Now tackle the financial statements, keeping in mind your risk assessment. First evaluate the reliability of the financial information. For statements prepared by an in-house bookkeeper or accountant, consider that individual’s skill level and whether the statements conform to Generally Accepted Accounting Principles. If statements are CPA-prepared, consider the level of assurance: compilation, review or audit.

Comprehensive statements include a balance sheet, income statement, statement of cash flows and footnote disclosures. Make sure the balance sheet “balances” — that is, assets equal liabilities plus equity. You’d be surprised how often internally prepared financial statements are out of balance.

Statements that compare two (or more) years of financial performance are ideal. If they’re not comparative, look at last year’s statements. Then, note any major swings in assets, liabilities or capital. Better yet, enter the data into a spreadsheet and highlight changes greater than 10% and $10,000 (a common materiality rule of thumb accountants use for private companies). You should also highlight changes that failed to meet the trends you identified in your risk assessment. For example, you expected something to change more than 10% but it didn’t.

Now ask yourself whether these changes make sense based on your preliminary risk assessment. Brainstorm possible explanations before asking the borrower. This allows you to apply professional skepticism when you hear borrowers’ explanations.

Ratios for analysis

Use your risk assessment to create a scorecard for each borrower. It often helps to discuss your risk assessment with co-workers and to specialize in an industry niche.

One ratio that belongs on every scorecard is profit margin (net income / sales). Every lender wants to know whether borrowers are making money. But a profitability analysis shouldn’t stop at the top and bottom of the income statement. It’s useful to look at individual line items, such as returns, rent, payroll, owners’ compensation, travel and entertainment, interest, and depreciation expense. This data can provide reams of information on your client’s financial health.

Other useful metrics include current ratio (current assets / current liabilities), which measures short-term liquidity or whether a company’s current assets (including cash, receivables and inventory) are sufficient to cover its current obligations (accrued expenses, payables and current debt maturities). High liquidity provides breathing room in volatile markets.

In addition, total asset turnover (sales / total average assets) is an efficiency metric that tells how many dollars in sales a borrower generates from each dollar invested in assets. Again, more in-depth analysis — for example, receivables aging or inventory turnover — is necessary to better understand potential weaknesses and risks.

Finally, calculating the interest coverage ratio (earnings before interest and taxes / interest expense) provides a snapshot of a company’s ability to pay interest charges. The higher a borrower’s interest coverage ratio is, the better positioned it is to weather financial storms.

When applying these metrics, compare a company to itself over time and benchmark it against competitors, if possible. If customers’ explanations don’t make sense, consider recommending that they hire a CPA to perform an agreed-upon-procedures engagement, targeting specific high-risk areas.

Worth the extra effort

Digging deeper into the financial statements to determine what’s really going on within the operations of existing and potential borrowers may seem unnecessary in the face of what they’re already reporting. But to ensure those reports are based on sound facts and analysis, take a closer look. The health of your bank’s loans depends upon it.

© 2023

The failures of Silicon Valley Bank (SVB) and Signature Bank and the self-liquidation of Silvergate Bank in March 2023 served as wake-up calls for banking regulators and lawmakers. Although industry experts agree that steps must be taken to avoid similar failures in the future, they disagree over whether the solution is to implement stricter banking regulations or simply to improve oversight under existing regulations. Whatever the answer, banks can expect regulators to watch them more closely, particularly regarding capital, liquidity, and interest rate risks.

What’s your level of risk?

The good news for community banks is that their approach to banking is typically different than the niche banks that recently failed. So they’re generally not as susceptible to the types of risks to which those banks were exposed. For example, all three banks that failed had high percentages of uninsured deposits and dangerously high deposit concentrations. (Silvergate and Signature were heavily concentrated in cryptocurrency, and SVB’s deposit base was largely made up of uninsured tech start-up venture capital.)

Nevertheless, community banks should review their deposit mixes. They need to evaluate their risk management policies and procedures to prepare for heightened regulatory scrutiny.

What happened?

Major contributors to recent bank failures included the rapid increase in interest rates during 2022 and early 2023, as well as the collapse of the FTX crypto exchange. Rising interest rates exposed dormant interest rate risks at many banks that had invested heavily in long-term assets in a quest for higher yields when interest rates had reached rock bottom. As interest rates increased, the value of these banks’ bond portfolios plummeted, resulting in significant unrealized losses.

As FDIC Chair Martin Gruenberg explained in a statement to the Senate Banking Committee, “When Silvergate Bank and SVB experienced rapidly accelerating liquidity demands, they sold securities at a loss. The now realized losses created both liquidity and capital risk for those firms, resulting in a self-liquidation and failure.” SVB, for example, announced that it was raising capital and sold $21 billion in underwater securities at a $1.8 billion loss. This triggered a run on deposits, and in a matter of days, $42 billion in deposits were withdrawn.

What’s next?

Government officials are considering several initiatives to address the underlying issues that contributed to recent bank collapses. Their objective is to strengthen capital and liquidity standards for banks with more than $100 billion in assets. Among other things, banking regulators and lawmakers are considering:

• Imposing more rigorous stress-testing requirements on midsize banks,
• Tightening liquidity rules,
• Expanding FDIC deposit insurance coverage, which is currently limited to $250,000 per depositor, per bank, in each account ownership category,
• Increasing capital requirements,
• Reversing a 2018 law that relaxed regulation of midsize banks by increasing the “too big to fail” threshold from $50 billion in assets to $250 billion in assets, and
• Reevaluating regulatory oversight of banks’ deposit mixes, deposit concentration and percentage of uninsured deposits.

Regulatory, legislative and oversight changes will target midsize and large institutions. However, stricter scrutiny of banking risks may trickle down to community banks.

How should community banks respond?

In light of recent events, community banks need to review their risk management policies and procedures. The policies should meet regulators’ expectations and help the bank withstand any further turmoil in the financial industry. Specifically, community banks should:

• Monitor deposit trends to ensure that deposit bases are diversified and that there aren’t high concentrations of deposits in specific industries or groups of related customers,
• Review customers’ average deposit sizes and avoid a high percentage of uninsured deposits,
• Evaluate their liquidity position and, if necessary, take steps to increase liquidity and build liquidity buffers,
• Watch out for accumulated losses in their securities portfolios, and
• Conduct periodic stress tests to evaluate their exposure to interest rate risk and other risks.

Your bank also should communicate with customers to be sure they understand why community banks aren’t exposed to the same level of risk as the institutions that failed. (See “Communication is key for community banks” below.)

Stay tuned

In the coming weeks and months, community banks will need to monitor the regulatory and legislative response to this year’s bank failures and the conditions that caused them. Although new laws or regulations likely won’t affect your bank directly, they may serve as a guide to best practices that can help your bank satisfy regulators and reassure customers.

Sidebar:   Communication is key for community banks

Recent bank failures have created fear among many depositors, so it’s critical for banks to assure them that their money is safe. For community banks, that means educating customers about how their approach to banking differentiates them from the institutions that collapsed in March. They should emphasize their commitments to managing liquidity and interest rate risk and maintaining a diverse deposit base from the communities they serve — rather than concentrating deposits in risky industries or customer segments. Community banks also tend to have low percentages of uninsured deposits.

Now is also a good time to remind customers of the other advantages that community banks have over their larger competitors. Examples include their ability to offer face-to-face engagement and personalized services.

© 2023