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The hidden tax cost of bank incentive rewards

10.09.18

Banks often provide awards to lure new customers or to strengthen customer loyalty. Awards can take the form of a simple gift (cash or non-cash) or can be more complex, such as a sweepstakes involving some element of chance, or a reward points program.

If you have received an award from a bank, the IRS, always ready to claim the government’s share, may come knocking on your door. Taxation is dependent on how you receive the awards, what the award is, and its value. In certain situations, banks are required to, and may send a Form 1099, which reports the award value to the IRS and the award recipient. Here are some different award scenarios and corresponding actions to take.

Awards for Opening an Account
Awards for opening accounts are generally considered interest income and are taxable to the account holder. If an award is paid in cash, the amount of interest income is the amount of cash paid. However, an award may also be non-cash, such as a gift card or a specified item (e.g., an item of merchandise from a rewards brochure). Gift cards are normally valued at the amount of the gift on the card and merchandise at retail value. Once the value of all rewards are tallied, the value should be added to any other interest earned on the account. If the total is at least $10, the IRS requires you to file a Form 1099-INT.

Cash awards are generally easier to administer as the award can be deposited to the customer’s account and credited as interest. In-kind awards often present additional complexity when filing Forms 1099. These awards are often purchased in bulk, and given to customers when they open an account. Therefore, you don’t include the value in the customer account and you can only capture it in the 1099 reporting processes using manual intervention. To ensure these values are captured, you should develop procedures to address any manual processes.

Miscellaneous Awards Programs
Awards provided for something other than the use of money (e.g., opening an account) may also be taxable. For example: amounts provided under a birthday gift program could be taxable. Assume, under a birthday gift program, all customers under the age of 19 receive a $5 gift on their birthday. As the amounts do not appear to be for the use of money (no new account necessary and no specified account balance necessary), these payments would NOT be included on Form 1099-INT.

However, the government still wants their portion. Oftentimes, amounts under these types of programs are very low and do not require tax reporting. If reporting is required, amounts would be included on Form 1099-MISC rather than Form 1099-INT.

You need to consider these payments under the 1099-MISC reporting rules. These rules, different than the 1099-INT rules, only require reporting when the aggregate payments during the year exceed $600. Therefore, no IRS reporting would be required under this program unless payments under this program and any other program which would require a 1099-MISC, exceed $600.

Account Opening Sweepstakes
Occasionally, an incentive program may take the form of a sweepstakes or similar give-away. Winners are chosen randomly, from a pool consisting of customers opening a new checking account during a specified time period and, perhaps, non-customers if a no-purchase required entry option is available. As these prizes are limited and determined by luck (not by skill or by virtue of having an account, other than it qualified them for entry) this is more properly reported as a gambling winning. Gambling winnings are reported on Form W-2G (when in excess of $600).

IRS rules require mandatory withholding for certain gambling prizes. IRS rules also require income tax withholding for proceeds of more than $5,000. The IRS provided an example in their rules that states when no wager is placed, withholding is not required. The example concerns those entered into the sweepstakes simply by virtue of purchasing a magazine subscription for which they paid the regular subscription price. As new checking account customers generally are not paying additional amounts or receiving different terms than the regular terms an account holder receives, they are not considered to have made a wager. Therefore, we believe withholding is not required because there is a withholding exception if no wager is placed.

Reward Points Programs
Benefits from reward points programs are more complex and may not be subject to tax and reporting, depending on the provisions of the program.

The IRS has ruled that a program that is not transferable and is not convertible into cash or cash equivalents should not create gross income to the enrollees. Therefore, amounts earned and collected under a similar program would not be subject to information reporting rules, and not included on Form 1099-MISC.

Furthermore, in some circumstances cash-back options do not create gross income because the cash-back options are treated as a discount on the purchase or a rebate. In short, you have actually paid less for your merchandise because of the discount/rebate provided by the credit card.

However, if there is an award or cash provided simply for signing up for the card (no purchase necessary) the benefit may be taxable and includible on Form 1099-MISC, if the minimum threshold of $600 is satisfied.

Incentive programs to acquire and retain customers may result in taxable income to the customer. Additionally, information reporting may be required if the aggregate amount of all benefits provided exceeds certain thresholds.

We recommend banks review their procedure with regard to incentive programs to ensure proper tax reporting. We also suggest developing a customer-facing communication plan when incentives involve a significant benefit, so that customers are informed of their obligations and not surprised by hidden and unexpected tax costs. We are happy to assist in this area.

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Read this if you are an employer with a defined contribution plan.

This article is the fourth in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. You can read the previous articles here.

One of the most common errors we identify during an audit of defined contribution plans is the definition of compensation outlined in the adoption agreement or plan document is not consistently or accurately applied by the plan sponsor. This can be a serious problem, as operational failures will require correction and those errors can become costly for plan sponsors. 

Calculation challenges and other common errors

It is important plan sponsors understand the options selected for the calculation of employee elective deferrals and employer non-elective and matching contributions into the plan. While calculating compensation sounds straightforward, it is often complicated by the fact that your adoption agreement or plan document may use different definitions of compensation for different purposes.

For example, the definition of compensation used to calculate deferrals could differ from the definition used for nondiscrimination testing and allocation purposes. Therefore, determining the correct amount of compensation requires a strong understanding of both your entity’s payroll structure and adoption agreement or plan document. Plan sponsors should work with both in-house personnel and plan administrators to ensure definitions of compensation are appropriately applied, and that any changes are quickly communicated to all involved.  

During an audit, we commonly identify pay types excluded from the definition of compensation in the adoption agreement or plan document that are incorrectly included in the compensation used in the calculation of employee deferrals and employer contributions. Taxable group term life insurance is a common example of compensation that is improperly included in the definition of compensation. Alternatively, we also identify codes for certain types of pay excluded from the calculation of employee deferrals and employer contributions that should be included based on the applicable definition of compensation. For example, retro pay, bonus payments, and manual checks are often incorrectly excluded in the definition of compensation.

Corrective actions

If errors are identified, we recommend that corrective actions including contributions, reallocation, or distributions are made in accordance with the Department of Labor regulations in a timely fashion.

If appropriate, the plan sponsor should consider amending the plan to align with the definition of plan compensation currently used in practice. We also recommend plan sponsors perform annual reviews of plan operations to ensure compliance and avoid the costs that can accompany non-compliance.

If you have questions about your specific situation, please contact our Employee Benefits consulting team. We’re here to help.

Article
Plan compensation and contributions: Common errors and solutions to fix them

Read this if you are an employer with employees on COBRA. There are tax credits available to you. 

The American Rescue Plan Act of 2021 (ARP) creates a requirement that employers treat the total payment for Consolidated Omnibus Budget Reconciliation Act (COBRA) continuation coverage due from certain eligible individuals as being “paid in full” for April 1 through September 30, 2021 (Subsidy Period). The eligible individuals with COBRA coverage will not receive the subsidy directly from the government; rather, they will have a premium holiday during which time the employer pays 100% of the applicable COBRA premium. The employer will be reimbursed in full through refundable payroll tax credits.

The ARP provisions do not apply to all COBRA-eligible individuals; eligibility is limited to employees who lost health care benefits due to an involuntary termination or reduction in hours. While the loss of coverage event can be linked to COVID-19, it is not required to be. A loss of coverage event could have occurred as far back as November 1, 2019, since the law requires an employer to offer a continuation of COBRA coverage for 18 months after an involuntary termination (18 months from November 1, 2019 is April 30, 2021). Eligible individuals who opted not to pay for COBRA coverage will be given another opportunity to elect the free coverage.

Employers and COBRA administrators should prepare to distribute new COBRA election and subsidy notices and to make operational changes soon after further guidance is released. Eligible individuals not already on COBRA will need to act quickly after receiving the notice to elect subsidized COBRA coverage. Failing to timely elect COBRA coverage could result in forfeiting this valuable benefit.

It is expected many people will rush to take advantage of this opportunity, which can provide up to six months of health insurance at no cost. However, employers should keep in mind that the subsidy is available only for certain limited situations.

Which employers are eligible for the new subsidy?

Employers subject to federal COBRA provisions or to a state program that provides comparable group health care continuation coverage are not allowed to charge eligible individuals for COBRA coverage during the Subsidy Period. The subsidy applies to workers in every industry, most tax-exempt employers (except churches who are exempt from COBRA) and union, governmental, and Indian tribal government workers. The federal COBRA provisions generally apply to all private-sector group health plans maintained by employers that had at least 20 employees on more than 50% of its typical business days in the previous calendar year. Both full- and part-time employees are counted to determine whether a plan is subject to federal COBRA coverage. Many states have “mini-COBRA” laws that apply to employers who have fewer than 20 employees. The subsidy is mandatory for all employer-sponsored group health plans (i.e., all employers must offer the subsidy, regardless of whether the plan is fully or partially insured, or self-insured).

During the Subsidy Period, generally, the federal government will reimburse COBRA costs to employers by allowing credits against employers' Medicare (not Social Security or income) taxes (but for union plans, the plan would receive the subsidy and for insured, state “mini-COBRA” plans, the insurer would receive the subsidy). Guidance is needed to clarify how the flow of funds for the subsidy would work. The full cost of COBRA continuation coverage (including up to a 2% administrative fee) at any coverage level (e.g., single, “single-plus-one”, or family coverage) for employees and former employees and their spouses and dependents is eligible for the subsidy via the payroll tax credit. The subsidy applies to health, prescription drug, dental and vision plans, but does not apply to health flexible spending accounts (FSAs), health savings accounts (HSAs), or long-term care plans (further guidance is needed to clarify the scope of the subsidy).  

Due to the fact that most individuals who elect COBRA group health care continuation coverage usually pay 100% of those premiums (and in many cases they must also pay up to a 2% administrative fee), the new subsidy via the employment tax credit keeps the free COBRA coverage at zero cost to the employer. While the employment tax credit is taxable income, it will be offset by the employer’s deductible payment of the healthcare premiums.

Impact on eligible individuals

An eligible individual with an existing or new COBRA election will be provided tax-free health care coverage (both the premium and any administrative charge) at no charge for their remaining COBRA period that overlaps with the Subsidy Period.   

The free COBRA provided during the Subsidy Period would be “affordable” coverage under the Affordable Care Act (ACA). But it is not clear how this “affordable” coverage affects an individual who has purchased coverage on the exchange before they had an offer of affordable coverage.

A recipient of the free health care coverage must notify the employer or plan administrator when they become eligible for Medicare or another group health plan—other than coverage under an excepted benefit, an FSA or a qualified small employer health reimbursement arrangement (QSEHRA). Individuals who fail to promptly give this notice could be subject to a $250 fine and other penalties.

Who is eligible?

Generally, individuals are eligible for free COBRA coverage if (1) they are involuntarily terminated or have a reduction in hours that qualifies them for federal or state COBRA coverage and (2) the Subsidy Period overlaps with their COBRA coverage period.

The new COBRA premium assistance is not available to the following individuals:

  • Employees who are terminated for gross misconduct.
  • Employees who voluntarily terminated their employment or who retired.
  • Individuals who are eligible for COBRA due to other reasons, like divorce, death, or loss of dependency status.
  • Individuals who are eligible for other group health care coverage (such as from a new employer) or Medicare.
  • Individuals who are beyond their normal COBRA coverage period connected to the original qualifying event (i.e., the employee’s involuntary termination or reduction in hours that caused a loss of group health plan coverage).
  • Domestic partners who are not federal income tax dependents of the employee.

What’s the coverage?

Generally, the COBRA coverage will be the same as the coverage elected just prior to the involuntary termination or reduction in hours. However, employers can (but are not required to) allow individuals who are eligible for premium assistance to change their coverage provided it does not result in an increased premium cost. Further guidance is needed regarding the scope of who can change to a lower cost health plan as a result of the new law.

Eligible individuals who lost health care coverage after October 31, 2019 but do not have COBRA coverage on April 1, 2021 due to nonelection or lapse of payment will have a new, 60-day opportunity to elect COBRA coverage. If timely elected, the COBRA covered period will begin on the date of the individual’s qualifying event, but it appears that no payment is due for months prior to April 2021 and no claims can be filed prior to April 1, 2021. For the months remaining in the COBRA period that coincide with April 1 through September 30, 2021, the employee makes no payment but will have claims paid in accordance with the plan’s provisions. To have continued coverage after September 30, 2021, the employee must make the payments required under the plan. If the individual finds this unaffordable, they can simply drop the coverage.

What notices are needed?

The federal government is expected to issue model required notices addressing the existence of the subsidy, the availability of the 60-day election period and advance notice of when the Subsidy Period will be ending. In the meantime, employers should prepare for the following new notice requirements.

  • Group health plans must modify their COBRA election notices for individuals who become eligible for federal or state COBRA during the Subsidy Period to notify them of the premium assistance (and, if applicable, the option to enroll in a lower priced plan).
  • By May 31, 2021, individuals who previously rejected (or terminated) COBRA coverage and to whom a new election period must be offered, must be notified of their new election period and the availability of the premium assistance. This essentially creates a special COBRA enrollment period for such individuals.
  • Between August 17 and September 15, 2021, group health plans must provide a notice to individuals receiving the premium assistance stating that the subsidy will expire on September 30, 2021, and that they may be eligible for COBRA coverage without the subsidy. But if the subsidy would end earlier for any individual, the plan must provide a notice that the subsidy is expiring no earlier than 45 days and no later than 15 days before the subsidy expiration date.

It is not clear how these required notices must be delivered (sending paper mail to former employees may be needed).

How does the subsidy work?

Individuals who are eligible for COBRA premium assistance do not receive a payment from the federal government, group health plan, employer, or insurer. Rather, their COBRA costs are waived during the Subsidy Period.

Employers that sponsor a fully insured plan would continue paying the full premium to the insurer for the assistance eligible participants. Employers that sponsor a self-insured plan would pay the claims incurred by the assistance eligible participants. In both cases, the employer would receive no payment from the eligible individual during the Subsidy Period but would instead recover its COBRA costs (102% of the COBRA premium) for the assistance-eligible individuals by claiming a refundable federal tax credit against the employer’s Medicare taxes.

The COBRA subsidy is prospective only and cannot begin before April 1, 2021.

Although the law does not require employers to pay for any COBRA coverage, some employers pay for some or all of COBRA coverage (for example, as part of a severance package). Such employers can cease those contributions during the Subsidy Period and the federal government will provide the subsidy for 6 months. And although the subsidy is tax-free to employees, employers who take the COBRA premium tax credit must increase their gross income by the amount of such credit for the taxable year which includes the last day of any calendar quarter with respect to which such credit is allowed.
 
Also, under a “no double dipping” rule, employers cannot take the COBRA premium tax credit for any amount which is taken into account as qualified wages for the employee retention credit (ERC) under the Coronavirus Aid, Relief, and Economic Security Act (CARES) and Consolidated Appropriations Act, 2021 (CAA), or as qualified health plan expenses for the Families First Coronavirus Response Act (FFCRA), as amended by CAA and ARP. Likewise, amounts attributable to the COBRA premium tax credit would not be eligible payroll costs under the Paycheck Protection Program (PPP).

Guidance from the Internal Revenue Service (IRS) is needed to clarify how exactly employers would claim the tax credit, but it appears that employers would claim the credit on their quarterly IRS Form 941 or in advance on IRS Form 7200 if the actual or estimated amount of the credit exceeds the employer's Medicare taxes for any calendar quarter. Further guidance is also needed regarding the mechanics of the subsidy for employers that have insured state COBRA coverage, since under Section 9501(b) of the ARP the tax credits reimbursements would go to the insurer, not the employer.

Other considerations

For past COVID-19 relief tax credits, such as the ERC and FFCRA, IRS guidance allowed employers to dip into withheld income and Social Security taxes as a source of claiming those refundable tax credits. But the IRS has not yet authorized such actions for the ARP COBRA subsidy tax credit. Social Security taxes may not be available as a source for the new COBRA tax credits, since the ARP was enacted under budget reconciliation rules which prohibit any changes to Social Security.

Employers are not allowed to voluntarily expand the group of people who are eligible for the special COBRA premium subsidy, because the federal government is paying the full COBRA premium for the designated class of assistance-eligible individuals.

We expect the IRS to issue FAQs on the new COBRA Medicare tax credits, similar to the FAQs that the IRS issued on the ERC and FFCRA payroll tax credits.

This new COBRA subsidy may be economically more valuable than using qualified health care expenses for the ERC, because ERC nets 70% on the dollar whereas the COBRA subsidy is 102% (premium plus administrative charge).

What should employers do now?

Employers should immediately identify all employees who lost group health plan coverage after October 31, 2019 due to an involuntary termination or reduction in hours, without regard to their COBRA elections, because such event would have entitled the individual to 18 months of COBRA coverage (i.e., through April 30, 2021). Guidance is needed on whether notices must be given to individuals in this group that declined COBRA due to eligibility in another employer’s plan or Medicare. Employers will need to notify individuals who have an unexpired COBRA period that premium assistance is available, and they have a right to reconsider their original COBRA election.  

Employers will also need to review and perhaps modify any existing, automatic processes that might otherwise terminate COBRA coverage when premiums are not received during the Subsidy Period.

Year-end reporting on health benefits should also be reviewed to ensure these increased COBRA participants receive the appropriate Form 1095-B or C for 2021.

Employers should develop a procedure to identify COBRA recipients who are eligible for the premium assistance and those who do not qualify (for example, employers will need to distinguish a voluntary quit from an involuntary termination of employment and whether the employee was fired for gross misconduct). For premium-assistance eligible individuals, employers must refund within 60 days any premiums paid during the Subsidy Period. Not all COBRA participants will qualify for the subsidy, so the plan administrator will still need to handle some premium payments from non-eligible individuals.

Vendor outreach

Many employers use outside service providers for their COBRA administration, so employers should reach out to their vendors as soon as possible to coordinate their response to the ARP changes to current COBRA rules, especially the special election period for certain assistance-eligible individuals.

Keep in mind that, separate from the ARP COBRA subsidy, many employees (and their family members) may currently have extended COBRA election rights due to COVID-19 deadline extensions. For example, ERISA Disaster Relief Notice 2021-1 issued on February 26, 2021, announced an individualized one-year deadline extension for COBRA elections, which begins on the date the clock for the particular deadline would have started running (i.e., the one-year extension is applied on a rolling basis to each deadline for each affected individual). But individuals electing retroactive COBRA coverage under those extended deadlines will generally have to pay the full COBRA premiums for such periods. Guidance is needed on how the deadline extension coordinates with the new COBRA subsidy.

Employers may recall that in February 2009, under the American Recovery and Reinvestment Act of 2009 (ARRA), the federal government subsidized 65% of COBRA premiums for certain individuals who were terminated or laid off between September 1, 2008 and March 31, 2010 due to the financial crisis linked to the bursting of the home mortgage lending bubble. The ARRA subsidy was extended through May 31, 2010, so perhaps with Democrats currently controlling both Congress and the White House, the ARP COBRA subsidy may be extended beyond September 30, 2021. Also, the ARRA may be a model for how the flow of funds will work for the ARP premium tax credits for insured state COBRA coverage.

If you have specific questions about your situation, please contact our Employee Benefits consulting team. We’re here to help. 

Article
"Free" COBRA for some employees: Employers may benefit, too

Read this if you are an employer with basic knowledge of benefit plans and want to learn more. 

This article is the third in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. Our first article covers the background of ERISA, while our second article covers the definitions and rules of parties-in-interest and prohibited transactions.

Form 5500 is an informational return filed annually with the US Department of Labor (DOL). The purpose of Form 5500 is to report information concerning the operation, funding, assets, and investments of pension and other employee benefit plans to the Internal Revenue Service (IRS) and DOL. All pension benefit plans covered by the Employee Retirement Income Security Act (ERISA), and, generally, health and welfare plans covering 100 or more participants are subject to filing Form 5500. Any retirement plan covering less than 100 participants at the beginning of the plan year may be able to file Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan. Read on for important filing requirements, as noncompliance can result in substantial penalties assessed by both the DOL and IRS. 

Who has to file, and which Form 5500 is required?

Pension plans

The most common types of pension benefit plan filers include:

  • Retirement plans qualified under Internal Revenue Code (IRC) § 401(a)
  • Tax sheltered annuity plans under IRC § 403(b)(1) and 403(b)(7)
  • SIMPLE 401(k) Plan under IRC § 401(k)(11)
  • Direct Filing Entity (DFE)

Which Form 5500 you should file depends on the type of plan. Small plans covering less than 100 participants as of the beginning of the plan year will normally file a Form 5500-SF. Conversely, large plans, mainly those plans covering 100 or more participants as of the beginning of the plan year, will file Form 5500 as a general rule. 

Participants include all current employees eligible for the plan, former employees still covered, and deceased employees who have one or more beneficiaries eligible for or receiving benefits under the plan.

Welfare plans

Generally, all welfare benefit plans covered by ERISA are required to file a Form 5500. Common types of welfare benefit plans include but are not limited to medical, dental, life insurance, severance pay, disability, and scholarship funds.

Similar to pension plans, the required Form 5500 to be filed typically depends on whether the plan is a small plan with less than 100 participants at the beginning of the year, or a large plan with 100 or more participants at the beginning of the plan year. However, certain welfare benefit plans are not required to file an annual Form 5500, including, but not limited to:

  • Plans with fewer than 100 participants at the beginning of the plan year and that are unfunded, fully insured, or a combination of the two
  • Governmental plans 
  • Employee benefit plans maintained only to comply with workers’ compensation, unemployment compensation, or disability insurance laws

Participants for welfare benefit plans include current employees covered by the plan, former employees still covered, and deceased employees who have one or more beneficiaries receiving or entitled to receive benefits under the plan (e.g., COBRA). 

Required financial schedules for Form 5500

Small plans that do not file Form 5500-SF require the following schedules to be filed along with the Form 5500:

  • Schedule A—Insurance information
  • Schedule D—DFE/Participating plan information
  • Schedule I—Financial information for a small plan

Large plans require the following schedules in addition to small plan schedules:

  • Plan Audit (Accountant’s Opinion)
  • Schedule C—Service provider information
  • Schedule G—Financial transaction schedules
  • Schedule H—Financial information (instead of Schedule I)

Welfare plans with 100 or more participants that are unfunded, fully insured or a combination of the two are not required to attach Schedule H or an Accountant’s Opinion. Also, pension plans will attach Schedule SB or MB reporting actuarial information, if required, along with Schedule R reporting retirement plan information.

When to File

Form 5500 must be filed electronically by the last day of the seventh calendar month after the end of the plan year. However, a two and one-half months’ extension of time to file can be requested. Penalties may be assessed by both the IRS and the DOL for failure to file an annual Form 5500-series return. For 2020, the IRS penalty for late filing is $250 per day, up to a maximum of $150,000 (applies only to retirement plans), and the DOL penalty can run up to $2,233 per day, with no maximum. Therefore, it is very important to track participant counts and ensure compliance with filing deadlines.

If you have questions about your specific situation, please contact our employee benefit consulting team. We’re here to help.

Article
Form 5500: An overview

Read this if you are a community bank.

The Federal Deposit Insurance Corporation (FDIC) recently issued its fourth quarter 2020 Quarterly Banking Profile. The report provides financial information based on call reports filed by 5,001 FDIC-insured commercial banks and savings institutions. The report also contains a section specific to community bank performance. In fourth quarter 2020, this includes the financial information of 4,559 FDIC-insured community banks. Here are our key takeaways from the community bank section of the report:

  • There was a $1.3 billion increase in quarterly net income from a year prior despite a 38.1% increase in provision expense and continued net interest margin (NIM) compression. This increase was mainly due to loan sales, which were up 159.2% from 2019. Year-over-year, net income is up 3.6%. However, the percentage of unprofitable community banks rose from 3.7% in 2019 to 4.4% in 2020.
  • Provision expense for the year increased $4.1 billion (a 141.6% increase) from 2019.
  • Year-over-year NIM declined 27 basis points to 3.39%. The average yield on earning assets fell 61 basis points to 4.00%.
  • Net operating revenue increased by $3.4 billion from fourth quarter 2019, a 14.5% increase. This increase is attributable to higher revenue from loan sales (increased $1.8 billion, or 159.2%) and an increase in net interest income.
  • Non-interest expenses increased 10.4% from fourth quarter 2019. This increase was mainly attributable to salary and benefit expenses, which saw an increase of $1.1 billion (12.6%). That being said, average assets per employee increased 16% from fourth quarter 2019.
  • Trends in loans and leases showed a moderate contraction from third quarter 2020, decreasing by 1.6%. This contraction was mainly seen in the C&I loan category, which was driven by a reduction in Paycheck Protection Program (PPP) loan balances. However, total loans and leases increased by 10.3% from fourth quarter 2019. Although all major loan categories expanded in 2020, the majority of growth was seen in C&I loans, which accounted for approximately two-thirds of the year-over-year increase in loans and leases. However, keep in mind, C&I loans include PPP loans that were originated in the first half of 2020.
  • Nearly all community banks reported an increase in deposit volume during the year. Growth in deposits above the insurance limit drove the annual increase while alternative funding sources, such as brokered deposits, declined.
  • Average funding costs fell 33 basis points to 61 basis points for 2020.
  • Noncurrent loans (loans 90 days or more past due or in nonaccrual status) increased $1.5 billion (12.8%) from fourth quarter 2019 as noncurrent balances in all major loan categories grew. However, the noncurrent rate remained relatively stable compared to fourth quarter 2019 at 77 basis points, partly due to strong year-over-year loan growth.
  • Net charge-offs decreased 4 basis points from fourth quarter 2019 to 15 basis points. The net charge-off rate for C&I loans declined most among major loan categories having decreased 24 basis points.
  • The average community bank leverage ratio (CBLR) for the 1,844 banks that elected to use the CBLR framework was 11.2%.
  • The number of community banks declined by 31 to 4,559 from third quarter 2020. This change includes two new community banks, four banks transitioning from non-community to community banks, three banks transitioning from community to non-community banks, 30 community bank mergers or consolidations, two community bank self-liquidations, and two community bank failures.

2020 was a strong year for community banks, as evidenced by the increase in year-over-year net income of 3.6%. However, tightening NIMs will force community banks to either find creative ways to increase their NIM, grow their earning asset bases, or find ways to continue to increase non-interest income to maintain current net income levels. Some community banks have already started dedicating more time to non-traditional income streams, as evidenced by the 40.1% year-over-year increase in non-interest income.

Furthermore, much uncertainty still exists. For instance, although significant charge-offs have not yet materialized, the financial picture for many borrowers remains uncertain. And payment deferrals have made some credit quality indicators, such as past due status, less reliable. The ability of community banks to maintain relationships with their borrowers and remain apprised of the results of their borrowers’ operations has never been more important.

As always, please don’t hesitate to reach out to BerryDunn’s Financial Services team if you have any questions. We're here to help.
 

Article
FDIC issues its fourth quarter 2020 Quarterly Banking Profile

Read this if you are an employee benefit plan fiduciary.

This article is the second in a series to help employee benefit plan fiduciaries better understand their responsibilities and manage the risks of non-compliance with Employee Retirement Income Security Act (ERISA) requirements. In our last article, we looked into the background of ERISA, which established important standards for the sound operation of employee benefit plans, as well as who is and isn’t a plan fiduciary, and what their responsibilities are. 

One important ERISA provision, found in Section 406(a), covers the types of transactions a plan fiduciary can and can’t engage in. ERISA terms the latter prohibited transactions, and they’re a lot like traffic lights—when it comes to avoiding conflicts of interest in business dealings, they’re your guide for when to stop and when to go. By knowing and abiding by these rules of the road, plan fiduciaries can steer clear of tickets, fines, and other damaging mishaps. 

Parties-in-interest—keep them out of the passenger seat 

Much like driver’s ed., fiduciary responsibility boils down to knowing the rules—plan fiduciaries need to have a strong working knowledge of what constitutes a prohibited transaction in order to ensure their compliance with ERISA. The full criteria are too detailed for this article, but one sure sign is the presence of a party-in-interest.

ERISA’s definition of a party-in-interest

The definition includes any plan fiduciary, the plan sponsor, its affiliates, employees, and paid and unpaid plan service providers, and 50%-or-more owners of stock in the plan sponsor. If you’d like to take a deeper dive into ERISA’s definition of parties-in-interest, see “ERISA's definition of parties-in-interest" at right.

Prohibited transactions—red lights on fiduciary road 

Now that we know who fiduciaries shouldn’t transact with, let’s look at what they shouldn’t transact on. ERISA’s definition of a prohibited transaction includes: 

  • Sale, exchange, and lease of property 
  • Lending money and extending credit 
  • Furnishing goods, services, and facilities 
  • Transferring plan assets 
  • Acquiring certain securities and real property using plan assets to benefit the plan fiduciary 
  • Transacting on behalf of any party whose interests are adverse to the plan’s or its participants’ 

Transacting in any of the above is akin to running a red light—serious penalties are unlikely, but there are other consequences you want to avoid. Offenders are subject to a 15% IRS-imposed excise tax that applies for as long as the prohibited transaction remains uncorrected. That tax applies regardless of the transaction’s intent and even if found to have benefited the plan. 

The IRS provides a 14-day period for plan fiduciaries to correct prohibited transactions and avoid associated penalties. 

Much like owning a car, regular preventative maintenance can help you avoid the need for costly repairs. Plan fiduciaries should periodically refresh their understanding of ERISA requirements and re-evaluate their current and future business activities on an ongoing basis. Need help navigating the fiduciary road? Reach out to the BerryDunn employee benefit consulting team today. 
 

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Prohibited transactions: Rules of the road for benefit plan fiduciaries

Read this if you are a business owner. 

Now that the Democrats have control of the Presidency, House of Representatives, and Senate, many in Washington, DC and around the country are asking “What is going to happen with business taxes?” 

While candidate Biden expressed interest in raising taxes on corporations and wealthy individuals, it is best to think of that as a framework for where the new administration intends to go, rather than a set-in-stone inevitability. We know his administration is likely to favor a paring back of some of the tax cuts made by the 2017 Tax Cuts and Jobs Act (TCJA). Biden has indicated his administration may consider changes to the corporate tax rate, capital gains rate, individual income tax rates, and the estate and gift tax exemption amount.

Procedurally, it is unclear how tax legislation would be formulated under the Biden administration. A tax package could be included as part of another COVID-19 relief bill. The TCJA could be modified, repealed, or replaced. It is also unclear how any package would proceed through Congress. Under current Senate rules, the legislative filibuster can limit the Senate’s ability to pass standalone tax legislation, thus leaving any such legislation to the budget reconciliation process, as was the case in 2017. It also remains unclear if the two parties will come together to work on any bill. Finally, it will be important to note who fills key Treasury tax positions in the Biden administration, as these individuals will have a strategic role in the development of administration priorities and the negotiation with Congress of any tax bill. Here are three ways tax changes could take shape:

  1. Part of a COVID-19 relief package
    With the Biden administration eager to provide immediate relief to individuals and small- and medium-sized businesses affected by the coronavirus pandemic, some tax changes could be included as part of an additional relief bill on which the administration is likely to seek bipartisan support. Such changes could take the form of tax cuts for some businesses and individuals, tax credits, expanded retirement contributions, and/or other measures. If attached to a COVID-19 relief bill, these changes would likely go into effect immediately and would provide rapid relief to businesses and individuals that have been particularly hard hit during the pandemic and economic downturn.
  2. Repeal and replace TCJA
    Another possibility is for Biden to pursue a full rollback of the TCJA and replace it with his own tax bill. This would be a challenge since the Democrats only have a slim majority in the Senate, meaning that Republicans could filibuster the bill unless Senate Democrats take steps to repeal the filibuster.

    Given that the Biden administration’s immediate priorities will be delivering financial assistance to individuals and businesses, ensuring the rollout of COVID-19 vaccines, and flattening the curve of cases, a repeal and replacement of the TCJA might not be voted on until at least late 2021 and likely would not go into effect until 2022 at the earliest.
  3. Pare back or modify the TCJA
    An overall theme of Biden’s campaign was not sweeping, radical change but making incremental shifts that he views as improvements. This theme may come into play in Biden’s approach to tax legislation. He may choose not to repeal the TCJA completely (prompting a return to 2016 taxation levels), but instead pare back some of the tax changes enacted in 2017. In practice, this could mean raising the corporate tax rate by a few percentage points, which could garner bipartisan support. Again, this likely would not be a legislative priority until after the country has passed through the worst of the COVID-19 pandemic.

Factors that will influence potential tax changes

Senate legislative filibuster

Currently, the minority party in the Senate can delay a vote on an issue if fewer than 60 senators support bringing a measure to a vote. Thus, Republicans would be likely to filibuster any bill that contains more ambitious tax rate increases. The uptick in the use of the filibuster in recent decades is perhaps a symptom of congressional deadlock, and there are calls from many Democrats to eliminate the filibuster in order to pass more ambitious legislation without bipartisan support (in fact, in recent years, the filibuster has been removed for appointments and confirmations). While President Biden and Senate Majority Leader Chuck Schumer may be open to ending or further limiting the filibuster, every Democratic senator would have to agree. West Virginia Senator Joe Manchin has said repeatedly that he will not vote to end the legislative filibuster.

If the filibuster remains in place as it appears it will, tax legislation would likely be passed as part of the budget reconciliation process, which only requires a simple majority to pass. However, the tradeoff is that any changes generally would have to expire at the end of the budget window, which typically is 10 years. This is how both the 2001 Economic Growth and Tax Relief Reconciliation Act and the TCJA were passed.

Appetite for bipartisanship

President Biden has signaled that he wants to work for all Americans and seek to heal the partisan divides in the country. He may be looking to reach across the aisle on certain legislation and seek bipartisan support, even if such support is not necessary to pass a bill. Biden stated during his campaign that he wants to increase the corporate tax rate—not to the 2017 rate of 35%—but to 28%. Achieving this middle ground rate might be viewed as a compromise approach.

As the new government takes office, it remains to be seen how much bipartisanship is desired, or even possible.

What this may mean for your business

It is important to note that sweeping tax changes probably are not an immediate priority for the incoming Biden administration. The new administration’s immediate focus likely will be on addressing the current fragmented approach to COVID-19 vaccinations, accelerating the distribution of the vaccines, taking steps to bring the spread of COVID-19 under control, and providing much needed economic relief. As noted above, there could be some tax changes and impacts resulting from future COVID-19 relief bills.

Those will be the bills to watch for any early tax changes, including cuts or credits, that businesses may be able to take advantage of. Larger scale tax changes, particularly any tax increases, may not go into effect until 2022 at the earliest. Here are some of the current rules and how Biden is proposing to deal with them.

If you have questions about your particular situation, please contact our team. We’re here to help. 

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Biden's tax plan: Tax reform details remain unclear

Read this if you are a bank.

Consolidated Appropriations Act
On December 27, 2020, the Consolidated Appropriations Act, 2021 (CAA) was signed into law. For financial institutions, aside from approving an additional $284 billion in Paycheck Protection Program funding, the CAA most notably extended troubled debt restructuring (TDR) relief. Originally provided in Section 4013 of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, this relief allows financial institutions to temporarily disregard TDR accounting under US generally accepted accounting principles for certain COVlD-19-related loan modifications. Under the CARES Act, this relief was set to expire on December 31, 2020. The CAA extends such relief to January 1, 2022.

Relief from CECL implementation was also extended from December 31, 2020 to January 1, 2022.

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If any questions arise, please contact the financial services team with any questions.

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TDR and CECL relief is extended for financial institutions

Read this if your company is seeking guidance on PPP loans.

The Consolidated Appropriations Act, 2021 (H.R. 133) was signed into law on December 27, 2020. This bill contains guidance on the existing Paycheck Protection Program (PPP) and guidelines for the next round of PPP funding.

Updates on existing PPP loans

Income and expense treatment of PPP loans. Forgiven PPP loans will not be included in taxable income and eligible expenses paid with PPP funds will be tax-deductible. This tax treatment applies to both current and future PPP loans.

Tax attributes and basis adjustments. Tax attributes such as net operating losses and passive loss carryovers, and basis increases generated from the result of the PPP loans will not be reduced if the loans are forgiven.

Economic Injury Disaster Loans (EIDL). Any previous or future EIDL advance will not reduce PPP loan forgiveness. Any borrowers who already received forgiveness of their PPP loans and had their EIDL subtracted from the forgiveness amount will be able to file an amended forgiveness application to have their PPP forgiveness amount increased by the amount of the EIDL advance. The SBA has 15 days from the effective date of this bill to produce an amended forgiveness application. 

Simplified forgiveness application for loans under $150,000. Borrowers who received PPP loans for $150,000 or less will now be able to file a simplified one-page forgiveness application and will not be required to submit documentation with the application. The SBA has 24 days from the effective date of this bill to make this new forgiveness application available. 

Use of PPP funds. Congress expanded the types of expenses that may be paid with PPP funds. Prior eligible expenses were limited to payroll (including health benefits), rent, covered mortgage interest, and utilities. Additional expenses now include software and cloud computing services to support business operations, the purchase of essential goods from suppliers, and expenditures for complying with government guidance relating to COVID-19.

These additional expenses apply to both existing and new PPP loans, but they do not apply to existing loans if forgiveness has already been obtained.
 
In addition, the definition of "payroll costs" has been expanded to include costs for group life, disability, dental, and vision insurance. These additions also apply to both existing and new loans.

Information for new PPP loans

Application deadline. March 31, 2021 

Eligibility for first-time borrowers. A business that did not previously apply for or receive a PPP loan may apply for a new loan. The same requirements apply from the first round of loans. The business must employ fewer than 500 employees per physical location and the borrower must certify the loan is necessary due to economic uncertainty.

Eligibility for second-time borrowers. Businesses that received a prior PPP loan may apply for a second loan, however the eligibility requirements are a little more stringent. The business must have fewer than 300 employees per physical location (down from 500 previously) and it must have experienced a decline in gross revenue of at least 25% in any quarter in 2020 as compared to the same quarter in 2019. The business must have also expended (or will expend) their initial PPP loan proceeds. 

Maximum loan amount. Lesser of $2 million or 2.5x average monthly payroll for either calendar 2019 or the 12-month period prior to the date of the loan. Businesses operating in the accommodations and food service industry (NAICS code 72) can use a 3.5x average monthly payroll multiple. If the business previously received a loan less than the new amount allowed, or if it returned a portion or all of the previous loan, it can apply for additional funds up to the maximum loan amount. 

New types of businesses eligible for loans.

  • Broadcast news stations, radio stations, and newspapers that will use the proceeds to support the production and distribution of local and emergency information 
  • Certain 501(c)(6) organizations with fewer than 300 employees and that are not significantly involved in lobbying activities 
  • Housing cooperatives with fewer than 300 employees 
  • Companies in bankruptcy if the bankruptcy court approves

Ineligible businesses. A business that was ineligible to receive a PPP loan during the first round is still ineligible to receive a loan in the new round. The new legislation also prohibits the following businesses from receiving a loan in the second round:

  • Publicly traded companies 
  • Businesses owned 20% or more by a Chinese or Hong Kong entity or have a resident of China on its board 
  • Businesses engaged primarily in political or lobbying activities
  • Businesses required to register under the Foreign Agents Registration Act 
  • Businesses not in operation on February 15, 2020 

Forgiveness qualifications. New PPP loans will be eligible for forgiveness if at least 60% of the proceeds are used on payroll costs. Partial forgiveness will still be available if less than 60% of the funds are used on payroll costs. 

Covered period. The borrower may choose a covered period (i.e., the amount of time in which the PPP funds must be spent) between 8 and 24 weeks from the date of the loan disbursement.

Employee Retention Tax Credit. The CARES Act prohibited a business from claiming the Employee Retention Tax Credit if they received a PPP loan. The new legislation retroactively repeals that prohibition, although it is unclear how an employer can claim retroactive relief. The new bill also expands the tax credit for 2021. 

Additional guidance is expected from the SBA in the coming weeks on many of these items and we will provide updates when the information is released.

We’re here to help.
If you have questions about PPP loans, contact a BerryDunn professional.

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Paycheck Protection Program: Updates on new and existing loans