New Wisconsin State Tax Exemptions for Financial Institutions
This blog was authored by my colleague Chan-Yu Wang, a tax director in our financial services group.
Wisconsin Exempts Certain Commercial and Agricultural Loan Income from State Taxation
On July 5, 2023, Tony Evers signed the Wisconsin 2023-2025 budget (2023 Wisconsin Act 19) which included a significant favorable exemption from taxation on commercial and agricultural loan income for financial institutions doing business in Wisconsin. The exemption is expected to significantly reduce or eliminate Wisconsin taxes paid by financial institutions which is a welcome benefit for some institutions in a year when margins are typically lower and many financial institutions may struggle to meet budget. This new tax law appears aimed at helping level the playing field for tax-paying banks against tax-exempt credit unions.
Overview
Effective for taxable years beginning after December 31, 2022, financial institutions are allowed to exempt from state taxation loan income including interest, fees, and penalties earned (“Exempt Income”) from commercial and agricultural loans of $5 million or less where the borrower resides or is located in Wisconsin (“Eligible Loans”).
Determining Eligible Loans
Financial institutions should analyze their loan trial balances to determine the amount of Exempt Income from Eligible Loans to make implementation decisions. Call report groupings can be utilized to identify loans consistent with the purpose and collateral definitions included in the Truth in Lending Act and Equal Credit Opportunity Act, therefore, those groupings provide a good starting point for identifying Eligible Loans. Since the physical address of the borrower in the financial institutions’ core data processing system should be accurate to comply with the Bank Secrecy Act, that field should help to efficiently identify most borrowers residing or located in Wisconsin. Financial institutions should then review the individual loans within those groupings for coding accuracy and other potential ineligibility.
Tax Accounting Considerations
For C-corporation financial institutions fully or primarily lending in Wisconsin, the amount of Exempt Income may result in state tax losses for the foreseeable future due to the exemption’s permanent status without additional legislative action. C-corporation financial institutions should then consider whether it is more likely than not the Wisconsin net business loss carryforward deferred tax asset will be realized.
Generally accepted accounting principles (GAAP) also requires that C-corporations determine if deferred taxes should be adjusted for the effect of a change in tax laws or rates. In this instance, any changes in effective tax rate related to their Exempt Income, would be recorded in income from continuing operations in the reporting period that includes the enactment date of the change, which in this case is quarter three (Q3) of 2023.
Preliminary Observations
We calculated a preliminary estimate of state tax benefit for each bank in Wisconsin. We have also obtained the loan trial balance from several banks for the purpose of calculating more precisely the amount of Exempt Income from Eligible Loans. Here are some preliminary observations:
- The greatest beneficiaries from this tax law appear to be S-corporation banks with most loans of $5 million or less. For example, an S-corporation bank with total assets of approximately $150 million could realize a state tax benefit of approximately $125,000 in 2023.
- C-corporation banks in a net deferred tax asset position may experience delayed benefit to GAAP net income until 2024 if they need to reduce the effective tax rate applied to their deferred taxes in Q3 of 2023.
- S-corporation financial institutions that have previously made the Wisconsin pass-through entity tax election should re-assess whether to make the election for tax year 2023.
- While Wisconsin-based banks may benefit the most due to all or a majority of their borrowers residing in or being located in the state, the exemption benefit also applies to any financial institutions that currently lend in Wisconsin and file Wisconsin tax returns.
How We Can Help
Financial institutions should consider this state tax benefit when calculating estimated payments or shareholder distributions due on September 15, 2023. The CLA Financial Services Group has a process in place to assist financial institutions with identifying the Eligible Loans to calculate the amount of Exempt Income and addressing any related accounting considerations. Contact Us for additional questions or for assistance on the impact of this state tax law change for your financial institution.
Dean has more than 25 years of experience providing audit, internal audit, and consulting services to financial services companies. He has provided consulting services in the areas of business lending, product costing and profitability, and asset/liability management. Dean has worked with a number of financial services companies on strategic issues such as board governance and enterprise risk management, as well as the role of internal audit and risk management, regulatory issues, and many accounting related topics.
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