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Tax Credits and Your Bank's Effective Tax Rate
Many bankers are re-focusing attention on effective tax rates due to increased earnings and the effect of our progressive tax rate structure that increases tax rates as income rises. This is true not only for banks taxed as regular corporations, but also for S corporation banks where owners pay the income taxes on the bank's earnings. New, higher tax rate brackets, the 3.8 percent net investment income tax and the phase-outs of certain deductions and exemptions can lift dramatically the tax rates applicable to individuals as S corporation earnings increase.
Even though the calculations can be challenging, it is important to monitor your bank's effective tax rate annually as part of managing income tax expense. When tax rates approach the highest levels, banks can look to investments in tax credit programs to reduce the effective tax rate.
- Governments, both federal and state, use tax credits to encourage certain types of activities perceived to have public benefits.
- Examples of preferred activities include construction of affordable housing and investment in low-income areas of our communities.
- Investors in these types of activities receive tax credits that reduce income tax expense dollar for dollar and boost return on investment.
- For banks, these investments frequently enhance Community Reinvestment Act (CRA) ratings, as well.
In the right circumstances, these and other tax credits not only reduce tax expense, they also provide reasonable rates of return and CRA "credit." Income tax projections looking forward several years are essential in determining which tax credit investments are suitable. For assistance with analyzing your bank's effective tax rate and assessing the potential benefits from investing in tax credit projects, please contact your local Eide Bailly tax professional.
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