Cameron Miranda
Banks profit from tax laws in a variety of ways. Firstly, they can benefit from tax credits and incentives offered by governments, such as those for community-based projects and investments in municipal bonds. Secondly, banks can take advantage of tax laws that allow them to offset losses, delay taxes on foreign income, and subtract bad loan reserves. Additionally, banks can structure their operations to take advantage of favourable tax treatments, such as by offering a wider range of financial services and dealing in various financial instruments. Furthermore, banks can profit from tax laws that are specifically designed for the financial sector, such as the ability to tax specific financial transactions separately from the institution's overall tax liability. Finally, banks can also benefit from the tax system's treatment of their income sources, such as shares held as trading stock and fees earned from a range of financial activities.
| Characteristics | Values |
|---|---|
| Bank tax | A tax on banks levied on the capital at risk of financial institutions, excluding federally insured deposits, with the aim of discouraging banks from taking unnecessary risks. |
| Bank levy | A tax on financial institutions that differs from a financial transaction tax, which is a tax on a specific type of financial transaction for a specific purpose. |
| Financial transaction tax (FTT) | A tax on specific transactions that are designated as taxable, rather than on the financial institution itself. |
| Special tax provisions for banking institutions | Section 475 requires banking institutions to mark-to-market all securities held in their trade and business. |
| Tax on gains and losses | Banks are taxed on gains and losses from fixed assets, such as premises, plant and machinery, and shares in subsidiaries, in the same way as other businesses under normal CIT provisions. |
| Treatment of bad debts | Unpaid interest on impaired debts may be credited to a loan suspense account, bypassing profit and loss calculations. Small banks may use a "reserve" method where additions to the bad debt reserve are tax-deductible. |
| Impact of tax increases on banks | Better-capitalized banks may increase lending and use financial flexibility to benefit from an enlarged tax shield of debt. Worse-capitalized banks may reduce lending as tax increases can make marginal loans unprofitable. |
| Impact on corporate financing and investment | Taxation of banks' gross profits leads to higher bank leverage and lower risk and credit supply, impacting corporate debt financing and investment activity. |
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What You'll Learn
Banks' income from financial services and instruments
Banks derive much of their income from a wide range of financial services and instruments. These services are usually offered on a fee basis, and banks deal in all kinds of financial instruments on their own account. Banks may handle general insurance, fund management, and even real estate agent business. They may also engage in finance leasing, securities trading, and venture capital, often through subsidiaries.
Banks accept deposits from consumers and businesses and pay interest in return. They use these deposits to invest in securities or extend loans to companies and consumers. When the interest earned from loans exceeds the interest paid on deposits, banks generate income from the interest rate spread. The size of this spread is a determinant of a bank's profit. Banks also earn interest from investing cash in short-term securities and from fees charged for their products and services, such as wealth management advice, checking account fees, overdraft fees, and ATM fees.
Financial instruments are assets that can be traded or exchanged, and they provide an efficient flow and transfer of capital among investors. They may be divided into two types: cash instruments and derivative instruments. Examples of financial instruments include stocks, bonds, derivatives, loans, mutual funds, and insurance policies.
Financial services are the processes by which consumers or businesses acquire financial goods. This includes payment systems that accept and transfer funds, such as credit cards and electronic funds transfers. Financial services also include financial advisors who manage assets and offer advice on behalf of clients. Banks can provide some financial services, but they cannot provide all, as some are offered by other financial institutions.
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Tax on bank liabilities
A bank tax, or bank levy, is a tax on banks that was introduced in the context of the 2008 financial crisis. It is levied on the capital at risk of financial institutions, excluding federally insured deposits, with the aim of discouraging banks from taking unnecessary risks. The tax is designed to be a small reimbursement of taxpayer funds used to bail out major banks during the financial crisis. It targets certain institutions and is carefully structured to counterbalance the various ways in which banks are subsidised by the tax system. For example, banks can subtract bad loan reserves, delay tax on interest received abroad, and buy other banks to offset future income with their losses.
The International Monetary Fund (IMF) has presented three options for taxing banks:
- Financial stability contribution (FSC): a tax on a financial institution's balance sheet, most likely on its liabilities or assets. The proceeds would be used to create an insurance fund to bail out the industry in future crises, rather than making taxpayers foot the bill.
- Financial activities tax (FAT): a tax on the sum of bank profits and bankers' remuneration packages, with proceeds going into general government revenues.
- Financial transactions tax (FTT): a tax on a broad range of financial instruments, including stocks, bonds, currencies and derivatives.
Some countries have implemented their own versions of a bank tax, with varying rates and bases. For example, the Slovak financial stability contribution, enacted in 2012, was a tax on bank liabilities after deducting basic capital. Initially set at 0.2%, this rate was due to expire at the end of 2020. However, Slovak lawmakers voted to extend the tax indefinitely and increase the rate to 0.4%. Despite criticism from the National Slovak Bank and the European Central Bank, who forecasted a 33% reduction in bank income, the tax was only abolished in January 2021.
In 2011, Iceland implemented a bank tax levied on total debt at a rate of 0.145%. The same year, Portugal introduced a bank tax with rates ranging from 0.01% to 0.11% on various bases. Sweden also implemented a tax in 2015, levying a rate of 0.05% on the total amount of liabilities net of equity and insured deposits. The United Kingdom has a tax rate ranging from 0.05% to 0.10% on the total amount of liabilities net of insured deposits.
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Tax preferences for credit unions
Credit unions are not-for-profit financial institutions that have been serving their members through financial highs and lows for over a century. They are owned by their members, who are also their depositors, rather than by shareholders.
Credit unions are exempt from most federal and state taxes, except for local property taxes. This tax preference was designed to level the playing field and ensure that credit unions could continue to meet the needs of underserved people and communities. However, in recent years, credit unions have been acquiring banks, causing many to question these tax incentives. When a credit union acquires a bank, state and local governments can lose much of the tax revenue that the bank was paying.
Some states have passed legislation to address this issue. For example, Washington State has implemented a business and occupation (B&O) tax, which subjects state-chartered credit unions to a 1.2% tax rate if they acquire a state-regulated bank.
The federal tax exemption for credit unions has been a topic of debate, with some arguing that it provides an unfair competitive advantage and that the original logic for the exemption has expired. Congress has been urged to revisit and re-examine the assumptions that underpin this policy, especially in light of the economic and fiscal instability of recent years.
Despite these discussions, credit union members and supporters have advocated for maintaining the tax-exempt status of credit unions, emphasizing their positive impact on the financial well-being of individuals and communities.
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Tax on offshore financial institutions
Banks and investment institutions offer accounts in their countries of origin and in jurisdictions around the world, particularly those known for their low tax rates and relaxed regulations. These offshore accounts are legal and respectable if set up appropriately. An offshore tax haven refers to a location, jurisdiction, territory, or country where minimal taxes are charged on investments.
Offshore tax havens have, in the past, not shared much information with governmental agencies, which reduces the tax liabilities in the investor's home country. As offshore banking has matured, some tax jurisdictions have dropped their tax rates even lower, kept fewer records, and done no reporting. These secrecy jurisdictions have been used for tax evasion, with more wealth flowing into them globally, leaving countries with minimal tax revenues.
Offshore accounts have several advantages, including privacy, stability if the investor's home economy is unstable, and access to funds while living abroad. However, there are also complicating factors, such as compliance issues and stringent reporting requirements. American taxpayers with qualifying foreign bank holdings must file a Foreign Bank and Financial Account (FBAR) report, and the IRS levies fines and penalties on those who fail to report their assets.
Offshore tax havens are accessible to large companies and wealthy individuals, and they have been used to avoid the 35% corporate tax rate in the US. Multinational companies establish subsidiaries in offshore tax havens, and the ultra-wealthy use tax-avoidance strategies to accumulate more wealth. Recent information leaks, such as the Panama Papers and Paradise Papers, have shed light on how these schemes work.
To combat offshore tax avoidance, Representatives and Senators in the US have introduced bills proposing to require reporting on foreign investments held by US taxpayers and treating foreign corporations managed in the US as domestic corporations for tax purposes. While these bills have not yet passed, they highlight the growing frustration with the tax system as the rich get richer while the less rich pay taxes.
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Tax on virtual currencies
The IRS treats virtual currency as property for federal tax purposes. This means that, depending on your circumstances, Bitcoin or other cryptocurrencies can be classified as business property, investment property, or personal property. For example, if you mine Bitcoin as part of a trade or business, it will be considered business property.
Because virtual currency is treated as property, general tax principles applicable to property transactions apply to transactions using virtual currency. This means that you must recognize any capital gain or loss on the sale of the virtual currency, subject to any limitations on the deductibility of capital losses. Your gain or loss will be the difference between your adjusted basis in the virtual currency and the amount you received in exchange for the virtual currency, which you should report on your Federal income tax return in U.S. dollars. Your adjusted basis is your basis increased by certain expenditures and decreased by certain deductions or credits in U.S. dollars. Your basis, also known as your "cost basis", is the amount you spent to acquire the virtual currency, including fees, commissions, and other acquisition costs in U.S. dollars.
If you receive virtual currency as payment for performing services, whether or not you perform the services as an employee, you must recognize ordinary income. The amount of income you must recognize is the fair market value of the virtual currency in U.S. dollars when received. If you use virtual currency to pay employee wages, the fair market value of the currency will be subject to federal income tax withholding, FICA, and FUTA taxes and must be reported on Form W-2.
If you are an independent contractor and receive virtual currency for performing services, the fair market value of the currency will be subject to self-employment tax. If you successfully mine virtual currency, you must include its fair market value in your income as of the date of receipt. Also, if the mining activity is a trade or business (and you are not considered an employee of the business), your net earnings (the fair market value of the virtual currency mined less allowable deductions) are subject to self-employment tax.
It is important to maintain detailed records on your virtual currency transactions. The records should summarize when the currency was received, the currency's fair market value on the date of receipt, and the purpose for which you are holding the currency (investment, inventory, etc.).
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Frequently asked questions
A bank tax, or bank levy, is a tax on banks that was introduced in the context of the 2008 financial crisis. It is levied on the capital at risk of financial institutions, excluding federally insured deposits, with the aim of discouraging banks from taking unnecessary risks.
Bank taxes are levied on a limited number of sophisticated taxpayers and target certain institutions. They aim to counterbalance the ways in which banks are subsidised by the tax system, such as being able to subtract bad loan reserves, delay tax on interest received abroad, and buy other banks to offset future income with their losses.
Banks can profit from tax laws by utilising tax credits and tax deductions. For example, banks can support community-based projects that are made possible through tax credits, such as Low-Income Housing Credits and Green credits. Banks can also deduct bad debts from their taxable income.
Critics argue that bank taxes may increase overall risk in the system if banks feel that the taxes provide a government guarantee of future bailouts. Bank taxes may also hurt consumers, disincentivise lending, and hinder economic growth.
No, the implementation of bank taxes varies across countries. While some countries like the UK, France, and Germany have implemented bank taxes, others have not. The G20 leaders declared in 2010 that a "global tax" was no longer "on the table," leaving it to individual countries to decide whether to implement a levy against financial institutions.
