Unlocking Earnings From Unexpected Places  

*This article was published in Bank Director magazine’s first quarter 2025 issue.

Effective tax rates (ETRs) vary significantly from bank to bank.

Some entities report ETRs from 13% to 14%, while others are closer to 27% to 28%. What differentiates them? Banks that consistently maintain lower effective tax rates typically have a better strategic approach to income tax management. A sound tax strategy can substantially enhance shareholder value in a competitive market where every line item counts.

From business growth to environmental responsibility, home ownership to healthcare, Congress creates incentives and disincentives with every law passed. We can see disincentivized activities manifest in the form of nondeductible expenses like excess executive compensation, disallowed capital losses, nondeductible merger expenses and FDIC insurance expenses for larger banks. These increase ETRs, and corporations need to find ways to offset the impact.

Taking Advantage of Credits
To decrease ETRs, banks have traditionally invested in nontaxable municipal securities and loans and bank-owned life insurance contracts (BOLI). While these reduce the ETR and may have other favorable attributes, such as Community Reinvestment Act credit, they tend to have lower yields and tie up liquidity. State and local taxes can also cause variability in ETRs. Banks should ensure appropriate structuring of activities that reduce these taxes, which may include creating real estate investment trusts, investment subsidiaries or diversifying activities across more favorable tax states.

Numerous tax credit opportunities are classified as general business credits, but they have historically not been in sufficient supply. A corporation can offset up to 75% of its federal tax liability with general business credits. It makes sense that banks have been investing in tax credits in their various forms for many years. Some preferred investments include Low Income Housing Tax Credits, New Markets Tax Credits, federal historic rehabilitation tax credit, and especially in the last several years, renewable energy Investment Tax Credits.

Opportunities in Renewables
Some tax credits have longer lives and a higher average balance, requiring long-term funding costs to be factored in and capital to be allocated against them. In contrast, the renewable energy Investment Tax Credits are recognized immediately and entirely the year that a renewable energy project is built and energized. This creates an immediate return of capital to the investor and reduces the average balance of the investment during the five-year holding period to a negligible amount, generating a significantly higher return on invested capital compared to other tax credit investments. Simply put, those are the most efficient federal tax credits available to banks.

Renewable energy tax equity investments have been available to corporations since 2007, and nearly every large national and superregional bank makes sizable annual investments in this asset class. The 2022 Inflation Reduction Act has created opportunities for community and regional bank investors to participate as well. The act significantly increased the supply of new, midsize solar projects in the marketplace for tax credit-seeking investors. It also provides for a three-year carryback and 22-year carry forward of the renewable energy Investment Tax Credits, along with direct transfers of these credits for buyers and sellers that prefer not to utilize tax equity.

While the election outcome has sparked concerns about the fate of the Inflation Reduction Act, a full repeal or major overhaul is highly unlikely. The legislation has created substantial benefits, most notably in job creation and energy growth, and has garnered significant bipartisan support.

These incentives have driven community and small regional banks to become more active in the solar tax equity and the renewable energy investment transfer market in recent years. The Inflation Reduction Act extended the renewable energy investment tax credit through at least 2033, so community banks can establish a program, making annual solar tax equity investments for at least another nine years — potentially enhancing earnings by up to 3% annually.

As with most tax credit investments, solar tax equity now qualifies for the Financial Accounting Standards Board’s recent expansion of the “proportional amortization method.” This simply means that the impacts of tax investments are recognized in the “income tax expense” line item. The 2023 rule greatly simplified the accounting for solar tax equity, boosting the number of community and regional banks making these investments.

The resulting sustained lower effective tax rate could contribute to higher valuations for banks investing in solar tax equity. If your effective tax rate is higher than that of your peers, it may be time to explore opportunities that enable you to be intentional about improving your bottom line.