Change to estate tax exemption offers M&A considerations

Blake Crow

The influx of capital into the market from tax reform prompts possible changes to bank merger and acquisition activity. Some bankers may use their tax savings to pursue acquisitions, while others may see the lowered tax rate as an opportunity to maximize profits.

A change to the estate tax exemption likewise could shift some attitudes about selling.

The 2017 tax reform law doubled the individual exemption to $11.2 million, and continues to index it for inflation through 2025. For married couples, the exemption is $22.4 million. “Somebody in that situation might have more pressure to not sell their bank currently,” said Blake Crow, a partner at Eide Bailly in Sioux Falls, S.D. “Instead, let it pass through their estate.”

By not selling the bank, an owner could set up the next generation with a bump in net profits if the day comes when the bank is sold. Consider a hypothetical example from Neil Falken and Tim Malecha of CliftonLarsonAllen in Minneapolis.

A married couple opens a C-corporation bank with $1 million of capital. They never invest more funds, and the bank grows to be worth $30 million at fair market value. If the couple were to sell the bank for that amount before they died, they would need to pay capital gains taxes on the $29 million profit from the original basis point. At 20 percent, that would equal $5.8 million. Then, when the couple dies, the remaining $24.2 million passes to the next generation, with $22.4 million of it exempt from federal estate taxes. The remaining $1.8 million would be taxed at a rate of 40 percent, or $720,000. In the end, the profits from the bank’s sale reached the next generation at the tune of $23.48 million.

If the couple did not sell the bank and instead followed Crow’s advice, passing it through their estate, the next generation would pay estate taxes on the $7.6 million exceeding the current federal exemption limit, equaling $3.04 million. At that point, though, the asset’s basis point resets to the fair market value it was acquired at, now $30 million. Thus, the heirs could sell the bank a week later for $30 million and pay no capital gains taxes. The inheritance from the bank’s sale would equal $26.96 million in that instance.

As Malecha pointed out, this dynamic was always a factor in bank sales and estate planning, but it will become much more of a consideration moving forward. If a bank at fair market value was part of an estate totaling less than $22.4 million, for instance, it could now pass to the next generation completely tax free.