Looking for a leg up in the competitive Atlanta market, a group organizing Southern National Bank in Marietta, Ga., is turning to the tax code.
Southern National, which is scheduled to open this fall, said it hopes to avoid corporate taxes by filing as an S corporation. Though this is a popular tactic for existing community banks-more than 600 have converted in the last 16 months-only 12 of the 180 banks chartered in 1997 were S corporations.
This tax status, first allowed for banking companies Jan. 1, 1997, is attractive because it lets a company avoid double taxation: Shareholders pay income taxes on the company's profits, but the company does not. The name comes from Subchapter S of the Internal Revenue Code, which outlines rules under which corporations can be treated as partnerships for income tax purposes.
Southern National said it plans to use the extra cash to pay higher salaries and attract top executive talent.
"This gives us 45 cents more on every dollar we earn both to give back to shareholders and to grow the bank," said Frank H. Roach, who would be president of Southern National. "That is a huge advantage to a bank trying to get off the ground."
If the company were taxed as an ordinary corporation instead of as a partnership, it would fall into the 39% federal tax bracket and the 6% Georgia tax bracket, Mr. Roach explained.
Not every start-up bank seeks S corporation status because most cannot afford it. The tax code requires that S corporations have no more than 75 shareholders, a tight limit for many investor groups trying to raise start- up capital.
"Not everyone has a group of friends with enough money to organize a bank," said Richard P. Hunt, president and chief executive of Kendrick, Pierce & Co., Tampa.
Barry Chandler said that he and fellow organizers of Oceanside Bank, Jacksonville Beach, Fla., discussed S corporation status before the bank was opened last July. Their priority, however, was to raise capital as quickly as possible, which required going to the community. Ultimately, Oceanside Bank raised $4 million by selling stock to about 900 investors.
Even if a small enough group can raise the capital needed, new banks often go to the market-and attract more shareholders-within a few years, said Richard A. Soukup, partner at Grant Thornton LLP, Chicago.
"Many banks grow faster than expected, and need to go out to raise capital again to sustain that growth," he said. "If you are going to eventually put yourself over the 75-person cap, why bother with S corp. status in the first place?"
Another downside: To get federal deposit insurance most new banks agree to pay no dividends to shareholders for the first three years. If an S corporation becomes profitable during this period, shareholders would have to pay tax on the profit while receiving no dividends to offset this liability.
Still, some say the pros outweigh the cons. S corporation bank shareholders can write off a company's losses against their personal income, said Patrick J. Kennedy Jr., a partner in the Kennedy, Baris & Lundy law firm in San Antonio. For example, if an S corporation bank lost $1 million its first year, a shareholder owning a 10% stake could deduct $100,000 from his personal income at tax time.
"There is still a place for small banks, but to compete, we need to find advantages," said Ross McKnight, chairman and chief executive officer of Olney Bancshares in Texas. His $350 million-asset company is parent of eight banks-all S corporations-including three of the 12 new charters granted in 1997.
"It's getting to the point where this singular taxation method is one of the only advantages we have," he said.
