Plan Would Double Number of Banks, Thrifts Eligible For Subchapter S

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A plan that could double the number of banks and thrifts eligible to become tax-advantaged S corporations is expected to be part of an economic stimulus package Congress takes up early this year.

Under existing law, only companies with 75 shareholders or fewer may take advantage of the tax breaks associated with S corporations. But after several years of lobbying by the banking industry, momentum is building to change the threshold to 150 shareholders. S corporations do not pay corporate income taxes; instead the tax obligation is passed on to shareholders.

If the law is changed, Paul Merski, the chief economist and director of federal tax policy at the Independent Community Bankers of America, estimates that as many as 2,000 more banks and thrifts would opt for S corporation status.

The Bush administration and many members of Congress view tax breaks to small businesses, community banks included, as keys to economic growth, Merski said.

The 150-shareholder threshold was included in a bill that Sens. Charles Grassley (R-IA) and Max Baucus (D-MO) introduced last fall in the Senate Finance Committee and are expected to reintroduce this year. Their "Small Business and Farm Economic Recovery Act of 2002" also included, among other things, additional changes in S corporation restrictions-changes the industry has been seeking ever since Congress first allowed banks and thrifts to convert six years ago.

'Better Shot'

"That bipartisan bill documented a whole list of things (related to S corporations) that we have been supporting," Merski said. "I think it has a better shot now than it has had in a long time."

Some lawmakers will undoubtedly object to the cost of revamping S corporation laws. The Grassley-Baucus bill projects that roughly $2 billion in tax revenues would be lost over 10 years.

But Richard Soukup, a partner at the accounting firm Grant Thornton and co-author of a study on S corporation conversions, said more of them would free up money for loans.

"S corporation status allows closely held financial institutions to eliminate double taxation of corporate income, helping to improve their competitive position in the marketplace and to remain independent organizations," he said. "By ending the payment of taxes on both corporate income and shareholder income, financial institutions increase the amount of resources available for community loans and other community investments."

A bank or thrift seeking to become S corporation must do so in the first 75 days of its tax year. If Congress raises the threshold there could be a flood of new banks and thrifts seeking S corporation status this year, added John Ziegelbauer, a partner in Grant Thornton's Washington office who was Soukup's co-author.

Conversions have leveled off in recent years. In 1997-98 more than 1,000 banks and thrifts became S corporations, but since then the average has been 200 a year, according to the Grant Thornton report.

Some May Be Awaiting Tax Reduction

"Most of those that have the ability to become S corporations have probably already done so," Soukup said. Ziegelbauer said the 75- shareholder rule is not the only obstacle. Another is that a significant portion of community bank stock is held in individual retirement accounts, which do not qualify as shareholders in S corporations.

Also, since shareholders inherit the tax liability S corporations escape, some banks may be waiting until individual tax rates go down before converting, Ziegelbauer said. The top rate is scheduled to drop from the current 38.6% to 35% by 2006.

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