More and more community banks are considering converting to S- corporation status to reduce taxes and bolster profits.

A study by Grant Thornton, the accounting firm, suggests that three out of every 10 community banks may adopt this new corporate structure in the coming years.

But Grant Thornton argues that there are many obstacles to conversion that bankers must consider when deciding if S-corp status is for them.

Though S corporations can eliminate corporate income taxes and the so- called double-taxation that shareholders have long endured on their distributions, it may not be right for just any small bank.

For example, while many community banks will have little problem meeting the threshold of 75 shareholders or less, it might be more difficult to meet other ownership requirements. The presence on the shareholder list of partnerships and corporations makes a bank ineligible.

In addition, because S corporations may have only one class of stock, banks choosing to convert cannot have preferred stock outstanding. And eliminating ineligible classes of stock in order to convert has been difficult, according to Grant Thornton.

Also, small banks that convert to S-corp status cannot continue to use the reserve method of accounting for bad debts, and the costs of changing to the chargeoff method can be significant for some banks and their shareholders.

Still, many closely held banks will find that S-corporation status makes sense for them, particularly if they are paying out at least 20% of their earnings as distributions to shareholders, says John R. Ziegelbauer, senior manager for Grant Thornton's office on federal tax services. "At that level, it's usually a no-brainer," he says.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.