The stream of banks converting to S corporations will rise in the next 10 years - maybe to flood proportions, if laws are passed to make conversion easier - according to a study released Tuesday by Grant Thornton LLP.
Four bills are pending that would affect S corporations. But even if they do not become law, lower personal tax rates will make the structure more attractive, says the Chicago accounting, tax, and management consulting firm.
Instead of paying the federal corporate tax, S corporations pass along earnings to shareholders, who then owe personal income taxes on the income. As a practical matter, however, S corporation banks typically subtract the amount owed and pay the Internal Revenue Service directly.
"The new tax law will make the S-corporation election more attractive each year as the differential between the top individual tax and the top corporate tax rate declines," Grant Thornton says.
If an S corporation bank "is making a lot of money, your shareholders may pay 39.6%," now the top personal tax rate, said John R. Ziegelbauer, a co-author of the study who is a tax partner with the firm.
The corporate tax rate is 35%. "That 4.6% differential can be pretty substantial," Mr. Ziegelbauer said, but it will narrow as the personal tax cuts enacted this year are phased in.
This year already looks like a big one for becoming an S corporation. In the first quarter 203 banks converted; only 172 did in all of last year.
"Making the S-corp decision is easy for a bank that is highly capitalized, paying out a lot of dividends, and closely held," Mr. Ziegelbauer said, "because they start saving immediately."
Legislative changes would spur even more conversions, Grant Thornton says.
Under current law, S corporations are limited to 75 shareholders and may issue only one kind of stock. Other restrictions include a prohibition against holding their shares in IRA accounts.
"I've had clients growing so fast they really needed capital" but raising it was made difficult by the S-corp limitations on number of shareholders and types of stock, Mr. Ziegelbauer said.
One key change Congress could make would be to double the permitted number of shareholders. One of the pending bills do just that.
Unless the law is changed "at some point to allow more people to do it, conversions will start to tail off," said another co-author of the study, Grant Thornton partner Richard A. Soukup.
Paul Merski, the director of federal tax policy for the Independent Community Bankers of America, said the four bills may be added to future tax bills or legislation to increase the minimum wage. He expressed optimism that Congress would endorse the provisions, noting that similar ones were included in a tax bill President Clinton vetoed last year.