More banks could qualify for the tax-advantaged S corporation structure under the minimum wage bill the Senate passed last week.
A package of tax breaks for small businesses would ease restrictions on S Corps, including liberalizing the type of shares they may issue and the income they may collect.
S Corps would still be limited to 100 shareholders holding a single class of stock, but special shares could be issued to directors.
"This was always a problem" for banks, said John Ziegelbauer, the national managing partner of Grant Thornton LLP's financial institutions industry practice. "They basically have laid out that bank director shares are OK."
The bill would not treat the interest or dividends a bank earned on assets such as stock in a Federal Home Loan bank as passive income. Also, income from the "regular conduct of a lending or finance business" would not be considered passive income.
These changes were designed to make it easier for more banks to qualify for the tax-advantaged structure, according to Paul Merski, the chief economist at Independent Community Bankers of America.
"We are getting a shot at changing some of the S corporation rules and will make it easier for the banks to convert and help the existing subchapter S banks," he said.
Doug McClure, the president and chief executive officer of the $119 million-asset Rocky Mountain Bank and Trust of Florence, Colo., said, "Making it easier to do a sub S conversion is helpful to bankers and shareholders, and at the end of the day will create more wealth for shareholders. That is what the banking business is supposed to do."
The Senate bill, approved Feb. 1, must be reconciled with the minimum wage increase the House adopted Jan. 10 in a 315-116 vote. Both versions would raise the minimum wage to $7.25 an hour over the next two years, but the House bill does not contain the Senate's small-business breaks.
Mark Baran, a counsel with Powell Goldstein LLP in Washington, predicted the broader Senate version will be enacted.
"In 1996, which was when the last minimum wage bill was passed, there were a number of small-business provisions attached to that, and one of them was allowing banks to be S Corps," he said.
Though he said other changes would benefit banks more, the bill's provisions are a good step.
"My initial reaction when I saw this was if you really want to excite banks, raise the number of shareholders to 150," Mr. Baran said. "For those banks that are impacted by one or some of these provisions, that's important enough. You're helping somebody."
Subchapter S of the Internal Revenue Code allows a corporation to avoid paying federal income tax by distributing all its earnings to shareholders.
Under law, banks that want to qualify for this treatment may not have more than 100 shareholders or issue more than one kind of stock. To ensure these companies are not merely tax shelters, the law bars them from gaining more than 25% of their gross revenue from passive investments for three consecutive years.
Tony Gorrell, the chief financial officer of the $309.5 million-asset Sutton Bank of Attica, Ohio, said eliminating taxes at the corporate level can help banks in two ways: enlarging returns to shareholders or giving the bank a thicker capital cushion if it decides to retain earnings.
"Anything you can do to make it easier to allow more banks and small businesses to elect Subchapter S is a good thing," he said.
Mr. Merski said the changes could help community banks remain independent.
"The investment in the bank gets you a higher rate of return," he said. "With all the mergers and consolidations, it lets banks remain independent. It has probably preserved the large number of community banks that we have."
