S Corp banks finally get clarity on tax reform

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Subchapter S corporation banks finally have guidance for tax reform enacted more than a year ago.

The Treasury Department released its final rule tied to the Tax Cuts and Jobs Act that lets shareholders in S Corps, including banks, take a 20% deduction on qualified business income. The rule is an improvement from a proposed rule released in August that did not clarify whether income from traditional products and services would qualify for the deduction.

Bankers, and their trade organizations, had long advocated for an expanded definition of qualified business income. The Independent Community Bankers of America, in particular, wanted greater parity between how C Corp and S Corp banks are taxed.

“If they had only given us one thing, that’s what we would have asked for,” said Alan Keller, the ICBA's first vice president of legislative policy. The latest guidance is "going to help hundreds of banks.”

The Treasury determined that qualified business income should include income from the origination and sale of loans, including mortgages.

The final rule quells questions over how the tax bill applies to S Corp banks, which account for about a third of all U.S. banks, based on data from FIG Partners and the Federal Deposit Insurance Corp. Most S Corp banks have less than $1 billion in assets.

“Subchapter S election allows an owner of a bank to take a longer view because of the single layer of taxation,” said Patrick Kennedy Jr., a lawyer at Kennedy Sutherland and president of the Subchapter S Bank Association.

The tax bill, which went into effect in January 2018, had bankers and their accountants, lawyers and analysts wondering if it would be beneficial for S Corp banks to transition to C Corps. The corporate tax rate fell to 21% under the new law, while most S Corp investors will be taxed at a 29.6% rate.

Many banks considered changes to their corporate structures in light of tax reform, said Robert Klingler, a lawyer at Bryan Cave. Mergers and acquisitions have also come up as part of those discussions.

“Arguably there should have been a conversation every year or two about, ‘Is this still the right path for us?’” Klingler said. “But if tax laws aren’t changing, banks tend not to change that much year to year. The tax law change was a sizable enough change that it absolutely encouraged more discussion ... and caused banks to take an internal look at it.”

Klingler said he has seen more banks shedding their S Corp status recently for a number of reasons.

“Whenever you have greater clarity, it helps facilitate those conversations,” Klingler said.

The final rule states that qualified business income exists when a business has gross receipts of $25 million or less, and less than a tenth of its total revenue comes from specified service trades or businesses, Keller said, based on ICBA analysis.

An S Corp bank may include more than one trade or business for tax purposes, which could be complicate banks’ accounting practices, Keller said.

“How that’s going to work in practice is to be determined," Keller said. "It’s something we're watching."

Despite progress, the final rule does not clarify whether income from wealth management and trust services qualifies for the deduction.

“ICBA looks forward to continuing our work with policymakers to maximize Sub S eligibility for the tax deduction,” the group said in a press release after the rule was released.

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