Community bankers are once again pushing Congress to further amend the tax code so that more banks would qualify as tax-advantaged Subchapter S corporations.
Congress has modified the S Corp statute twice in the last four years. At a House subcommittee hearing Wednesday, Cynthia Blankenship, chairwoman of the Independent Community Bankers of America, testified that community banks could better compete with the likes of larger banks, credit unions, and Farm Credit lenders if more changes were made.
The most significant change banks are seeking is an increase in the maximum number of shareholders in an S Corp, currently 100, to 150. Many small banks are ineligible to convert to S Corps because they have too many shareholders.
Other proposed reforms include allowing new individual retirement account shares to be invested in Subchapter S entities and allowing S Corps to issue preferred stock.
"Community banks are small businesses and should be allowed the flexibility and choice afforded other small businesses to select a business form that best suits the need of the business and the community," Ms. Blankenship, a Texas community banker, said in her testimony. "Additional tax code reform and simplification in the S Corporation status would go a long way in allowing community-based banks to convert to S Corporation status."
Congress is considering three bills — the Communities First Act, the S Corp Modernization Act, and the Small business Growth and Opportunity Act — that include provisions to amend the S Corp statute and Mark Baran, a director with Deloitte Tax LLP's Washington National Tax Office, said the proposed changes would encourage many more banks to convert to S Corps.
But Mr. Baran said he believes Congress would be reluctant to approve the measures unless it could find another way to make up for the lost revenue.
"I don't think the chances are very high" that the bills will become law, he said. "These items are most likely very costly, and I'm not sure, given other priorities Congress is working on, if they would be appropriately offset."
By electing an S Corp status under the Internal Revenue Services Code, a corporation avoids paying taxes by distributing all its income to shareholders.
Banks and other small businesses were first allowed to elect S Corp status in 1997, In 2005 the American Jobs Creation Act increased the number of shareholders an S Corp could have from 75 to 100, opening the door for more banks to elect S Corp status, and the statute was further amended in last year's Small Business and Work Opportunity Act. That law eased the passive-income test for S Corps so that capital gains on S Corp investments, such as gains on sales of securities, would no longer be treated as passive income, and let banks start issuing special shares to directors without them counting toward the 100-shareholder cap.
Today almost one-third of banks are S Corps. In the first quarter 82 made the switch to S Corp status, according to Federal Deposit Insurance Corp. data, bringing the total to 2,509.
Paul Merski, the ICBA's chief economist and director of federal tax policy, said that at Wednesday's hearing before the Subcommittee on Tax and Finance of the House Small Business Committee there was "a lot of agreement" that small businesses need some tax relief.
He said that with "some tweaks" he believes changes presented on behalf of community banks and other small businesses stand a good chance of being approved by Congress, either as stand-alone legislation or as amendments to other bills. (Last year's modifications to the S Corp statute were tucked into a war-funding bill.)
The confining S Corp structure is something Ms. Blankenship, vice chairman and chief operating officer of the $246 million-asset Bank of the West in Grapevine, Tex., knows personally. In 2006 the unit of the $276 million-asset Greater Southwest Bancshares Inc. in Irving, Tex., was able to make the switch after one of the bank's original shareholders opted to be bought out, she said.
"There were a lot of years that we could have benefited from being an S Corp," Ms. Blankenship said in an interview before the hearing. "We were taxed as a C Corp at the highest rate, and then if there were any distributions to shareholders, it was taxed again. Our shareholders got taxed twice. And it really does hinder your ability to build capital and equity."
