A small Utah bank is in the process of becoming the first established bank to convert to a limited liability company, but whether it will get the tax benefits that accompany that status remains to be seen.
The Internal Revenue Service does not recognize banks as LLCs, and until it does America West Bank in Layton would not realize any tax advantages under the structure.
But Douglas M. Durbano, America West's chairman and president, hopes that its pending conversion to an LLC from a subchapter S corporation will prompt the IRS to rethink the policy.
"I think it creates an impetus, because they have to do something with our entity," Mr. Durbano said. "We are a real live case that requires a decision."
How the IRS responds to America West's conversion will probably be of considerable interest to small, relatively new banks and organizers of start-ups. In fact, a spokesman at the $224 million-asset Medallion Bank, a Salt Lake City industrial loan bank that opened in late 2003, told American Banker this week that it would consider converting to an LLC if the agency changes its policy.
Why would only young or start-up banks be interested in becoming LLCs?
Mark Baran, a lawyer in the Washington office of the Atlanta law firm Powell Goldstein LLP, said it would be costly for a long-established company to "unwind" from a typical corporate structure, because of the one-time tax it would have to pay on its accumulated value.
But small, newer banks - America West, founded in 2000, has just $68 million of assets - or banks in organization could find the LLC more attractive than the S-corporation structure, because it has fewer restrictions.
"Clearly if the option is available you would see many more de novos organize as LLCs," Mr. Baran said.
An LLC does not have to pay corporate income tax, because the tax obligation is passed along to its shareholders. A bank can receive similar tax benefits as an S corporation, but under that arrangement it can have a maximum of 100 shareholders. Most start-up banks have hundreds of investors.
America West would be the first bank to convert to the structure. The only other LLC bank, Providence Bank in South Holland, Ill., opened as one in September.
But Providence Bank's decision to form as an LLC did not put immediate pressure on the IRS, because it could be 18 to 24 months before the start-up turns a profit and pays taxes. America West, on the other hand, made $1.1 million last year.
It cleared the first hurdle in its conversion quest when the Federal Deposit Insurance Corp. approved the request last week.
Mr. Baran, who represents America West, called it a "trailblazer" and said that a letter from the bank to the FDIC several years ago prompted the agency to rewrite its regulations to give deposit insurance to banks that become LLCs or are formed as such.
A Treasury Department spokesman said this week that the IRS is considering the matter, but he gave no details.
Mr. Baran said he recently met with IRS officials to discuss LLC issues. In an interview Thursday, he questioned why restaurants, law firms, and many other types of companies can form as or convert to LLCs, but banks cannot.
"Every small business has an option of how they would like to be taxed, but banks are among the few that are limited in their options," he said.
Several prominent senators who sit on the committee that oversees the IRS share that view. Last year Sens. Orrin Hatch, R-Utah, John Breaux, D-La., and Gordon Smith, R-Ore., sent a letter to the IRS' Office of Tax Policy requesting that it review "outdated" regulations.
America West is taking a gamble in converting to an LLC, because, for now, it will be treated as a corporation by the IRS - meaning it can no longer pass its tax obligations on to shareholders.
Mr. Durbano said that after talks with the IRS and Sen. Hatch, he is confident that the IRS will eventually let banks adopt the more tax-friendly LLC structure.
"We've received positive feedback and are hopeful that the logical result will occur," he said.
