What is a Subchapter S bank?

A Subchapter S bank is typically a community bank that has elected taxfavored treatment under

Subchapter S of the Internal Revenue Code. Subchapter S was added to the Code in 1958 to reduce the tax burden on small business.

At that time, banks were not allowed to become S Corporations. Congress made Subchapter S available to closely held banks for the first time in the Small Business Job Protection Act of 1996 (P.L. 104-188). The Code defines an S Corporation bank as a small business corporation that does not use the reserve method of accounting for bad debts and does not:

(a) have more than 75 shareholders;

(b) have shareholders who are not individuals or certain specially qualified estates and trusts or certain exempt organizations;

(c)have a non-resident alien shareholder; or

(d)have more than 1 class of stock. [1]

An S Corporation is taxed similar to a partnership. Earnings are not taxed at the corporate level. Instead, taxes are passed through and taxed to the shareholders, whether or not the earnings are distributed.

S Corporation banks enjoy some other significant advantages over regular C Corporation banks:

* S Corporations are not subject to the corporate alternative minimum tax, corporate accumulated earnings tax, or personal holding company tax.

* S Corporation shareholders' tax basis is adjusted annually for income and distributions of the corporation, and will likely increase in value over time.

* S Corporations and shareholders are not subject to consequences of a denial of the deductibility of unreasonable compensation. [2]

However, certain rules unintentionally work against S Corporation banks. For example:

* S Corporations, with C Corporation earnings and profits, and passive investment income totaling more than 25% of gross receipts, are subject to a corporate-level income tax imposed at the highest corporate rate.

* The S Corporation election automatically terminates after 3 consecutive years earning such excess passive income.

* Banks that operated as C Corporations prior to converting to S Corporations may also be subject to a "built-in gains" tax on certain appreciated assets and income items.

To better accommodate banks, the Subchapter S Modernization Act [31 would reform S Corporation rules. [4] Enactment would allow more community banks to convert to Subchapter S [5] and enhance their ability to compete.

Congressional tax writers plan to take up Subchapter S in connection with a larger small business tax package, which has not yet been scheduled for further consideration.

For More, CLICK HERE Government Affairs www.cuna.org

By J. Leon Peace, Jr., Esq.

Manager, Tax, Pensions & Housing Credit Union National Association

Copyright Credit Union National Association, Inc. Jul 29, 2002
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