Expanding access to Subchapter S and limited liability corporation (LLC) organization formats.
Legislative changes in 2004, 2005, and 2007 made significant improvements to Subchapter S, enhancing the viability of the Subchapter S option for banking institutions. ABA supports further improvements that will eliminate other barriers to the Subchapter S election for banking institutions, including an increase in the permissible number of shareholders. In addition, ABA supports extending pass-through income tax treatment to banks organized as limited liability corporations (LLCs).
Subchapter S of the Internal Revenue Code was first enacted in 1958 to eliminate the double taxation on the profits of small corporations. In effect, small corporations became subject to a structure of taxation similar to that imposed on partnerships. While shareholders are taxed on corporate profits regardless of whether those profits were actually distributed to them as dividends, the Subchapter S corporation is not itself subject to taxation. In contrast, a regular (or Subchapter C) corporation pays tax on its profits, and its shareholders also pay tax on the dividends paid to them.
Congress made Subchapter S status available to insured depository institutions for the first time in 1996, but many existing institutions had been unable to make the election because, at that time, a corporation was not eligible to make the election if it had more than 75 shareholders.
The American Jobs Creation Act of 2004 (AJCA) (as amended by the Gulf Opportunity Zone Act of 2005), enhanced the viability of the Subchapter S election for banks through provisions that: (1) increased the number of eligible shareholders from 75 to 100; (2) permitted family members to be treated as one shareholder; (3) permitted certain IRAs to be eligible shareholders for bank, thrift, and holding company S Corporations; and (4) clarified that interest earned by banks, thrifts, and holding companies and dividends earned on assets required to be held by a bank or thrift (such as Federal Reserve Bank shares and Federal Home Loan Bank shares) are not disqualifying passive income under the passive income test applicable to S Corporations. The Small Business and Work Opportunity Tax Act of 2007 further enhanced the viability of the S corporation option by clarifying that under certain circumstances director shares would not be treated as a second class of stock.
ABA supports further improvements that will: (1) increase the number of eligible shareholders to at least 150; (2) clarify that a current law reduction in the amount of deductions a regular corporation can claim with respect to tax-exempt obligations will not apply to a bank after it has been a Subchapter S corporation for three years; and (3) permit IRAs to make new investments in Subchapter S Corporations.
In addition, ABA supports pass-through income tax treatment for banking institutions to be organized as limited liability corporations (LLCs). In a manner similar to Subchapter S banks, this treatment would avoid double taxation of bank income at both the bank level and the equity owner level by taxing a bank income only as income of the equity owners. Pass-through treatment of bank LLCs will attract more capital to banking.
In July 2008, Senators Hatch and Lincoln introduced a bill that would allow banks to structure as LLCs and receive the same federal flow through tax treatment that is currently available to Subchapter S banks (S. 3254 - The Small Bank Tax Equity Act). ABA supports any legislation that will achieve the result contained in this bill.
Contact for further information: Fran Mordi (202) 663-5317.