Subchapter S, One Year Later

By Baran, Mark | ABA Banking Journal, April 1998 | Go to article overview

Subchapter S, One Year Later


Baran, Mark, ABA Banking Journal


Mark Baran, ABA senior tax counsel, wrote "Should you bank on Subchapter S?" in our December 1996 issue.

Almost 600 banks have made the switch to Sub S tax status, but many questions remain. Herewith, some answers

Community bankers across the nation are raving about the tax benefits Associated with electing Subchapter S status.

This option has been available since enactment of a provision in the Small Business Job Protection Act of 1996 allowing banks that don't use the reserve method of accounting for bad debts to become Subchapter S (or small business) corporations. By electing Subchapter S status, banks are treated as partnerships for federal income tax purposes, and can avoid paying a federal corporate-level tax. Almost 600 banks elected Sub S status in 1997. Many more institutions will likely follow suit this year.

Even seasoned tax professionals are instinctively cautious when it comes to advising bank clients on Subchapter S issues. This is because, for 40 years, the small business corporation tax laws, rules, regulations, and other technical pronouncements were developed for non-bank companies. While introducing banks into the Subchapter S tax world was a big plus for community banks, making the transition into this new status presents challenges-and traps.

In short, a continual process of education is necessary in order to preserve and protect the tax savings associated with electing S corp status.

Many technical tax, planning, and banking questions predictably arise both before and after a banking institution's S corporation election.

The following are some common Subchapter S questions and answers recently asked by community bankers..

Q. Are there new eligible shareholders for 1998?

A. Yes. The S rules for banks were implemented in two stages.

First, understand that as a general rule, all of a banking institution's shareholders must be individuals, estates, or certain kinds of trusts. The Small Business Job Protection Act of 1996 liberalized many of the traditional Subchapter S eligibility rules. For example, the number of permissible shareholders was raised from 35 to 75. Also, a new type of trust shareholder-- called an Electing Small Business Trust (ESBT)--that may accumulate income and have multiple beneficiaries is now a permissible S corporation shareholder. These rules were effective for the 1997 tax year.

For tax years beginning after 1997, employee stock ownership plans (ESOPs), pension plans, and certain charities are eligible shareholders. Individual retirement accounts, however, continue to be ineligible S corporation shareholders. These new shareholder rules could afford new opportunities for banking institutions interested in electing Subchapter S in the future without incurring the added costs associated with complex restructuring.

Q. How is it determined if a bank's passive investment income assets (i.e., securities portfolio) are subject to the applicable 25% limitation on passive investment income?

A. The tax laws impose a corporate-level "sting" tax on any amount of "passive investment income" that exceeds 25% of the gross receipts of the S corporation. "Passive investment income" is defined as gross receipts derived from royalties, rents, dividends, annuities, and sales or exchanges of stock or securities. If an S corporation exceeds this 25% limitation for three consecutive years, the Subchapter S election will be terminated.

This area of the law has proved to be one of the most troublesome for banks, especially for those experiencing low loan demand or who hold a considerable portion of passive investment assets for other sound banking reasons.

The Internal Revenue Service attempted to address these concerns in IRS Notice 97-5, which outlines the list of banking assets not subject to the passive investment tax rules. Except for the last catch-all paragraph, the assets not subject to the passive income rules in Notice 975 are fairly straight forward; they include real estate mortgage investment conduit (REMIC) interests, Federal Reserve Bank or Federal Home Loan Bank stock, and certain pledged assets. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Subchapter S, One Year Later
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.