Are community banks trying to emulate the credit union model? It appears so.
Following the IRS changes to the Subchapter S code in December 1996, banks
suddenly became eligible for the new classification. As of March 2004 over 2100
banks are mirroring the credit unions’ tax structure- more than 3.5 times
the number operating under this corporate structure in 1997. Approximately
one out of every four banks and thrifts with less than $1 billion in assets
has chosen to switch to Subchapter S status.
Instead of paying taxes to the federal government, Subchapter S Corporations
distribute the net income to shareholders who in turn report and pay taxes on
their individual returns. In other words, the flow of payments is identical
to that of credit unions. If a Subchapter S Corporation elects to keep its net
income as capital, the shareholders’ stock increases by the amount of
income recognized by the company. When shareholders do choose to sell their
stock, they will recognize a smaller gain than a “C” corporation,
thus paying fewer taxes on the sale overall. However, Subchapter S Corporations
will still pay taxes on retained earnings while credit unions do not.
The IRS also relaxed in December 1996 certain restrictions that prohibited
banks from seeking Subchapter S status. First, it increased the maximum number
of shareholders from 35 to 75. Second, the corporation could now own up to 100
percent of another corporation or subsidiary whereas the limit was 80 percent
prior to the ruling.
Look for more banks to pursue Subchapter S status in the next few years to
reduce their tax liabilities. The million-dollar question is how this “advantage”
will impact banks’ profitability and market share.