Banking Taxation

Banks represent a small percentage of all S-corporations (so called because they meet the requirements of subchapter S of the Internal Revenue Code--including the businesses that must be a domestic corporation with only one class of stock and no more than 75 shareholders, all of whom must be individuals who agree to the S status). S-corporations pass through corporate income and losses to their shareholders for federal tax purposes. As of the end of 1999, there were about 1,300 S-corporation banks--about 13 percent of all banks and thrifts in the United States (holding about two percent of total bank assets), mostly located in Minnesota, Texas, Iowa, Illinois, and Kansas. This report responds to a congressional mandate requiring GAO to analyze possible revisions to the rules governing S-corporations and the potential impact of those changes primarily on community banks' decisions to elect S-corporation status.

GAO noted that: (1) GAO studied five possible revisions to the tax rules governing S-corporations; (2) the proposed provisions were written to address perceived obstacles to becoming S-corporations cited by representatives of the banking industry; (3) two of the five proposed tax changes that GAO analyzed--increasing the number of shareholders and allowing individual retirement accounts as shareholders--would affect both nonbank and bank corporations; (4) expanding the number of eligible shareholders would allow more firms to choose to become S-corporations; (5) increasing the shareholder limit, however, appears to be more important to the banking industry than to other industries because S-corporation banks have significantly more shareholders than S-corporations from other industries; (6) the three remaining provisions--clarifying passive income rules, tax treatment of bank director shares, and tax accounting of bad debts--specifically affect individual banks' corporate strategies; (7) banks face certain obstacles in becoming S-corporations that are situational to an individual bank's history and business strategy; (8) the proposed tax provisions would allow allow more and larger banks to benefit from not paying corporate tax by electing S-corporation status, and the overall impact on community banks would be determined by this expansion; (9) it is difficult to project how many banks could be affected by the proposed tax changes; (10) estimates ranged from about 300 to 5,700 banks and thrifts; (11) the proposed provisions could help community banks become more competitive relative to credit unions to the extent that converting banks provide the same services offered by credit unions; (12) the benefits of these proposed provisions for community banks relative to larger banks would depend on the characteristics of the converting banks; and (13) other potential impacts of the proposed provisions include: (a) tax revenue losses estimated by the Joint Committee on Taxation to be at least $748 million over a 5-year period; and (b) behavioral changes--higher dividends and lower capital in S-corporation banks, relative to comparable banks, that might have regulatory implications.