Sub S Issues & Opportunities Bank Holding Company Association Spring Seminar May 4, 2015 Kevin Powers Partner, Crowe Horwath LLP Dub Sutherland Partner, Kennedy Sutherland LLP
The information provided herein is educational in nature and is based on authorities that are subject to change. You should contact your tax adviser regarding application of the information provided to your specific facts and circumstances. Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International. 2015 Crowe Horwath LLP Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 2
Agenda Key advantages / disadvantages of being a Sub S bank Basel III considerations Hypothetical Sub S bank analysis Challenges & opportunities in managing Sub S shareholders Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 3
Key Advantages of Sub S Banks Avoidance of double taxation via increase in shareholder basis for S Corp taxable income, net of distributions Avoidance of 3.8% tax on net investment income for active shareholders For passive shareholders, S Corp income may be used to offset passive losses generated from other activities General exclusion from IRC Section 291 interest expense disallowance rules Use of the overall cash method of accounting (with some exceptions) Favorable tax treatment of ESOP shareholders Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 4
Key Disadvantages of Sub S Banks Limitation of the number and types of shareholders Restriction to a single class of stock Immediate shareholder taxation regardless of distributions Taxable dividends if distributions exceed S Corp AAA Use of stock for acquisitions likely to be limited Complexity of shareholder tax returns, particularly for multi-state operations Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 5
Basel III Capital Conservation Buffer Initial thoughts & considerations There is a general concern that the capital conservation buffer will restrict Sub S banks from paying dividends to shareholders to cover taxes on their pass-thru share of the bank s earnings Due to the extended phase-in of the capital conservation buffer, this issue is unlikely to present itself in specific cases for a number of years Historical experience with bank capital ratios suggests that few S Corp banks likely would be affected by this pass-thru tax issue solely because of the operation of the capital conservation buffer Sub S banks falling within the 0 to 20 percent rows of the maximum payout ratio (see table on next slide) have likely generated losses in recent years and thus may not have a need for shareholder distributions to cover taxes Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 6
Basel III Capital Conservation Buffer Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 7
Basel III Capital Conservation Buffer Financial Institutions Letter ( FIL ) 40-2014 Issued by FDIC on July 21, 2014 Describes how the FDIC will consider requests from S Corp banks to pay dividends to shareholders to cover taxes on their pass-thru share of the bank s earnings, when those dividends would otherwise not be permitted under the capital conservation buffer requirements Restrictions imposed by the buffer not fully effective until January 1, 2019 Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 8
Basel III Capital Conservation Buffer (cont d) Financial Institutions Letter ( FIL ) 40-2014 The FDIC will consider the following 4 factors in evaluating requests 1. Is the S Corp requesting a dividend of no more than 40% of net income? 2. Does the requesting S Corp believe the dividend payment is necessary to allow the shareholders of the bank to pay income taxes associated with their pass-thru share of the bank s earnings? 3. Is the requesting S Corp bank rated 1 or 2 under the Uniform Financial Institutions Rating System and not subject to a written supervisory directive? 4. Is the requesting S Corp bank at least adequately capitalized, and would it remain adequately capitalized after the requested dividend? If S Corp satisfies each of these factors, the requested dividend generally would be approved absent significant safety-and-soundness concerns Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 9
Hypothetical Sub S Bank Analysis Basic Assumptions Annual taxable income equals pre-tax book income, less tax-exempt interest income no other permanent or temporary book-tax differences included C Corp book tax expense based on pre-tax income, less tax-exempt interest income no other permanent book-tax differences included 4% annual asset growth rate; pre-tax book income increases in relation to asset growth rate 3.8% additional Medicare contribution tax will apply as if all shareholders are passive (i.e., no shareholder-employees) See Assumptions page for additional information Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 10
Summary of S Corp v. C Corp Benefits Primary benefit of S Corp election is the present value tax benefit from the shareholder basis increase Due to the lower individual tax rate on dividends, the overall annual tax obligation of a C Corp and its shareholders will generally be lower than the overall annual tax obligation of that same corporation electing to be an S Corp Level of C Corp dividends directly impacts this analysis (if dividend ratio is higher, the C Corp shareholder tax liability increases without impacting the comparable S Corp shareholder tax liability) An increase in the tax rate on dividends will increase the C Corp shareholder tax liability without impacting the comparable S Corp shareholder tax liability Capital ratios are not substantially impacted by the decision to be an S Corp versus a C Corp Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 11
Other Considerations S corporations face limitations in the number and types of shareholders Those limitations should be considered as part of any S Corp analysis Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 12
Questions?? Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 13
For more information, contact: Kevin F. Powers Direct 630.586.5140 kevin.powers@crowehorwath.com Dub Sutherland Direct 210.259.3885 dsutherland@kslawllp.com Crowe Horwath LLP is an independent member of Crowe Horwath International, a Swiss verein. Each member firm of Crowe Horwath International is a separate and independent legal entity. Crowe Horwath LLP and its affiliates are not responsible or liable for any acts or omissions of Crowe Horwath International or any other member of Crowe Horwath International and specifically disclaim any and all responsibility or liability for acts or omissions of Crowe Horwath International or any other Crowe Horwath International member. Accountancy services in Kansas and North Carolina are rendered by Crowe Chizek LLP, which is not a member of Crowe Horwath International. 2015 Crowe Horwath LLP Audit Tax Advisory Risk Performance 2015 Crowe Horwath LLP 14