Now that the 2017 Tax Cuts and Jobs Act has been signed into law, most every S corporation bank will re-visit the question of whether it makes sense to maintain their current tax status or revert to a C corporation. While each situation would be fact-specific, we wanted to pass along some considerations to consider as management contemplates its next steps.
Possible Advantages to C Corporations
- In 2018 the corporate rate will be a flat 21% for federal purposes. Combined with state tax rates of 6%, the blended corporate rate will be approximately 27%. In comparison, maximum effective tax rates on individuals will be about 34%, after taking advantage of the new 20% deduction allowed on S corporation bank earnings.
- For an S corporation bank the potential savings for converting to a C corporation is approximately $74,000 on each million earned. S corporation banks looking to retain more capital should carefully evaluate the potential advantage of operating as a C corporation.
- With the new tax law individuals will be limited to a $10,000 Schedule A income tax deduction. This limitation will not apply to C Corporation who will be allowed to deduct state income taxes.
Possible Disadvantages to C Corporations
- Assuming a sale of the bank after a 10-year timeline and annual growth of 3%, the shareholders would net about $1 million more in after-tax dollars as an S corporation versus a C corporation. This means that the long-term benefits of an S corporation still have considerable value.
- Cash verse Accrual – A C corporations on the cash basis of accounting for tax purposes will need to convert to accrual basis when their gross revenue exceeds $25 million. This would require recapturing the prior income deferral and paying the related income taxes.
- Deferred Taxes – S corporations that revoke their status will have to reinstate their income tax accounts, most likely recording a net deferred tax asset.
- Quarterly Estimates – As a C corporation, you must begin paying quarterly corporate estimated taxes and recording a current tax provision. Depending on the combination of current tax liability and deferred tax asset, the bank would report either a net tax benefit or expense for the year.
- Distribution of previously taxed income – Upon revoking an S election, the bank would generally have one year to distribute out any S corporation earnings that have already been taxed. Beyond that it would be able to make distributions proportionately allocated between previously-taxed earnings and corporate earnings and profits.
- Shareholder Restrictions – Reverting to a C corporation would alleviate concerns about eligible shareholders and the number of shareholders. Also, the single class of stock restriction would no longer apply. This might make matters simpler for a capital raise or for an acquisition involving a swap of equity.
The facts and circumstances surrounding a bank would need to be analyzed on a case-by-case basis, but our overall general conclusion is that C corporations are going to be a lot less ‘expensive’ from a tax standpoint and more attractive in administration and flexibility. Except in the case where an S corporation bank can foresee a taxable sale in its future, we feel that the benefits of an S corporation have been greatly diminished over time and that C corporations may be a more desirable status for community banks in the future.
We would be happy to discuss the various advantages and disadvantages of an S status revocation regarding your institution.