Highlight: Understanding a common community bank tax structure

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• Congress created the Subchapter S under provisions of the Internal Revenue Code in 1958, which allows S-corporations (“S-corps”) to pass corporate income to their shareholders for federal income taxes. Banks became eligible for S-corp status in 1997 with the passage of the Small Business Job Protection Act. S-corps can be attractive because their shareholders are not subject to “double taxation,” as earnings are taxed only at the shareholder level.
• However, the statute contains several restrictions on S-corps. Initially Congress limited the number of shareholders to ten, but over time increased the number to 100.^_ As a result of this restriction, Scorp banks are not publicly traded.^_Slightly less than 7 percent of community banking organizations (CBOs) are publicly traded.^_
• S-corps can have only one class of stock, which means an S-corp cannot issue any additional tier 1 capital instruments, such as perpetual preferred stock. An S-corp can issue subordinated debt, which can be eligible as a tier 2 capital instrument under the capital rules.
• As of September 30, 2024, 1,447 CBOs, or 38 percent, reported a Subchapter S election. The percentage peaked at 40 percent in 2017. The Tax Cuts and Jobs Act that year permanently reduced the corporate tax rate from 35 percent to 21 percent, which could have changed the potential value of the Subchapter S election to some CBO shareholders.

Questions or comments? Please contact KC.SRM.SRA.CommunityBankingBulletin@kc.frb.org