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WASHINGTON-A recent proposal by the Federal Deposit Insurance Corp. (FDIC) would allow federally insured, state banks to register as Limited Liability Companies (LLCs) and open up new avenues of tax avoidance for the for-profit institutions. Currently, banks are also seeking legislatively to expand Subchapter S eligible companies, another tax avoiding mechanism, from those with 75 shareholders to 150. Considering all this relief, credit union groups believe that banks should keep quiet about the credit union tax exemption. “The premise for going after credit unions’ tax-exempt status has been that the tax exemption gives a significant advantage, etcetera, over thrifts, community banks, and others in terms of competition,” CUNA Manager of Tax, Pensions and Housing Leon Peace, a former tax attorney with the American Bankers Association, explained. “What this.LLC ruling does is say that banks of any size can now become limited liability companies, avoid paying a corporate level tax, which, in essence, if there is an advantage, there is none now. Banks, once this becomes final, will be able to organize as limited liability companies and the hypocrisy, I think, would be pretty visible to tax writers on the Hill.” CUNA Vice President and Senior General Counsel Gary Kohn pointed to a study CUNA had performed demonstrating that banks’ Subchapter S tax savings would outpace credit unions’ tax exemption by 2007. “Under this scenario, it would be greatly accelerated. It would far surpass any tax benefits that credit unions could get,” he said. An LLC weaves together the protection of individual liability like “incorporation” with the “pass-through” tax treatment of a partnership, regardless of size, according to the FDIC’s notice of proposed rulemaking that appeared in the July 23 edition of the Federal Register. “Pass-through” tax treatment means that each shareholder pays taxes on the company’s income rather than the company. Subchapter S companies are restricted to 75 shareholders, which can only be individuals, estates, trusts, or some tax-exempt entities; resident shareholders; and only one type of stock. “If the FDIC deems that an appropriate form of corporate ownership for banks, we don’t object to that,” NAFCU Senior Vice President and General Counsel Bill Donovan commented. “It’s wholly appropriate for the regulator to make those decisions.” CUNA’s Kohn concurred, “Our position is we’re concerned about preserving our tax-exempt status. If others want to go ahead and try and get tax breaks for themselves, that’s all well and good. We just want to point out that they can’t have their cake and eat it too. The hypocrisy, as Leon mentioned, is overwhelming, so if they want to go out and get tax breaks for themselves, that’s fine, but get off our backs.” “Generally, the Limited Liability Company regime in the tax law is beginning to replace the Subchapter S regime, Subchapter S being a tax-favored status for closely held businesses. This activity has significant implications because congressional tax writers have basically had some sympathy for the banking industry’s argument to Congress for expanding the Subchapter S rule to better accommodate banks based upon the belief that banking regulators would not and do not allow banks to organize as Limited Liability Companies,” Peace said. “Now it appears that the banking industry has successfully lobbied the FDIC to allow banks to organize as Limited Liability Companies and I think this is significant because this action in favor of the banking industry, in my opinion, effectively takes the taxation of credit unions out of any further discussion.” CUNA Senior Vice President of Government Affairs John McKechnie further stated, “Credit unions, our tax-exempt status, rests in large part on our not-for-profit status, where as banks that are for-profit-that are in the business to be for-profit-they’re now engaging in tax avoidance in a broader way, and. I think there’s public policy implications for that and I think Congress may start to ruminate over that in the coming months as well.” Bankers do not plan to cooperate. While credit union lobbyists said this proposal should keep bankers from hammering away at credit unions’ tax-exempt status, the American Bankers Association (ABA) is playing down the impact of the proposal. “It’s an important step, but it’s not the only step necessary for banks to register as LLCs,” ABA Spokesperson Charlotte Birch commented. If the proposal is approved, the Internal Revenue Service (IRS) would still have to change its regulations to allow banks to become LLCs. Birch said the potential new tax breaks for banks still would not stop bankers’ calls for credit union taxation and pointed out that the issue still exists that “banks pay taxes on their earnings and credit unions don’t.” ABA Director and Senior Tax Counsel Mark Baran expanded on the proposal saying that for many banks, the costs for conversion would be quite expensive. “The `toll tax’ may be too much of a burden for many banks,” he explained. Baran predicted that probably only new banks and de novo banks would be interested. However, he admitted that the ABA included the issue as a recommendation in a community banking tax report from January of 2000. “The option should be made available if one bank takes advantage of it or several,” Baran said of the ABA’s position. The ABA plans to write a comment letter to the FDIC while the credit unions groups are still mulling over whether or not to write. Written comments are due to the FDIC by October 12. [email protected]

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