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Banking industry lobbyists are a creative lot. They find a way to oppose virtually everything credit unions do. The only thing that would get bank trade group executives off the backs of credit unions would be the disappearance of credit unions from the American landscape. On the other hand, credit union lobbyists rarely if ever oppose anything the banking industry wants to do. Banks decide to impose ATM surcharges? That’s their business. Banks rush to merge into near monopoly size? So be it. Banks get backdoor permission to sell insurance? No problem. Banks seek to become major players in the real estate business? Have at it. More recently, banks discovered the tax advantages of converting from “C” corporations to Subchapter S corporations. So what? “S” corporations have been around for over 40 years, but only became available to banks about six years ago. And oh boy has the banking industry not only been taking advantage of this relatively new right to covert to S corporations, but they are actively lobbying to make S corporations for banks even better. The banking industry has even created a separate S corporation trade association to represent their interests. It is currently hard at work lobbying for an entire wish list of changes, such as increasing the number of permissible S Corps stockholders from 75 to 150 so that more community banks can make the switch from “C” to “S” and profits can be spread over a larger base. Should credit unions oppose the explosive growth of S corporation banks? No. What converting banks are doing is completely legal and permissible. Current rules give at least the smaller (community) banks another option regarding how to handle their tax obligation. As for the improvements they are seeking, trying to make a good-for-banks thing even better, is certainly understandable. What isn’t understandable is why the banking industry can’t bring itself to have the same laissez-faire attitude toward credit unions that credit unions have toward banks. Take the credit unions’ not-for-profit tax-exemption for example. The rules clearly spell out why credit unions are tax-exempt. Yet, banking lobbyists have been whining about it non-stop almost from the day the first credit union was organized. They want the rules changed. They want the credit union tax-exemption eliminated. In the near future, credit unions can expect to hear a lot more, not less, about the banking industry’s love affair with S corporations. Although credit unions won’t interfere with the banking industry’s attempt to seek more favorable tax treatment, it might be well for credit unions to understand just what an S Corps of the Internal Revenue Code actually is, how it works, and why banks have embraced the concept from a taxation perspective. S corporations were first introduced by the IRS in 1958 in an effort to help small businesses by reducing their annual tax burden. As mentioned, banks were not included under the definition of small business back then. Even very small, family-owned and controlled banks were not initially eligible to become S Corps. The change to include community banks made sense. They are small businesses. As S Corps, small banks don’t pay corporate taxes. Instead, the tax obligation is met by passing the earnings through to the stockholders. In other words, if a bank makes $1 million in profit, and it has 10 stockholders, each stockholder will have an additional $100,000 in income reflected on his or her W-2 form for that year. Since 10 times $100,000 equals the $1 million in profit, the entire profit of the bank that year is taxed. Using the S Corps method, IRS gets taxes from every dollar of a bank’s profits, but at the individual tax rate rather than the corporate rate. Keep in mind two things: it is not likely that all 10 stockholders in this hypothetical example are at the same tax rate so some will pay more taxes than others; secondly, all 10 stockholders are liable for their stockholder percentage of the profit even if none of that profit is distributed to them. The tax advantages to the bank are obvious. But what’s the advantage to the 10 stockholders in the example, especially if a cash-short bank can’t divvy up the profits by making a full or even partial distribution? Consider this: if the bank has at least some excess cash, it can pay each stockholder a dividend. This dividend can be of an amount sufficient to pay the added tax obligation brought about by the additional $100,000 in profit not actually paid to each stockholder. Chances are there may be something left over too. Cheaper for the bank than coming up with $1 million, right? The 10 stockholders didn’t each get $100,000, but they did get a dividend sufficient in size to cover their added taxes, they probably got at least a little extra, and they probably got some satisfaction knowing they helped the bank, possibly family-owned, come out ahead. It is easy to see why banks have rushed to get in line to convert to Subchapter S corporations. Something else is not so easy to see. Why, since the banking industry obviously believes in taking advantage of existing rules and is seeking ways to improve them, it doesn’t understand that since day one credit unions have also been following the rules of not-for-profit financial cooperatives. Naturally the banking industry has endorsed the Subchapter S Modernization Act. Naturally credit unions will not oppose it. In fact, a CUNA spokesperson said recently that credit unions are sympathetic towards the banking industry’s efforts to reduce their tax obligations. However, CUNA also noted that the banking industry continues to demonstrate its blatant inconsistency by pursuing broader tax exemptions for banks while trying to eliminate credit unions’ perfectly legal and long-standing tax-exemption. To which I would only add, so what else is new? Comments? Call 1-800-345-9936, Ext. 15, or Fax 561-683-8514, or E-mail [email protected]

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Peter Westerman

Credit Union Times

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