ABA approves of state banks as LLCs reg, while smaller groups find fault

WASHINGTON-While three of the major banking trade associations generally approved of the Federal Deposit Insurance Corp.’s (FDIC’s) proposal to allow state chartered banks to organize as Limited Liability Companies (LLCs), the American Bankers Association (ABA) offered no recommendations, but the groups specifically focused on community banking had a few suggestions. Community and de novo banks stand to get the most out of the proposal that could allow LLC banks to receive preferential tax treatment. The comment period closed October 21. An LLC is a hybrid of a partnership and a corporation, according to CUNA Legislative Affairs Manager Leon Peace, a tax specialist formerly with the ABA. He explained that LLCs get the advantage of flow through tax treatment, where the individual partners and not the business is taxed, and also shield the individuals from personal liability. It is more advantageous than a Subchapter S charter because there is no limit on shareholders and there are no restrictions on income, among other technical rules, he said. “In an era of rapid change and consolidation in the banking industry, community banks find it increasingly difficult to provide a personal level of service while remaining competitive with larger banks and other tax-advantaged financial institutions,” the ABA’s comment letter read. When asked exactly what this meant, ABA Senior Tax Counsel Mark Baran said that he did not write that portion of the letter, but his interpretation was, “It’s a highly competitive marketplace out there and many bankers are distracted by competition, unfair competition specifically.” He also pointed out that if the FDIC approves this proposal, it is only one step among numerous hurdles, including getting the Internal Revenue Service on board and the many states that permit different corporate structures. The Independent Community Bankers of America’s (ICBA’s) comment letter, however, requested a hierarchy of the four specific characteristics of a corporation-perpetual succession, centralized management, limited liability, and free transferability of stocks-offered by the FDIC, adding that the organization does not believe necessarily that they all should be requisites. The letter pointed out that some of these factors are more important than others. For example, ICBA President and CEO Ken Guenther wrote, perpetual succession is more critical to bank operations than the free transferability of stocks. “However, many exiting banks operate as closely held companies, and it is common for a closely held corporation or its shareholders to place restrictions on the sale of stock, perhaps the most common being a requirement that stock be offered to other shareholders of the corporation before being sold to others,” he explained. “Moreover, since closely held company stock is almost never traded on a public exchange, valuing that stock can present hurdles that limit its transferability.” Guenther also indicated that the provision does not even apply to mutuals. Additionally, ICBA said, “While the FDIC can consider the enumerated factors in assessing whether a particular structure can be operated safely and soundly, ultimately the question should be whether the structure is recognized as a legal entity under the state law.” America’s Community Bankers (ACB) agreed with this point, asking that the definition of “incorporated” be left to state law and that states should be encouraged to allow a choice of corporate forms eligible for federal deposit insurance. “Tying the hands of state legislatures and state regulators by requiring that all institutions possess the four historic attributes identified by the FDIC as defining the traditional corporate form does not serve any public purpose,” ACB Senior Regulatory Counsel and Director of Regulatory Affairs Charlotte Bahin wrote in the group’s comment letter. She also wrote that the potential changes would aid banks’ growth. “Allowing states to offer a choice of corporate forms that are eligible for federal deposit insurance provides incorporators with the opportunity to select the corporate form that best suits the strengths and needs of their customers and communities. It also provides business flexibility and economic freedom, which promote growth,” Bahin argued. “Given the significance of maintaining the dual banking system, we believe that permitting state banks chartered as LLCs to have federal deposit insurance is an important a factor in providing choices to all charter forms. It is this type of innovation and flexibility that has made the state banking system a strong competitor to the national scheme,” said Bahin. Credit union groups are not worried about banks receiving this additional tax break increasing the competition and are not opposing it. “For years banks have said that the only reason consumers get a better deal at a credit union is because of the credit unions’ tax exemption. If the LLC expansion is approved, the bankers can put their money where their mouth is,” CUNA Senior Vice President for Government Affairs John McKechnie challenged. He added that his bet is the consumers will not see a dime of the savings. Mark Wolff, CUNA senior vice president of communications, added that credit unions “will show again that the better deal does not come from our tax status.” “One reason we find it so attractive is the central argument of the banking industry [in attacking credit unions] gets taken off the table,” Peace said. He also pointed out that the increased consumer choice among financial institutions is a good thing. Not so fast, according ABA’s Baran. He said that banks and credit unions would still be a long way from an even playing field and banks will continue to challenge credit unions’ tax-exempt status. Wolff pointed out that LLC taxation is passed down to the investors’ income the same way credit union members pay taxes on interest income and dividends. Also, credit unions do pay property taxes and some state level taxes. Baran’s response: “apples and oranges.” [email protected]