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CHICAGO-Twenty-one percent of all banks and 8% of all thrifts have converted to Subchapter S status as of March 31, 2002, according to Grant Thornton. This is up from the global accounting firm’s 2001 findings of the same time period, when 18.6% of banks and 6.1% of thrifts elected the Sub S route. According to a new Grant Thornton study, 210 banks and 10 thrifts converted from C Corporation to S Corporation status. However, this only accounts for a net gain of 166 banks because 15 opted out of Subchapter S election, while 29 others merged into other institutions. Since 1997, when the option became available for banks and thrifts, the study said, 1,849 financial institutions have made the Sub S election. The firm also pointed out that the total assets of federally insured credit unions-$438.6 billion as of March 31-are more than double that of Sub S banks and thrifts. “The total FDIC-insured (Federal Deposit Insurance Corporation) assets of institutions electing S Corporation status are dwarfed by the total insured assets held by credit unions,” Grant Thornton’s report explained. “Credit unions are similar to S Corporations in that they are not subject to federal income taxes at the corporate level.” This is the first time credit unions have been mentioned since the study began in 1997, John Ziegelbauer, co-author of the study and a tax partner with Grant Thornton’s Office of Financial Services, said. Because the issue of bank and thrifts’ Sub S option versus credit unions’ tax exemption has been in the press frequently lately, credit union assets were included in the study, he explained. A point that is not often noted by banks is that credit unions do pay a fair amount of taxes within the 50 individual states. While not all states assess the same taxes, some of the main ones are corporate income tax, corporate franchise tax, tangible personal property tax, intangible personal property tax, real property tax, stamp or transfer tax, and sales and use tax, among several others. Unlike Sub S banks, which did not seem to favor any asset category, the thrifts that elected S Corp status tended to be larger, the study found. While 69.9% of Sub S banks had assets under $100 million, 25 of 49 thrifts that have converted to Sub S hold assets over $100 million. The average assets at an S Corp bank were around $105 million, but the assets of the Sub S thrift averaged $476 million, according to the firm’s research. Additionally, eight banks and seven savings institutions with more than $1 billion in total assets have converted. The largest Sub S financial institution is a $6.7 billion savings bank in Oklahoma. The total S Corp financial institutions represent just 2.7% of all FDIC-insured deposits. Grant Thornton’s analysis predicted that the trend would only continue. “Although more than 19 percent of the 9,519 FDIC-insured banks and thrifts have made the S Corporation election, it is important to note that the institutions that have elected S Corporation status represent only a small fraction of the total assets of all financial institutions,” the report read. “As of March 31, 2002, total assets of banks and thrifts electing S Corporation status exceeded $213.2 billion-Given a recent change in the tax law, the number of C Corporations considering a change to S Corporation status is likely to increase. The Economic Growth and Tax Relief Reconciliation Act of 2001 decreased individuals top income tax rate. While, prior to 2002, the top rate exceeded 39 percent, the new tax law reduces the rate gradually to 35 percent.(by 2006).” Grant Thornton’s 2002 S Corporation analysis also found that the Southwest region has the highest percentage of financial institution S Corporations (32.5% of banks and 15.6% of thrifts). The Midwest follows at a close second with 27.9% of banks and 6.4% of thrifts electing Sub S status. “Banks and thrifts that are able to convert start saving immediately upon conversion.” Grant Thornton Assurance Partner Dick Soukup, co-author of the study, commented. “By ending the payment of taxes on both corporate income and the shareholder income, financial institutions increase the amount of resources available for community loans and other community investments,” he said, adding that the tax relief also aids their overall position in the financial services marketplace. In addition, Ziegelbauer said that Subchapter S status is not all about saving the financial institution money on taxes. In fact, depending upon the dividends paid out by the institution, it may not be beneficial at all. “It isn’t for everybody. It’s for a healthy institution; it’s for a more mature institution,” Ziegelbauer clarified. “An S Corporation may not be for an institution that’s hungry for capital.” While a more stable institution that pays out dividends regularly can save on its taxes, growing institutions that retain more earnings are slammed with taxes up front, but do better in the future. Even after converting to a Sub S, institutions can be paying taxes at the corporate level if it sells a security-held while it was a C Corporation-at a gain after it converts to an S Corporation, Ziegelbauer said. Financial institutions often sell a losing security at the same time to offset the gains tax, he said. However, the Sub S Corporation structure can also make smaller banks more difficult to take over, he said. According to Ziegelbauer, the idea is not so much to even the playing field with credit unions as it is about helping smaller banks to compete with larger ones. However, the study also identified numerous barriers for banks and thrifts looking to convert to Sub S Corporations. A survey Grant Thornton conducted earlier this year found that 16% of financial institutions still would like to convert to Subchapter S, but have not due partially to existing barriers in the law. “There are many institutions that would benefit from S Corporation status but cannot conform to existing requirements,” Ziegelbauer explained. “The restriction on the types of entities that can own S Corporation stock, the 75 shareholder limit, and the individual retirement account restrictions are all major hurdles for financial institutions. Other than the stockholder restriction, other obstacles include the ineligible stockholder classifications (58% of those wanting to convert provided this reason for not converting) and some state tax codes that do not make Sub S more advantageous. Ziegelbauer also offered, “Some institutions may also be waiting for the next phase of the Economic Growth and Tax Relief Reconciliation Act of 2001 to take advantage of the convergence of individual and corporate tax rates.” [email protected]

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