CUNA Comment Letter

Subchapter S Status

April 26, 2004

Mr. Glenn Kirkland
Internal Revenue Service
111 Constitution Avenue NW
Room 6411
Washington, DC 20224

Dear Mr. Kirkland:

On February 25, 2004, the Internal Revenue Service published a Notice and Request for Comments regarding the election of information relative to the agency’s existing final rule on the Election, Revocation, Termination and Tax Effect of Subchapter S Status. On behalf of the Credit Union National Association, I appreciate the opportunity to file these comments in response to the agency’s request. The Credit Union National Association represents over 90% of the nation’s more than 9,600 state and federal credit unions, which serve 85 million members.

The legislative history of the Subchapter S provisions indicate Congress wanted to allow small businesses to be able to choose which corporate structure best suited their needs without having to expend resources to determine the form that would provide the most advantageous tax treatment. Subchapter S status allows small businesses to achieve benefits of pass-through taxation similar to those of partnerships, without having to discern the complexities of tax rules applicable to partnerships.

CUNA’s primary interest in Subchapter S relates to its use by banking institutions. For almost forty years after Congress adopted the Subchapter S provisions in 1958, banks remained ineligible to use them. Then, with little explanation, in 1996 Congress authorized banks to elect Subchapter S status. Today, there are 2,010 banking institutions (banks, savings and loan associations) with $272 billion in assets that enjoy Subchapter S status.

In response to the agency’s request for comments, we want to raise three issues regarding Subchapter S reporting and information requirements for banking institutions.

For some time, the banking industry has been arguing that larger credit unions should not benefit from the credit union tax exemption. Among the banking institutions that have elected Subchapter S status, 248 have assets of over $250 million. Eighteen of these institutions have assets of over $1 billion, and the largest banks operating as Subchapter S, Union Federal Bank of Indianapolis, Beak Bank of Texas, and MidFirst Bank of Oklahoma City, have assets of $3.69 billion; $5.54 billion and $9 billion, respectively. It is inequitable and hypocritical in the extreme for banking organizations to apply a litmus test of size to credit unions while such relatively large banks are taking advantage of Subchapter S authority to avoid tax liability. We urge the IRS, through its data collection process, to monitor the size of such banking institutions and work with Congress to address whether billion-dollar banks should be the beneficiaries of treatment intended for small businesses.

Another issue we would like to raise relates to the ownership of stock by Subchapter S corporation banks. Directors of national banks are required to own stock in their bank for a variety of public policy reasons. This requirement may result in a conflict with the requirements that a Subchapter S corporation have no more than 75 shareholders and only one class of stock conferring identical rights of distribution and liquidation proceeds on all stockholders.

Some bank organizations, in an effort to reconcile these requirements without changing their operations, have utilized an arrangement under which directors of the bank transfer their shares back to the bank or bank holding company. We are aware that IRS Private Letter Ruling 2002-17-048 addresses this issue to afford flexibility to banks in this area, even though it is nonprecedential and nonbinding on the agency. We are also aware that legislation is pending to address this issue and other matters and would significantly enhance the advantageous treatment for banking institutions under Subchapter S.

In light of the fact that there is no direction from Congress on this issue, we urge the IRS to ensure there is sufficient reporting by banks of the use of such agreements to meet the Subchapter S shareholder limitations. We also respectfully request the agency consider whether this issue needs to be resolved through a rulemaking procedure.

The last issue we wish to raise relates to the purpose of Subchapter S treatment for banks. It is clear that Congress wanted to give small businesses favorable tax treatment under Subchapter S to encourage their growth and development. What is less clear is why banks were provided Subchapter S election-authority. Subchapter S status bestows an enormous public benefit on the banking institutions that make use of this preference. In light of this fact, we respectfully request the agency to consider collecting information from Subchapter S banking institutions that shows how they use this tax preference to benefit the public and their communities.

Thank you for the opportunity to express our views on these issues. Please do not hesitate to contact me at 202-508-6736 if you would like further information about our recommendations.


Mary Mitchell Dunn
Associate General Counsel
and Senior Vice President