Insights: Article

House Tax Reform Bill: Concern for S Corporation Banks

November 08, 2017

On November 2, 2017, House Ways and Means Committee Chairman Kevin Brady (R-TX) introduced H.R. 1, the “Tax Cuts and Jobs Act,” a 429-page bill that is the first step in the tax reform process. Our Insights article on the bill can be found here.

If enacted, the bill would affect nearly every taxpayer and industry. Of utmost interest to community banks are the proposed decreases in the maximum tax rates on business income starting in 2018.

Tax Rate Cuts Proposed
For regular corporations, the bill reduces the current 35 percent top corporate tax rate to 20 percent. In addition, it proposes a top tax rate of 25 percent on the “business income” from sole proprietorships and pass-through entities, including S corporation banks. 

On the surface, this sounds like great news for both regular and S corporation banks. However, for S corporations, qualifying for the 25 percent rate is anything but straight-forward under the draft language in the bill.

Benefit Limited for Some S Shareholders
Provisions in the bill can limit “active” shareholders (for example, employees or others significantly involved in bank management or operations) from fully realizing the benefits of the 25 percent tax rate. In fact, as drafted, no more than 30 percent of an S corporation bank shareholder’s pro-rata income would typically qualify for the lower rate. The portion of a shareholder’s income not qualifying for the favorable 25 percent tax rate would be treated as compensation income subject to ordinary tax rates, up to the top individual rate of 39.6 percent, and would be included in self-employment income calculations. 

Expect Debate
We expect these proposed rules to be subject to intense lobbying by bank trade associations and extensive debate in Congress. The House Ways and Means Committee will be holding hearings this week. The Senate Finance Committee expects to release its own version of tax reform later this week. 

The tax reform process is just starting; none of the bill’s provisions are final by any means. We will provide updates and more detailed insights as the tax reform process continues to develop.

Should you have any questions related to the proposed tax rates on business income or planning for other aspects of tax reform, please contact your Eide Bailly, LLP tax professional.