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Legislation Introduced to Permit Banks to Operate as LLCs

August 14, 2015

On July 29, 2015, Representative Kenny Marchant of Texas introduced HR 3287, the "Community Bank Flexibility Act," that may be of interest to bankers. This bill, if enacted, would permit banks and bank holding companies to organize - or reorganize - as limited liability companies (LLCs).

LLC Proposal
Federal and state banking laws require organizers of de novo banks to incorporate; that is, form a corporation to obtain a charter and operate traditional banking activities. Thus, banks have not been permitted to operate as LLCs, which is one of the more popular business structures that provides owners limited liability similar to a corporation and "pass-through" tax treatment similar to a partnership. Many business owners believe LLCs offer the "best of both worlds" for liability protection and tax efficiency (though this is not always the case).

In addition to allowing de novo banks and bank holding companies to organize as LLC's, HR 3287 provides a five-year transition period during which banks and bank holding companies currently organized as corporations, whether taxed as regular or S corporations, can reorganize as LLCs without triggering current income taxes at either the corporate or shareholder levels. It also contains a "built-in gains tax" provision similar to that applicable to S corporations that were formerly taxed as regular corporations.

Formation as LLCs could offer banks certain advantages:

  1. For a bank taxed currently as a regular corporation, conversion to an LLC would permit pass-through tax treatment similar to an S corporation.
  2. For a bank taxed currently as an S corporation, conversion would allow more flexibility in the number and types of permitted owners and fewer restrictions on approaches to raising capital.

Potential disadvantages to LLCs often relate to greater self-employment tax exposure for owners and increased tax complexity. Careful analysis to evaluate the relative benefits, if any, offered by LLCs would be essential before making any change in a bank's structure.

S Corporation Changes Proposed
The LLC proposal comes on the heels of the introduction in June of HR 2789, the "Capital Access for Small Business Banks Act," designed to help S corporation banks raise capital. This act would increase the S corporation shareholder limit from 100 to 500, allow S corporation banks to issue preferred stock and provide an income tax deduction for preferred stock dividends paid by S corporation banks.

Outlook
These proposals may be "long-shots" for swift enactment. However, they bear watching because legislators may attempt to include these or similar ideas in tax reform discussions expected in Congress after the 2016 elections.