Treasury Issues Regulations Affecting Sub S Banks: Good News with Some Wrinkles The Need ironing
Special thanks to Patrick J. Kennedy, Jr., Managing Partner at Kennedy Sutherland and President of the Subchapter S Bank Association, for the following information.
The U.S. Treasury issued proposed regulations on August 8, 2018 on section 199A of the Tax Cuts and Jobs Act, which establishes the 20 percent qualified business deduction (QBI) for Sub S banks and other pass-through entities. We have been working diligently with a coalition of Independent Community Bankers Association and American Bankers Association professionals to make sure that the Treasury regulations clearly implemented the Congressional intent that Sub S bank shareholders were intended to be eligible for the QBI deduction.
We were successful in that the regulations proposed make clear that Sub S banks are eligible for the deduction by clarifying that the term financial services (a specified service that is not eligible for the deduction) should be narrowly defined to include “services provided by financial advisors, investment bankers, wealth planners and retirement advisors and other similar professionals, but does not include taking deposits or making loans.”
The regulations, which cover 184 pages, initially appear to have eliminated another concern for the majority of Sub S banks with regard to income generated by Sub S banks from excluded specified services trade or business (SSBT) such as “investing and investment management, trading and dealing in securities or brokerage.” However, there remain questions about how this will be applied. While we urged blanket availability of the QBI deduction for any bank business activity permitted by law, we also suggested establishment of a “de minimus” rule that Treasury has proposed. Unfortunately, the way the de minimus rule is proposed, an S bank would lose its entire ability to deduct any QBI if 10 percent of its gross receipts consist of SSBT income if the total gross receipts are $25MM or less and 5 percent of gross receipts if its gross receipts are in excess of $25MM.
The regulation states: “For a trade or business with gross receipts of $25MM or less for the taxable year, a trade or business is not an SSBT if less than 10 percent of the gross receipts of the trade or business are attributable to (SSBT type income).” It does appear to permit a Sub S bank to take the QBI deduction from such activities so long as it does not exceed 10 percent of the entity’s gross receipts and total gross receipts of the bank are $25MM or less. We believe that a bank’s gross receipts are generally interest income, non-interest income and gain on sale of assets such as loans.
In addition, we are concerned that many Sub S banks may be deemed to be “dealing in securities” by virtue of their originating and selling loans or parts of loans. The proposal makes specific reference to existing code provisions that categorize such activity as dealing in securities, but also contain an exception where the activity involves fewer than 60 individual loan sales per year. Based on our initial review, this could impact a number of banks who are active mortgage originators and sellers to Freddie, Fannie or other institutional buyers.
There are numerous other obligations that are imposed on Sub S banks by virtue of these regulations, including making a determination about the amount of QBI, W-2 wages and the unadjusted basis immediately after acquisition (UBIA) of qualified property for use in a trade or business and whether the relevant reporting entity (RPE) – that is a bank, bank holding company or operating subsidiary is engaged in any SSBT.
We will continue to work with ICBA, ABA and a small group of tax professionals with whom we have collaborated on these Sub S bank issues since the initial draft of HR 1 was introduced last year and intend to submit comments within the required 45-day period and potentially have other meetings with Treasury and the IRS as a result of these remaining issues. For the majority of banks that do not engage in any of the activities that are defined as SSBTs—that is investing, investment management, trading or dealing in securities or brokerage, including trust services—the guidance clearly establishes that Sub S banks are entitled to take the QBI deduction as intended by Congress.
The regulations also confirm that Electing Small Business Trusts are entitled to take the QBI deduction. We will be asking for input from our Sub S bank members and other interested parties as we study the proposal more carefully in the coming days and formulate additional recommendations for Treasury.