Main Street Matters ICBA Blog

Subchapter S Sit-down

Nov 01, 2018

AlanKeller_200pxCatching up on the unresolved tax deduction for pass-through businesses

By Alan Keller and Steve Keen

ICBA has been working with policymakers to ensure the ICBA-advocated Subchapter S tax deduction is workable for all Sub S community banks. Main Street Matters sat down with ICBA’s Alan Keller, first vice president of legislative policy, and Steve Keen, vice president of congressional relations, to check in on the issue.

Let’s start from the beginning. What is the issue at hand?

Keller: The tax-reform law that passed at the end of 2017—the Tax Cuts and Jobs Act—includes lower tax rates for shareholders of Subchapter S corporations and other pass-through businesses. SteveKeen_200pxThe law was a big community bank success and generally provides that Sub S shareholders are eligible for a deduction equal to 20 percent of their qualified business income, subject to certain limitations. How those limitations are interpreted is what is being debated now.

Keen: While most Sub S banks shouldn’t have problems using the 20 percent deduction, the law lays out certain “specified services” that are not eligible. ICBA is advocating for a broad interpretation that would ensure all community bank activities are eligible.

What does the law say about these ineligible services?

Keller: Section 199A of the law says income from a “specified service trade or business” is not eligible for the deduction. The specified services include “financial services” but not “banking,” so our position is that all permissible banking activities should be eligible for the deduction. Specified services also include “brokerage,” “investing or investment management,” and “dealing in securities.”

Do the regulators implementing the law disagree with ICBA’s position?

Keller: In their proposed rule, the Treasury Department and IRS included various financial services that do not qualify for the deduction, such as trust or fiduciary services, wealth management, retirement planning, and income from loans sold to be securitized.

Keen: It also established de minimis thresholds to qualify for the full deduction. Businesses that have $25 million or less in gross receipts and earn less than 10 percent of those receipts from these services would be eligible for the full deduction. Same for businesses with more than $25 million in gross receipts that earn less than 5 percent from those services. It’s kind of confusing, but basically Treasury is carving out pieces of the banking business that won’t qualify for the deduction.

Keller: In a joint comment letter, ICBA and other groups also called on the IRS to raise the de minimis thresholds to a flat 25 percent in addition to allowing all activities permissible for a bank to qualify for the deduction.

That all sounds pretty complicated for Sub S bankers doing their taxes.

Keller: Complicated and costly. The big concern is that this disincentivizes the Subchapter S model and encourages Sub S banks to transition to C-corps.

Keen: Which Congress did not want to do.

Keller: Yes. ICBA and community bankers worked hard during the tax debate to create parity or near parity in the taxation of C banks and S banks. We felt that we ended up in a good place when the law was signed, but now the proposed rule threatens to undo some of our work and, we believe, the intent of Congress.

So where are we now?

Keller: In addition to the comment letter, ICBA has been working with the administration to make our case. We met over the summer with staff from the White House and Office of Management and Budget. There were also four community bankers who testified at an IRS hearing a couple weeks ago. Collectively, we’re making the case that a broad interpretation of the law would bolster lending and support economic growth, which was the whole point of tax reform.

Is anyone else weighing in?

Keen: Yes, a group of 12 senators led by Sen. Jerry Moran (R-Kan.) recently called on Treasury to revisit the proposed rule. They said the proposed rule unreasonably limits the deduction, which is important because it conveys congressional intent.

What’s next?

Keen: We’re going to keep working the issue with Congress and the administration. We made a big grassroots push during the comment period, so expect more of that as well.

Keller: We’ll need everyone to weigh in on this issue. Generational tax reform was an important breakthrough that is reaping a lot of benefits, but the Sub S issue is important unfinished business.