A controversy has arisen over whether subchapter S banks can take 100 percent of the Section 199A Qualified Business Income deduction. Congress created the deduction to reduce differences in income taxes paid by sub S and C corporations. The solution is dependent upon better communication between federal agencies.
You recall that the Tax Cuts and Jobs Act passed last December offers a 20 percent deduction for pass-through businesses, including sub S banks. The deduction is designed to keep sub S entities on a par with C corporations, which got a hefty reduction in the corporate income tax. Confusion has arisen, however, because apparently some services that sub S banks might offer don’t qualify for the deduction. If the revenue derived from these non-qualifying business lines (known as a “specified service trade or business”) exceeds certain levels, a sub S bank is denied the deduction for the entire bank. An estimated 150 to 300 sub S banks across the country have SSTB generating revenue over the IRS thresholds.
Treasury officials told representatives of the Subchapter S Bank Association that sub S banks with SSTB should segregate those business lines when filing their taxes and take the deduction on the other business income. This sounds like a paperwork nightmare!
The IRS took public comments on this issue through Oct. 1, so I am hopeful this will be clarified and sub S banks can take the entire deduction without worrying whether specific business lines they offer don’t qualify. Keep in mind that banking is a highly regulated business. Any product or business line being offered by a bank is well known to regulators. Why can’t regulators work with the IRS to broaden its understanding of typical banking services? Then the IRS could clarify that sub S banks qualify for the entire deduction.
“Dealing in securities,” for example, is an SSTB and doesn’t qualify for the deduction. One expert informed me a bank that originates a mortgage and sells it into the secondary market is dealing in securities so revenue derived from that business line would not be eligible for the deduction. But underwriting mortgages sold into the secondary market is a classic community bank business practice. The regulators know this. They should inform their friends at the IRS. Bankers certainly don’t need the additional recordkeeping responsibilities, and I can’t believe when it passed tax reform that Congress wanted to create a significant tax difference between sub S and C corp banks.