Currently, banks would be required by Basel III to hold a certain level of capital; failure to do so could result in a prohibition against paying dividends to shareholders. Dividends are critical to those investors, who rely on the payments to cover tax obligations if the bank is profitable. For that reason, S Corp banks believe they face a greater burden under Basel III than C corporations, where the company is taxed for its profit. Concerns also exist that the proposed rules could force more S Corps to delay growth plans or opt to sell themselves.
Basel III will require banks to have a common equity Tier 1 capital ratio of 4.5% plus a 2.5% capital conservation buffer. Banks that fall below 7% can have their ability to deploy capital, like paying dividends or bonuses, limited. S Corp shareholders are responsible for paying their share of the company’s profits on their personal tax returns. Shareholders would have to pay those taxes out of pocket if a profitable S Corp is barred from paying dividends to cover their costs. That burden could discourage some people from investing in S Corps, industry experts say.
In the article, Mr. Kennedy states, “If the rule is implemented, more S Corps could choose to switch to a C Corp structure. But this could also cause more banks to consider selling. The C Corp structure isn’t an effective structure for a closely held bank since you are basically double taxed and you’re competing against credit unions that aren’t taxed at all.”