Depository holding companies benefit from technical corrections act.
The AJCA provisions ignored the reality that a large number of banks, if not a majority of banks nationwide, are in fact structured as subsidiaries of holding companies. In the S corporation context, the S corporation is the holding company with the bank subsidiary operating under a qualified subchapter S subsidiary (QSub) election.
At the time of the AJCA's enactment, most commentators and tax professionals were of the opinion that the AJCA provisions as originally written applied only to banks and not to bank holding companies. The oversight in the AJCA could be explained by the last-minute additions of various AJCA provisions and the compressed congressional timeline that the AJCA's passage was operating under. No rational explanation exists for providing the benefits of the AJCA to a stand-alone bank while denying them to a bank operating as a subsidiary of a holding company, or operating as a QSub.
After major tax legislation is enacted there is often a technical corrections act to fix the unintended errors or omissions in the original legislation. Language was inserted in the early versions of the correcting legislation expanding the IRA-related provisions to depository holding companies by amending Secs. 1361(c) (2) (A) (vi) and 4975(d)(16). These provisions, along with other technical corrections, were attached to the Gulf Opportunity Zone Act of 2005. While enacted too late in 2005 to realistically allow for efficient and timely 2006 S corporation planning for calendar-year taxpayers, depository holding companies, defined as bank holding companies and thrift companies, may review their current ownership structure and consider the benefits of an S election for 2007, as may banks or thrifts reporting on a noncalendar year--end. Although the new legislation allows S depository holding companies to have IRA shareholders, the real benefit is for existing C holding companies with IRA shareholders, to have those IRAs transfer the holding company shares to their beneficiaries in conjunction with making an S election.
Generally, IRAs are not the best shareholders for S corporations. IRAs will pay unrelated business income tax (UBIT) on income apportioned by the S corporation to the IRA; this results in an immediate tax cost. Distributions by the S corporation to the IRA are tax-free, however. If the IRA later sells the S stock, UBIT is paid on the gain. This results in a tax cost at the time of sale. Later, when the beneficiary receives a distribution from the IRA of either the amounts of the tax-free distributions from the S corporation to the IRA or a distribution of the proceeds from the sale of the S stock, the beneficiary is taxed at ordinary income rates on the amount of the distribution received. Also contributing to the downside of owning S stock in an IRA is that no build-up of basis is allowed the IRA on the stock it owns.
The real benefit of the expansion of the AJCA provisions to depository holding companies is for existing C corporations, with IRA shareholders, that are considering electing S status. However, to qualify for the AJCA provisions, the shares must have been owned by the IRA on Oct. 22, 2004 (the original enactment date of the AJCA). Assuming that the IRA held the holding company shares on that date, those corporations should consult with their tax advisers regarding the potential benefits of electing S status and availing themselves of the recent expansion of the AJCA benefits.
FROM GREG HAGGE, CPA, J.D., MINNEAPOLIS, MN
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|Publication:||The Tax Adviser|
|Date:||Apr 1, 2006|
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