New Tax Act Highlights
Community Bank Advisor, 2007 Summer  

On May 25, the president signed the Small Business and Work Opportunity Tax Act of 2007 (SBWOTA). Passed in conjunction with legislation to continue funding the war in Iraq and to raise the minimum hourly wage, the tax-related provisions are designed in part to help both C Corporation and S Corporation banks and their small business customers. The key provisions enacted into law will:

• Exclude capital gains from passive investment income for Subchapter S businesses. The law eliminates the gain on the sale of stocks and securities from the passive income definition. These changes should prevent community banks from paying additional taxes or having their S Corporation status adversely impacted due to passive income earnings.
• Ease the treatment of Subchapter S bank directors’ shares retroactive to 1997. Since S Corporations may only have one class of stock, a bank directors’ qualifying shares often trip up both existing S Corporations and banks considering S election. Under the new law, qualifying directors’ stock is ignored as outstanding stock, and directors’ qualifying shares are not counted as a second class of stock.
• Improve the tax treatment of bank bad debt reserves. This is available to banks making an S election in 2007 and beyond. In essence, the change allows a bank to recapture all of its bad debt reserves in its last C Corporation year free of built-in gains.
• Improve the treatment of the sale of interest in a qualified Subchapter S subsidiary. This provision prevents taxation on 100 percent recognition in the gain on the sale of a Q Sub when only a portion of the interest (stock) was sold, by applying prorated treatment verses 100 percent.
• Ease the interest expense of an electing small business trust to acquire S Corporation stock. The new law is beneficial to electing small business trusts and makes interest on the debt to buy S Corporation stock deductible by the S Corporation portion of the electing small business trusts.
• Extend the Section 179 election and enhance the immediate expensing for the purchase of equipment and software through 2009. Under the law a small business gets an immediate tax write-off for expenses up to $125,000 in equipment or software investments.

Overall, these tax relief measures will help existing Subchapter S community banks and will allow additional banks to more easily elect the tax-saving S Corporation status. Currently one-third of U.S. banks or about 2,400 community financial institutions have elected S Corporation status. Please contact us if we can assist you in any way.