FDIC Outlines Exceptions to Tax Payment Rules for S Corporation Banks
The Federal Deposit Insurance Corporation (FDIC) recently clarified how it will evaluate requests by S corporation banks to pay dividends that would otherwise be prohibited under new Basel III capital rules.
Financial Institution Letter FIC-40-2014, released on July 21, 2014, describes situations in which the FDIC would make exceptions from the Basel III rule that S corporation banks with assets under $1 billion are prohibited from paying dividends to shareholders.
“This guidance is helpful to community banks, many of whom would have to make major changes to their capital structure if they were unable to receive an exception to the Basel III capital conservation buffer,” says John Matthiesen, a financial institutions principal at CliftonLarsonAllen.
New Basel III rules
In April 2014, the FDIC approved new Basel III capital rules, which includes a capital conservation buffer that limits the dividends a bank can pay. The buffer is phased-in over a number of years and takes full effect by January 1, 2019.
Federal income taxes of S corporation banks are paid by its shareholders. When the bank is restricted from paying dividends due to the Basel III capital conservation buffer, the shareholders are liable for taxes without receiving a corresponding cash distribution from the bank.
The FDIC’s letter indicates that it understands the concern that the new capital conservative buffer increases the potential for S corporation shareholders to incur a tax liability without receiving a dividend. This situation may also make it more difficult for S corporation banks to attract capital.
Requesting a tax distribution
On a case-by-case basis, the FDIC will consider specific requests to allow a tax distribution when the bank is subject to dividend restrictions under the capital conservation buffer. The FDIC will take the following factors into consideration:
- Is the bank requesting a dividend of no more than 40 percent of net income?
- Does the bank believe the dividend payment is necessary to allow the shareholders of the bank to pay income taxes associated with their pass-through share of the institution’s earnings?
- Is the bank rated in the top two levels under the Uniform Financial Institutions Rating System (meaning it has the strongest performance and risk management practices) and not subject to a written supervisory directive?
- Is the bank at least adequately capitalized, and would it remain adequately capitalized after the requested dividend? (If not, the dividend is not permitted pursuant to statutory PCA, 12 U.S.C. §1831o(d)(1)(A).)
Upon review of the request and if the factors are met, the letter indicates the request will generally be granted. The letter also states the FDIC will be providing additional instructions on how to request this exemption pursuant to their streamlined review process.
How we can help
Your tax advisor can help with any questions about the FDIC’s new guidance or how the capital conservation buffer affects your bank.