The Sub S Bank Report – December 2016 (Volume 19, Issue 4)

No question that the post-election enthusiasm in the Banking industry is palpable. We have repeated our true story about visiting with four bank client CEOs the day after the election and how each one expressed genuine enthusiasm and a great sense of relief at the results with expressions like – “there is a future for us in banking,” “this will allow us to roll back Dodd Frank,” and “this will change the regulatory environment.” This level of enthusiasm is certainly being felt across numerous, if not all, industries and business communities and continues today. The enthusiasm and optimism will no doubt be a powerful antidote for the economy and the banking business and we need to do all we can to encourage the House, the Senate and the new Administration to push forth with initiatives to ease regulatory burden, enact tax reform and return to a simpler free enterprise market driven regulatory environment.
Legislation vs Regulatory Answer to Burden

The Association management team of Kennedy Sutherland made a trip to Washington in mid-December coincident with the last few days of the 114th Congress. We met with Senators and Members and Ways and Means Committee staff on fundamental tax reform issues and Subchapter S legislation. During the visit, Congressman Will Hurd, who spoke at the Association’s Annual Conference, came from the floor of the House and inquired whether we thought Congress needed to enact banking regulatory reform or whether Congress with the help of the incoming Administration could roll back regulatory burden without new legislation. The question was an excellent one and underlying it was obviously a powerful theme and recognition among Members of Congress that President-elect Trump’s focus on reducing regulatory burden can have powerful results by simply striking a new tone rather than enacting new legislation. In our view, we should continue to encourage the change in tone effort given the wide range of “regulatory discretion” in how laws and regulations are applied and administered. We nevertheless indicated our strong belief that certain provisions of Dodd Frank and other statutes and their related regulations should be targeted for repeal or reformed.

Tax reform and Subchapter S banks
Our primary purpose in our December DC meetingswas to encourage the current Brady-Ryan Tax reform proposal which is outlined in more detail in this Report and to make certain that the Subchapter S legislation that we have been working on for the past two years remains a priority. If the Brady-Ryan Plan is enacted as proposed, Subchapter S bank owners will enjoy significant tax relief. The current maximum rate of 39.6% plus the 3.8% net investment tax would melt down to a 25% rate, all in, which would flow through to individual Subchapter S shareholders. The President elect has proposed a 15% rate, but the details of his plan are by no means evident and our hope is that there would be a place in the middle or even at the Brady Ryan number that would prevail.

We delivered this message to several key members of the Ways and Means Committee and Committee staff who we have been working with us on the Subchapter S initiatives. Members of the Ways and Means Committee have been working through December to flesh out details of proposed tax reform legislation. Committee Members agreed to come back to Washington the week following the last day of the session for a working session among the Committee staff and presumably the new Administration. We await details of these meetings, but they certainly signal a strong will to enact tax reform as soon as possible in the New Congress.

We encourage all Subchapter S banks and shareholders to write their Congressional representatives to move quickly to enact these tax reforms and the inclusion of our Subchapter S capital access provisions, enabling Subchapter S banks to expand their shareholder base and increase capital alternatives.

Congressman Marchant’s staff has been working with the Congressional Legislative Counsel to fine tune provisions of HR 2789 per recommendations of the Ways and Means Committee staff and of the Joint Committee on Taxation staff. These have been concluded, and the bill is being readied for reintroduction in the New Congress. We met with several other Ways and Means Committee Member staffs who are enthusiastic about the bill and have helped develop a strategy to deliver more sponsors and bipartisan sponsorship. We will be working on this over the next few weeks and encourage the Subchapter S bank community to encourage their representatives whether Democrat or Republican to sign on to the bill which must be reintroduced in the New Congress.

Next Steps
It has been our view that the President-elect and the House are anxious to push tax reform forward as quickly as possible. Many share this view as well; however, the reality of the process and all that can bog it down is on the minds of astute observers. Nevertheless, encouragement from business leaders from all over the country can help propel these efforts. In one of our meetings, one astute tax legislative assistant referred to the book written  about the last comprehensive tax reform effort in the US which took place in 1986 under the Reagan Administration- "Showdown at Gucci Gulch: Lawmakers, Lobbyists and the Unlikely Triumph of Tax Reform " as a good and thoughtful read coming into the new session.

On the Senate side, the first few months will likely be taken up by confirmation  hearings for the new Administration. There is a strong desire on the part of the leadership  to work through  tax reform in a bipartisan  manner, but to the extent necessary and possible, there is still a strong will to move forward with something like the Ryan Brady Plan. We anticipate being able to introduce  the Subchapter S capital access bill in the Senate and are working on getting co­ sponsors from key Democrats as well. The plan will be to hold a markup of the bill early in the new Congress so the bill will be ready when the time comes for tax reform legislation from the House to be considered by the Senate – estimated to be sometime in early summer.

We cannot underscore  the importance  that each Subchapter S banker can make by picking up the phone or making a visit to your Congressman or even District staff members on pushing the Ryan Brady plan and our Subchapter S capital Access initiatives.

Please do not hesitate to reach out to us for further  information  and guidance on these matters.

Patrick J. Kennedy, Jr. is founder of the Subchapter S Bank Association and managing partner of Kennedy Sutherland LLP, which provides comprehensive legal services to banks, bank holding companies, and directors, officers and shareholders. He can be reached at pkennedy@kslawllp.com or 210-228-4431.

A common  question  for  community banks  revolves around  the  appropriate  and  most  efficient tax  strategy  for maximizing  net profits to shareholders.  Many bankers are interested in the opportunities that electing to be taxed as an S corporation  under  the Internal  Revenue Code may provide to the business of their bank. With the impending inauguration of Donald Trump, and a Republican majority in Congress, many bankers are now concerned with whether or not to make, or maintain  for that matter, an S election for their institution.  Tax reform was a top priority for Mr. Trump as well as congressional Republicans and it is likely that we could see significant tax reforms in the early days of the new administration. While Trump has posited his own plan, the House GOP, under  the leadership of Paul Ryan and Kevin Brady has also proposed a tax reform plan. While it is not certain what exactly the final tax reform measures will look like, the following article attempts  to provide a summary  of each of the proposed plans compared  to the current system, especially with respect to their potential effects on community banks.

Many of our clients have been asking whether they should maintain their S election or switch to a C corporation. The bottom line for Subchapter S banks is that based on the House GOP plan, Subchapter S banks will be significantly better off from a tax perspective than they are now and will continue to enjoy a fairly substantial income tax advantage over C corporation organizations plus their capital gains advantage.

House GOP Plan: “A Better Way”

With “A Better Way,” Ryan and Brady have proposed consolidating individual tax rates into three tax brackets of 12, 25 and 33 percent, with single filers earning more than $190,150 and joint filers earning more than $231,450 making up the highest tax bracket. Additionally, the GOP plan would simplify the currentsystem of tax deductions, exemptions and credits for individuals and families by eliminating most itemized deductions, but provides taxpayer relief by increasing the standard deduction to $24,000 for joint filers, $18,000 for single filers with children, and $12,000 for other individuals as well as simplifying child and education related credits.Alternatively, based on the goal of “strengthening civil society,” the GOP plan would allow individuals and families the opportunity to itemize deductions for mortgage interest and charitable contributions if such a deduction would be greater than the larger standard deduction provided under the plan.

For corporate filers, the plan proposes to reduce the corporate income tax to 20% from the current 35%. Moreover, the plan will reduce the effect of double taxation of corporate income by limiting the tax on dividends and capital gains to half of the regular individual income tax rate. This means a shareholder will not pay more than 16.5% tax on any distributions or capital gains paid on their C corporation shares. In addition to reducing the corporate income tax, the House GOP plan would limit the tax rate that individuals pay on small business and pass-through income to 25%. Accordingly, shareholders of banks or bank holding companies that have elected S corporation status will not pay more than 25% on the earnings of the bank. This represents a significant tax savings for S corporation shareholders from the current potential tax rate of 43.4% on pass-through business income.

In addition to the reduced tax burden on both large and small businesses, the GOP plan provides additional tax benefits to individuals and businesses. First the alternative minimum tax would be repealed for both individuals and businesses as taxes will be based on a simplified structure of income and deductions. Another important benefit under the GOP plan is that of a fully and immediately writing off or expensing of the cost of investments. Essentially, the plan would allow for a 0% marginal effective tax rate on new investment. With the sole exception of investment in land, this system of immediate cost recovery will apply to investments in both tangible and intangible property. The plan will eliminate deductions for net interest (except against interest income), but it is anticipated that allowing investments to be immediately written off will provide a strong incentive to invest, equalize tax treatment for different types of financing, and eliminate a tax-based incentive for businesses to increase their debt load beyond reasonable amounts. Although such rules have not been specifically delineated, it is expressly noted in the GOP plan that the Ways and Means Committee will work to develop special rules with respect to interest deductions for financial services companies, including banks, in order to account for the role of interest income and interest expense in their business models.

As an example of the investment incentive under the GOP plan, consider the purchase of a community bank, with $7 million financed on a $10 million purchase price. Under the current tax structure, the investors are only able to take deductions on the interest payments to service the $7 million loan over the life of the loan. As we understand, although the investors will not be able to take deductions on interest payments of any debt, under the GOP plan, the investors will be able to take an immediate write-off on the entire $10 million purchase price. This potential write-off for investors would allow greater flexibility when considering the finance structure of the purchase, without concern for maximizing the tax incentive of taking on debt.

It is likely that operating as an S corporation under the proposed House GOP plan will continue to make sense for those banks that qualify. Even with a 15% reduction in the corporate tax rate and a substantial reduction in the individual tax rate on distributions to 16.5% (from potentially 43.4%), S corporation shareholders can avail themselves of the single level tax structure at no more than 20% of company earnings and still enjoy the benefit of reduced capital gains through basis adjustment rules.

Trump Tax Plan

Trump has proposed the same three consolidated tax brackets as the House GOP plan with slightly lower earnings thresholds. For example, single filers earning more than $112,500 and joint filers earning more than $225,000, will fall into the highest 33% tax bracket. Like the House GOP plan, Trump intends to increase the standard deduction, although the deduction would be significantly higher for joint filers at $30,000 and moderately higher at $15,000 for single filers. Trump intends to eliminate “special interest tax breaks” but he would continue to allow itemized deductions up to $100,000 for single and $200,000 for married filers. Further, Trump’s plan retains the existing capital gains rate structure, with a maximum rate of 20%.

With respect to corporate taxes, Trump has proposed an even larger reduction in the corporate income tax to a maximum of 15% tax on corporate earnings. This represents a significant reduction in the corporate tax rate from the current 35% rate paid at the corporate level. Additionally, the summary of Trump’s tax plans states that this maximum tax is “available to all businesses, both small and large, that want to retain the profits within the business.” The implications for pass-through businesses, including S corporation banks is slightly ambiguous, as such a business would certainly be included in “all businesses” and early versions of Trump’s tax plan indicated that the lower corporate tax rate needed to help “small businesses and pass-through entities [that were] taxed at the high personal income tax rates.” However, S corporation banks might not meet the qualification of “[wanting] to retain the profits within the business” as specified in the most recent version of the tax plan. In fact, conflicting articles, both published in the September 15, 2016 Wall Street Journal, summarized the effect of Trump’s tax plans on pass-through businesses in different manners, with one article proposing that the 15% rate would apply to pass-through business, and the second article suggesting passthrough income would be taxed at individual rates.5 However, an analysis of Donald Trump’s tax plan by the Tax Policy Institute published on October 18, 2016 notes that owners of pass-through entities could elect to be taxed at the 15% flat rate on such business income instead of being taxed at their individual rates.6 Such an election would allow those lower income tax payers to be taxed at just 12% and higher income taxpayers to be taxed at a rate less than their individual rates. It is important to note that the Tax Policy Center’s analysis points out that distributions from larger pass-through businesses received by owners who elected the 15% tax rate would be taxed as dividends, but available summaries of Trump’s tax plan do not specify how the size of pass-through businesses would be determined.

Despite the ambiguities identified in Trump’s tax plan for S corporations, for those businesses that qualify, electing to be taxed as an S corporation might continue to provide economic benefits. C corporation shareholders will certainly benefit from a lowered corporate tax rate, but will continue to pay a second level of taxes on all distributions of company earnings, either as ordinary income, or at a maximum 20% for qualified distributions. Ideally, S corporation shareholders will realize a single 15% tax on pass-through earnings, but even if the shareholders are unable to utilize this flat corporate tax rate, there will remain only one level of taxation, at substantially lower rates than currently exist. In fact, should S corporation shareholders be required to pay at the highest individual tax rate of 33%, the shareholder would still pay slightly less than the combined 15% corporate level tax and 20% individual tax on qualified distributions.

In addition to the above described changes to the current tax plan, Trump has also proposed additional reforms similar to the House GOP plan. Like the House GOP plan, Trump intends to repeal the alternative minimum tax for both individuals and businesses. Further, businesses engaged in manufacturing within the United States will have the opportunity to elect to expense capital investment in lieu of deducting corporate interest expenses. While this may not
have a direct impact on banks, it may encourage businesses to make investments and finance equipment and inventory at higher than current levels.

Summary
It is likely that the final tax plan to cross Mr. Trump’s desk in the Oval Office will be a blend of the above described plans. Regardless, any reform to the tax code by the current administration is certain to have a significant impact on the amount of taxes paid and amount that remains available for corporations and individuals to reinvest. Further, it appears likely that banks electing S corporation tax treatment will continue to realize a significant tax savings over the C corporation structure. Both tax reform proposals will significantly reduce and limit the amount of taxes to be paid on S corporation earnings from the current maximum of 43.4% for those in the highest individual tax bracket with passive business income. Further, S corporation shareholders will continue to avoid the double taxation structure that will continue under either plan.

J. Lucas Lechler is an attorney at Kennedy Sutherland LLP, which provides comprehensive legal services to banks, bank holding companies, and directors, officers and shareholders. He can be reached at llechler@kslawllp.com or 210-585-2187.

A common concern among Subchapter S banks is inadvertent termination of its S election. Inadvertent terminationscan be caused by attempted transfers of stock to ineligible stockholders and oftentimes these attempted transfers are not discovered until long after the date of transfer, leading to a complicated process of seeking a waiver and correction of the terminating event from the IRS.

In evaluating potential termination events, it is essential to determine whether a terminating event actually occurred and whether a waiver from the IRS is in fact necessary. In recent reviews of potential terminations caused by transfers to ineligible shareholders, it was determined, based on a review of the bank’s shareholders’ agreement, that no transfer had actually taken place as transfers that would jeopardize the bank’s S election were prohibited transfers and prohibited transfers would be void ab initio and not recognized as a valid transfer on the books of the bank. Moreover, several private letter rulings from the IRS noted that if an attempted stock transfer is void under state law, the IRS would not view the transfer as occurring and accordingly, there was not a terminating event and the company would be treated as continuing to be an S corporation from the date of its S election and no waiver of an inadvertent termination would be necessary. One such letter ruling even determined that an attempted shareholder transfer initiated intentionally to terminate the company’s S election would not be recognized by the IRS as it violated the company’s shareholder agreement. As evidenced by these letter rulings, a well drafted shareholders’ agreement can provide essential protection to Subchapter S banks and their shareholders. Such an agreement can mean the difference of an inadvertent termination and simply ignoring a transaction that under state law did not occur.

When evaluating a potential termination, Subchapter S banks should seek the advice of legal counsel for a thorough review of its shareholders’ agreement and relevant state law. In informal conversations over the years with the Chief Counsel’s office at the IRS, we have heard differing views about the “void ab initio” argument and about the applicability of state law. These are issues that should be carefully fleshed out before a course of action is decided upon, as they are fact dependent. Nonetheless, Subchapter S banks should make efforts to ensure their shareholders’ agreements are up to date and in accordance with current law in order minimize possibilities for inadvertent terminations and provide adequate protections to the bank and its shareholders for costs that might be incurred related to such transactions.

J. Lucas Lechler is an attorney at Kennedy Sutherland LLP, which provides comprehensive legal services to banks, bank holding companies, and directors, officers and shareholders. He can be reached at llechler@kslawllp.com or 210-585-2187.

1. Does the IRS has any procedure whereby an S corp could obtain a copy of their election forms to verify the election was filed correctly?

Answer: Entity’s Request for Election Verification

If the entity wants a copy of their Form 2553, they should submit Form 4506, Request for Copy of Tax Return, to the center that processed the Form 2553. There is a fee for the request.

If they want a Letter 385C (S election approval), they can call the BMF toll free line (1-800-829-0115) and request the letter be faxed.

If you find out there is not an S election you can request late election relief if:

• The entity intended to be classified as an S corporation, is an eligible entity and failed to qualify as an S corporation solely because the election was not timely;
• The entity has reasonable cause for its failure to make the election timely;
• The entity and all shareholders reported their income consistent with an S corporation election in effect for the year the election should have been made and all subsequent years; and
• Less than three years and 75 days have passed since the effective date of the election

In addition, if the electing entity is requesting a late corporate classification election to be effective on the same date that the S corporation election was intended to be effective, the requesting entity must also meet the following additional requirements:

• The entity is an eligible entity as defined in Treas. Reg. § 301.7701-3(a);
• The entity failed to qualify as a corporation solely because Form 8832 was not timely filed; and
• The entity timely filed all Forms 1120S consistent with its requested classification as an S corporation.

If other requirements are met, late election relief may be obtained currently for 2014 and subsequent years. Prior years would need to go for a PLR.

2. How will the repair regs affect IRS audits? What will the agents be looking for? When will audits include repair rev issues?

The Tangibles Property Regulations, are effective for taxable years beginning on or after 1-1-2014. As with any issue, documentation is important. Ensure that your clients have documentation to support a position taken on their returns. The Final Tangibles Regulations have many examples. Therefore, it is helpful to provide the examiner the specific regulation section and any example that was relied upon in the treatment of an item or items on a return. More information is located on IRS.gov. Tangible Property Regulations – Frequently Asked Questions. https://www.irs. gov/businesses/small-businesses-self-employed/tangible-property-final-regulations?_ga=1.71461851.978901568.1426169393

3. Any udates in shareholder compensation rules for closely held s-corps?

No real updates in this arena. Bottom line if the employee-shareholder is paid for services rendered, it should be a wage. If you have a one man show and his services generate all the profits, there is little justification on why any payment he
receives should not be classified as a wage. IRS.gov has a couple pages dealing with officer’s compensation.

4. Will the IRS ever issue rules to allow for penalty abatement of late S Corp filing that parallels the late filing for partnerships?

S corporations do not qualify under the Small Partnership Provisions, Rev. Proc. 84-35. Under Rev. Proc. 84-35 a domestic partnership consisting of ten or fewer partners and coming within the exceptions outlined in IRC § 6231(a)(1)(B) will be considered to have met the reasonable cause test and will not be subject to the penalty imposed by IRC §6698 for the failure to file a complete or timely partnership return, provided that the partnership, or any of the partners, establishes, if so requested by the Internal Revenue Service, that all partners have fully reported their shares of the income, deductions, and credits of the partnership on their timely filed income tax returns.

          (B) Exception for small partnerships.–

                     (i) In general.–The term “partnership” shall not include any partnership having 10 or fewer partners each of whom is an individual (other than a non-resident alien), a C corporation, or an estate of a deceased partner. For purposes of the preceding sentence, a husband and wife (and their estates) shall be treated as 1 partner.
                     (ii) Election to have subchapter apply.–A partnership (within the meaning of subparagraph (A)) may for any taxable year elect to have clause (i) not apply. Such election shall apply for such taxable year and all subsequent taxable year unless revoked with the consent of the Secretary.

Requirements: Non-TEFRA partnership and all partners reported their share of income, deductions, and credits on a timely filed return. Each partner is either an individual (excluding nonresident aliens), or the estate of a deceased partner and each partner’s items of income, deductions, and credits are allocated in the same proportion as all other items of income, deductions, and credits.

NOTE: This provision does not apply to an S corporation.

Net Investment Income (NII) Tax

• IRC § 1411 imposes 3.8% surtax on the NII of individuals, estates and trusts
• Effective for tax years beginning after December 31, 2012
• Form 8960, Net Investment Income Tax – Individuals, Estates, and Trusts
• Individuals pay an additional 3.8% tax on the lesser of; 1.) NII or 2.)The excess of the taxpayer’s modified adjusted gross income (MAGI) over the applicable threshold amount (NII Modified AGI = AGI unless he has foreign earned income).
• Modified AGI: 1.) Joint & Qualifying Widow(er) with dependent child = $250,000 2.) Single & Head of household with qualifying person = $200,000 3.) Married filing separately = $125,000 4. Trusts (defined in IRC § 67(e)

The threshold is established at the dollar amount at which the highest tax bracket in IRC § 1(e) begins for such taxable year. See the Form 1041 – Instructions, Schedule G, line 1a and the Form 1041-QFT Instructions, line 13. Because the threshold is tied to the tax bracket, the threshold amounts are adjusted for inflation, unlike the threshold amounts for individuals.

Category 1 – IRC § 1411(c)(1)(A)(i):

• Interest
• Dividends
• Annuities
• Royalties
• Rents

Unless derived in the ordinary course of a trade or business that is not passive or trading activity

Category 2 – IRC § 1411(c)(1)(A)(ii):

• Net income from passive trade or business activity under IRC § 469, or
• Net income from a trade or business of trading in financial instruments or commodities.

Category 3 – IRC § 1411(c)(1)(A)(iii):

• Net gain from disposition of property
• Other than disposition of property used in the taxpayer’s non-passive, non-trading business.

The following categories of income are not NII:

• Wages and alimony,
• Operating income from non-passive business that is not a trading activity,
• Distributions from retirement plans, 401(k) plans and traditional and Roth IRA’s,
• Social Security benefits,
• Tax exempt interest, qualified dividends, and
• Unemployment compensation.
• Income that is included in self-employment income is NOT included in NII.
• Income that is NOT included in self-employment income may or may not be included in NII.

Distributions
Generally an entity that has always been taxed as an S corporation will only have non-dividend distributions. But if the corporation ever operated as a C corporation or the entity acquired a C corporation with a carryover basis (for example through a merger) then it can have C corporation earnings and profits which, when distributed, are dividend distributions.

• The S corporation is responsible for determining the amount of the total distributions that are dividend and non-dividend distributions. The non-dividend distributions are reflected on Box 16d. They reduce stock (not debt) basis, but not below zero. If the shareholder receives a dividend distribution, it should be reported on Form 1099-DIV. A dividend distribution does not increase or decrease the shareholder’s basis.
• The other item I will mention relating to distributions is that distributions can be disproportionate in a given year. But keep in mind that an S corporation can only have one class of stock. So if I am the 20% shareholder, I am entitled to 20% of the distributions and liquidation rights of the company. I can receive more or less in a given year, but in a later year, it should balance out. Treas. Reg. § 1.1361-1(l)(2)(vi).
• Finally, payments to a shareholder for services rendered by the shareholder should be wages (subject to employment taxes) and not distributions.

This cannot be sited as authority , but other thoughts….

Material participation
A taxpayer materially participates in an if he works on a regular, continuous and substantial basis in operations. IRC 469(h). If a taxpayer does not materially participate, losses are nondeductible in the absence of passive income. Material participation is time sensitive. A taxpayer materially participates in an activity only if he meets one of the 7 tests in Reg.1.469-5T(a) for material participation. Certain hours, while they may actually be performed, are not counted in computing the hourly tests: investor-type activities, work not ordinarily done by an owner, and prior year time. See Reg. 1.469-5T(f).

Being the final decision-maker or having managerial authority does not constitute material participation. Making managerial decisions, having oversight responsibility, and having a significant financial investment do not necessarily constitute material participation – unless the taxpayer meets one of the 7 time sensitive hourly tests in Reg. 1.469-5T(a). The regulations hold that a taxpayer materially participates if and only if he rises to one of the tests, the most common being the 500 hour test. Material participation is determined at the individual level, not the entity level.

Travel Time: The following was copied from a TC Summary Opinion:
Petitioners treated all of their time traveling to and from the condominiums as “work” for purposes of determining their material participation in the condominium activities. The Court recognizes that travel in some circumstances can be “work” done in connection with a trade or business. The legislative history of section 469 suggests, however, that only participation that is integral to the operation of the business is to be counted for purposes of the material participationtest. S. Rept. 99-313, at 732 (1986), 1986-3 C.B. (Vol. 3) 1, 732. The Court finds that petitioners’ travel to their properties was not integral to their operation and will not be considered work for purposes of determining their materialparticipation in the condominium activities. See Toups v. Commissioner, T.C. Memo. 1993-359.

QSub
Info from my resources on QSub indicates that there are special rules for banks, so I did not pursue the issue further. After the QSub election is effective, the subsidiary is ignored for federal tax purposes. Though the subsidiary still exists under state law, it is a disregarded entity for federal income tax purposes. As such, only the parent is required to file a tax return and that return includes the QSub’s assets, liabilities, and items of income, loss, deduction and credit. Transactions between the subsidiary and parent are disregarded. For example, any “debt” between the subsidiary and its parent is not recognized and there is no interest deduction or any income inclusion as a consequence of inter-company payments.

The S corporation does need to track the activities of the subsidiary separately. For if it ever ceased to qualify as a QSub, there is a deemed recapitalization of the subsidiary with its assets, liabilities and history of profit or loss. One exception to this general deemed liquidation tax treatment is provided for entities that meet the definition of a bank. Any special rules applicable to banks continue to apply separately to the bank parent or the bank subsidiary as if the deemed liquidation of any QSub had not occurred.

Susan L. Kerrick has been a national S corporation technical advisor for S Corporations since September 2001. She is a Certified Public Accountant and has been with the Internal Revenue Service since July of 1984. Her duties include coordinating tax issues, training, outreach to the public, assisting National Office with various projects, conducting revenue agent case visits and answering examiner questions. During her career with the IRS, she has done extensive teaching both internally to IRS’s SB/SE and LB&I examiners, and externally to practitioners. Most recently she was involved in the 2016 IRS National Tax Forum. She has developed resources and provides guidance on S corporation and their shareholders.

ADA website-accessibility standards have not been issued by the federal government. In 2010, the US Department of Justice (DOJ) announced that was considering issuing regulations applying the ADA to websites. Originally, it was expected that DOJ would issue website-accessibility standards for places of public accommodation by the spring of 2014, [1] but the DOJ has now delayed issuing those regulations until 2018. The fact that there are no ADA rules and regulations currently governing website accessibility, however, has not stopped aggressive plaintiffs’ lawyers from filing lawsuits or threatening litigation based on allegedly inaccessible websites. Lawsuits claiming website violations of the ADA will face other legal obstacles in some circuits, including whether websites are subject to any accessibility requirements. In addition, plaintiff lawyer’s claims may understate the actual quality of accessibility features on a website. In evaluating lawsuit threats and allegations of ADA violations, the proprietor of the website should not assume that the threats or allegations are valid, but should independently evaluate the website’s accessibility features, make proactive enhancements to accessibility, and engage counsel to evaluate the validity of the claimed violations in the relevant federal circuit. We are working closely with a number of Banks and other Trade Associations on strategies to effectively and efficiently respond to these “hold-ups”. We are also hopeful that the Trump Administration takes a more aggressive and pro-business view to these matters.

Brent Farley is an attorney with Kennedy Sutherland LLP where he focuses on regulatory, compliance, corporate and transactional matters for financial institutions. Brent can be reached at bfarley@kslawllp.com or 210-610-2753.

Please join us at the Grand Hyatt in San Antonio, Texas on October 26-27, 2017!

Look for more information to come this Spring. If you have topics you would live to see covered or would like to sponsor please contact atrevino@kslawllp.com.

“If you’re complacent and just want to die slowly, that’s a choice. And we wanted to make another choice.” –Jill Castilla, CEO of Citizens Bank of Edmond, discussing the bank’s next 115 years.

Strategic planning is a concept that is as varied as the boards and senior management that conduct it. No one does it the same and many are not sure why they even do it. For some it is simply a part of their annual process – for others it is a hassle that is conducted to appease the regulators. Still for others, it isn’t even done (in these instances, someone in senior management is tasked with simply updating a template every couple of years). The fact that more boards of directors don’t buy-in to strategic planning is not surprising, this is, after all, an industry that believes “we know our customers” is a stand-alone strategy. In my experience, the typical community bank board composition is that of successful professionals and business owners who don’t conduct strategic planning in their own business, so why would it be needed in the bank?

Why you need a strategic plan.
“Plans are worthless, but planning is everything.” -Dwight D. Eisenhower

You can’t lead a team or an organization without a plan or roadmap. Your staff members want to know where their organization is headed and why. I understand that plans need to change quite frequently, (and that is why I like the 6X6 model for executing on strategic plans developed by Bill Hybels) but in the process of planning you have identified the priorities for your team and the reason for those priorities. You have empowered them to make decisions and move forward rather than simply react to the busyness of the day. This is invaluable.

For those of you who dismiss the preceding sentences and believe that your staff should simply stick to their assigned tasks and be content, I will talk to you another time about what you are missing by not creating a culture of empowerment in your bank and the benefits of building a high-performance organization.

Why “we know our customers” is not a strategic plan.
Knowing someone happens by virtue of being around them. Knowing someone does not mean that you are equipped to deal with any of their requests or respond to any problems they may have. I know that my oldest daughter is in a Spanish immersion program, but it doesn’t mean I am the best person to work with her on her homework or teach her Spanish, especially considering I didn’t retain any of it from high-school or college. And while I can identify a potential problem she may be having at school, as opposed to someone who isn’t aware, I lack both the knowledge and tools to provide her with an effective solution. The same applies to banking. Just because you know your customers doesn’t mean you are the best bank to provide for their banking needs. Your processes, products, services, and delivery systems must match those needs. Given the fact that banking is inherently profitable, few banks are directed by their boards to segment their customers by type and needs and then
outline the solution sets that the bank should offer. Instead banks rely on one of two options for determining solution sets (1) what we have always done or (2) whatever the guys across the street are doing.

Customer Loyalty is Overrated – Harvard Business Review Article by A.G. Lafley and Roger L. Martin from the January-February 2017 Issue
Most of my thoughts and opinions in this article came from years of working with and in community banks. But I also reviewed some of my favorite material regarding strategy and strategic planning, and during that effort I came across a new article in the latest edition of HBR. I found the article interesting and worth sharing. Given my belief that knowing your customer is only an opportunity to develop a strategy, and not a strategy in and of itself, and the current intersection of traditional banking and fintech, it is important to work harder to understand customer behaviors and identify what strategies banks should use to address potential threats.

The simple takeaway is that customers purchase things or make buying decisions in exactly the same way science has shown we make other decisions – as quickly as possible and with the least amount of effort. The Authors’ point is that, while the standard competitive advantage principles apply, once you leave the area of clear product or feature differentiation and into simpler buying decisions between comparable products or services our brains try to process information as quickly and easily as possible – read, our brains are lazy.

“Intuition—thoughts, opinions, and preferences that come to mind quickly and without reflection but are strong enough to act on—is the product of this process. It’s not just what gets filled in that determines our intuitive judgments, however. They are heavily influenced by the speed and ease of the filling-in process itself, a phenomenon psychologists call processing fluency. When we describe making a decision because it “just feels right,” the processing leading to the decision has been fluent.” Customer Loyalty is Overrated – Harvard Business Review   -Article by A.G. Lafley and Roger L. Martin

If you are serious about knowing your customers and making them happy, you need to work to continuously improve the process fluency by which they interact with you – this includes process, not just products or services. These interactions “cumulate,” as the Authors describe it, and lead to your customers choosing you over and over again because it is easy and builds a habit. Banks are being out done by fintech companies in the area of process fluency because fintech companies focus on delivering the best possible user experience (see Venmo, Starbucks App, Lending Club-the process, not the underwriting, Rocket Mortgage). Banks will have a competitive advantage in the area of storing deposits for some time to come, but they may lose their place as the point of interaction between customers and their money in the very near future.

 Here are some tips the Authors provide to build cumulative advantage:

1. Become popular early. My takeaway – don’t be the last to adopt new processes, products, services, or delivery platforms. Imbed innovation in your culture and build a framework for introducing it in an appropriate, non-shocking way.
2. Design for habit. My takeaway – focus on the user experience, build with beautiful design in mind. One of my biggest issues with community banks is that too few have adopted a philosophy of continuous improvement, which has broad applicability. As it relates to building customer habits, banks aren’t thinking about the process and way they interact with their customers and how it can be improved. Meanwhile fintech companies think about it and work on it daily.
3. Innovate inside the brand. My takeaway – This is something that we can all agree on: when you have a great brand, leverage it. Don’t get too cute.
4. Keep communication simple. My takeaway – As the Authors point out and I repeated, our brains are lazy, so keep your message simple. Save the complex message for the situations where the customer needs to be familiarized with something new. Additionally, the Authors reference Daniel Kahneman and his book Thinking, Fast and Slow (2011). I highly recommend this book. It provides great insight into how we make decisions – without even realizing it – and how to recognize your cognitive bias in action. A great animatedbook review is located here: https://youtu.be/tiyTYGY5X3Y

Your strategic plan preparation should include a review of your processes, products, services, and delivery systems in order to identify where you have a cumulative advantage that should be built upon and where you don’t and need to start.

Get Started

1. Write out your six goals for the year.
2. Write out your organization’s six goals for the year.
3. Pick a time and location (I recommend offsite for a day and a half) for your strategic planning meeting and provide everyone who will participate in it with the tasks in #1 and #2.
4. Find a facilitator and write up your agenda and meeting objectives.
5. Host the meeting.
6. Develop the plan from the meeting.
7. Set your checkpoints and project management plans from your six strategic goals.
8. Call me or email me with any questions.

William “Dub” Sutherland VI is a partner at Kennedy Sutherland LLP and advises the firm’s banking, business and not for profit clients on a range of corporate and strategic issues. He can be reached at 210-228-4444 or dsutherland@kslawllp.com.