Tax Cuts To Take Center Stage

Taxes are expected to dominate the initial agenda of the incoming presidential administration and the new Congress. And it’s a topic that appeals to bank directors, too.

Under President-elect Donald Trump’s prior administration, Congress passed the Tax Cuts and Jobs Act of 2017. That bill significantly overhauled the tax code, including permanently cutting the corporate tax rate from 35% to 21%.

However, Congress also enacted other changes that are set to expire at the end of 2025. This included creating a provision known as 199A, which allows taxpayers with income from a pass through entity, such as a Subchapter S corporation, to deduct up to 20% of their qualified business income. That change helped to reduce the top tax rate for qualified business income for owners of S corporations, sole proprietors and partnerships to 29.6%. 

About a third of all banks are organized as S corporations, meaning that a significant portion of the industry could be negatively impacted if Congress fails to extend the provision, according to Patrick Kennedy, Jr., founding partner of the law firm Kennedy Sutherland and president of the Subchapter S Bank Association.

If Congress doesn’t act to extend the 199A provision then that would give C corporations a tax advantage and could make converting to this type of entity more desirable for many institutions. 

“When the 2017 Tax Cuts and Jobs Act was passed, there was a lot of analysis happening,” says J. Michael Cornett, managing director in the national tax office of the professional services firm Forvis Mazars US. “The 199A cap, which gave S corps a reduced rate, allowed many to remain as S corps. You will see the same sort of analysis happen if 199A is not extended. Whether banks convert would depend on the individual bank’s shareholders and the complexity of their structure.”

Republicans have made it clear that extending the tax cuts from the 2017 legislation is a priority, says Kasey Pittman, director of the accounting firm Baker Tilly’s tax policy practice. Lawmakers have pledged to take up the matter within the first 100 days of the new administration, which would be by April 30. Republicans are widely expected to do this through budget reconciliation, an expedited process for legislation tied to spending, taxes and the debt ceiling that’s exempt from filibuster rules in the Senate. That’s key since Republicans will have only a slim majority at 53 seats in that chamber, far short of the 60 required to prevent a filibuster.

Republicans are also expected to hold a majority in the House, though, again, this will be small. As of Tuesday morning, 219 House seats had been called for Republicans, one more than needed for a majority. There were still three races undecided.

“There will be small margins. When that happens, that means individual lawmakers will have a big influence. We saw that in 2023 when eight Republicans essentially ousted the House speaker,” Pittman noted, referring to when a handful of Republicans joined House Democrats to narrowly vote to replace then-Speaker Kevin McCarthy last year.

Experts agree that it is far more likely now that the 2017 tax cuts will be extended. But how that is done is still to be determined. Republicans still need to write their instructions outlining what they will allow in terms of changes to the debt limit, revenue and spending and over what time period for this new legislation.

To stay within the parameters Republicans eventually outline, lawmakers may have to make concessions, and there are some competing interests within the party, Pittman says. For instance, there are deficit hawks who will be concerned about adding to the national debt. There is also a strong caucus of Republicans who are eager to see the elimination of the $10,000 cap on deducting state and local taxes — commonly referred to as SALT — from federally taxable income, Pittman adds. The SALT cap was also imposed by the 2017 bill and is set to expire at the end of 2025. And there are several Republicans who have signaled a willingness to slightly increase the corporate tax rate in order to offset tax cuts in other areas.

All of that is to say bank leaders will need to watch to see how any extension of provisions from the 2017 legislation or new changes that could be enacted will affect their overall tax obligations. These finer details should become clearer early next year.

“That’s what we don’t know — it’s all of that horse trading,” Pittman says. “We do know that Republicans are united in the general premise.”

Kennedy is hopeful that Congress will not only extend the 199A provision but actually improve upon it. Currently, some taxpayers can’t use the full benefit of the deduction on certain types of income, such as earnings from the bank’s trust department, which is considered investment management income under the 199A provision. “It’s complex and an additional burden,” he adds.

If the tax cuts from the 2017 bill expire then the top marginal tax rate for many business owners would increase from the current 29.6% to 39.6%. If that happens, Subchapter S banks may have to rethink their structure.

Unlike a C corporation, Subchapter S businesses do not pay federal income taxes on earnings. Instead, that tax obligation is passed on to shareholders who pay taxes at their personal rate. This avoids that income being taxed twice – once at the corporate level and then again when shareholders pay taxes on distributions they receive.

However, the structure also has certain disadvantages. For instance, S corporations are limited to 100 shareholders who must be individuals, though there are a few exceptions. That can make it more difficult for Subchapter S banks to raise capital for growth, acquisitions or other needs. 

“When the corporate and personal tax rates are close together, the primary benefit of an S corp is the tax liability is passed onto the shareholder instead of being at the corporation. There is no double taxation,” says Jeff Davis, managing director at Mercer Capital, a financial advisory firm. “If the 199A provision is extended, then nothing changes. If it expires, I think what you would see is the advantage of being an S corp is greatly diminished.”

For right now, Ryan James, CEO of Surety Financial Holdings in Deland, Florida, is far more optimistic about the 199A provision being extended now that Republicans control both chambers of Congress and the White House. The $206 million Surety Bank has been an S corporation for “many years,” he says. James likes this structure because he believes that since S corporations have a limited number of shareholders, each one has a bigger stake in the company’s success.

“We wouldn’t change our structure unless something drastically changed,” James says. “[Subchapter S] management and board members have a lot of skin in the game. They are aware of that and realize that they can be directly affected by every transaction at the bank.”