[Congressional Record Volume 154, Number 114 (Friday, July 11, 2008)]
[Senate]
[Pages S6605-S6607]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. HATCH (for himself and Mrs. Lincoln):
  S. 3254. A bill to amend the Internal Revnue Code of 1986 to allow 
banks to be taxed as limited liability companies, and for other 
purposes; to the Committee on Finance.
  Mr. HATCH. Mr. President, on behalf of myself and my dear friend and 
colleague, Senator Lincoln, I rise today to introduce the Small Bank 
Tax Equity Act.
  One of the many important duties of Congress is to ensure that the 
various laws that govern commerce in this Nation are working as 
efficiently as possible. This can be a significant challenge because of 
the rate of change and innovation occurring in our world today. 
Nevertheless, we need to be aware that changing circumstances can lead 
to obsolescence in our laws, which can have a limiting effect on 
economic growth and on our ability to compete in an ever-more 
challenging marketplace.
  This is as true of our tax laws as it is with any other laws. We 
often speak of the many problems of the Internal Revenue Code, and most 
of them have to do with complexity and perceived unfairness. However, I 
believe that the issue of outdated or obsolete provisions that no 
longer reflect the realities of our changing world is also an obstacle 
that deserves our attention.

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  This is why I am pleased today to be introducing legislation that 
would reverse an outdated administrative rule and allow banks the 
flexibility to be structured in a much more tax-efficient manner. Under 
our bill, the Small Bank Tax Equity Act, banks that are organized as 
limited liability companies would be able to elect to be taxed on a 
flowthrough basis. Under this treatment, the bank's shareholders would 
be taxed each year on the bank's income, but the bank would not also be 
subject to a second layer of tax on that same income at the entity 
level.
  A little history is in order here. Treasury Department regulations 
have long allowed limited liability companies to be classified for tax 
purposes as flowthrough entities. Under this classification, the 
company's owners are subject to tax on the company's income on a flow-
through basis. This allows the very significant advantage of not being 
subject to the double taxation characteristic of corporations, as all 
banks are currently taxed.
  Those same Treasury Department regulations specifically deny banks 
that are organized as limited liability companies the benefit of flow-
through tax treatment, even though this favorable treatment is 
available to other types of businesses. While banks can organize as 
limited liability companies, for tax purposes, they are taxed as 
corporations.

  It is important to note that at the time the Treasury Department 
issued these regulations, banking laws actually required all banks to 
be organized in the corporate form under state law in order to obtain 
federal deposit insurance. In fact, this requirement was cited in the 
regulations as the reason for the denial of flow-through tax treatment 
to banks that have federal deposit insurance.
  However, this aspect of the banking laws has been changed. In 2003, 
the Federal Deposit Insurance Corporation FDIC, issued regulations 
permitting banks to be organized as limited liability companies and to 
qualify for federal deposit insurance.
  Following this FDIC action, it was expected that the Treasury 
Department would likewise change its regulations to allow banks 
organized as LLCs to enjoy flowthrough tax treatment. However, despite 
the urging of several Members of Congress, including myself, Treasury 
has declined to make this change administratively. The continued denial 
of flow-through tax treatment of bank limited liability companies is, 
in my view, unjustified and anti-competitive. Moreover, it fails to 
bring the law up to date with current business practices.
  In 1996, Congress amended the Subchapter S corporation rules, which 
provide flow-through tax treatment, to allow banks to be organized as S 
corporations. This change reflected Congress's belief that the S 
corporation election should be allowed for banks, just as it is allowed 
for other businesses meeting the qualifications for this important tax 
regime.
  The legislation we are introducing today is based on exactly the same 
belief. The flow-through treatment that would be made available under 
the bill will give America's smaller banks, including the community 
banks on which we depend to provide funding to allow small businesses 
to expand and thrive, another option for organizing in the most 
efficient manner.
  The changes we made in 1996 to Subchapter S to allow banks to elect 
flowthrough tax treatment was very well received by the banking 
community, and today there are thousands of S corporation banks 
throughout America. The Small Bank Tax Equity Act will mean that banks 
would be able to choose the limited liability company structure, which 
allows even greater flexibility in raising capital than does the S 
corporation form of entity. I expect that the election for flow-through 
tax treatment for LLCs allowed under this bill to be as well received 
as the election for S corporation status has been and that many smaller 
banks, especially newly-established ones, will avail themselves of this 
opportunity.
  My home State of Utah in 2004 enacted laws allowing banks to be 
organized as limited liability companies. In light of the 2003 FDIC 
rule change that allowed LLC banks to qualify for federal deposit 
insurance, Utah enacted this legislation in order to facilitate the 
most efficient and flexible structure for small banks. Other states 
have passed, or are considering, similar laws. Many others would likely 
follow suit if the tax rules paralleled the deposit insurance 
treatment. However, the goals of these states in passing these laws 
will not be realized until the tax law is also updated to provide 
flowthrough tax treatment for banks that choose to operate in this 
form.
  The following is a brief technical description of the Small Bank Tax 
Equity Act.
  The Small Bank Tax Equity Act would provide qualifying banks with an 
election to be classified for tax purposes as a partnership or to be 
disregarded as a separate entity, in the case of a bank with only a 
single ownernlecting this classification would provide flow-through tax 
treatment to the electing bank. Under the bill, the election is 
available to State-chartered business entities that conduct banking 
activities, that have federal deposit insurance, and that are organized 
as limited liability companies. These are the banks that are excluded 
from flow-through treatment under the existing Treasury regulations 
that were written based on pre-2003 FDIC rules.
  If a bank makes the election allowed under the Small Business Tax 
Equity Act before the end of a two taxable year transition period 
following enactment, the election would not subject the bank to 
immediate tax on any appreciation in its assets. Instead, the electing 
bank would be subject to special rules with respect to the taxation of 
gains and losses that are recognized during the ten-year period 
following the election. These special rules mirror the special rules 
that apply when an entity elects to convert to S corporation status.
  These special rules would not apply, however, to an electing bank 
that had begun conducting banking activities after February 12, 2003, 
the date of the FDIC action allowing State-chartered banks organized as 
limited liability companies to obtain federal deposit insurance. These 
banks acted with the expectation that flow-through tax treatment would 
be available and should not be penalized for the delay in being able to 
obtain that treatment. Thus, under the Small Bank Tax Equity Act, 
making the election for flow-through treatment will not trigger any 
special tax consequences with respect to inherent gains or losses for 
these banks.
  Small businesses are the backbone of the American economy. They are 
responsible for creating the most jobs in this Nation, particularly 
during economic slowdowns, such as we are experiencing now. Smaller 
banks are important for at least two reasons. They are small businesses 
themselves, and they serve other small businesses and provide them with 
the capital they need to grow and create jobs.
  It is our duty to ensure that America's small businesses operate as 
efficiently as possible. This means that our tax laws need to be 
friendly and offer flexibility, rather than hidebound and obsolete, in 
order to encourage the kind of growth of which our small business 
sector is capable. This bill would take a very significant step in that 
direction, and I encourage our colleagues to support this legislation.
  Mr. President, I ask unanimous consent that the text of the bill be 
printed in the Record.
  There being no objection, the text of the bill was ordered to be 
placed in the Record, as follows:

                                S. 3254

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. ELECTION FOR CERTAIN BANKING ENTITIES TO BE TAXED 
                   AS LIMITED LIABILITY COMPANIES.

       (a) In General.--Section 7701 of the Internal Revenue Code 
     is amended by redesignating subsection (p) as subsection (q) 
     and by inserting after subsection (o) the following new 
     subsection:
       ``(p) Classification Election for Certain Banking 
     Entities.--
       ``(1) In general.--For purposes of this title, an entity 
     described in paragraph (2) may elect to be treated as a 
     partnership or, if the entity has a single owner, to be 
     disregarded as an entity separate from the owner.
       ``(2) Entity described.--An entity is described in this 
     paragraph if--
       ``(A) it is a State-chartered business entity conducting 
     banking activities,
       ``(B) any of its deposits are insured under the Federal 
     Deposit Insurance Act (12 U.S.C. 1811 et seq.) or a similar 
     Federal law, and
       ``(C) it is organized as a limited liability company under 
     the laws of a State.

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       ``(3) Treatment of entity.--An entity that makes an 
     election under paragraph (1) shall not be considered a bank 
     as defined in section 581.
       ``(4) Transitional rule.--
       ``(A) In general.--In the case of an entity that makes an 
     election under paragraph (1) before the beginning of the 
     third taxable year beginning after the date of the enactment 
     of this subsection--
       ``(i) no gain or loss shall be recognized to the entity or 
     its owners by reason of such election, and
       ``(ii) rules similar to the rules of section 1374 shall 
     apply to the entity.
       ``(B) Exception.--Subparagraph (A)(ii) shall not apply to 
     an entity that began conducting banking activities after 
     February 12, 2003.''.
       (b) Effective Date.--The amendments made by this section 
     shall apply to elections made after the date of the enactment 
     of this Act with respect to taxable years ending on or after 
     December 31, 2007.
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