written by Jacque Mattson

Things to consider about Basel III and tax planning for your bank.

The capital conservation buffer requirement under Basel III will restrict the amount of capital distributions banks are allowed to make to their shareholders. Sub S banks are most affected by this requirement because the bank distributes income to its shareholders who pay the tax whether the bank is able to pay out distributions or not. C-Corp banks with taxable income are able to pay out the taxes owed whether they issue dividends or not. However, Sub S bank shareholders rely on the distributions given out during the year in order to help offset the taxes they will owe due to the bank’s income.

Starting January 1, 2016, banks will be required to keep a risk based ratio of at least 8.625% (0.625% above the minimum requirement) in order to issue distributions to their shareholders. The buffer increases by 0.625% a year until it levels out at 2.5% in 2019 (or risk based ratio of 10.5%). If the risk based ratio of 10.5% cannot be met by a Sub-S bank, then the FDIC allows for the bank to request an exception to the capital conservation buffer dividend limits in order to help shareholder’s cover the potential income taxes they would owe on the bank’s income. The request is based upon facts and circumstances with four factors that the bank can use in order to make its case with the FDIC for approval.

If in 2019, the bank has a risk based ratio exceeding the minimum requirement by 2.5% (i.e., above 10.5%), they would not be affected by the capital conservation buffer requirement and would be able to issue dividends to shareholders without limitation. If the bank’s buffer is above 1.875% but below 2.5%, they would be limited in the amount of distributions that could be issued to their shareholders (dividends of no more than 60% of eligible retained income). The amount of distributions that can be issued to shareholders continues to be reduced based upon the reduction in the bank’s buffer: above 1.25% but below 1.875% – no more than 40% of eligible retained income; above 0.625% but below 1.25% – no more than 20% of eligible retained income; below 0.625% – no distributions allowed to be issued to shareholders.

For Sub S banks, these new requirements raise some important questions: does the cost of holding more capital outweigh the cost of the double taxation incurred by C-Corp banks? How do we plan for or watch the ratio calculations in order to determine if approval will be needed before distributions are made to shareholders? Sub S banks that want to keep their Sub S status will likely need to start thinking about tax planning and complete this planning towards the end of 2015 in order to determine how their risk based ratio stands currently and what actions need to be taken in order to meet the new requirements for 2016 and beyond.

If you would like to know more about the new Basel III capital requirements will affect you, please contact us 417-881-0145.