The Influence of Tax and Non-Tax Factors on Banks' Choice of Organizational Form

Abstract

This paper identifies tax and non-tax factors that influence commercial banks conversion from taxable C-corporation to nontaxable S-corporation from 1997 to 1999. A 1996 tax-law change allowed banks to elect S-corporation status for the first time. We find that banks are more likely to convert when conversion saves dividend taxes, avoids alternative minimum taxes, and minimizes state income taxes. As well, banks are less likely to convert when conversion restricts access to equity capital, nullifies corporate tax loss carryforwards, and creates potential penalty taxes on unrealized gains existing at the conversion date. Moreover banks that would be required to write-off large deferred tax assets are less likely to convert because conversion decreases regulatory capital and exposes the bank to costly regulatory intervention. We also investigate the strategic choices banks made in anticipation of an S-election. We conclude that converting banks made anticipatory changes to their capital structure, deliberately sold appreciated assets, and strategically cut dividends to augment the net benefits from a planned election.

Keywords: organizational form, S-corporation, regulatory costs, strategic behavior, deferred tax

JEL Classification: G21, G32, M41, H25