The ABA Tax Section has submitted comments to the IRS on Proposed Regulations under Section 1363(b) Concerning S Corporation Banks.  Here is the Executive Summary:

The IRS has proposed to amend the section 1363 regulations with respect to the application of certain banking provisions to banks that are either S corporations or qualified subchapter S subsidiaries.1 The Proposed Regulations would apply the 20-percent proportionate disallowance provisions of section 291(a)(3) and (e)(1)(B) relating to financial institution preference items to a bank that is an S corporation. These Proposed Regulations would apply to an S corporation that has never been a C corporation, as well as to an S corporation that has passed the three-year period specified in section 1363(b)(4). They would presumably also apply to determine the income of a bank that is a qualified subchapter S subsidiary.

We respectfully submit that the Proposed Regulations are inconsistent with the relevant provisions of the statute.

The application of the section 291 tax-preference provisions to an S corporation is governed by section 1363(b)(4). Section 1363(b)(4) states that section 291 applies to an S corporation if the corporation has been a C corporation during any of the preceding three taxable years. The meaning of this provision is clear and unambiguous. Under the statutory provision, after the expiration of the three-year period for an S corporation, that corporation is no longer subject to any of the provisions of section 291, including the provision that reduces the allowable deduction for interest expense incurred by a bank.

We find no other relevant statutory provision that either conflicts with the application of section 1363(b)(4) to an S corporation bank or creates an ambiguity in the application of this rule to such banks. We believe that, if the Service seeks to attain the result provided by the Proposed Regulations, Congress would need to amend section 1363(b)(4). We take no position in these Comments regarding the policy arguments in support of or against such a legislative modification.