bank report Proposed 199A Regulations Could Disqualify Some Banks from the QBI Deduction - Call to Action by those affected In This Issue

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1 the sub bank report Volume 21, Issue 2 September 2018 Subchapter S Bank Association, Inc. 112 E. Pecan St., Ste San Antonio, TX (210) President Patrick J. Kennedy, Jr. pkennedy@kslawllp.com Executive Director Amy Willcox awillcox@kslawllp.com Advisory Board Guy Colado Chairman & CEO Commerce National Bancshares of Florida, Inc. Winter Park, FL Peter J. Haddeland President & CEO F.N.B. in Mahnomen Mahnomen, MN Alfred B. Jones Director American Bank, N.A. Corpus Christi, TX John J. Madden President & CEO F.N.B. of La Grange La Grange, IL Randy Rouse Executive Vice President & Chief Investment Offi cer Broadway Bank San Antonio, TX Jill Castilla President Citizens Bank of Edmond Edmond, OK Proposed 199A Regulations Could Disqualify Some Banks from the QBI Deduction - Call to Action by those affected By: Patrick J. Kennedy, Jr., and William Dub Sutherland, VI We advised our members that the US Treasury had proposed regulations under section 199A of the Tax Cuts and Jobs Act on August 8, The proposal was published in the Federal Register on August 16, 2018 and the comment period is open until October 1, A public hearing has been tentatively scheduled in Washington DC for October 16, The proposal clearly affi rms that Subchapter S Banks are entitled to the 20% qualifi ed business income (QBI) deduction. This deduction was Congress way of creating parity for Subchapter S banks whose C corp counterparts were receiving a tax rate reduction from 35% to 25%. In essence the top federal income tax rate was 39.5% and after calculating the QBI deduction, Sub S Bank income will be taxed at 29.5%. Unfortunately, the regulation does not clarify that all core banking activities qualify for the deduction which we believe Congress intended. The issue arises because certain core banking activities could potentially be classifi ed as specifi ed services trade or business (SSTB). It appears Treasury sought In This Issue Proposed 199A Regulations Could Disqualify Some Banks from the QBI Deduction - Call to Action by those affected...1 Banks Maintain S Elections...3 Proposed Regulations and Sub S Banks: Key Points for Consideration...4 Tax reform - S bank letter to Treasury...6 What are Gross Receipts under Proposed 199A Regulations? Subchapter S Bank Association, Inc. All rights reserved.

2 to address this by proposing a de minimis rule; however, the de minimis rule as proposed may immediately result in over 200 Subchapter S Banks being completely ineligible for the QBI deduction if certain of the SSTB -like activities they conduct exceed the de minimis gross receipts limits. The regulation specifically lists 13 activities that are deemed to be SSTBs. Five of these potentially describe business activities that banks are generally empowered to conduct and can be considered to be traditional or core banking activities. The first is financial services which is further defined in the proposed regulation to include managing wealth, advising clients with respect to finances, developing retirement plans, provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions and raising capital and acting as a client s agent in the issuance of securities and similar services and also specifically includes services provided by financial advisors, investment bankers, wealth planners and retirement advisors and other similar professionals performing in their capacity as such. The introductory Background to the proposed regulations makes clear that Treasury agrees that Congress did not intend to include banks in the definition of financial services under Section 1202 (e) (3) (A), notably though the above definition of financial services includes a number of activities that Banks conduct directly or through separately incorporated subsidiaries or holding company affiliates. The other four SSTB activities defined in the proposed regulation are listed below and also describe activities banks may be conducting. Brokerage services as described in (b)2(x) Investing and investment management as described in (b)2)(xi) Trading as described in (b)(2)(xii) and Dealing in securities (as defined in section 475(c) ((2) of the Code and (b)(2)(xiii) of the proposed regulation. While trust management services are not among listed SSTB activity, our informal discussions with client banks indicates a wide variation in the way trust and custodial customers are charged for services and that many rely on a fee for assets under management which could be considered a SSTB like activity. Similarly, the definition of dealing in securities could include such core banking activities as originating and selling mortgage or other loans, including loan participations and government guaranteed loans. The proposed rule contains a provision that we believe may have been designed to deal with the above concern of Sub S Banks though not specifically addressed to banks. In Section 1.199A-5, a de minimis rule is proposed which provides that a trade or business is not an SSTB if less than 10% of the gross receipts (5% if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. If a bank reaches or exceeds these amounts, the plain meaning of the provision would treat the entire bank trade or businesses as an SSTB and disqualify it for the QBI deduction. Our review of Sub S Bank call report data indicates that over 300 Sub Banks would exceed this de minimus rule. Further, using a gross receipts test does not take into account the inevitable swings in interest rates which affect bank gross receipts dramatically as rates rise. The proposal does not provide any way for these changes to be considered so as rates rise, the number of Banks exceeding the de minimis rule could dramatically increase. Some professionals have suggested an interpretation of the proposed regulations would allow a bank to treat such SSTB like activity as a separate trade or business and therefore not be subject to the de minimis rule. Assuming this is permitted or intended by the Treasury, such income would not be eligible for the QBI deduction. We think this result, if intended by Treasury is not consistent with Congressional intent to provide parity for Sub S banks by including them in the QBI deduction. We do not think there is enough clarity to support this interpretation with certainty and would not recommend reliance on this interpretation without further clarity from Treasury. The Association is actively reviewing the 184 pages of the regulation and preparing to submit comments and has scheduled a meeting with Treasury officials responsible for drafting the proposed regulations. We will be taking the position that we believe that Congress intended that all Sub S Bank income should be eligible for the QBI deduction. A result different than that would be unfair and would put Sub S Banks at a competitive and financial disadvantage to C corp Bank, certainly not the intent of Congress. Page 2

3 We need the assistance of every Subchapter S Bank in the country to identify particular issues that we can bring to the attention of the Treasury during these discussions and comment period. In preparing our comments and meetings with Treasury we would like to obtain as much detailed information from Sub S banks as possible. If your institution is involved in any of the foregoing activities, you should review the de minimis rule carefully and determine whether you are close to or exceed the de minimis threshold of 10% of gross receipts. If you do, please contact us and we will be pleased to try to include your particular facts in the examples and discussions we plan to have with US Treasury. Thanks very much for your continued support as we fight to resolve these issues in a manner which confirms that the QBI deduction is applicable to all Subchapter S Bank or bank holding company income. Please contact any one of the following regarding the proposed regulation and the potential issues your institution may be facing. Patrick J. Kennedy, Jr pkennedy@kslawllp.com Dub Sutherland dsutherland@kslawllp.com Amy Willcox awillcox@subsbanks.org Banks Maintain S Elections As of December 31, 2017, there were 1,965 sub S banks; as of March 31, 2018, 45 reported on call reports that they were no longer Sub S. At June 30, 2018, an additional 11 banks that were Sub S at year end 2017 had converted to C. Of the total conversions, 35 were due to mergers. These numbers support our experience with members and clients; most Sub S banks are pleased with their status and are looking forward to taking advantage of the 20% Qualified Business Income Deduction created by the Tax Cuts and Jobs Act. Qualified Business Income Deduction Guidance Section 199A of the IRC established the Qualified Business Income (QBI) deduction which was the Senate s way of providing tax cuts to S corporations and other pass through business entities. Our last issue described the genesis of the deduction and outlined a number of complexities involved in its application. The informal working group we established with the ABA and ICBA shortly after the filing of HR 1 continues to be engaged in working on these issues. We met with Treasury officials in February to discuss the unique interpretive issues that some banks and bank holding companies have. These interpretive issues arise from certain activities that some banks conduct as a part of their business which could be described as specified services under the IRC, such as investment management and dealing in securities. Prior to that meeting the Association surveyed membership and discovered that approximately one third of respondents were involved in certain activities that might be subject to these concerns but that such activities in responding banks constituted less than 10% of the Bank s revenue sources. A subsequent ICBA survey confirmed these results. Our working group has put together a letter addressed to Treasury which outlines the issues and provides a rationale and basis for eliminating these concerns and simply following the clear Congressional intent to permit banks to receive the QBI deduction. We anticipate further discussion with Treasury officials and others. A copy of the letter is included in this Report. With the publication of the 199A regulation proposal, we believe Treasury sought to resolve the issue by creating a de minimus rule which is based on gross receipts. See our article on the definition of gross receipts in this Report. Unfortunately, 10% of net income can be quite different that 10% of gross receipts. As such we plan to revisit the issue with Treasury and are preparing a series of comment letters to Treasury which will urge revision of the regulations to declare all core banking activities, including those that may arguably be the same or similar to certain specified services, eligible for the QBI deduction. Page 3

4 Frequently Asked Questions About The Qbi Deduction And Proposed Regulations The complexity of Section 199A has created some confusion about its application and raised questions in many banker s minds and in the minds of some of their professional advisors. Here are some of the most frequent misconceptions we have encountered and have been working to clarify. Q. Is a bank s QBI deduction limited to the $157,000/$315,000 limits stated in Section 199A (e) (2)? A. No, Banks are not limited by the provisions of Section 199A (e)(2). That provision creates an exception to the Specified Service limitation of the QBI deduction and permits those engaged in a Specified Service, who are specifically excluded from taking the QBI deduction, to take the 20% deduction regardless of their income coming from a Specified Service so long as the taxpayers total individual/joint income does not exceed $157K/$315K. There is a phaseout of the deduction amount at $257K/$415K. Q. Does the 50% of W-2 wage limitation apply on an individual basis or on a corporate basis? A. This limit is applied using the shareholder s pro-rata portion of the S corp s entire W-2 wages against the shareholder s pro-rata portion of taxable income. Q. What constitutes the gross receipts of a Sub S Bank or bank holding company? A. Total gross receipts are defined at 26 CFR and include total interest income, total non interest income and gains from sale of loans or other assets and are not offset by expenses or losses. See separate article in this Report. Q. If my Bank has income from investment management, brokerage or loan sales which in the aggregate, exceed 10% of gross receipts, must we separate this income and not apply the QBI deduction? A. The proposed de minimus rule of 1.199A- 5 is drafted in such a way that if a bank exceeds the de minimus rule, all of its income regardless of source will be treated as coming from a specified service and thus will not permit any QBI deduction. This is of course a draconian result that we hope was not intended by Treasury which we will be seeking to clarify. Some professionals have suggested that a bank could simply separate the trades or businesses that would be considered specified services and apply the deduction to the balance of the bank s income; however, we and many other professionals see no clear cut basis for this position. Proposed Regulations and Sub S Banks: Key Points for Consideration The provisions under proposed reg. section 1.199A- 5 on a specified service trade or business (SSTB) address: the effect of classification as an SSTB (as defined in the regs), exceptions for taxpayers below the threshold amount, a de minimis exception, guidance on the meaning of the activities listed in the definition of SSTB, and the rules for determining whether a trade or business is treated as part of an SSTB. Under the de minimis rule, a trade or business is not an SSTB if less than 10% of the gross receipts (5% if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. 1. The regulations clarify that Congress intended Subchapter S banks to be eligible for the QBI deduction. We urge further clarification that there should be no limit on the type of activities that generate QBI for a Subchapter S bank so long as such activity is consistent with core banking activities. Certain of the SSTB type activities Page 4

5 described in Section 1.199A-5(b) (1) are core banking activities. If these core banking activities are treated as SSTB activities, a significant number of Subchapter S banks will exceed the 10% or 5% threshold proposed in section 1.199A-5(c)(1). We do not believe this was Congress intent. a. Many community banks conduct investment management, advisory and brokerage services as a regular part of their trust business for their customers. Most Subchapter S banks are located in rural areas that have limited access to such services. b. Many community banks regularly sell loans they originate to assure they have the liquidity and balance sheet room to continue to make loans in their communities. In many Subchapter S bank communities, that bank may provide the only mortgage lending opportunity, and without the ability to sell loans these banks cannot offer 15 year or 30 year mortgages. c. Subchapter S banks and their communities should not be penalized or forced to curtail such services to their communities as a result of the regulations, especially while C corp banks will be allowed to apply the new lower corporate rate to all of their activities. d. Congress intended Subchapter S banks to be eligible for the QBI as a way of providing parity to the C Corp 25% rate; it would be unfair to force Subchapter S banks to curtail, carve out or disqualify themselves altogether by making them subject to the SSTB rules. 2. We believe there is a distinction between SSTB activities such as investment management, advisory and brokerage when they are conducted by a community bank as opposed to similar activities conducted by an individual. A bank conducts such activity as core banking business and integral to and incidental to the business of making loans and deposits and serving the banking needs of their communities. In addition, there is a clear distinction between the IRS goal of limiting the QBI for businesses that rely on the performance of services and may have very little in the way of assets or investment in the business, but banks deploy significant capital and maintain significant payrolls in the delivery of their business. 3. Use of a de minimis rule is problematic for a number of reasons: a. The use of $25MM in gross receipts as an amount at which you limit benefits is arbitrary and an inappropriate measure to judge when applied to banks. Banking, as opposed to many SSTBs, generates large gross receipts in comparison to their actual industry size. Further, banking is subject to interest rate shifts and gross receipts will shift dramatically in a rising rate environment and shrink in a falling rate environment; therefore, there is no logic to applying a reduction from 10% to 5% when gross receipts exceed $25MM.; b. Because of the integral role the above referenced SSTB type activity plays in the core community banking industry, if a de minimis rule were to be established, it should be much higher in order to ensure that all Subchapter S banks income qualifies for the QBI deduction. c. Congress clearly did not intend for Subchapter S banks to be limited in the use of the QBI deduction as a result of permitted bank activities. 4. The aggregation rules seem to be overly complex and will be difficult for Subchapter S banks and their shareholders to apply. 5. The reporting and other determinations required of Subchapter S banks are particularly onerous and will put Subchapter S banks at a competitive disadvantage which is not what Congress intended. 6. The proposal advises qualified businesses that the rules become effective at the end of the tax year in which the regulations are finalized, but further advise that taxpayers may rely on the current draft. This creates significant uncertainty and risk to Subchapter S banks this year and next. For example, the current rule would disqualify a Subchapter S bank entirely if its SSTB income exceeds the 5 or 10 percent threshold. How can that bank operate, advise its shareholders or properly report to the IRS during the next 18 months while the regulations are being finalized. Page 5

6 Tax reform - S bank letter to Treasury VIA ELECTRONIC MAIL September 21, 2018 Internal Revenue Service 1111 Constitution Avenue, N.W. Washington, DC RE: Comments on Proposed Regulations under Section 199A of the Internal Revenue Code; IRS and REG Dear Sir or Madam: We are submitting this comment letter on behalf of America s banks operating or considering operating under Subchapter S of the Internal Revenue Code (IRC). Our organizations (the American Bankers Association, 1 the Independent Community Bankers of America, 2 and the Subchapter S Bank Association 3 ) collectively represent most of the banks in the United States, including those banks that have elected Subchapter S (S Banks). Section 199A of the IRC was introduced through the Tax Cuts and Jobs Act (TCJA). This new code section provides for a 20% deduction for qualified business income earned in pass-through entities; including S Banks. Earlier this year, we submitted a comment letter to Treasury regarding our reading of the statute and included recommendations for inclusion in the proposed regulations. This letter includes selected background from our original letter and incorporates comments on and recommendations for the proposed regulations under Section 199A issued on August 8, 2018 (the proposed regulations). We are very appreciative of how the proposed regulations address a number of issues related to banking and specifically recognize the unique nature of our business in the preamble. However, now that we have detailed proposed regulations to consider, we have received a number of inquiries and recommendations from our organizations members and other industry participants with respect to certain issues. These issues and related recommendations are included below. 1 The American Bankers Association is the voice of the nation s $1 trillion banking industry, which is comprised of small, regional, and large banks that together employ more than 2 million people, safeguard $13 trillion in deposits, and extend more than $9 trillion in loans. 2 The Independent Community Bankers of America, the nation s voice for nearly 5,700 community banks of all sizes and charter types, is dedicated exclusively to representing the interests of the community banking industry and its membership through effective advocacy, best-in-class education and high-quality products and services. With approximately 52,000 locations nationwide, community banks employ 760,000 Americans, hold $4.9 trillion in assets, $3.9 trillion in deposits, and $3.3 trillion in loans to consumers, small businesses, and the agricultural community. 3 Subchapter S Bank Association members share a common interest in their dedication to protecting and enhancing shareholder value through subchapter S treatment. Because of this unique link between its members, the Association is able to represent the interests of its members as a whole without regard to the size, location, charter type or market coverage of the individual members. Page 6

7 Background Banks Operating as Pass-Through Entities and Serving Their Communities There are 5,670 banks in the U.S. as of December 31, Of that number, approximately 2,000 have elected Subchapter S. Nearly two thirds of those banks have total assets less than $200M and over 200 have total assets less than $50M. These banks play a critical role in communities across the country. They operate as, and in support of small businesses. Collectively, community banks, both in S and C status, are estimated to be responsible for over 50% of all small business loans and over 70% of all agriculture bank loans. Our Prior and Continuing General Recommendations The application of the Section 199A deduction to S Banks should be consistent with the language of the statute and the overall intention of Congress to help pass-through businesses remain competitive in the context of a corporate rate reduction. 4 Moreover, S Banks are a critical source of capital for the small business community, and their eligibility for the pass-through deduction is consistent with the broader goal of Section 199A to help small businesses. Because S Banks are highly regulated and limited in their activities, rules clarifying the availability of the Section 199A to S banks should be narrow and limited in application. We ask you to reconsider the approach taken in the proposed regulations that could be interpreted by some as limiting common banking qualified business income. As will be discussed further below, clarification is needed particularly with respect to definitions of specified service trade or businesses (SSTBs) and the creation of a de minimis test and related calculations. The approach required under the proposed regulations is complex, administratively burdensome, and may require segregation of activities that should be considered part of an integrated business; community banking. We continue to believe there is a simpler approach that would ensure that S Banks and their customers receive the full and intended benefit of tax reform while guarding against abuse. We previously urged that the proposed regulations consider: Congress clearly intended banks 5 to be excluded from the definition of specified service trade or business and as such, S Banks are eligible for the deduction created by Section 199A. Guidance should clarify that a specified service trade or business does not include banking. Read in context, banking is not a specified service trade or business and revenues derived from banking are qualified business income. If Congress wanted banks to be excluded from the deduction, the statute would have been drafted differently. Banks are highly regulated and their permissible activities are clearly defined by statute and regulation. Thus, all of their permissible activities should be eligible for the deduction created by Section 199A. A banking trade or business could be appropriately defined as a trade or business conducted in an entity (i) that is engaged in activities that qualify it as a bank as defined in section 2 of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1841) or (ii) that is engaged solely 4 Unless otherwise provided herein, all Section references are to the Internal Revenue Code of 1986, as amended. 5 Wherever we refer to banks in this letter, we are also referring to federal and state savings associations and savings banks. Page 7

8 in activities permissible under section 4 of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1843), and regulations issued thereunder, and is regulated by the Board of Governors of the Federal Reserve System. Certain references to ancillary activities in the statute (such as dealing in securities ) should be read narrowly, consistent with congressional intent, to capture only those entities that were intended to be excluded from the 199A benefits. Banks are Highly Regulated Entities All banks operate under either a state or a federal charter. State chartered banks are regulated at the state level and federally chartered banks are regulated by the Comptroller of the Currency. In addition, at the federal level, state chartered non-member (that is, not members of the Federal Reserve System) banks are regulated by the Federal Deposit Insurance Corporation (FDIC), and state member banks are regulated by the Federal Reserve. The FDIC, as provider of federal deposit insurance, has back-up regulatory authority with respect to all FDIC insured banks it does not regulate directly. All bank holding companies are regulated by the Federal Reserve. As discussed further below, the activities of banks and bank holding companies are carefully circumscribed: banks by their charters and by state and federal law; and bank holding companies by federal law. These limitations on the activities of banks and bank holding companies are enforced by their regulators, including through examinations on a regular basis. Subchapter S banks are typically organized with a holding company that makes the S election. The subsidiary bank makes an election to be a Qualified Subchapter S Subsidiary (Q Sub). Generally, the holding company and the bank are treated as a single taxpayer, similar to the treatment of a single member limited liability corporation (also known as an LLC ). Certain tax rules unique to banks also apply to S banks. A Q Sub bank or its holding company may have subsidiaries which engage in banking activities. All of the activities of a bank or bank holding company are regulated activities, regardless of whether the activities are in a separate subsidiary or conducted directly by the bank or its holding company. Eligibility of Banking Income for the Section 199A Deduction Section 199A provides that an individual taxpayer generally can deduct 20 percent of qualified business income from a partnership, S corporation or sole proprietorship. Qualified business income is determined for each qualified trade or business of the taxpayer. A qualified trade or business generally means any trade or business other than a specified service trade or business and other than the trade or business of being an employee. A specified service trade or business is defined in Sections 199A(d)(2)(A) and (B). Section 199A(d)(2)(A) cross references Section 1202(e)(3)(A) and generally provides the businesses enumerated in that section, including financial services, are specified service trades or businesses. Financial services are, however, clearly something other than banking, which is a separate business activity listed in Section 1202(e)(3)(B). The list in Section 1202(e)(3)(B) refers to any banking, insurance, financing, leasing, investing or similar business. Had Congress meant to treat banking as a specified service trade or business, drafters simply would have extended the cross reference to Section 1202(e)(3)(B). As discussed below, banking is specifically cited in the preamble to the proposed regulations as falling outside the definition of financial services. We are appreciative of this guidance and include a recommendation for additional clarification in an addendum to this letter. Page 8

9 While we believe this analysis alone should be conclusive, there have been questions about the application of the second part of the specified service trade or business definition in Section 199A(d)(2)(B). Section 199A(d)(2)(B) defines specified service trades or businesses to include a trade or business which involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2), partnership interests, or commodities (as defined in section 475(e)(2)). Investing and investment management as well as trading or dealing in securities are traditional activities that banks are permitted to conduct. Liquidity and diversification of the loan portfolio are critical to bank safety and soundness. Therefore, community banks routinely sell loans in whole, in part and in securitized pools. For example, a community bank that makes a significant amount of mortgage loans will often sell some of them to provide liquidity and to avoid an over-concentration in that business. While such activities, in certain cases, may technically involve dealing in securities within the meaning of Section 475(c)(1), we do not believe the definition in Section 199A(d)(2)(B) includes banks in such cases. The phrase involves the performance of services, which appears in Section 1202(e)(3)(A) and also in Section 199A(d)(2)(B), is properly understood to mean rendering services to unrelated third parties. Otherwise, any business that employs a general counsel or maintains an accounting department, for example, would be a specified service trade or business within the meaning of Section 199A(d)(2)(A), because the business involves the performance of services in the fields of law or accounting. Properly understood, the definition in Section 199A(d)(2)(A) applies to law and accounting firms, the businesses of which involve the performance of legal and accounting services for third parties, but not to a widget maker that employs an in-house lawyer or accountant. Similarly, the definition in Section 199A(d)(2)(B) should not apply to a bank that sells its loans or participations in loans. Making loans and the sale of a bank s loans and participations in loans, just like taking deposits, is a long-standing, fundamental part of the business of banking and is significantly regulated by governmental agencies as one business line, governed by safe and sound lending practices, not multiple lines. We believe the proposed regulations are helpful in this area. This issue is discussed further below. There have been some suggestions, for tax purposes, that a bank be required to split its business into qualified and non-qualified activities. We believe that the core business of banking includes well understood and integrated activities regulated as banking activities. These activities should not be split up. Any such effort would not be consistent with our understanding of the intent of policy makers. Moreover, any artificial separation of these activities would impose a significant and unnecessary administrative burden on banks, complicate tax administration, and ultimately raise costs for borrowers, including small businesses, undermining the objective of the tax law changes. Moreover, Congress provided C corporation banks, along with other C corporations, a steep reduction in tax rates from 35% to 21% and clearly intended Section 199A to accomplish the same relative goals for S Banks. It would be unfair to provide a different result for S Banks by requiring them to separate out SSTB-like income. We were active participants in the legislative process that resulted in the TCJA and are confident that is not what Congress intended. To address any potential ambiguity in the interpretation of Section 199A, we suggest that final regulations provide guidance that clarifies income from a banking trade or business is qualified income for purpose of the Section 199A deduction. Properly defined, a banking trade or business will include only the limited set of activities in which regulated banks and bank holding companies are permitted to engage, and the clarification does not run the risk of becoming an unintended loophole. Page 9

10 Banking Regulations Provide a Natural Governor on the Activities of Banks Banks and bank holding companies are regulated entities with significant capital, employees, technology, premises, processes, etc. that represent an integrated business. The regulation of banks and bank holding companies is significant and includes reviews of compensation practices. Banks and bank holding companies may only engage in activities that are considered permissible under banking law. Examples of such activities include trust and fiduciary services, insurance brokerage, originating and selling mortgages, assisting customers in retirement planning, safe deposit and safekeeping of customer assets, and other related financial service activities. These activities may be performed in a bank holding company, a bank, or in one of more subsidiaries. There are significant financial requirements and regulatory supervision for forming a new bank, purchasing a bank and ongoing operations. As noted above, we believe these requirements provide a safeguard against unsafe banking practices and would also deter any alleged tax planning or abusive structures to allow the benefits of the 199A deduction for unintended purposes. It is also important to note that Congress has long recognized that banks may perform certain brokerage activities without being considered to be a broker under federal securities law, because those activities are part of traditional banking activities. In recent surveys conducted by ICBA and the Subchapter S Bank Association, S banks indicated that they provide a variety of services in addition to accepting deposits and making loans. The level of revenue and income generated by these activities is dependent on the individual bank. For the vast majority of banks, these activities represent a relatively small portion of the activities of the bank. As discussed below, the de minimis tests in the proposed regulations, though exceptionally low, may provide relief from a potential SSTB classification. All of these permissible activities are part of an integrated business activity: banking. In fact, the services in question are vital aspects that are often required to support the safety and soundness of a banking institution in addition to serving the needs of communities in which such services would not otherwise by locally available. Congressional Intent During the development and drafting of the TCJA legislation, we had extensive discussions with Congressional staff and various members in both the House and Senate. In the course of these discussions, we were assured repeatedly that S Banks would qualify for the lower tax rate for passthrough businesses provided by Section 199A. Since the passage of the TCJA, we have met with staff of the tax-writing committees and various Members who have confirmed the intent of policy makers with respect to S banks. Our Specific Comments on the Proposed Regulations We are appreciative of the guidance in the preamble suggesting a narrow interpretation of financial services included in section 1202(e)(3)(A) that is referenced in section 199A(d)(2)(A). Further, the reference to banking and taking deposits and making loans provides welcomed assurance that traditional banking business is not a SSTB. We respectfully ask that this Page 10

11 important guidance be clarified to include all permissible activities conducted by a bank. Our arguments for this approach were made previously and we believe are in line with the intent of the policy makers. In line with our position regarding permissible activities in a bank, we similarly believe that the SSTB s included in Section 199A(d)(2)(B) should not be applicable for a bank. There are important questions about whether certain activities in Section 199A(d)(2)(B) are applicable to traditional banking activities. The issues are discussed below. Regardless, we respectfully ask that guidance be included to exempt permissible banking activities from the SSTB definition of Section 199A(d)(2)(B). Again, our arguments for this approach were made previously and we believe are in line with the intent of the policy makers. As a result of the requested guidance above, we are hopeful that the application of the SSTB restrictions will not be applicable to banks. That said, we urge you to consider additional guidance in the following areas: o o o There is uncertainty on how to define a trade or business. This has important implications for purposes of identifying and quantifying a potential SSTB limitation. If a reporting pass-through entity (RPE) has multiple trades or businesses that includes both qualified business income (QBI) and SSTB income, Treasury should clarify that the language of the de minimis rule is not intended to imply that a non-sstb trade or business becomes an SSTB if the gross receipts attributable to the associated SSTB activity are at or above the de minimis threshold. Treasury should make clear in that event the SSTB activity will be treated as a separate trade or business (if it qualifies as a separate trade or business under the principles of section 162) and that it will not be aggregated with a trade or business that is not an SSTB. This approach is consistent with the rule that an SSTB may not be aggregated with another trade or business set forth in proposed regulations section 1.199A-4(b)(1). The de minimis thresholds seem exceptionally low and may not achieve the intended result of avoiding unnecessary administrative burden for relatively small amounts of SSTB income. We recommend increasing the threshold to a flat rate of 25%, regardless of gross receipts level. Revenue from SSTBs may be highly variable from year to year due to factors outside of a bank s control. Banks that do not exceed the thresholds today may well exceed them in the future as they evolve to meet the needs of their markets. Asset and revenue growth may shift many banks from the 10 percent to the 5 percent threshold, especially since the gross receipts threshold is not indexed. In addition, the proposed rule could have a chilling effect on a bank s ability to raise capital as investors understandably require certainty as to whether the deduction will be available at the time of investment and in the future. The proposed regulations contain a favorable rule for consulting services that are ancillary to a sale of goods or to another non-sstb service business (the ancillary services rule), which was added in response to the concern noted by commenters that in certain kinds of sales transactions it is common for businesses to provide consulting services in connection the purchase of goods by customers. According to the preamble of the proposed regulations, if a trade or business involves the selling or manufacturing of goods, and such trade or business provides ancillary consulting Page 11

12 services that are not separately purchased or billed, then such trades or businesses are not in a trade or business in the field of consulting. Accordingly, proposed regulation section 1.199A-5(b)(2)(vii) provides that the field of consulting does not include consulting that is embedded in, or ancillary to, the sale of goods or the performance of services on behalf of a trade or business that is not otherwise an SSTB... if there is no separate payment for the consulting services. The preamble indicates in this regard that the de minimis rule may not always provide adequate relief for such services. There is no good or clear reason for also carving out such embedded or ancillary services from other non-sstb trades or businesses. Indeed, while commentators have referred to widget manufacturers, the proposed regulation also refers to consulting services provided that are ancillary to the performance of services that themselves would not be an SSTB. We think the Treasury should make the ancillary services rule generic. o We appreciate the guidance provided with respect to the definition of dealing in securities in both the preamble and the proposed regulations. As discussed above, originating and in certain circumstances, selling loans, is a critical part of the banking business. The language in the preamble and the Proposed Regulations provides helpful language that is distinguishable from the dealer definition found in section 475 and should exempt most traditional bank activities. We respectfully ask for an additional clarification regarding the definition of customer that should resolve questions in this activity. We have attached an addendum with suggested modifications to the preamble and the proposed regulations that we hope you find helpful in considering these issues. In summary, it is clear from the statute that banking is a qualified trade or business. It is our position that the definition of banking should include activities that fall within the scope of well understood permissible, regulated banking activities. The definition should include activities that are conducted either inside a bank legal entity, its holding company, or their regulated subsidiaries. As noted elsewhere, a regulated banking organization operates under very specific rules as to what is permissible. Thank you for your consideration. Please do not hesitate to contact us with any questions or requests for further information. Our contact information is below. Sincerely, American Bankers Association John P. Kinsella jkinsella@aba.com Independent Community Bankers of America J. Alan Keller Alan.keller@icba.org Subchapter S Bank Association Patrick J. Kennedy, Jr pkennedy@kslawllp.com CC: Thomas West, Tax Legislative Counsel, U.S. Department of Treasury Audrey Ellis, Attorney Advisor, U.S. Department of Treasury Krishna Vallabhaneni; Deputy Tax Legislative Counsel, U.S. Department of Treasury Karl Walli; Senior Counsel; U.S. Department of Treasury Attachment Page 12

13 We previously filed a detailed comment letter with the Department of the Treasury on April 30, The following letter was filed on September 21st, 2018 in response to the proposed regulation. Addendum to Comment Letter on Proposed Regulations Under Section 199A Suggested Modifications to the Preamble and the Proposed Regulations Preamble Language: Pages 51-52: Section 199A defines an SSTB to include any trade or business that involves the performance of services in a specified service activity. Although the statute, read literally, does not suggest that a certain quantum of specified service activity is necessary to find an SSTB, the Treasury Department and the IRS believe that requiring all taxpayers to evaluate and quantify any amount of specified service activity would create administrative complexity and undue burdens for both taxpayers and the IRS. Therefore, analogous to the regulations under section 448, it is appropriate to provide a de minimis rule, under which a trade or business will not be considered to be an SSTB merely because it provides a small amount of services in a specified service activity. Accordingly, proposed 1.199A-5(c)(1) provides that a trade or business (determined before the application of the aggregation rules in proposed 1.199A-4) is not an SSTB if the trade or business has gross receipts of $25 million or less (in a taxable year) and less than 1025 percent of the gross receipts of the trade or business that is attributable to the performance of services in an SSTB. For trades or business with gross receipts greater than $25 million (in a taxable year), a trade or business is not an SSTB if less than 5 percent of the gross receipts of the trade or business are attributable to the performance of services in an SSTB. Pages 61-62: h. Financial services Commenters requested guidance as to whether financial services includes banking. These commenters noted that section 1202(e)(3)(A) includes the term financial services, but that banking in separately listed in section 1202(e)(3)(B) which suggests that banking is not included as part of financial services in section 1202(e)(3)(A). The Treasury Department and the IRS agree with such commenters that this suggests that financial services should be more narrowly interpreted here. Therefore, proposed 1.199A-5(b)(2)(ix) limits the definition of financial services to services typically performed by financial advisors and investment bankers and provides that the field of financial services includes the provision of financial services to clients including managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in title 11 or similar cases), and raising financial capital by underwriting, or acting as the client s agent in the issuance of securities, and similar services. This includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals, but does not include taking deposits, or making loans or other permissible activities conducted by a bank. Pages 66-68: SSTBs described in 199A(d)(2)(B) As mentioned previously, section 199A(d)(2)(B) provides that an SSTB also includes any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)). This rule does not appear in section 1202(e)(3)(A) or section 448(d)(2). Page 13

14 Section 475(c)(2) provides a detailed list of interests treated as securities, including stock in a corporation; ownership interests in widely held or publicly traded partnerships or trusts; notes, bonds, debentures, or other evidences of indebtedness; interest rate, currency, or equity notional principal contracts; evidences of an interest in, or derivative financial instruments in any of the foregoing securities or any currency, including any option, forward contract, short position, or any similar financial instruments; and certain hedges with respect to any such securities. Section 475(e)(2) provides a similarly detailed list of property treated as a commodity, including any commodity which is actively traded (within the meaning of section 1092(d)(1)) or any notional principal contract with respect to any such commodity, evidences of an interest in, or derivative financial instruments in any of the foregoing commodities, and certain hedges with respect to any such commodities. Consistent with the guidance provided for banks under 199A(d)(2)(A), for purposes of Section 199A(d)(2)(B), permissible activities conducted by a bank shall not be considered a SSTB. a. Investing and investment management Proposed 1.199A-5(b)(2)(xi) uses the ordinary meaning of investing and investment management and provides that any trade or business that involves the performance of services that consist of investing and investment management means a trade or business that earns fees for investment, asset management services, or investment management services including providing advice with respect to buying and selling investments. The performance of services that consist of investing and investment management would include a trade or business that receives either a commission, a flat fee, or an investment management fee calculated as a percentage of assets under management. The performance of services of investing and investment management does not include directly managing real property. b. Trading Proposed 1.199A-5(b)(2)(xii) provides that any trade or business involving the performance of services that consist of trading means a trade or business of trading in securities, commodities, or partnership interests. Whether a person is a trader is determined taking into account the relevant facts and circumstances. Factors that have been considered relevant to determining whether a person is a trader include the source and type of profit generally sought from engaging in the activity regardless of whether the activity is being provided on behalf of customers or for a taxpayer s own account. See Endicott v. Commissioner, T.C. Memo ; Nelson v. Commissioner, T.C. Memo , King v. Commissioner, 89 T.C. 445 (1987). A person that is a trader under these principles will be treated as performing the services of trading for purposes of section 199A(d)(2)(B). c. Dealing in securities, partnership interests, and commodities For purposes of proposed 1.199A-5(b)(2)(xiii), the performance of services that consist of dealing in securities (as defined in section 475(c)(2)) means regularly purchasing securities from and selling securities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. For purposes of the preceding sentence, a taxpayer that regularly originates loans in the ordinary course of a trade or business of making loans but engages in no more than negligible sales of the loans to customers is not dealing in securities for purposes of section 199A(d)(2). See 1.475(c)- Page 14

15 1(c)(2) and (4) for the definition of negligible sales. Further, for purposes of this section, selling loans to customers does not include sales to government sponsored entities, loan aggregators, broker-dealers, or other parties for purposes of management of liquidity, capital, interest rate, credit risk or other related business reasons. For purposes of proposed 1.199A-5(b)(2)(xiii), the performance of services that consist of dealing in partnership interests means regularly purchasing partnership interests from and selling partnership interests to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in partnership interests with customers in the ordinary course of a trade or business. For purposes of proposed 1.199A-5(b)(2)(xiii), the performance of services that consist of dealing in commodities (as defined in section 475(e)(2)) means regularly purchasing commodities from and selling commodities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in commodities with customers in the ordinary course of a trade or business. Proposed Regulations: Page 160: Add new paragraph (b)(2)(ii) and renumber proposed paragraphs (b)(2)(ii) through (xiv) (ii) Ancillary services. The performance of services in one of the fields listed in paragraph (b)(1) of this section ( listed services ) does not include the performance of such listed services embedded in, or ancillary to, the sale of goods or the performance of services on behalf of a trade or business that is otherwise not an SSTB if there is no separate payment for the listed services. For example, consulting services do not include the typical services provided by a building contractor. Pages (ix) Meaning of services performed in the field of financial services. For purposes of section 199A(d)(2) and paragraph (b)(1)(viii) of this section only, the performance of services in the field of financial services means the provision of financial services to clients including managing wealth, advising clients with respect to finances, developing retirement plans, developing wealth transition plans, the provision of advisory and other similar services regarding valuations, mergers, acquisitions, dispositions, restructurings (including in title 11 or similar cases), and raising financial capital by underwriting, or acting as a client s agent in the issuance of securities and similar services. This includes services provided by financial advisors, investment bankers, wealth planners, and retirement advisors and other similar professionals performing services in their capacity as such, but does not include taking deposits, making loans or other permissible activities conducted by a bank.. (x) Meaning of services performed in the field of brokerage services. For purposes of section 199A(d)(2) and paragraph (b)(1)(ix) of this section only, the performance of services in the field of brokerage services includes services in which a person arranges transactions between a buyer and a seller with respect to securities (as defined in section 475(c)(2)) for a commission or fee. This includes services provided by stock brokers and other similar professionals, but does not include services provided by real estate agents and brokers, or insurance agents and brokers. Page 15

16 (xi) Meaning of the provision of services in investing and investment management. For purposes of section 199A(d)(2) and paragraph (b)(1)(x) of this section only, the performance of services that consist of investing and investment management refers to a trade or business involving the receipt of fees for providing investing, asset management, or investment management services, including providing advice with respect to buying and selling investments. The performance of services of investing and investment management does not include directly managing real property. (xii) Meaning of the provision of services in trading. For purposes of section 199A(d)(2) and paragraph (b)(1)(xi) of this section only, the performance of services that consist of trading means a trade or business of trading in securities (as defined in section 475(c)(2)), commodities (as defined in section 475(e)(2)), or partnership interests. Whether a person is a trader in securities, commodities, or partnership interests is determined by taking into account all relevant facts and circumstances, including the source and type of profit that is associated with engaging in the activity regardless of whether that person trades for the person s own account, for the account of others, or any combination thereof. A taxpayer, such as a manufacturer or a farmer, who engages in hedging transactions as part of their trade or business of manufacturing or farming is not considered to be engaged in the trade or business of trading commodities. (xiii) Meaning of the provision of services in dealing--(a) Dealing in securities. For purposes of section 199A(d)(2) and paragraph (b)(1)(xii) of this section only, the performance of services that consist of dealing in securities (as defined in section 475(c)(2)) means regularly purchasing securities from and selling securities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of a trade or business. For purposes of the preceding sentence, however, a taxpayer that regularly originates loans in the ordinary course of a trade or business of making loans but engages in no more than negligible sales of the loans to customers is not dealing in securities for purposes of section 199A(d)(2) and this section. See 1.475(c)-1(c)(2) and (4) for the definition of negligible sales. Further, for purposes of this section, selling loans to customers does not include sales to government sponsored entities, loan aggregators, broker-dealers, or other parties for purposes of management of liquidity, capital, interest rate, credit risk or other related business reasons. (B) Dealing in commodities. For purposes of section 199A(d)(2) and paragraph (b)(1)(xii) of this section only, the performance of services that consist of dealing in commodities (as defined in section 475(e)(2)) means regularly purchasing commodities from and selling commodities to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in commodities with customers in the ordinary course of a trade or business. (C) Dealing in partnership interests. For purposes of section 199A(d)(2) and paragraph (b)(1)(xii) of this section only, the performance of services that consist of dealing in partnership interests means regularly purchasing partnership interests from and selling partnership interests to customers in the ordinary course of a trade or business or regularly offering to enter into, assume, offset, assign, or otherwise terminate positions in partnership interests with customers in the ordinary course of a trade or business. Page 16

17 Pages : 3) Examples. The following examples illustrate the rules in paragraphs (a) and (b) of this section. The examples do not address all types of services that may or may not qualify as specified services. Unless otherwise provided, the individual in each example has taxable income in excess of the threshold amount. Example 1. A, a singer, records a song. A is paid a mechanical royalty when the song is licensed or streamed. A is also paid a performance royalty when the recorded song is played publicly. A is engaged in the performance of services in an SSTB in the field of performing arts within the meaning of paragraphs (b)(1)(v) and (b)(2)(vi) of this section. The royalties that A receives for the song are not eligible for a deduction under section 199A. Example 2. B is a partner in Partnership, which solely owns and operates a professional sports team. Partnership employs athletes and sells tickets to the public to attend games in which the sports team competes. Therefore, Partnership is engaged in the performance of services in an SSTB in the field of athletics within the meaning of paragraphs (b)(1)(vii) and (b)(2)(viii) of this section. B is a passive owner in Partnership and B does not provide any services with respect to Partnership or the sports team. However, because Partnership is engaged in an SSTB in the field of athletics, B s distributive share of the income, gain, loss, and deduction with respect to Partnership is not eligible for a deduction under section 199A. Example 3. C is in the business of providing services that assist unrelated entities in making their personnel structures more efficient. C studies its client's organization and structure and compares it to peers in its industry. C then makes recommendations and provides advice to its client regarding possible changes in the client's personnel structure, including the use of temporary workers. C is engaged in the performance of services in an SSTB in the field of consulting within the meaning of paragraphs (b)(1)(vi) and (b)(2)(vii) of this section. Example 4. D is in the business of licensing software to customers. D discusses and evaluates the customer s software needs with the customer. The taxpayer advises the customer on the particular software products it licenses. D is paid a flat price for the software license. After the customer licenses the software, D helps to implement the software. D is engaged in the trade or business of licensing software and not engaged in an SSTB in the field of consulting within the meaning of paragraphs (b)(1)(vi) and (b)(2)(vii) of this section. Example 5. E is in the business of providing services to assist clients with their finances. E will study a particular client s financial situation, including, the client s present income, savings and investments, and anticipated future economic and financial needs. Based on this study, E will then assist the client in making decisions and plans regarding the client's financial activities. Such financial planning includes the design of a personal budget to assist the client in monitoring the client's financial situation, the adoption of investment strategies tailored to the client's needs, and other similar services. E is engaged in the performance of services in an SSTB in the field of financial services within the meaning of paragraphs (b)(1)(viii) and (b)(2)(ix) of this section. Example 6. F is in the business of executing transactions for customers involving various types of securities or commodities generally traded through organized exchanges or other similar networks. Customers place orders with F to trade securities or commodities based on the taxpayer's recommendations. F's compensation for its services typically is based on Page 17

18 completion of the trade orders. F is engaged in an SSTB in the field of brokerage services within the meaning of paragraphs (b)(1)(ix) and (b)(2)(x) of this section. Example 7. G owns 100% of Corp, an S corporation, which operates a bicycle sales and repair business. Corp has 8 employees, including G. Half of Corp s net income is generated from sales of new and used bicycles and related goods, such as helmets, and bicyclerelated equipment. The other half of Corp s net income is generated from bicycle repair services performed by G and Corp s other employees. Corp s assets consist of inventory, fixtures, bicycle repair equipment, and a leasehold on its retail location. Several of the employees and G have worked in the bicycle business for many years, and have acquired substantial skill and reputation in the field. Customers often consult with the employees on the best bicycle for purchase. G is in the business of sales and repairs of bicycles and is not engaged in an SSTB within the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section. Example 8. H is a well-known chef and the sole owner of multiple restaurants each of which is owned in a disregarded entity. Due to H s skill and reputation as a chef, H receives an endorsement fee of $500,000 for the use of H s name on a line of cooking utensils and cookware. H is in the trade or business of being a chef and owning restaurants and such trade o business is not an SSTB. However, H is also in the trade or business of receiving endorsement income. H s trade or business consisting of the receipt of the endorsement fee for H s skill and/or reputation is an SSTB within the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section. Example 9. J is a well-known actor. J entered into a partnership with Shoe Company, in which J contributed her likeness and the use of her name to the partnership in exchange for a 50% interest in the capital and profits of the partnership and a guaranteed payment. J s trade or business consisting of the receipt of the partnership interest and the corresponding distributive share with respect to the partnership interest for J s likeness and the use of her name is an SSTB within the meaning of paragraphs (b)(1)(xiii) and (b)(2)(xiv) of this section. Example 10. M is a shareholder of a regulated bank that has elected S corporation status. In addition to making loans and taking deposits, the bank may sell selected loans to government sponsored entities as part of its trade or business for purposes of managing liquidity, capital and interest rate risk. These activities do not constitute dealing in securities within the meaning of Section 199A(d)(2)(B). (c) Special rules. (1) De minimis rule.--(i) Gross receipts of $25 million or less. For a trade or business with gross receipts of $25 million dollars or less for the taxable year, aa trade or business is not an SSTB if less than 1025 percent of the gross receipts of the trade or business are attributable to the performance of services in a field described in paragraph (b) of this section. For purposes of determining whether this 1025 percent test is satisfied, the performance of any activity incident to the actual performance of services in the field is considered the performance of services in that field.. If the gross receipts attributable to the performance of services in a field described in paragraph (b) of this section exceed the de minimis threshold, such activity shall be treated as a separate trade or business (if it qualifies as a separate trade or business under the principles of section 162) that shall not be aggregated with the trade or business that is not an SSTB. Page 18

19 (ii) Gross receipts of greater than $25 million. For a trade or business with gross receipts of greater than $25 million for the taxable year, the rules of paragraph (c)(1)(i) of this section are applied by substituting 5 percent for 10 percent each place it appears. What are Gross Receipts under Proposed 199A Regulations? Banks typically do not talk in terms of gross receipts and there has understandably been some confusion of what that means, particularly since a Sub S Bank s gross receipts are an important metric under the proposed regulations. The term is used in Section 1.199A-5 where a de minimis rule is proposed which provides that a trade or business is not an SSTB if less than 10% of the gross receipts (5% if the gross receipts are greater than $25 million) of the trade or business are attributable to the performance of services in a specified service activity. If a bank reaches or exceeds these amounts, the plain meaning of the provision would treat the entire bank trade or businesses as an SSTB and disqualify it for the QBI deduction. The 199A proposal does not define gross receipts but the Internal Revenue Code and regulations contain the following provisions which define gross receipts at 26 CFR The definition is set forth below and again does not contemplate a typical bank income statement, but we believe it is clear that gross receipts means total interest income and noninterest income plus any capital gains, dividends, fees or commissions. We believe it is clear that gross receipts does not include cost of goods sold, expenses (such as interest expense or non-interest expense) and is not reduced by losses. The following is the actual regulation Definition of gross receipts. (a) General rule. Under section 993(f), for purposes of sections 991 through 996, the gross receipts of aperson for a taxable year are - (1) The total amounts received or accrued by the person from the sale or lease of property held primarily for sale or lease in the ordinary course of a trade or business, and (2) Gross income recognized from all other sources, such as, for example, from - (i) The furnishing of services (whether or not related to the sale or lease of property described in subparagraph (1) of this paragraph), (ii) Dividends and interest, (iii) The sale at a gain of any property not described in subparagraph (1) of this paragraph, and (iv) Commission transactions as and to the extent described in paragraph (e) of this section. (b) Nongross receipts items. For purposes of paragraph (a) of this section, gross receipts do not includeamounts received or accrued by a person from - (1) The proceeds of a loan or of the repayment of a loan, or (2) A receipt of property in a transaction to which section 118 (relating to contribution to capital) or 1032 (relating to exchange of stock for property) applies. (c) Nonreduction of total amounts. For purposes of paragraph (a) of this section, the total amountsreceived or accrued by a person are not reduced by returns and allowances, costs of goods sold, expenses, losses, a deduction for dividends received under section 243, or any other deductible amounts. (d) Method of accounting. For purposes of paragraph (a) of this section, the total amounts received or accrued by a person shall be determined under Page 19

20 the method of accounting used in computing its taxable income. If, for example, a DISC receives advance or installment payments for the sale or lease of propertydescribed in paragraph (a)(1) of this section, for the furnishing of services, or which represent recognizedgain from the sale of property not described in paragraph (a)(1) of this section, any amount of such advancepayments is considered to be gross receipts of the DISC for the taxable year for which such amount is included in the gross income of the DISC. (e) Commission transactions. (1) In the case of transactions which give rise to a commission on the sale or lease of property or the furnishing of services by a principal, the amount recognized by the commission agent as gross income from all such transactions shall be the gross receipts derived by the principal from the sale or lease of the property, or the gross income derived by the principal from the furnishing of services, with respect to which the commissions are derived. In the case of a commission agent for a related supplier (as defined in (a)(3)(ii)), the gross receipts or gross income of such agent shall be determined as if it used the same method of accounting as its related supplier. In the case of a commission agent for a principal other than a related supplier, the gross receipts or gross income of such principal shall be determined as if such principal used the same method of accounting as its agent. (2) If the commission arrangement provides that the commission agent will receive a commission only with respect to sales or leases of export property, or the furnishing of services, which result in qualified export receipts, the commission agent will not take into account the gross receipts or gross income, as the case may be, derived by the principal from any transaction for which the commission agent would not be entitled to a commission under the commission arrangement. (f) Example. The provisions of this section may be illustrated by the following example: EXAMPLE. During 1973, M, a related supplier (as defined in (a)(3)(ii)) of N, is engaged in the manufacture of machines in the United States. N, a calendar year taxpayer, is engaged in the sale and lease of such machines in foreign countries. N furnishes services which are related and subsidiary to its sale and lease of such machines. N also acts as a commission agent in foreign countries for Z, an unrelated supplier, with respect to Z s sale of products. N receives dividends on stock owned by it in a related foreign export corporation (as defined in ), interest on producer s loans made to M, and proceeds from sales of business assets located outside the United States resulting in a recognized gains and losses. N s gross receipts for 1973 are $3,550, computed on the basis of the additional facts assumed in the table below: (1) (2) (3) (4) N's sales receipts for machines manufactured by M (without reduction for cost of goods sold and selling expenses) N's lease receipts for machines manufactured by M (without reduction for depreciation and leasing expenses) N's gross income from services for machines manufactured by M (without reduction for service expenses) Z's sale receipts for products manufactured by Z (without reduction for Z's cost of goods sold, commissions on sales, and commission sales expenses) $1,500 (5) Dividends received by N 150 (6) Interest received by N on producer's loans 200 (7) Proceeds received by N representing recognized gain (but not losses) from sales of business assets located outside the United States (8) N's gross receipts 3, [T.D. 7514, 42 FR 55468, Oct. 17, 1977] Page 20

21 SAVE THE DATE FOR THE 2018 ANNUAL CONFERENCE! Join us for the only conference built directly for S Corp banks with S corp speakers that will share their experiences & knowledge on not just the what and the why, but the how. Registration is open! Date: October 25th-26th Location: The Westin Riverwalk in San Antonio To Register: go to or contact Amy Willcox at awillcox@subsbanks.org for more information Page 21