Majority Not Enough On Sub S Conversions
This letter is in response to your “Straight Talk” column from the Nov. 7 issue. You state that a problem exists because “S” election requires unanimous consent of the shareholders. That rule goes back to the original 1958 sub-chapter “S” act when the number of permitted shareholders was five shareholders.
The reason for the unanimous shareholder requirement is that converting to “S” status has a significant impact on the shareholders’ tax return. The shareholder must recognize on his personal tax return his or her pro rata share of the income of the corporation. Therefore, a management decision not to pay dividends can have a significant financial impact upon a shareholder.
The converse to that is that a minority shareholder may receive a premium for his or her stock by not consenting to “S” election. With the current tax rates, a corporation and its shareholders pay approximately a 20 percent pre-tax income penalty for being a “C” corporation. Between the tax on corporate earnings and the tax on dividends to shareholders, there is 20 percent less net to the shareholders than they would have in an “S” corporation. That is the reason most banks want to convert to “S” status. Many banks have passive shareholders and “S” dividends are a more efficient way to distribute money to the shareholders than paying corporate income tax before paying dividends.
I don’t believe Congress will ever allow corporations to convert to “S” status on a mere majority vote. A more realistic change would be to attempt to obtain legislation permitting an “S” election when shareholders representing a super-majority of the shares, for example, 80 percent, consent to “S” status.
David W. Johnson
Attorney at Law
Copyright NFR Communications Inc Dec 5, 1998
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