The Tax Cuts and Jobs Act (TCJA) enacted in December 2017 included a deduction of up to 20 percent of qualified business income (QBI) for businesses operating as sole proprietors, partnerships or S corporations. This deduction is widely viewed as a benefit to taxpayers in the above categories that were not benefited by the reduction in the C corporation tax rate to a flat 21 percent rate. However, the QBI deduction is not available to specified service trades, such as financial services, brokerage services and investment management, once the taxable income threshold of $415,000 for marrieds filing jointly or $207,500 for other taxpayers is met.

Because some banks engage in one or more of the specified service trades within their banking business, there has been concern about how these banks might be treated. The final regulations issued in January 2019 provide some answers. First, the final regulations specifically state that the specified service trade of financial services does not include taking deposits or making loans, providing further clarity for banks to qualify for the QBI deduction.

Second, the August 2018 proposed regulations contained two de minimus "cliffs" for businesses having specified income trades within their overall gross receipts: (1) for businesses having gross receipts of $25 million or less, receipts from specified services trades are considered de minimus if receipts from specified service trades are less than 10 percent of the total gross receipts; and (2) for businesses having gross receipts of more than $25 million, the de minimus threshold is five percent of total gross receipts. However, even if those thresholds are exceeded, the final regulations provide a helpful example involving a specified service trade (veterinarian) also selling dog food, a non-specified trade, within a single business entity. Even though the veterinarian receipts exceeded the de minimus threshold, because the entity separately invoiced for both activities, maintained separate books and records for them, had separate employees and otherwise treated the two activities as separate trades or businesses, a QBI deduction would be available for the dog food business despite no QBI deduction being available for the veterinary operation. The time and expense of legally separating the two businesses in order to qualify for the deduction is avoided, provided the other requirements are satisfied.

Thus, more clarity has been provided to banks who might be concerned about the activities of providing financial services, brokerage services or investment management services tainting the availability of a QBI deduction for banking activities. If the activities are similar to the veterinarian in the example, with separate invoices, books and records and employees such that the activities are treated as separate trades or businesses, the bank should qualify for the QBI deduction for the banking business while the services businesses would not qualify.

Several S corporation banks have considered converting to C corporation status due to the lower federal tax rate. In addition, the QBI deduction is only in effect through 2025, whereas the reduced 21 percent C corporation federal income tax rate is permanent (unless a future Congress decides to change the tax rate). However, before converting, a careful study should be made of the dividend paying history of the bank to its shareholders, as well as dividends anticipated to be paid in the future. Finally, consideration should be given to the likelihood of future taxable business asset sales, as either or both of these considerations may support the bank continuing as an S corporation rather than converting to a C corporation. Once an election is made to terminate an S corporation's election and become a C corporation, the tax code imposes a five-year moratorium on once again electing S corporation status.