A brief note on subchapter S banks

Bank trade organizations complain almost incessantly about credit unions not paying income taxes. If they’re not saying it in the public sphere, they’re saying it in meetings with policy makers.

One must wonder how Subchapter S banks feel about these complaints. After all, Subchapter S corporations don’t pay federal income taxes. They are pass-through entities, which means that income is passed on to owners, who then pay taxes on that income.[1] The tax treatment is similar to the tax treatment of credit unions, since credit union members pay taxes on the interest they earn on their shares.

The primary difference between a credit union’s income tax exemption, and that of a Subchapter S bank, is that at a Subchapter S bank the bank owners benefit from the tax exemption. At a credit union, the member-owners—the ones who have the deposits in the credit union—the average person—benefit from the tax exemption.

At a Subchapter S bank, profits are extracted from the customers and passed on to owners without being taxed. At a credit union, profits are fed back into the credit union to benefit the customers—the member-owners.

The credit union is not-for-profit, the Subchapter S is for-profit. Yet they share similar tax treatment. Why? Because their structures are different than the usual for-profit structure.

It’s not about size

Bankers would have you believe that some credit unions are too big and should pay income taxes. Why don’t they make the same claims about Subchapter S banks?


Type of financial institutionNumberNumber with more than $1 billion in assets% with assets over $1 billionAverage asset size
Subchapter S Bank1,5351248%$452 million
Credit Union4,7454299%$475 million

While credit unions have far more institutions over $1 billion, likely as a function of having triple the number of institutions, credit unions and Subchapter S banks are of a similar size, and the relative number over $1 billion is similar to that of Subchapter S banks. [2]

Also, since there are 4,623 banks, 33% of them do not pay corporate income taxes.

Consider that: 33% of banks don’t pay corporate income taxes!

Granted, while that percentage is high, it comprises only 2.95% of assets held in banks. Nevertheless, the average Subchapter S bank is roughly the same size as the average credit union.

Size is not the reason for the Subchapter S income tax exemption. Structure is.

More about Subchapter S ownership

Publicly held banks are owned by a large group of stockholders. Subchapter S banks are limited to 100 owners. Structurally, the public bank and the Subchapter S bank are different. Thus, the corporate income tax exemption.

Interestingly, the structural difference may not be as dramatic as one might think, because there’s a loophole—the banker’s favorite fallback.

However, there are exceptions that permit family members to elect to be counted as just one shareholder, which can greatly increase the limit. Family members include the descendants of a common ancestor, no more than six generations above the youngest owner at the time of the elections. Spouses are also included. For example, if you, your spouse, your children, and your sister and her children own shares, you can elect to count all of you as just one shareholder. [3]

Using this confusing exception[4], the potential ownership of the subchapter S corporation (bank) could easily reach into the tens of thousands of people—and potentially still go much higher.

The point is that the credit union tax exemption derives from the unique credit union structure: it’s a cooperative, owned by and operated for members. The income tax exemption does not derive from credit union size, field of membership, suite of products, or anything else—just as Subchapter S exemption does not derive from anything else.