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| ## Co |   |                                                      |   |
| mptro |   |                                                      |   |
| ller  |   |                                                      |   |
| of th |   |                                                      |   |
| e Cur |   |                                                      |   |
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| > Adm |   |                                                      |   |
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| > of  |   |                                                      |   |
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| ional |   |                                                      |   |
| >     |   |                                                      |   |
| Banks |   |                                                      |   |
+-------+---+------------------------------------------------------+---+
| #     |   | ## Buy-Sell Agreements between S                     |   |
| # Sub |   | ubchapter S Corporations and National Bank Directors |   |
| ject: |   |                                                      |   |
+-------+---+------------------------------------------------------+---+

**TO:** Chief Executive Officers of All National Banks, Department and
Division Heads, and All Examining Personnel

##### PURPOSE

##### 

This advisory letter is intended to refer national banks, especially
community national banks, that seek to qualify as Subchapter S
corporations for federal tax purposes to an Internal Revenue Service
ruling that may be relevant to them.

##### 

##### BACKGROUND

The Internal Revenue Service (IRS) issued a private letter ruling that
may be of interest to national banks and bank holding companies that
seek to qualify, or continue to qualify, as Subchapter S corporations
for federal tax law purposes.[^1] The IRS private letter ruling responds
to an inquiry from a bank holding company about an agreement between the
holding company and the directors of its subsidiary bank (the Directors
Agreement).[^2] The IRS Letter discusses how the Directors Agreement may
have affected the ability of the bank holding company to qualify as a
Subchapter S corporation. In particular, the IRS Letter discusses how
the Directors Agreement may have resulted in the bank holding company
having more than one class of stock, which under federal tax law would
have disqualified the holding company from being treated as a Subchapter
S corporation.

##### DISCUSSION

The IRS Letter is of particular interest to community national banks and
their holding companies. These entities often seek Subchapter S status
and could have buy-sell agreements similar to the Directors Agreement.
Under 12 USC 72, directors of national banks must own "qualifying"
shares. This statutory qualifying share requirement is designed to
ensure that national bank directors will have sufficient interest in
their bank to induce them to be vigilant in protecting the bank's
interests.

Under section 72, a national bank director generally must own a
qualifying equity interest of \$1,000 in the stock of a national bank or
its holding company. In an interpretive ruling, the OCC has stated that
the qualifying equity interest may include common or preferred stock
that has an aggregate par value of \$1,000, an aggregate shareholders'
equity of \$1,000, or an aggregate fair market value of \$1,000. The
value of the qualifying interest is determined as of the date purchased
or the date on which a person became a director, whichever value is
greater.[^3] The OCC also has endorsed legislation that would amend
section 72 to enable the OCC to allow a national bank director to
satisfy the qualifying share requirement by holding a subordinated debt
instrument that would not be treated as a separate class of stock for
Subchapter S purposes.[^4]

Under Subchapter S, a small business corporation can have no more than
75 shareholders.[^5] In order to limit the total number of shareholders
to no more than 75, qualifying shares sometimes are subject to buy-sell
agreements that require a director to sell back the shares on specified
terms upon ceasing to be a director. These agreements sometimes also
provide that all dividends and other distributions from qualifying
shares received by the director will be returned. These agreements and
similar arrangements involving qualifying shares may, depending on their
specific terms, affect the ability of a national bank or its holding
company to qualify as a Subchapter S corporation. National banks and
their holding companies that have elected Subchapter S treatment,
therefore, should review their qualifying share arrangements for
compliance with all applicable IRS requirements.

**General Description of Relevant IRS Regulations**

Under Subchapter S of the IRS Code,[^6] a corporation may have only one
class of stock outstanding.[^7] A Subchapter S corporation is treated as
having only one class of stock outstanding if all the shares confer
identical rights to distribution and liquidation proceeds.[^8] A bona
fide buy-sell agreement is generally disregarded for purposes of
determining whether a corporation's outstanding shares confer identical
rights to distribution and liquidation proceeds. However, the buy-sell
agreement is not disregarded if, among other things, the agreement
establishes a purchase price that, at the time the agreement is entered
into, significantly deviates from the fair market value of the stock. As
indicated in the IRS Letter, buy-sell agreements "that provide for the
purchase or redemption of stock at book value or at a price between fair
market value and book value are not considered to establish a purchase
price that is significantly in excess or below the fair market value."
[^9]

##### 

##### Facts of the IRS Letter

As indicated above, the IRS Letter involved a bank holding company that
sold shares of its stock to the directors of its subsidiary bank subject
to a buy-sell agreement.[^10] The Directors Agreement provided that each
director of the national bank would sell his or her shares back to the
holding company for the same price for which the director had purchased
the shares upon the director ceasing to hold the office of director. The
Directors Agreement also provided that each director would assign to the
holding company all dividends and other distributions on the shares.
Sometime after putting in place the Directors Agreement, the holding
company became concerned that the terms of the agreement may have
inadvertently resulted in the creation of a second class of stock that
would disqualify the holding company for Subchapter S treatment. The
holding company, therefore, amended the Directors Agreement to: (1)
provide that the bank holding company would repurchase the shares at
their fair market value and (2) eliminate the requirement that the
directors assign dividends and distributions back to the bank holding
company. The IRS Letter indicates that the amended Directors Agreement
did not create a second class of stock.

#####  

##### CONCLUSION

As a private letter ruling, the IRS Letter is expressly nonprecedential
and nonbinding upon the IRS.[^11] National banks should recognize,
however, that its reasoning could be applicable to their situations.
Accordingly, a national bank that has a qualifying share arrangement
similar to the one described in the IRS Letter may wish to consult
competent tax counsel to ensure that the arrangement fully complies with
all applicable federal tax requirements.

\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_

Julie L. Williams

First Senior Deputy Comptroller and Chief Counsel

[^1]: A Subchapter S corporation generally is treated as a "conduit" for
    tax purposes. The net income or loss of a Subchapter S corporation
    is passed through to the corporation's individual shareholders, who
    include it in their individual tax returns. Subchapter S status
    results in corporate earnings being taxed only once, rather than
    being taxed twice like the earnings of other corporations, which are
    taxed once at the corporate level and then taxed again at the
    shareholder level when the earnings are distributed as dividends.
    *See* 26 USC 1361 *et seq*.

[^2]: Priv. Ltr. Rul. 2002-17-048 (Jan. 24, 2002)(the IRS Letter). The
    IRS Letter is available on the IRS Internet Website at
    http://www.irs.gov/pub/irs-wd/0217048.pdf.

[^3]: *See* 12 CFR 7.2005.

[^4]: *See* Financial Services Regulatory Relief Act of 2002, H.R. 3951,
    107^th^ Cong. 101.

[^5]: 26 CFR 1.1361-1(b)(1)(i).

[^6]: 26 USC 1361 *et seq*.

[^7]: 26 USC 1361(b)(1)(D).

[^8]: 26 CFR 1.1361-1(l)(1).

[^9]: IRS Letter (citing 26 CFR 1.1361-1(l)(2)(iii)).

[^10]: The IRS Letter also is relevant to situations involving a
    national bank that does not have a holding company. Such a bank
    could also seek to qualify for Subchapter S treatment and have a
    qualifying share arrangement similar to the one described in the IRS
    Letter.

[^11]: *See* 26 USC 6110(j)(3).