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ROTH & COMPANY COMMENTS ON PROPOSED BANK S CORPORATION RULES

November 21, 2006

Roth & Company today submitted its comments on the proposed regulations on the application of the "TEFRA disallowance" of interest expense to S corporations. Our view: the statute clearly says the 20% disallowance of Section 291 goes away after three years as an S corporation. The proposed regulations say otherwise.

Our comments our reproduced below in the extended entry. November 22 is the deadline for submitting comments at www.regulations.gov.

Prior Tax Update Coverage:

IRS ISSUES CHALLENGE TO S CORPORATION BANK DEDUCTION

RE: Section 291 “TEFRA” Interest Expense Disallowance – New Proposed Regulations; Document RS-2006-0459-0001

We are a public accounting firm in Des Moines, Iowa, serving over 125 Iowa community banks. We currently provide income tax return services to over 75 Subchapter S banks.

We believe the proposed regulations on the application of Section 291 to S corporation banks issued in August 2006 (REG-158677-05) are fundamentally flawed and should be withdrawn.

“TEFRA” Disallowance and S Corporation Banks.

TEFRA, the 1982 tax bill, added Code Section 291(a)(3) to disallow the interest deduction for 20% of interest expense attributable to bank-qualified tax-exempt securities. This provision is known in the industry as the “TEFRA disallowance.”

In 1996, Congress amended Section 1361 to allow banks and bank holding companies to become Subchapter S corporations. Section 1363(b)(4), an S corporation provision enacted in 1984, provides that Section 291 ceases to apply to S corporations beginning with the fourth year after the S election. When Congress enacted legislation allowing banks to become S corporations, it did not alter this provision.

Hundreds of banks made S corporation elections following the 1996 changes. Banks routinely stopped computing the Section 291 disallowance in their fourth S corporation year. This position was discussed in detail at several national banking conferences. In discussions with IRS personnel, national bank tax experts were told that written guidance on this issue was unnecessary given the clear language of the statute. The IRS has issued guidance addressing specific bank issues (e.g., Notice 97-4, 1997-1 CB 351) without addressing TEFRA disallowance.

The Proposed Regulations Are Not Authorized By Statute.

The IRS has recently changed its position. It now asserts that the rule of Section 291(a)(3) does not apply to prevent TEFRA disallowance after the third S corporation year. Likewise, the proposed regulations declare that the TEFRA disallowance continues to apply to S corporation banks after the third S corporation year.

The unambiguous terms of Section 291(a)(3) allow S corporation banks to stop computing the 20% TEFRA disallowance beginning with their fourth S corporation year.

If Congress had intended to require Subchapter S banks to continue applying the 20% TEFRA disallowance after three S years, it would have changed the statute to require the disallowance. Congress has amended Subchapter S many times since 1996 without changing Section 1363(b)(4) or otherwise addressing how Section 291(a)(3) applies to banks.

Congress has not given the Treasury authority to issue “legislative” regulations under the financial institution S corporation rules. There is no provision under Section 1361 comparable to that provided for passive losses by Section 469(l), for example. Absent such authority, the Treasury may not override a specific statutory provision; as the proposed regulations attempt to do just that, they overreach. We therefore urge the Treasury to withdraw the proposed regulations.

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