To amend the Internal Revenue Code of 1986 to expand S corporation eligibility for banks, and for other purposes.

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Small Business and Financial 
Institutions Tax Relief Act of 2003''.

SEC. 2. EXPANSION OF BANK S CORPORATION ELIGIBLE SHAREHOLDERS TO 
              INCLUDE IRAS.

    (a) In General.--Section 1361(c)(2)(A) of the Internal Revenue Code 
of 1986 (relating to certain trusts permitted as shareholders) is 
amended by inserting after clause (v) the following new clause:
                            ``(vi) In the case of a corporation which 
                        is a bank (as defined in section 581), a trust 
                        which constitutes an individual retirement 
                        account under section 408(a), including one 
                        designated as a Roth IRA under section 408A, 
                        but only to the extent of the stock held by 
                        such trust in such bank as of the date of the 
                        enactment of this clause.''.
    (b) Treatment as Shareholder.--Section 1361(c)(2)(B) of such Code 
(relating to treatment as shareholders) is amended by adding at the end 
the following new clause:
                            ``(vi) In the case of a trust described in 
                        clause (vi) of subparagraph (A), the individual 
                        for whose benefit the trust was created shall 
                        be treated as a shareholder.''.
    (c) Sale of Stock in IRA Relating to S Corporation Election Exempt 
From Prohibited Transaction Rules.--Section 4975(d) of such Code 
(relating to exemptions) is amended by striking ``or'' at the end of 
paragraph (14), by striking the period at the end of paragraph (15) and 
inserting ``; or'', and by adding at the end the following new 
paragraph:
            ``(16) a sale of stock held by a trust which constitutes an 
        individual retirement account under section 408(a) to the 
        individual for whose benefit such account is established if 
        such sale is pursuant to an election under section 1362(a).''.
    (d) Conforming Amendment.--Section 512(e)(1) of such Code is 
amended by inserting ``1361(c)(2)(A)(vi) or'' before ``1361(c)(6)''.
    (e) Effective Date.--The amendments made by this section shall 
apply to trusts which constitute individual retirement accounts on the 
date of the enactment of this Act.

SEC. 3. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM PASSIVE INCOME 
              TEST FOR BANK S CORPORATIONS.

    (a) In General.--Section 1362(d)(3)(C) of the Internal   Revenue 
Code of 1986 (defining passive investment income) is amended by adding 
at the end the following:
                            ``(v) Exception for banks; etc.--In the 
                        case of a bank (as defined in section 581) or a 
                        bank holding company (as defined in section 
                        246A(c)(3)(B)(ii)), the term `passive 
                        investment income' shall not include--
                                    ``(I) interest income earned by 
                                such bank or bank holding company, or
                                    ``(II) dividends on assets required 
                                to be held by such bank or bank holding 
                                company to conduct a banking business, 
                                including stock in the Federal Reserve 
                                Bank, the Federal Home Loan Bank, or 
                                the Federal Agricultural Mortgage Bank 
                                or participation certificates issued by 
                                a Federal Intermediate Credit Bank.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 4. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS TO 150.

    (a) In General.--Section 1361(b)(1)(A) of the Internal Revenue Code 
of 1986 (defining small business corporation) is amended by striking 
``75 shareholders'' and inserting ``150 shareholders''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 5. TREATMENT OF QUALIFYING DIRECTOR SHARES.

    (a) In General.--Section 1361 of the Internal Revenue Code of 1986 
is amended by adding at the end the following:
    ``(f) Treatment of Qualifying Director Shares.--
            ``(1) In general.--For purposes of this subchapter--
                    ``(A) qualifying director shares shall not be 
                treated as a second class of stock, and
                    ``(B) no person shall be treated as a shareholder 
                of the corporation by reason of holding qualifying 
                director shares.
            ``(2) Qualifying director shares defined.--For purposes of 
        this subsection, the term `qualifying director shares' means 
        any shares of stock in a bank (as defined in section 581) or in 
        a bank holding company registered as such with the Federal 
        Reserve System--
                            ``(i) which are held by an individual 
                        solely by reason of status as a director 
of such bank or company or its controlled subsidiary; and
                            ``(ii) which are subject to an agreement 
                        pursuant to which the holder is required to 
                        dispose of the shares of stock upon termination 
                        of the holder's status as a director at the 
                        same price as the individual acquired such 
                        shares of stock.
            ``(3) Distributions.--A distribution (not in part or full 
        payment in exchange for stock) made by the corporation with 
        respect to qualifying director shares shall be includible as 
        ordinary income of the holder and deductible to the corporation 
        as an expense in computing taxable income under section 1363(b) 
        in the year such distribution is received.''
    (b) Conforming Amendments.--
            (1) Section 1361(b)(1) of the Internal Revenue Code of 1986 
        is amended by inserting ``, except as provided in subsection 
        (f),'' before ``which does not''.
            (2) Section 1366(a) of such Code is amended by adding at 
        the end the following:
            ``(3) Allocation with respect to qualifying director 
        shares.--The holders of qualifying director shares (as defined 
        in section 1361(f)) shall not, with respect to such shares of 
        stock, be allocated any of the items described in paragraph 
        (1).''
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 6. RECAPTURE OF BAD DEBT RESERVES.

    In the case of a bank which makes an S corporation election which 
first takes effect for a taxable year beginning after December 31, 
2003, the entire adjustment required by section 481 of the Internal 
Revenue Code of 1986 by reason of changing its accounting method for 
recognizing bad debts from the reserve method under section 585 or 593 
of such Code to the charge-off method under section 166 of such Code 
may be taken into in the year of the change or the preceding taxable 
year (whichever is elected by the bank).

SEC. 7. CLARIFICATION OF 3-YEAR S CORPORATION RULE FOR CORPORATE 
              PREFERENCE ITEMS.

    (a) In General.--Section 1363(b) of the Internal Revenue Code of 
1986 (relating to computation of corporation's taxable income) is 
amended by adding at the end the following new flush sentence:
``Nothing in the preceding sentence shall be construed to apply section 
291 to any taxable year which is more than 3 taxable years after the S 
corporation (or any predecessor) was a C corporation.''
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 8. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.

    (a) In General.--Paragraph (1) of section 1361(c) of the Internal 
Revenue Code of 1986 (relating to special rules for applying subsection 
(b)) is amended to read as follows:
            ``(1) Members of family treated as 1 shareholder.--
                    ``(A) In general.--For purpose of subsection 
                (b)(1)(A)--
                            ``(i) except as provided in clause (ii), a 
                        husband and wife (and their estates) shall be 
                        treated as 1 shareholder, and
                            ``(ii) in the case of a family with respect 
                        to which an election is in effect under 
                        subparagraph (E), all members of the family 
                        shall be treated as 1 shareholder.
                    ``(B) Members of the family.--For purpose of 
                subparagraph (A)(ii), the term `members of the family' 
                means the common ancestor, lineal descendants of the 
                common ancestor and the spouses (or former spouses) of 
                such lineal descendants or common ancestor.
                    ``(C) Common ancestor.--For purposes of this 
                paragraph, an individual shall not be considered a 
                common ancestor if, as of the later of the effective 
                date of this paragraph or the time the election under 
                section 1362(a) is made, the individual is more than 3 
                generations removed from the youngest generation of 
                shareholders.
                    ``(D) Effect of adoption, etc.--In determining 
                whether any relationship specified in subparagraph (B) 
                or (C) exists, the rules of section 152(b)(2) shall 
                apply.
                    ``(E) Election.--An election under subparagraph 
                (A)(ii)--
                            ``(i) must be made with the consent of 
                        shareholders (including those that are family 
                        members) holding in the aggregate more than 
                        one-half of the shares of stock in the 
                        corporation on the day the election is made,
                            ``(ii) in the case of--
                                    ``(I) an electing small business 
                                trust, shall be made by the trustee of 
                                the trust, and
                                    ``(II) a qualified subchapter S 
                                trust, shall be made by the beneficiary 
                                of the trust,
                            ``(iii) under regulations, shall remain in 
                        effect until terminated, and
                            ``(iv) shall apply only with respect to 1 
                        family in any corporation.''.
    (b) Relief From Inadvertent Invalid Election or Termination.--
Section 1362(f) of such Code (relating to inadvertent invalid elections 
or terminations) is amended--
            (1) by inserting ``or under section 1361(c)(1)(A)(ii)'' 
        after ``subsection (a)'' in paragraph (1), and
            (2) by inserting ``or under section 1361(c)(1)(E)(iii)'' 
        after ``subsection (d)'' in paragraph (1)(B).
    (c) Effective Dates.--
            (1) Subsection (a).--The amendment made by subsection (a) 
        shall apply to taxable years beginning after December 31, 2003.
            (2) Subsection (b).--The amendments made by subsection (b) 
        shall apply to elections and terminations made after December 
        31, 2003.

SEC. 9. ISSUANCE OF PREFERRED STOCK PERMITTED.

    (a) In General.--Section 1361 of the Internal Revenue Code of 1986, 
as amended by section 5(a), is amended by adding at the end the 
following:
    ``(g) Treatment of Qualified Preferred Stock.--
            ``(1) In general.--For purposes of this subchapter--
                    ``(A) qualified preferred stock shall not be 
                treated as a second class of stock, and
                    ``(B) no person shall be treated as a shareholder 
                of the corporation by reason of holding qualified 
                preferred stock.
            ``(2) Qualified preferred stock defined.--For purposes of 
        this subsection, the term `qualified preferred stock' means 
        stock which meets the requirements of subparagraphs (A), (B), 
        and (C) of section 1504(a)(4). Stock shall not fail to be 
        treated as qualified preferred stock solely because it is 
        convertible into other stock.
            ``(3) Distributions.--A distribution (not in part or full 
        payment in exchange for stock) made by the corporation with 
        respect to qualified preferred stock shall be includible as 
        ordinary income of the holder and deductible to the corporation 
        as an expense in computing taxable income under section 1363(b) 
        in the year such distribution is received.''
    (b) Conforming Amendments.--
            (1) Section 1361(b)(1) of the Internal Revenue Code of 
        1986, as amended by section 5(b)(1), is amended by striking 
        ``subsection (f)'' and inserting ``subsections (f) and (g)''.
            (2) Section 1366(a) of such Code, as amended by section 
        5(b)(2), is amended by adding at the end the following:
            ``(4) Allocation with respect to qualified preferred 
        stock.--The holders of qualified preferred stock (as defined in 
        section 1361(g)) shall not, with respect to such stock, be 
        allocated any of the items described in paragraph (1).''
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2003.

SEC. 10. INFORMATION RETURNS FOR QUALIFIED SUBCHAPTER S SUBSIDIARIES.

    (a) In General.--Section 1361(b)(3)(A) of the Internal Revenue Code 
of 1986 (relating to treatment of certain wholly owned subsidiaries) is 
amended by inserting ``and in the case of information returns required 
under part III of subchapter A of chapter 61'' after ``Secretary''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

SEC. 11. ADJUSTMENT TO BASIS OF S CORPORATION STOCK FOR CERTAIN 
              CHARITABLE CONTRIBUTIONS.

    (a) In General.--Paragraph (2) of section 1367(a) of the Internal 
Revenue Code of 1986 (relating to adjustments to basis of stock of 
shareholders, etc.) is amended by adding at the end the following new 
flush sentence:
        ``The decrease under subparagraph (B) by reason of a charitable 
        contribution (as defined in section 170(c)) of property shall 
        be the amount equal to the shareholder's pro rata share of the 
        adjusted basis of such property.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2003.

Summary: Small Business and Financial Institutions Tax Relief Act of 2003 - Amends the Internal Revenue Code to make a trust-individual retirement account (IRA) an eligible bank S corporation shareholder. Exempts from prohibited transaction rules any sale of stock in an IRA pursuant to a small business corporation's election to be an S corporation. Excludes from the definition of passive income for purposes of S status termination any interest income earned by or dividends on assets required to be held by a bank, a bank holding company, or a qualified subchapter S subsidiary bank. Increases to 150 the maximum number of shareholders a small business organization may have to be eligible to elect S corporation treatment. States that stock held by a bank director as required by banking regulations shall not be considered a disqualifying second class of S corporation stock. Permits a bank which makes an S corporation election to recapture certain bad debt reserves in the year of election or the preceding year. Limits any special rules regarding corporate income preference items to the three years following S corporation election. Treats a husband and wife as one shareholder. Permits, and sets forth criteria for, an election to treat all members of a family as one shareholder. Permits the issuance of qualified preferred stock, which shall not be treated as second class stock. Makes any distribution made by an S corporation with respect to qualified preferred stock includible as ordinary income of the holder and deductible to the corporation as an expense. Revises exceptions to the criteria for the treatment of certain wholly owned subchapter S subsidiaries with reference to required information returns. Provides for a charitable contribution basis adjustment of S corporation stock based upon the shareholder's pro rata share of adjusted basis.