I

104TH CONGRESS

1ST SESSION H. R. 2039

To amend the Internal Revenue Code of 1986 to provide for S corporation

reform, and for other purposes.

IN THE HOUSE OF REPRESENTATIVES

JULY 13, 1995

Mr. SHAW (for himself, Mr. MATSUI, Mr. PORTMAN, Mr. CHRISTENSEN, Mr.

MCDERMOTT, Mr. LEWIS of Georgia, Mr. LEVIN, Mr. HERGER, Mr.

HANCOCK, Mr. THOMAS, Mr. BUNNING of Kentucky, Mr. ENGLISH of

Pennsylvania, Mrs. MEYERS of Kansas, Mr. HOUGHTON, Mr. CAMP, Mr.

SPRATT, Ms. DUNN of Washington, Mr. FUNDERBURK, Mr. CRANE, Mr.

GORDON, Mr. PAYNE of Virginia, Mr. LONGLEY, Mr. NEAL of Massachusetts, Mrs. JOHNSON of Connecticut, Mr. MCCRERY, Mr. KLECZKA, and

Mr. ZIMMER) introduced the following bill; which was referred to the

Committee on Ways and Means

A BILL

To amend the Internal Revenue Code of 1986 to provide

for S corporation reform, and for other purposes.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 SECTION 1. SHORT TITLE; AMENDMENT OF 1986 CODE;

4 TABLE OF CONTENTS.

5 (a) SHORT TITLE.—This Act may be cited as the ‘‘S

6 Corporation Reform Act of 1995’’.
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1 (b) AMENDMENT OF 1986 CODE.—Except as other2 wise expressly provided, whenever in this Act an amend3 ment or repeal is expressed in terms of an amendment

4 to, or repeal of, a section or other provision, the reference

5 shall be considered to be made to a section or other provi6 sion of the Internal Revenue Code of 1986.

7 (c) TABLE OF CONTENTS.—The table of contents is

8 as follows:

Sec. 1. Short title; amendment of 1986 Code; table of contents.

TITLE I—ELIGIBLE SHAREHOLDERS OF S CORPORATION

Subtitle A—Number of Shareholders

Sec. 101. S corporations permitted to have 75 shareholders.

Sec. 102. Members of family treated as 1 shareholder.

Subtitle B—Persons Allowed As Shareholders

Sec. 111. Certain exempt organizations.

Sec. 112. Financial institutions.

Sec. 113. Nonresident aliens.

Sec. 114. Electing small business trusts.

Subtitle C—Other Provisions

Sec. 121. Expansion of post-death qualification for certain trusts.

TITLE II—QUALIFICATION AND ELIGIBILITY REQUIREMENTS FOR

S CORPORATIONS

Subtitle A—One Class of Stock

Sec. 201. Issuance of preferred stock permitted.

Sec. 202. Financial institutions permitted to hold safe harbor debt.

Subtitle B—Elections and Terminations

Sec. 211. Rules relating to inadvertent terminations and invalid elections.

Sec. 212. Agreement to terminate year.

Sec. 213. Expansion of post-termination transition period.

Sec. 214. Repeal of excessive passive investment income as a termination event.

Subtitle C—Other Provisions

Sec. 221. S corporations permitted to hold subsidiaries.

Sec. 222. Treatment of distributions during loss years.

Sec. 223. Consent dividend for AAA bypass election.

Sec. 224. Treatment of S corporations under subchapter C.
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Sec. 225. Elimination of pre-1983 earnings and profits.

Sec. 226. Allowance of charitable contributions of inventory and scientific property.

Sec. 227. C corporation rules to apply for fringe benefit purposes.

TITLE III—TAXATION OF S CORPORATION SHAREHOLDERS

Sec. 301. Uniform treatment of owner-employees under prohibited transaction

rules.

Sec. 302. Treatment of losses to shareholders.

TITLE IV—EFFECTIVE DATE

Sec. 401. Effective date.

1 TITLE I—ELIGIBLE SHAREHOLD2 ERS OF S CORPORATION

3 Subtitle A—Number of

4 Shareholders

5 SEC. 101. S CORPORATIONS PERMITTED TO HAVE 75

6 SHAREHOLDERS.

7 Subparagraph (A) of section 1361(b)(1) (defining

8 small business corporation) is amended by striking ‘‘35

9 shareholders’’ and inserting ‘‘75 shareholders’’.

10 SEC. 102. MEMBERS OF FAMILY TREATED AS 1 SHARE11 HOLDER.

12 Paragraph (1) of section 1361(c) (relating to special

13 rules for applying subsection (b)) is amended to read as

14 follows:

15 ‘‘(1) MEMBERS OF FAMILY TREATED AS 1

16 SHAREHOLDER.—

17 ‘‘(A) IN GENERAL.—For purposes of sub18 section (b)(1)(A)—
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1 ‘‘(i) except as provided in clause (ii),

2 a husband and wife (and their estates)

3 shall be treated as 1 shareholder, and

4 ‘‘(ii) in the case of a family with re5 spect to which an election is in effect

6 under subparagraph (E), all members of

7 the family shall be treated as 1 share8 holder.

9 ‘‘(B) MEMBERS OF THE FAMILY.—For

10 purposes of subparagraph (A)(ii), the term

11 ‘members of the family’ means the lineal de12 scendants of the common ancestor and the

13 spouses (or former spouses) of such lineal de14 scendants or common ancestor.

15 ‘‘(C) COMMON ANCESTOR.—For purposes

16 of this paragraph, an individual shall not be

17 considered a common ancestor if, as of the later

18 of the effective date of this paragraph or the

19 time the election under section 1362(a) is

20 made, the individual is more than 6 generations

21 removed from the youngest generation of share22 holders.

23 ‘‘(D) EFFECT OF ADOPTION, ETC.—In de24 termining whether any relationship specified in
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1 subparagraph (B) or (C) exists, the rules of

2 section 152(b)(2) shall apply.

3 ‘‘(E) ELECTION.—An election under sub4 paragraph (A)(ii)—

5 ‘‘(i) must be made with the consent of

6 all shareholders,

7 ‘‘(ii) shall remain in effect until termi8 nated, and

9 ‘‘(iii) shall apply only with respect to

10 1 family in any corporation.’’.

11 Subtitle B—Persons Allowed as

12 Shareholders

13 SEC. 111. CERTAIN EXEMPT ORGANIZATIONS.

14 (a) CERTAIN EXEMPT ORGANIZATIONS ALLOWED TO

15 BE SHAREHOLDERS.—

16 (1) IN GENERAL.—Subparagraph (B) of section

17 1361(b)(1) (defining small business corporation) is

18 amended to read as follows:

19 ‘‘(B) have as a shareholder a person (other

20 than an estate, a trust described in subsection

21 (c)(2), or an organization described in sub22 section (c)(7)) who is not an individual,’’.

23 (2) ELIGIBLE EXEMPT ORGANIZATIONS.—Sec24 tion 1361(c) (relating to special rules for applying
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1 subsection (b)) is amended by adding at the end the

2 following new paragraph:

3 ‘‘(7) CERTAIN EXEMPT ORGANIZATIONS PER4 MITTED AS SHAREHOLDERS.—For purposes of sub5 section (b)(1)(B), an organization described in sec6 tion 401(a) or 501(c)(3) may be a shareholder in an

7 S corporation.’’

8 (b) CONTRIBUTIONS OF S CORPORATION STOCK.—

9 Section 170(e)(1) (relating to certain contributions of or10 dinary income and capital gain property) is amended by

11 adding at the end the following sentence: ‘‘For purposes

12 of applying this paragraph in the case of a charitable con13 tribution of stock in an S corporation, rules similar to the

14 rules of section 751 shall apply in determining whether

15 gain on such stock would have been long-term capital gain

16 if such stock were sold by the taxpayer.’’

17 (c) SPECIAL RULES APPLICABLE TO PARTNERSHIPS

18 AND S CORPORATIONS.—

19 (1) IN GENERAL.—Subsection (c) of section

20 512 (relating to unrelated business tax income) is

21 amended—

22 (A) by inserting ‘‘or S corporation’’ after

23 ‘‘partnership’’ each place it appears in para24 graphs (1) and (3),
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1 (B) by inserting ‘‘or shareholder’’ after

2 ‘‘member’’ in paragraph (1), and

3 (C) by inserting ‘‘AND S CORPORATIONS’’

4 after ‘‘PARTNERSHIPS’’ in the heading.

5 (2) REPORTING REQUIREMENT.—Section 6037

6 (relating to return of S corporation) is amended by

7 adding at the end the following new subsection:

8 ‘‘(c) SEPARATE STATEMENT OF ITEMS OF UNRE9 LATED BUSINESS TAXABLE INCOME.—In the case of any

10 S corporation regularly carrying on a trade or business

11 (within the meaning of section 512(c)(1)), the information

12 required under subsection (b) to be furnished to any

13 shareholder described in section 1361(c)(7) shall include

14 such information as is necessary to enable the shareholder

15 to compute its pro rata share of the corporation’s income

16 or loss from the trade or business in accordance with sec17 tion 512(a)(1), but without regard to the modifications de18 scribed in paragraphs (8) through (15) of section 512(b).’’

19 SEC. 112. FINANCIAL INSTITUTIONS.

20 Subparagraph (B) of section 1361(b)(2) (defining in21 eligible corporation) is amended to read as follows:

22 ‘‘(B) a financial institution which uses the

23 reserve method of accounting for bad debts de24 scribed in section 585 or 593,’’.
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1 SEC. 113. NONRESIDENT ALIENS.

2 (a) NONRESIDENT ALIENS ALLOWED TO BE SHARE3 HOLDERS.—

4 (1) IN GENERAL.—Paragraph (1) of section

5 1361(b) (defining small business corporation) is

6 amended—

7 (A) by adding ‘‘and’’ at the end of sub8 paragraph (B),

9 (B) by striking subparagraph (C), and

10 (C) by redesignating subparagraph (D) as

11 subparagraph (C).

12 (2) CONFORMING AMENDMENTS.—Paragraphs

13 (4) and (5)(A) of section 1361(c) (relating to special

14 rules for applying subsection (b)) are each amended

15 by striking ‘‘subsection (b)(1)(D)’’ and inserting

16 ‘‘subsection (b)(1)(C)’’.

17 (b) NONRESIDENT ALIEN SHAREHOLDER TREATED

18 AS ENGAGED IN TRADE OR BUSINESS WITHIN UNITED

19 STATES.—

20 (1) IN GENERAL.—Section 875 is amended—

21 (A) by striking ‘‘and’’ at the end of para22 graph (1),

23 (B) by striking the period at the end of

24 paragraph (2) and inserting ‘‘, and’’, and

25 (C) by adding at the end the following new

26 paragraph:
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1 ‘‘(3) a nonresident alien individual shall be con2 sidered as being engaged in a trade or business

3 within the United States if the S corporation of

4 which such individual is a shareholder is so en5 gaged.’’

6 (2) APPLICATION OF WITHHOLDING TAX ON

7 NONRESIDENT ALIEN SHAREHOLDERS.—Section

8 1446 (relating to withholding tax on foreign part9 ners’ share of effectively connected income) is

10 amended by redesignating subsection (f) as sub11 section (g) and by inserting after subsection (e) the

12 following new subsection:

13 ‘‘(f) S CORPORATION TREATED AS PARTNERSHIP,

14 ETC.—For purposes of this section—

15 ‘‘(1) an S corporation shall be treated as a

16 partnership,

17 ‘‘(2) the shareholders of such corporation shall

18 be treated as partners of such partnership, and

19 ‘‘(3) any reference to section 704 shall be treat20 ed as a reference to section 1366.’’

21 (3) CONFORMING AMENDMENTS.—

22 (A) The heading of section 875 is amended

23 to read as follows:
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1 ‘‘SEC. 875. PARTNERSHIPS; BENEFICIARIES OF ESTATES

2 AND TRUSTS; S CORPORATIONS.’’

3 (B) The heading of section 1446 is amend4 ed to read as follows:

5 ‘‘SEC. 1446. WITHHOLDING TAX ON FOREIGN PARTNERS’

6 AND S CORPORATE SHAREHOLDERS’ SHARE

7 OF EFFECTIVELY CONNECTED INCOME.’’

8 (4) CLERICAL AMENDMENTS.—

9 (A) The item relating to section 875 in the

10 table of sections for subpart A of part II of

11 subchapter N of chapter 1 is amended to read

12 as follows:

‘‘Sec. 875. Partnerships; beneficiaries of estates and trusts; S corporations.’’

13 (B) The item relating to section 1446 in

14 the table of sections for subchapter A of chap15 ter 3 is amended to read as follows:

‘‘Sec. 1446. Withholding tax on foreign partners’ and S corporate shareholders’

share of effectively connected income.’’

16 (c) PERMANENT ESTABLISHMENT OF PARTNERS

17 AND S CORPORATION SHAREHOLDERS.—Section 894 (re18 lating to income affected by treaty) is amended by adding

19 at the end the following new subsection:

20 ‘‘(c) PERMANENT ESTABLISHMENT OF PARTNERS

21 AND S CORPORATION SHAREHOLDERS.—If a partnership

22 or S corporation has a permanent establishment in the

23 United States (within the meaning of a treaty to which
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1 the United States is a party) at any time during a taxable

2 year of such entity, a nonresident alien individual or for3 eign corporation which is a partner in such partnership,

4 or a nonresident alien individual who is a shareholder in

5 such S corporation, shall be treated as having a permanent

6 establishment in the United States for purposes of such

7 treaty.’’

8 SEC. 113. ELECTING SMALL BUSINESS TRUSTS.

9 (a) GENERAL RULE.—Subparagraph (A) of section

10 1361(c)(2) (relating to certain trusts permitted as share11 holders) is amended by inserting after clause (iv) the fol12 lowing new clause:

13 ‘‘(v) An electing small business trust.’’

14 (b) CURRENT BENEFICIARIES TREATED AS SHARE15 HOLDERS.—Subparagraph (B) of section 1361(c)(2) is

16 amended by adding at the end the following new clause:

17 ‘‘(v) In the case of a trust described

18 in clause (v) of subparagraph (A), each po19 tential current beneficiary of such trust

20 shall be treated as a shareholder; except

21 that, if for any period there is no potential

22 current beneficiary of such trust, such

23 trust shall be treated as the shareholder

24 during such period.’’
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1 (c) ELECTING SMALL BUSINESS TRUST DEFINED.—

2 Section 1361 (defining S corporation) is amended by add3 ing at the end the following new subsection:

4 ‘‘(e) ELECTING SMALL BUSINESS TRUST DE5 FINED.—

6 ‘‘(1) ELECTING SMALL BUSINESS TRUST.—For

7 purposes of this section—

8 ‘‘(A) IN GENERAL.—Except as provided in

9 subparagraph (B), the term ‘electing small

10 business trust’ means any trust if—

11 ‘‘(i) such trust does not have as a

12 beneficiary any person other than an indi13 vidual, an estate, or an organization de14 scribed in section 401(a) or 501(c)(3),

15 ‘‘(ii) no interest in such trust was ac16 quired by purchase, and

17 ‘‘(iii) an election under this subsection

18 applies to such trust.

19 ‘‘(B) CERTAIN TRUSTS NOT ELIGIBLE.—

20 The term ‘electing small business trust’ shall

21 not include—

22 ‘‘(i) any qualified subchapter S trust

23 (as defined in subsection (d)(3)) if an elec24 tion under subsection (d)(2) applies to any
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1 corporation the stock of which is held by

2 such trust, and

3 ‘‘(ii) any trust exempt from tax under

4 this subtitle.

5 ‘‘(C) PURCHASE.—For purposes of sub6 paragraph (A), the term ‘purchase’ means any

7 acquisition if the basis of the property acquired

8 is determined under section 1012.

9 ‘‘(2) POTENTIAL CURRENT BENEFICIARY.—For

10 purposes of this section, the term ‘potential current

11 beneficiary’ means, with respect to any period, any

12 person who at any time during such period is enti13 tled to, or at the discretion of any person may re14 ceive, a distribution from the principal or income of

15 the trust. If a trust disposes of all of the stock which

16 it holds in an S corporation, then, with respect to

17 such corporation, the term ‘potential current bene18 ficiary’ does not include any person who first met

19 the requirements of the preceding sentence during

20 the 60-day period ending on the date of such dis21 position.

22 ‘‘(3) ELECTION.—An election under this sub23 section shall be made by the trustee in such manner

24 and form, and at such time, as the Secretary may

25 prescribe. Any such election shall apply to the tax-
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1 able year of the trust for which made and all subse2 quent taxable years of such trust unless revoked

3 with the consent of the Secretary.

4 ‘‘(4) CROSS REFERENCE.—

‘‘For special treatment of electing small business

trusts, see section 641(d).’’

5 (d) TAXATION OF ELECTING SMALL BUSINESS

6 TRUSTS.—Section 641 (relating to imposition of tax on

7 trusts) is amended by adding at the end the following new

8 subsection:

9 ‘‘(d) SPECIAL RULES FOR TAXATION OF ELECTING

10 SMALL BUSINESS TRUSTS.—

11 ‘‘(1) IN GENERAL.—For purposes of this chap12 ter—

13 ‘‘(A) the portion of any electing small busi14 ness trust which consists of stock in 1 or more

15 S corporations shall be treated as a separate

16 trust, and

17 ‘‘(B) the amount of the tax imposed by

18 this chapter on such separate trust shall be de19 termined with the modifications of paragraph

20 (2).

21 ‘‘(2) MODIFICATIONS.—For purposes of para22 graph (1), the modifications of this paragraph are

23 the following:
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1 ‘‘(A) Except as provided in section 1(h),

2 the amount of the tax imposed by section 1(e)

3 shall be determined by using the highest rate of

4 tax set forth in section 1(e).

5 ‘‘(B) The exemption amount under section

6 55(d) shall be zero.

7 ‘‘(C) The only items of income, loss, deduc8 tion, or credit to be taken into account are the

9 following:

10 ‘‘(i) The items required to be taken

11 into account under section 1366.

12 ‘‘(ii) Any gain or loss from the dis13 position of stock in an S corporation.

14 ‘‘(iii) To the extent provided in regu15 lations, State or local income taxes or ad16 ministrative expenses to the extent alloca17 ble to items described in clauses (i) and

18 (ii).

19 No deduction or credit shall be allowed for any

20 amount not described in this paragraph, and no

21 item described in this paragraph shall be appor22 tioned to any beneficiary.

23 ‘‘(D) No amount shall be allowed under

24 paragraph (1) or (2) of section 1211(b).
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1 ‘‘(3) TREATMENT OF REMAINDER OF TRUST

2 AND DISTRIBUTIONS.—For purposes of determin3 ing—

4 ‘‘(A) the amount of the tax imposed by

5 this chapter on the portion of any electing small

6 business trust not treated as a separate trust

7 under paragraph (1), and

8 ‘‘(B) the distributable net income of the

9 entire trust,

10 the items referred to in paragraph (2)(C) shall be

11 excluded. Except as provided in the preceding sen12 tence, this subsection shall not affect the taxation of

13 any distribution from the trust.

14 ‘‘(4) TREATMENT OF UNUSED DEDUCTIONS

15 WHERE TERMINATION OF SEPARATE TRUST.—If a

16 portion of an electing small business trust ceases to

17 be treated as a separate trust under paragraph (1),

18 any carryover or excess deduction of the separate

19 trust which is referred to in section 642(h) shall be

20 taken into account by the entire trust.

21 ‘‘(5) ELECTING SMALL BUSINESS TRUST.—For

22 purposes of this subsection, the term ‘electing small

23 business trust’ has the meaning given such term by

24 section 1361(e)(1).’’
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1 Subtitle C—Other Provisions

2 SEC. 121. EXPANSION OF POST-DEATH QUALIFICATION FOR

3 CERTAIN TRUSTS.

4 Subparagraph (A) of section 1361(c)(2) (relating to

5 certain trusts permitted as shareholders) is amended—

6 (1) by striking ‘‘60-day period’’ each place it

7 appears in clauses (ii) and (iii) and inserting ‘‘2-year

8 period’’, and

9 (2) by striking the last sentence in clause (ii).

10 TITLE II—QUALIFICATION AND

11 ELIGIBILITY REQUIREMENTS

12 FOR S CORPORATIONS

13 Subtitle A—One Class of Stock

14 SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.

15 (a) IN GENERAL.—Section 1361 is amended by add16 ing at the end the following new subsection:

17 ‘‘(f) TREATMENT OF QUALIFIED PREFERRED

18 STOCK.—

19 ‘‘(1) IN GENERAL.—For purposes of this sub20 chapter—

21 ‘‘(A) qualified preferred stock shall not be

22 treated as a second class of stock, and

23 ‘‘(B) no person shall be treated as a share24 holder of the corporation by reason of holding

25 qualified preferred stock.
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1 ‘‘(2) QUALIFIED PREFERRED STOCK DE2 FINED.—For purposes of this subsection, the term

3 ‘qualified preferred stock’ means stock which meets

4 the requirements of subparagraphs (A), (B), and (C)

5 of section 1504(a)(4). Stock shall not fail to be

6 treated as qualified preferred stock merely because

7 it is convertible into other stock.

8 ‘‘(3) DISTRIBUTIONS.—A distribution (not in

9 part or full payment in exchange for stock) made by

10 the corporation with respect to qualified preferred

11 stock shall be includible as interest income of the

12 holder and deductible to the corporation as interest

13 expense in computing taxable income under section

14 1363(b) in the year such distribution is received.

15 ‘‘(4) REGULATIONS.—The Secretary shall pre16 scribe such regulations as may be necessary or ap17 propriate to provide for the proper treatment of

18 qualified preferred stock under this title and for the

19 coordination of such treatment with other provisions

20 of this title.’’

21 (b) CONFORMING AMENDMENTS.—

22 (1) Paragraph (1) of section 1361(b) is amend23 ed by inserting ‘‘, except as provided in subsection

24 (f),’’ before ‘‘which does not’’.
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1 (2) Subsection (a) of section 1366 is amended

2 by adding at the end the following new paragraph:

3 ‘‘(3) ALLOCATION WITH RESPECT TO QUALI4 FIED PREFERRED STOCK.—The holders of qualified

5 preferred stock (as defined in section 1361(f)) shall

6 not, with respect to such stock, be allocated any of

7 the items described in paragraph (1).’’

8 SEC. 202. FINANCIAL INSTITUTIONS PERMITTED TO HOLD

9 SAFE HARBOR DEBT.

10 Subparagraph (B) of section 1361(c)(5) (defining

11 straight debt) is amended by adding ‘‘and’’ at the end of

12 clause (i) and by striking clauses (ii) and (iii) and insert13 ing the following:

14 ‘‘(ii) in any case in which the terms of

15 such promise include a provision under

16 which the obligation to pay may be con17 verted (directly or indirectly) into stock of

18 the corporation, such terms, taken as a

19 whole, are substantially the same as the

20 terms which could have been obtained on

21 the effective date of the promise from a

22 person which is not a related person (with23 in the meaning of section 465(b)(3)(C)) to

24 the S corporation or its shareholders, and

25 ‘‘(iii) the creditor is—
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1 ‘‘(I) an individual,

2 ‘‘(II) an estate,

3 ‘‘(III) a trust described in para4 graph (2), or

5 ‘‘(IV) a person which is actively

6 and regularly engaged in the business

7 of lending money.’’

8 Subtitle B—Elections and

9 Terminations

10 SEC. 211. RULES RELATING TO INADVERTENT TERMI11 NATIONS AND INVALID ELECTIONS.

12 (a) GENERAL RULE.—Subsection (f) of section 1362

13 (relating to inadvertent terminations) is amended to read

14 as follows:

15 ‘‘(f) INADVERTENT INVALID ELECTIONS OR TERMI16 NATIONS.—If—

17 ‘‘(1) an election under subsection (a) by any

18 corporation—

19 ‘‘(A) was not effective for the taxable year

20 for which made (determined without regard to

21 subsection (b)(2)) by reason of a failure to meet

22 the requirements of section 1361(b) or to ob23 tain shareholder consents, or

24 ‘‘(B) was terminated under paragraph (2)

25 of subsection (d),
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1 ‘‘(2) the Secretary determines that the cir2 cumstances resulting in such ineffectiveness or ter3 mination were inadvertent,

4 ‘‘(3) no later than a reasonable period of time

5 after discovery of the circumstances resulting in

6 such ineffectiveness or termination, steps were

7 taken—

8 ‘‘(A) so that the corporation is a small

9 business corporation, or

10 ‘‘(B) to acquire the required shareholder

11 consents, and

12 ‘‘(4) the corporation, and each person who was

13 a shareholder in the corporation at any time during

14 the period specified pursuant to this subsection,

15 agrees to make such adjustments (consistent with

16 the treatment of the corporation as an S corpora17 tion) as may be required by the Secretary with re18 spect to such period,

19 then, notwithstanding the circumstances resulting in such

20 ineffectiveness or termination, such corporation shall be

21 treated as an S corporation during the period specified

22 by the Secretary.’’

23 (b) LATE ELECTIONS.—Subsection (b) of section

24 1362 is amended by adding at the end thereof the follow25 ing new paragraph:
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1 ‘‘(5) AUTHORITY TO TREAT LATE ELECTIONS

2 AS TIMELY.—If—

3 ‘‘(A) an election under subsection (a) is

4 made for any taxable year (determined without

5 regard to paragraph (3)) after the date pre6 scribed by this subsection for making such elec7 tion for such taxable year, and

8 ‘‘(B) the Secretary determines that there

9 was reasonable cause for the failure to timely

10 make such election,

11 the Secretary may treat such election as timely

12 made for such taxable year (and paragraph (3) shall

13 not apply).’’

14 (c) AUTOMATIC WAIVERS.—The Secretary of the

15 Treasury shall provide for an automatic waiver procedure

16 under section 1362(f) of the Internal Revenue Code of

17 1986 in cases in which the Secretary determines appro18 priate.

19 (d) EFFECTIVE DATE.—The amendments made by

20 subsections (a) and (b) shall apply with respect to elec21 tions for taxable years beginning after December 31,

22 1982.

23 SEC. 212. AGREEMENT TO TERMINATE YEAR.

24 Paragraph (2) of section 1377(a) (relating to pro

25 rata share) is amended to read as follows:
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1 ‘‘(2) ELECTION TO TERMINATE YEAR.—

2 ‘‘(A) IN GENERAL.—Under regulations

3 prescribed by the Secretary, if any shareholder

4 terminates the shareholder’s interest in the cor5 poration during the taxable year and all af6 fected shareholders agree to the application of

7 this paragraph, paragraph (1) shall be applied

8 to the affected shareholders as if the taxable

9 year consisted of 2 taxable years the first of

10 which ends on the date of the termination.

11 ‘‘(B) AFFECTED SHAREHOLDERS.—For

12 purposes of subparagraph (A), the term ‘af13 fected shareholders’ means the shareholder

14 whose interest is terminated and all sharehold15 ers to whom such shareholder has transferred

16 shares during the taxable year. If such share17 holder has transferred shares to the corpora18 tion, the term ‘affected shareholders’ shall in19 clude all persons who are shareholders during

20 the taxable year.’’

21 SEC. 213. EXPANSION OF POST-TERMINATION TRANSITION

22 PERIOD.

23 (a) IN GENERAL.—Paragraph (1) of section 1377(b)

24 (relating to post-termination transition period) is amended

25 by striking ‘‘and’’ at the end of subparagraph (A), by re-
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1 designating subparagraph (B) as subparagraph (C), and

2 by inserting after subparagraph (A) the following new sub3 paragraph:

4 ‘‘(B) the 120-day period beginning on the

5 date of any determination pursuant to an audit

6 of the taxpayer which follows the termination of

7 the corporation’s election and which adjusts a

8 subchapter S item of income, loss, or deduction

9 of the corporation arising during the S period

10 (as defined in section 1368(e)(2)), and’’.

11 (b) DETERMINATION DEFINED.—Paragraph (2) of

12 section 1377(b) is amended by striking subparagraphs (A)

13 and (B), by redesignating subparagraph (C) as subpara14 graph (B), and by inserting before subparagraph (B) (as

15 so redesignated) the following new subparagraph:

16 ‘‘(A) a determination as defined in section

17 1313(a), or’’.

18 (c) REPEAL OF SPECIAL AUDIT PROVISIONS FOR

19 SUBCHAPTER S ITEMS.—

20 (1) GENERAL RULE.—Subchapter D of chapter

21 63 (relating to tax treatment of subchapter S items)

22 is hereby repealed.

23 (2) CONSISTENT TREATMENT REQUIRED.—Sec24 tion 6037 (relating to return of S corporation), as
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1 amended by section 111(c)(2), is amended by adding

2 at the end the following new subsection:

3 ‘‘(d) SHAREHOLDER’S RETURN MUST BE CONSIST4 ENT WITH CORPORATE RETURN OR SECRETARY NOTI5 FIED OF INCONSISTENCY.—

6 ‘‘(1) IN GENERAL.—A shareholder of an S cor7 poration shall, on such shareholder’s return, treat a

8 subchapter S item in a manner which is consistent

9 with the treatment of such item on the corporate re10 turn.

11 ‘‘(2) NOTIFICATION OF INCONSISTENT TREAT12 MENT.—

13 ‘‘(A) IN GENERAL.—In the case of any

14 subchapter S item, if—

15 ‘‘(i)(I) the corporation has filed a re16 turn but the shareholder’s treatment on

17 his return is (or may be) inconsistent with

18 the treatment of the item on the corporate

19 return, or

20 ‘‘(II) the corporation has not filed a

21 return, and

22 ‘‘(ii) the shareholder files with the

23 Secretary a statement identifying the in24 consistency,

25 paragraph (1) shall not apply to such item.
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1 ‘‘(B) SHAREHOLDER RECEIVING INCOR2 RECT INFORMATION.—A shareholder shall be

3 treated as having complied with clause (ii) of

4 subparagraph (A) with respect to a subchapter

5 S item if the shareholder—

6 ‘‘(i) demonstrates to the satisfaction

7 of the Secretary that the treatment of the

8 subchapter S item on the shareholder’s re9 turn is consistent with the treatment of the

10 item on the schedule furnished to the

11 shareholder by the corporation, and

12 ‘‘(ii) elects to have this paragraph

13 apply with respect to that item.

14 ‘‘(3) EFFECT OF FAILURE TO NOTIFY.—In any

15 case—

16 ‘‘(A) described in subparagraph (A)(i)(I)

17 of paragraph (2), and

18 ‘‘(B) in which the shareholder does not

19 comply with subparagraph (A)(ii) of paragraph

20 (2),

21 any adjustment required to make the treatment of

22 the items by such shareholder consistent with the

23 treatment of the items on the corporate return shall

24 be treated as arising out of mathematical or clerical

25 errors and assessed according to section 6213(b)(1).
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1 Paragraph (2) of section 6213(b) shall not apply to

2 any assessment referred to in the preceding sen3 tence.

4 ‘‘(4) SUBCHAPTER S ITEM.—For purposes of

5 this subsection, the term ‘subchapter S item’ means

6 any item of an S corporation to the extent that reg7 ulations prescribed by the Secretary provide that, for

8 purposes of this subtitle, such item is more appro9 priately determined at the corporation level than at

10 the shareholder level.

11 ‘‘(5) ADDITION TO TAX FOR FAILURE TO COM12 PLY WITH SECTION.—

‘‘For addition to tax in the case of a shareholder’s

negligence in connection with, or disregard of, the

requirements of this section, see part II of subchapter A of chapter 68.’’

13 (3) CONFORMING AMENDMENTS.—

14 (A) Section 1366 is amended by striking

15 subsection (g).

16 (B) Subsection (b) of section 6233 is

17 amended to read as follows:

18 ‘‘(b) SIMILAR RULES IN CERTAIN CASES.—If a part19 nership return is filed for any taxable year but it is deter20 mined that there is no entity for such taxable year, to the

21 extent provided in regulations, rules similar to the rules

22 of subsection (a) shall apply.’’
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1 (C) The table of subchapters for chapter

2 63 is amended by striking the item relating to

3 subchapter D.

4 SEC. 214. REPEAL OF EXCESSIVE PASSIVE INVESTMENT IN5 COME AS A TERMINATION EVENT.

6 (a) IN GENERAL.—Section 1362(d) (relating to ter7 mination) is amended by striking paragraph (3).

8 (b) MODIFICATION OF TAX IMPOSED ON EXCESSIVE

9 PASSIVE INVESTMENT INCOME.—

10 (1) INCREASE IN THRESHOLD.—Subsections

11 (a)(2) and (b)(1)(A)(i) of section 1375 (relating to

12 tax imposed when passive investment income of a

13 corporation having subchapter C earnings and prof14 its exceeds 25 percent of gross receipts) are each

15 amended by striking ‘‘25 percent’’ and inserting ‘‘50

16 percent’’.

17 (2) TAX RATE INCREASE AFTER THIRD CON18 SECUTIVE YEAR.—Section 1375 is amended by re19 designating subsections (c) and (d) as subsections

20 (d) and (e), respectively, and by inserting after sub21 section (b) the following new subsection:

22 ‘‘(c) TAX RATE INCREASE AFTER THIRD CONSECU23 TIVE YEAR.—

24 ‘‘(1) IN GENERAL.—If an S corporation is de25 scribed in subsection (a) for more than 3 consecutive
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1 taxable years, then the rate of tax imposed under

2 subsection (a) with respect to each succeeding con3 secutive taxable year (if any) shall be determined

4 under the following table:

‘‘In the case of the— The rate of tax imposed under

subsection (a) shall be

equal to such rate of tax for

the 3rd taxable year, plus

the following percentage

points:

4th taxable year ....................................................................... 10

5th taxable year ....................................................................... 20

6th taxable year ....................................................................... 30

7th taxable year ....................................................................... 40

8th taxable year and thereafter ............................................... 50.

5 ‘‘(2) YEARS TAKEN INTO ACCOUNT.—No tax

6 shall be increased under paragraph (1) for any tax7 able year beginning before January 1, 1996.’’

8 (c) CONFORMING AMENDMENTS.—

9 (1) Section 1362(f)(1) is amended by striking

10 ‘‘or (3)’’.

11 (2) Subsection (b) of section 1375 is amended

12 by striking paragraphs (3) and (4) and inserting the

13 following new paragraphs:

14 ‘‘(3) SUBCHAPTER C EARNINGS AND PROF15 ITS.—The term ‘subchapter C earnings and profits’

16 means earnings and profits of any corporation for

17 any taxable year with respect to which an election

18 under section 1362(a) (or under section 1372 of

19 prior law) was not in effect.
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1 ‘‘(4) GROSS RECEIPTS FROM SALES OF CAPITAL

2 ASSETS (OTHER THAN STOCK AND SECURITIES).—In

3 the case of dispositions of capital assets (other than

4 stock and securities), gross receipts from such dis5 positions shall be taken into account only to the ex6 tent of the capital gain net income therefrom.

7 ‘‘(5) PASSIVE INVESTMENT INCOME DE8 FINED.—

9 ‘‘(A) IN GENERAL.—Except as otherwise

10 provided in this paragraph, the term ‘passive

11 investment income’ means gross receipts de12 rived from royalties, rents, dividends, interest,

13 and annuities.

14 ‘‘(B) EXCEPTION FOR INTEREST ON

15 NOTES FROM SALES OF INVENTORY.—The term

16 ‘passive investment income’ shall not include in17 terest on any obligation acquired in the ordi18 nary course of the corporation’s trade or busi19 ness from its sale of property described in sec20 tion 1221(1).

21 ‘‘(C) TREATMENT OF CERTAIN LENDING

22 OR FINANCE COMPANIES.—If the S corporation

23 meets the requirements of section 542(c)(6) for

24 the taxable year, the term ‘passive investment

25 income’ shall not include gross receipts for the
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1 taxable year which are derived directly from the

2 active and regular conduct of a lending or fi3 nance business (as defined in section

4 542(d)(1)).

5 ‘‘(D) SPECIAL RULE FOR OPTIONS AND

6 COMMODITY DEALINGS.—

7 ‘‘(i) IN GENERAL.—In the case of any

8 options dealer or commodities dealer, pas9 sive investment income shall be determined

10 by not taking into account any gain or loss

11 (in the normal course of the taxpayer’s ac12 tivity of dealing in or trading section 1256

13 contracts) from any section 1256 contract

14 or property related to such a contract.

15 ‘‘(ii) DEFINITIONS.—For purposes of

16 this subparagraph—

17 ‘‘(I) OPTIONS DEALER.—The

18 term ‘options dealer’ has the meaning

19 given such term by section

20 1256(g)(8).

21 ‘‘(II) COMMODITIES DEALER.—

22 The term ‘commodities dealer’ means

23 a person who is actively engaged in

24 trading section 1256 contracts and is

25 registered with a domestic board of
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1 trade which is designated as a con2 tract market by the Commodities Fu3 tures Trading Commission.

4 ‘‘(III) SECTION 1256 CON5 TRACT.—The term ‘section 1256 con6 tract’ has the meaning given to such

7 term by section 1256(b).

8 ‘‘(E) COORDINATION WITH SECTION

9 1374.—The amount of passive investment in10 come shall be determined by not taking into ac11 count any recognized built-in gain or loss of the

12 S corporation for any taxable year in the rec13 ognition period. Terms used in the preceding

14 sentence shall have the same respective mean15 ing as when used in section 1374.’’

16 (3) The heading for section 1375 is amended by

17 striking ‘‘25’’ and inserting ‘‘50’’.

18 (4) The table of sections for part III of sub19 chapter S of chapter 1 is amended by striking ‘‘25’’

20 in the item relating to section 1375 and inserting

21 ‘‘50’’.

22 (5) Clause (i) of section 1042(c)(4)(A) is

23 amended by striking ‘‘section 1362(d)(3)(D)’’ and

24 inserting ‘‘section 1375(b)(5)’’.
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1 Subtitle C—Other Provisions

2 SEC. 221. S CORPORATIONS PERMITTED TO HOLD SUBSIDI3 ARIES.

4 (a) IN GENERAL.—Paragraph (2) of section 1361(b)

5 (defining ineligible corporation), as amended by section

6 112, is amended by striking subparagraph (A) and by re7 designating subparagraphs (B), (C), (D), and (E) as sub8 paragraphs (A), (B), (C), and (D), respectively.

9 (b) TREATMENT OF CERTAIN WHOLLY OWNED S

10 CORPORATION SUBSIDIARIES.—Section 1361(b) (defining

11 small business corporation) is amended by adding at the

12 end thereof the following new subsection:

13 ‘‘(3) TREATMENT OF CERTAIN WHOLLY OWNED

14 SUBSIDIARIES.—

15 ‘‘(A) IN GENERAL.—For purposes of this

16 title—

17 ‘‘(i) a corporation which is a qualified

18 subchapter S subsidiary shall not be treat19 ed as a separate corporation, and

20 ‘‘(ii) all assets, liabilities, and items of

21 income, deduction, and credit of a qualified

22 subchapter S subsidiary shall be treated as

23 assets, liabilities, and such items (as the

24 case may be) of the S corporation.
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1 ‘‘(B) QUALIFIED SUBCHAPTER S SUBSIDI2 ARY.—For purposes of this subsection, the term

3 ‘qualified subchapter S subsidiary’ means any

4 corporation 100 percent of the stock of which

5 is held by an S corporation as of the later of

6 the effective date of the S election of the S cor7 poration or the acquisition of the subsidiary,

8 and at all times thereafter.

9 ‘‘(C) TREATMENT OF TERMINATIONS OF

10 QUALIFIED SUBCHAPTER S SUBSIDIARY STA11 TUS.—For purposes of this subtitle, if any cor12 poration which was a qualified subchapter S

13 subsidiary ceases to meet the requirements of

14 subparagraph (B), such corporation shall be

15 treated as a new corporation acquiring all of its

16 assets (and assuming all of its liabilities) imme17 diately before such cessation from the S cor18 poration in exchange for its stock.’’.

19 (c) CERTAIN DIVIDENDS NOT TREATED AS PASSIVE

20 INVESTMENT INCOME.—Section 1375(b)(5) (defining pas21 sive investment income), as added by section 214(c)(2),

22 is amended by adding at the end the following new sub23 paragraph:

24 ‘‘(F) TREATMENT OF CERTAIN DIVI25 DENDS.—If an S corporation holds stock in a
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1 C corporation meeting the requirements of sec2 tion 1504(a)(2), the term ‘passive investment

3 income’ shall not include dividends from such C

4 corporation to the extent such dividends are at5 tributable to the earnings and profits of such C

6 corporation derived from the active conduct of

7 a trade or business.’’

8 (d) CONFORMING AMENDMENTS.—

9 (1) Subsection (c) of section 1361, as amended

10 by sections 111(a)(2) and 201(a), is amended by

11 striking paragraph (6) and redesignating paragraph

12 (7) as paragraphs (6).

13 (2) Subsection (b) of section 1504 (defining in14 cludible corporation) is amended by adding at the

15 end the following new paragraph:

16 ‘‘(8) An S corporation.’’

17 SEC. 222. TREATMENT OF DISTRIBUTIONS DURING LOSS

18 YEARS.

19 (a) ADJUSTMENTS FOR DISTRIBUTIONS TAKEN INTO

20 ACCOUNT BEFORE LOSSES.—

21 (1) Subparagraph (A) of section 1366(d)(1)

22 (relating to losses and deductions cannot exceed

23 shareholder’s basis in stock and debt) is amended by

24 striking ‘‘paragraph (1)’’ and inserting ‘‘paragraphs

25 (1) and (2)(A)’’.
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1 (2) Subsection (d) of section 1368 (relating to

2 certain adjustments taken into account) is amended

3 by adding at the end the following new sentence:

4 ‘‘In the case of any distribution made during any taxable

5 year, the adjusted basis of the stock shall be determined

6 with regard to the adjustments provided in paragraph (1)

7 of section 1367(a) for the taxable year.’’

8 (b) ACCUMULATED ADJUSTMENTS ACCOUNT.—Para9 graph (1) of section 1368(e) (relating to accumulated ad10 justments account) is amended by adding at the end the

11 following new subparagraph:

12 ‘‘(C) NET LOSS FOR YEAR DISREGARDED.—

13 ‘‘(i) IN GENERAL.—In applying this section

14 to distributions made during any taxable year,

15 the amount in the accumulated adjustments ac16 count as of the close of such taxable year shall

17 be determined without regard to any net nega18 tive adjustment for such taxable year.

19 ‘‘(ii) NET NEGATIVE ADJUSTMENT.—For

20 purposes of clause (i), the term ‘net negative

21 adjustment’ means, with respect to any taxable

22 year, the excess (if any) of—

23 ‘‘(I) the reductions in the account for

24 the taxable year (other than for distribu25 tions), over
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1 ‘‘(II) the increases in such account for

2 such taxable year.’’

3 (c) CONFORMING AMENDMENTS.—Subparagraph (A)

4 of section 1368(e)(1) is amended—

5 (1) by striking ‘‘as provided in subparagraph

6 (B)’’ and inserting ‘‘as otherwise provided in this

7 paragraph’’, and

8 (2) by striking ‘‘section 1367(b)(2)(A)’’ and in9 serting ‘‘section 1367(a)(2)’’.

10 SEC. 223. CONSENT DIVIDEND FOR AAA BYPASS ELECTION.

11 Section 1368(e)(3) (relating to election to distribute

12 earnings first) is amended by adding at the end the follow13 ing new subparagraph:

14 ‘‘(C) CONSENT DIVIDEND.—Under regula15 tions prescribed by the Secretary, an S corpora16 tion may, subject to the election under this

17 paragraph, consent to treat as a distribution

18 the amount specified in such consent, to the ex19 tent such amount does not exceed the accumu20 lated earnings and profits of such corporation.

21 The amount so specified shall be considered—

22 ‘‘(i) as distributed in money by the

23 corporation to its shareholders on the last

24 day of the taxable year of the corporation

25 and as contributed to the capital of the
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1 corporation by the shareholders on such

2 day, and

3 ‘‘(ii) if any such shareholder is an or4 ganization described in section 511(a)(2),

5 as unrelated business taxable income (as

6 defined in section 512) to such share7 holder.’’

8 SEC. 224. TREATMENT OF S CORPORATIONS UNDER SUB9 CHAPTER C.

10 Subsection (a) of section 1371 (relating to applica11 tion of subchapter C rules) is amended to read as follows:

12 ‘‘(a) APPLICATION OF SUBCHAPTER C RULES.—Ex13 cept as otherwise provided in this title, and except to the

14 extent inconsistent with this subchapter, subchapter C

15 shall apply to an S corporation and its shareholders.’’

16 SEC. 225. ELIMINATION OF PRE-1983 EARNINGS AND

17 PROFITS.

18 (a) IN GENERAL.—If—

19 (1) a corporation was an electing small business

20 corporation under subchapter S of chapter 1 of the

21 Internal Revenue Code of 1986 for any taxable year

22 beginning before January 1, 1983, and

23 (2) such corporation is an S corporation under

24 subchapter S of chapter 1 of such Code for its first

25 taxable year beginning after December 31, 1995,
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1 the amount of such corporation’s accumulated earnings

2 and profits (as of the beginning of such first taxable year)

3 shall be reduced by an amount equal to the portion (if

4 any) of such accumulated earnings and profits which were

5 accumulated in any taxable year beginning before January

6 1, 1983, for which such corporation was an electing small

7 business corporation under such subchapter S.

8 (b) CONFORMING AMENDMENTS.—

9 (1)(A) Subsection (a) of section 1375 is amend10 ed by striking ‘‘subchapter C’’ in paragraph (1) and

11 inserting ‘‘accumulated’’.

12 (B) Subsection (b) of section 1375, as amended

13 by section 214(c)(2), is amended by striking para14 graph (3) and by redesignating paragraphs (4) and

15 (5) as paragraphs (3) and (4), respectively.

16 (C) The section heading for section 1375 is

17 amended by striking ‘‘SUBCHAPTER C’’ and insert18 ing ‘‘ACCUMULATED’’.

19 (D) The table of sections for part III of sub20 chapter S of chapter 1 is amended by striking ‘‘sub21 chapter C’’ in the item relating to section 1375 and

22 inserting ‘‘accumulated’’.

23 (2) Clause (i) of section 1042(c)(4)(A), as

24 amended by section 214(c)(5), is amended by strik-
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1 ing ‘‘section 1375(b)(5)’’ and inserting ‘‘section

2 1375(b)(4)’’.

3 SEC. 226. ALLOWANCE OF CHARITABLE CONTRIBUTIONS

4 OF INVENTORY AND SCIENTIFIC PROPERTY.

5 (a) IN GENERAL.—Section 170(e) (relating to certain

6 contributions of ordinary income and capital gain prop7 erty) is amended—

8 (1) by striking ‘‘(other than a corporation

9 which is an S corporation)’’ in paragraph (3)(A),

10 and

11 (2) by striking clause (i) of paragraph (4)(D)

12 and by redesignating clauses (ii) and (iii) of such

13 paragraph as clauses (i) and (ii), respectively.

14 (b) STOCK BASIS ADJUSTMENT.—Paragraph (1) of

15 section 1367(a) (relating to adjustments to basis of stock

16 of shareholders, etc.) is amended by striking ‘‘and’’ at the

17 end of subparagraph (B), by striking the period at the

18 end of subparagraph (C) and inserting ‘‘, and’’, and by

19 adding at the end the following new subparagraph:

20 ‘‘(D) the excess of the deductions for char21 itable contributions over the basis of the prop22 erty contributed.’’
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1 SEC. 227. C CORPORATION RULES TO APPLY fOR FRINGE

2 BENEFIT PURPOSES.

3 (a) IN GENERAL.—Section 1372 (relating to partner4 ship rules to apply for fringe benefit purposes) is repealed.

5 (b) PARTNERSHIP RULES TO APPLY FOR HEALTH

6 INSURANCE COSTS OF CERTAIN S CORPORATION SHARE7 HOLDERS.—Paragraph (5) of section 162(l) is amended

8 to read as follows:

9 ‘‘(5) TREATMENT OF CERTAIN S CORPORATION

10 SHAREHOLDERS.—

11 ‘‘(A) IN GENERAL.—This subsection shall

12 apply in the case of any 2-percent shareholder

13 of an S corporation, except that—

14 ‘‘(i) for purposes of this subsection,

15 such shareholder’s wages (as defined in

16 section 3121) from the S corporation shall

17 be treated as such shareholder’s earned in18 come (within the meaning of section

19 401(c)(1)), and

20 ‘‘(ii) there shall be such adjustments

21 in the application of this subsection as the

22 Secretary may by regulations prescribe.

23 ‘‘(B) 2-PERCENT SHAREHOLDER DE24 FINED.—For purposes of this paragraph, the

25 term ‘2-percent shareholder’ means any person

26 who owns (or is considered as owning within
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1 the meaning of section 318) on any day during

2 the taxable year of the S corporation more than

3 2 percent of the outstanding stock of such cor4 poration or stock possessing more than 2 per5 cent of the total combined voting power of all

6 stock of such corporation.’’

7 (b) CONFORMING AMENDMENT.—The table of sec8 tions for part III of subchapter S of chapter 1 is amended

9 by striking the item relating to section 1372.

10 TITLE III—TAXATION OF S

11 CORPORATION SHAREHOLDERS

12 SEC. 301. UNIFORM TREATMENT OF OWNER-EMPLOYEES

13 UNDER PROHIBITED TRANSACTION RULES.

14 The last sentence of section 4975(d) (relating to ex15 emptions from prohibited transactions) is amended by

16 striking ‘‘a shareholder-employee (as defined in section

17 1379, as in effect on the day before the date of the enact18 ment of the Subchapter S Revision Act of 1982),’’.

19 SEC. 302. TREATMENT OF LOSSES TO SHAREHOLDERS.

20 (a) TREATMENT OF LOSSES IN LIQUIDATIONS.—Sec21 tion 331 (relating to gain or loss to shareholders in cor22 porate liquidations) is amended by redesignating sub23 section (c) as subsection (d) and by inserting after sub24 section (b) the following new subsection:
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1 ‘‘(c) LOSSES ON LIQUIDATIONS OF S CORPORA2 TION.—

3 ‘‘(1) IN GENERAL.—The portion of any loss rec4 ognized by a shareholder of an S corporation (as de5 fined in section 1361(a)(1)) on amounts received by

6 such shareholder in a distribution in complete liq7 uidation of such S corporation which does not exceed

8 the ordinary income basis of stock of such S cor9 poration in the hands of such shareholder shall not

10 be treated as a loss from the sale or exchange of a

11 capital asset but shall be treated as an ordinary loss.

12 ‘‘(2) ORDINARY INCOME BASIS.—For purposes

13 of this subsection, the ordinary income basis of stock

14 of an S corporation in the hands of a shareholder of

15 such S corporation shall be an amount equal to the

16 portion of such shareholder’s basis in such stock

17 which is equal to the aggregate increases in such

18 basis under section 1367(a)(1) resulting from such

19 shareholder’s pro rata share of ordinary income of

20 such S corporation attributable to the complete liq21 uidation.’’

22 (b) CARRYOVER OF DISALLOWED LOSSES AND DE23 DUCTIONS UNDER AT-RISK RULES ALLOWED.—Para24 graph (3) of section 1366(d) (relating to carryover of dis25 allowed losses and deductions to post-termination transi-
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1 tion period) is amended by adding at the end the following

2 new subparagraph:

3 ‘‘(D) AT-RISK LIMITATIONS.—To the ex4 tent that any increase in adjusted basis de5 scribed in subparagraph (B) would have in6 creased the shareholder’s amount at risk under

7 section 465 if such increase had occurred on

8 the day preceding the commencement of the

9 post-termination transition period, rules similar

10 to the rules described in subparagraphs (A)

11 through (C) shall apply to any losses disallowed

12 by reason of section 465(a).’’

13 TITLE IV—EFFECTIVE DATE

14 SEC. 401. EFFECTIVE DATE.

15 (a) IN GENERAL.—Except as otherwise provided in

16 this Act, the amendments made by this Act shall apply

17 to taxable years beginning after December 31, 1995.

18 (b) TREATMENT OF CERTAIN ELECTIONS UNDER

19 PRIOR LAW.—For purposes of section 1362(g) of the In20 ternal Revenue Code of 1986 (relating to election after

21 termination), any termination or revocation under section

22 1362(d) of such Code (as in effect on the day before the

23 date of the enactment of this Act) shall not be taken into

24 account.

Æ
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