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[Congressional Bills 104th Congress]
[From the U.S. Government Publishing Office]
[H.R. 2039 Introduced in House (IH)]

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.
    Be it enacted by the Senate and House of Representatives of the 
United States of America in Congress assembled,

SECTION 1. SHORT TITLE; AMENDMENT OF 1986 CODE; TABLE OF CONTENTS.

    (a) Short Title.--This Act may be cited as the ``S Corporation 
Reform Act of 1995''.
    (b) Amendment of 1986 Code.--Except as otherwise expressly 
provided, whenever in this Act an amendment or repeal is expressed in 
terms of an amendment to, or repeal of, a section or other provision, 
the reference shall be considered to be made to a section or other 
provision of the Internal Revenue Code of 1986.
    (c) Table of Contents.--The table of contents is 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.
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.
            TITLE I--ELIGIBLE SHAREHOLDERS OF S CORPORATION

                   Subtitle A--Number of Shareholders

SEC. 101. S CORPORATIONS PERMITTED TO HAVE 75 SHAREHOLDERS.

    Subparagraph (A) of section 1361(b)(1) (defining small business 
corporation) is amended by striking ``35 shareholders'' and inserting 
``75 shareholders''.

SEC. 102. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.

    Paragraph (1) of section 1361(c) (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 purposes 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 purposes of 
                subparagraph (A)(ii), the term `members of the family' 
                means the 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 6 
                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 all 
                        shareholders,
                            ``(ii) shall remain in effect until 
                        terminated, and
                            ``(iii) shall apply only with respect to 1 
                        family in any corporation.''.

              Subtitle B--Persons Allowed as Shareholders

SEC. 111. CERTAIN EXEMPT ORGANIZATIONS.

    (a) Certain Exempt Organizations Allowed To Be Shareholders.--
            (1) In general.--Subparagraph (B) of section 1361(b)(1) 
        (defining small business corporation) is amended to read as 
        follows:
                    ``(B) have as a shareholder a person (other than an 
                estate, a trust described in subsection (c)(2), or an 
                organization described in subsection (c)(7)) who is not 
                an individual,''.
            (2) Eligible exempt organizations.--Section 1361(c) 
        (relating to special rules for applying subsection (b)) is 
        amended by adding at the end the following new paragraph:
            ``(7) Certain exempt organizations permitted as 
        shareholders.--For purposes of subsection (b)(1)(B), an 
        organization described in section 401(a) or 501(c)(3) may be a 
        shareholder in an S corporation.''
    (b) Contributions of S Corporation Stock.--Section 170(e)(1) 
(relating to certain contributions of ordinary income and capital gain 
property) is amended by adding at the end the following sentence: ``For 
purposes of applying this paragraph in the case of a charitable 
contribution of stock in an S corporation, rules similar to the rules 
of section 751 shall apply in determining whether gain on such stock 
would have been long-term capital gain if such stock were sold by the 
taxpayer.''
    (c) Special Rules Applicable to Partnerships and S Corporations.--
            (1) In general.--Subsection (c) of section 512 (relating to 
        unrelated business tax income) is amended--
                    (A) by inserting ``or S corporation'' after 
                ``partnership'' each place it appears in paragraphs (1) 
                and (3),
                    (B) by inserting ``or shareholder'' after 
                ``member'' in paragraph (1), and
                    (C) by inserting ``and S Corporations'' after 
                ``Partnerships'' in the heading.
            (2) Reporting requirement.--Section 6037 (relating to 
        return of S corporation) is amended by adding at the end the 
        following new subsection:
    ``(c) Separate Statement of Items of Unrelated Business Taxable 
Income.--In the case of any S corporation regularly carrying on a trade 
or business (within the meaning of section 512(c)(1)), the information 
required under subsection (b) to be furnished to any shareholder 
described in section 1361(c)(7) shall include such information as is 
necessary to enable the shareholder to compute its pro rata share of 
the corporation's income or loss from the trade or business in 
accordance with section 512(a)(1), but without regard to the 
modifications described in paragraphs (8) through (15) of section 
512(b).''

SEC. 112. FINANCIAL INSTITUTIONS.

    Subparagraph (B) of section 1361(b)(2) (defining ineligible 
corporation) is amended to read as follows:
                    ``(B) a financial institution which uses the 
                reserve method of accounting for bad debts described in 
                section 585 or 593,''.

SEC. 113. NONRESIDENT ALIENS.

    (a) Nonresident Aliens Allowed To Be Shareholders.--
            (1) In general.--Paragraph (1) of section 1361(b) (defining 
        small business corporation) is amended--
                    (A) by adding ``and'' at the end of subparagraph 
                (B),
                    (B) by striking subparagraph (C), and
                    (C) by redesignating subparagraph (D) as 
                subparagraph (C).
            (2) Conforming amendments.--Paragraphs (4) and (5)(A) of 
        section 1361(c) (relating to special rules for applying 
        subsection (b)) are each amended by striking ``subsection 
        (b)(1)(D)'' and inserting ``subsection (b)(1)(C)''.
    (b) Nonresident Alien Shareholder Treated as Engaged in Trade or 
Business Within United States.--
            (1) In general.--Section 875 is amended--
                    (A) by striking ``and'' at the end of paragraph 
                (1),
                    (B) by striking the period at the end of paragraph 
                (2) and inserting ``, and'', and
                    (C) by adding at the end the following new 
                paragraph:
            ``(3) a nonresident alien individual shall be considered as 
        being engaged in a trade or business within the United States 
        if the S corporation of which such individual is a shareholder 
        is so engaged.''
            (2) Application of withholding tax on nonresident alien 
        shareholders.--Section 1446 (relating to withholding tax on 
        foreign partners' share of effectively connected income) is 
        amended by redesignating subsection (f) as subsection (g) and 
        by inserting after subsection (e) the following new subsection:
    ``(f) S Corporation Treated as Partnership, Etc.--For purposes of 
this section--
            ``(1) an S corporation shall be treated as a partnership,
            ``(2) the shareholders of such corporation shall be treated 
        as partners of such partnership, and
            ``(3) any reference to section 704 shall be treated as a 
        reference to section 1366.''
            (3) Conforming amendments.--
                    (A) The heading of section 875 is amended to read 
                as follows:

``SEC. 875. PARTNERSHIPS; BENEFICIARIES OF ESTATES AND TRUSTS; S 
              CORPORATIONS.''

                    (B) The heading of section 1446 is amended to read 
                as follows:

``SEC. 1446. WITHHOLDING TAX ON FOREIGN PARTNERS' AND S CORPORATE 
              SHAREHOLDERS' SHARE OF EFFECTIVELY CONNECTED INCOME.''

            (4) Clerical amendments.--
                    (A) The item relating to section 875 in the table 
                of sections for subpart A of part II of subchapter N of 
                chapter 1 is amended to read as follows:

``Sec. 875. Partnerships; beneficiaries of estates and trusts; S 
                            corporations.''
                    (B) The item relating to section 1446 in the table 
                of sections for subchapter A of chapter 3 is amended to 
                read as follows:

``Sec. 1446. Withholding tax on foreign partners' and S corporate 
                            shareholders' share of effectively 
                            connected income.''
    (c) Permanent Establishment of Partners and S Corporation 
Shareholders.--Section 894 (relating to income affected by treaty) is 
amended by adding at the end the following new subsection:
    ``(c) Permanent Establishment of Partners and S Corporation 
Shareholders.--If a partnership or S corporation has a permanent 
establishment in the United States (within the meaning of a treaty to 
which the United States is a party) at any time during a taxable year 
of such entity, a nonresident alien individual or foreign corporation 
which is a partner in such partnership, or a nonresident alien 
individual who is a shareholder in such S corporation, shall be treated 
as having a permanent establishment in the United States for purposes 
of such treaty.''
SEC. 113. ELECTING SMALL BUSINESS TRUSTS.

    (a) General Rule.--Subparagraph (A) of section 1361(c)(2) (relating 
to certain trusts permitted as shareholders) is amended by inserting 
after clause (iv) the following new clause:
                            ``(v) An electing small business trust.''
    (b) Current Beneficiaries Treated as Shareholders.--Subparagraph 
(B) of section 1361(c)(2) is amended by adding at the end the following 
new clause:
                            ``(v) In the case of a trust described in 
                        clause (v) of subparagraph (A), each potential 
                        current beneficiary of such trust shall be 
                        treated as a shareholder; except that, if for 
                        any period there is no potential current 
                        beneficiary of such trust, such trust shall be 
                        treated as the shareholder during such 
                        period.''
    (c) Electing Small Business Trust Defined.--Section 1361 (defining 
S corporation) is amended by adding at the end the following new 
subsection:
    ``(e) Electing Small Business Trust Defined.--
            ``(1) Electing small business trust.--For purposes of this 
        section--
                    ``(A) In general.--Except as provided in 
                subparagraph (B), the term `electing small business 
                trust' means any trust if--
                            ``(i) such trust does not have as a 
                        beneficiary any person other than an 
                        individual, an estate, or an organization 
                        described in section 401(a) or 501(c)(3),
                            ``(ii) no interest in such trust was 
                        acquired by purchase, and
                            ``(iii) an election under this subsection 
                        applies to such trust.
                    ``(B) Certain trusts not eligible.--The term 
                `electing small business trust' shall not include--
                            ``(i) any qualified subchapter S trust (as 
                        defined in subsection (d)(3)) if an election 
                        under subsection (d)(2) applies to any 
                        corporation the stock of which is held by such 
                        trust, and
                            ``(ii) any trust exempt from tax under this 
                        subtitle.
                    ``(C) Purchase.--For purposes of subparagraph (A), 
                the term `purchase' means any acquisition if the basis 
                of the property acquired is determined under section 
                1012.
            ``(2) Potential current beneficiary.--For purposes of this 
        section, the term `potential current beneficiary' means, with 
        respect to any period, any person who at any time during such 
        period is entitled to, or at the discretion of any person may 
        receive, a distribution from the principal or income of the 
        trust. If a trust disposes of all of the stock which it holds 
        in an S corporation, then, with respect to such corporation, 
        the term `potential current beneficiary' does not include any 
        person who first met the requirements of the preceding sentence 
        during the 60-day period ending on the date of such 
        disposition.
            ``(3) Election.--An election under this subsection shall be 
        made by the trustee in such manner and form, and at such time, 
        as the Secretary may prescribe. Any such election shall apply 
        to the taxable year of the trust for which made and all 
        subsequent taxable years of such trust unless revoked with the 
        consent of the Secretary.
            ``(4) Cross reference.--

                                ``For special treatment of electing 
small business trusts, see section 641(d).''
    (d) Taxation of Electing Small Business Trusts.--Section 641 
(relating to imposition of tax on trusts) is amended by adding at the 
end the following new subsection:
    ``(d) Special Rules for Taxation of Electing Small Business 
Trusts.--
            ``(1) In general.--For purposes of this chapter--
                    ``(A) the portion of any electing small business 
                trust which consists of stock in 1 or more S 
                corporations shall be treated as a separate trust, and
                    ``(B) the amount of the tax imposed by this chapter 
                on such separate trust shall be determined with the 
                modifications of paragraph (2).
            ``(2) Modifications.--For purposes of paragraph (1), the 
        modifications of this paragraph are the following:
                    ``(A) Except as provided in section 1(h), the 
                amount of the tax imposed by section 1(e) shall be 
                determined by using the highest rate of tax set forth 
                in section 1(e).
                    ``(B) The exemption amount under section 55(d) 
                shall be zero.
                    ``(C) The only items of income, loss, deduction, or 
                credit to be taken into account are the following:
                            ``(i) The items required to be taken into 
                        account under section 1366.
                            ``(ii) Any gain or loss from the 
                        disposition of stock in an S corporation.
                            ``(iii) To the extent provided in 
                        regulations, State or local income taxes or 
                        administrative expenses to the extent allocable 
                        to items described in clauses (i) and (ii).
                No deduction or credit shall be allowed for any amount 
                not described in this paragraph, and no item described 
                in this paragraph shall be apportioned to any 
                beneficiary.
                    ``(D) No amount shall be allowed under paragraph 
                (1) or (2) of section 1211(b).
            ``(3) Treatment of remainder of trust and distributions.--
        For purposes of determining--
                    ``(A) the amount of the tax imposed by this chapter 
                on the portion of any electing small business trust not 
                treated as a separate trust under paragraph (1), and
                    ``(B) the distributable net income of the entire 
                trust,
        the items referred to in paragraph (2)(C) shall be excluded. 
        Except as provided in the preceding sentence, this subsection 
        shall not affect the taxation of any distribution from the 
        trust.
            ``(4) Treatment of unused deductions where termination of 
        separate trust.--If a portion of an electing small business 
        trust ceases to be treated as a separate trust under paragraph 
        (1), any carryover or excess deduction of the separate trust 
        which is referred to in section 642(h) shall be taken into 
        account by the entire trust.
            ``(5) Electing small business trust.--For purposes of this 
        subsection, the term `electing small business trust' has the 
        meaning given such term by section 1361(e)(1).''

                      Subtitle C--Other Provisions

SEC. 121. EXPANSION OF POST-DEATH QUALIFICATION FOR CERTAIN TRUSTS.

    Subparagraph (A) of section 1361(c)(2) (relating to certain trusts 
permitted as shareholders) is amended--
            (1) by striking ``60-day period'' each place it appears in 
        clauses (ii) and (iii) and inserting ``2-year period'', and
            (2) by striking the last sentence in clause (ii).

TITLE II--QUALIFICATION AND ELIGIBILITY REQUIREMENTS FOR S CORPORATIONS

                     Subtitle A--One Class of Stock

SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.

    (a) In General.--Section 1361 is amended by adding at the end the 
following new subsection:
    ``(f) 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 merely 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 
        interest income of the holder and deductible to the corporation 
        as interest expense in computing taxable income under section 
        1363(b) in the year such distribution is received.
            ``(4) Regulations.--The Secretary shall prescribe such 
        regulations as may be necessary or appropriate to provide for 
        the proper treatment of qualified preferred stock under this 
        title and for the coordination of such treatment with other 
        provisions of this title.''
    (b) Conforming Amendments.--
            (1) Paragraph (1) of section 1361(b) is amended by 
        inserting ``, except as provided in subsection (f),'' before 
        ``which does not''.
            (2) Subsection (a) of section 1366 is amended by adding at 
        the end the following new paragraph:
            ``(3) Allocation with respect to qualified preferred 
        stock.--The holders of qualified preferred stock (as defined in 
        section 1361(f)) shall not, with respect to such stock, be 
        allocated any of the items described in paragraph (1).''

SEC. 202. FINANCIAL INSTITUTIONS PERMITTED TO HOLD SAFE HARBOR DEBT.

    Subparagraph (B) of section 1361(c)(5) (defining straight debt) is 
amended by adding ``and'' at the end of clause (i) and by striking 
clauses (ii) and (iii) and inserting the following:
                            ``(ii) in any case in which the terms of 
                        such promise include a provision under which 
                        the obligation to pay may be converted 
                        (directly or indirectly) into stock of the 
                        corporation, such terms, taken as a whole, are 
                        substantially the same as the terms which could 
                        have been obtained on the effective date of the 
                        promise from a person which is not a related 
                        person (within the meaning of section 
                        465(b)(3)(C)) to the S corporation or its 
                        shareholders, and
                            ``(iii) the creditor is--
                                    ``(I) an individual,
                                    ``(II) an estate,
                                    ``(III) a trust described in 
                                paragraph (2), or
                                    ``(IV) a person which is actively 
                                and regularly engaged in the business 
                                of lending money.''

                 Subtitle B--Elections and Terminations

SEC. 211. RULES RELATING TO INADVERTENT TERMINATIONS AND INVALID 
              ELECTIONS.

    (a) General Rule.--Subsection (f) of section 1362 (relating to 
inadvertent terminations) is amended to read as follows:
    ``(f) Inadvertent Invalid Elections or Terminations.--If--
            ``(1) an election under subsection (a) by any corporation--
                    ``(A) was not effective for the taxable year for 
                which made (determined without regard to subsection 
                (b)(2)) by reason of a failure to meet the requirements 
                of section 1361(b) or to obtain shareholder consents, 
                or
                    ``(B) was terminated under paragraph (2) of 
                subsection (d),
            ``(2) the Secretary determines that the circumstances 
        resulting in such ineffectiveness or termination were 
        inadvertent,
            ``(3) no later than a reasonable period of time after 
        discovery of the circumstances resulting in such 
        ineffectiveness or termination, steps were taken--
                    ``(A) so that the corporation is a small business 
                corporation, or
                    ``(B) to acquire the required shareholder consents, 
                and
            ``(4) the corporation, and each person who was a 
        shareholder in the corporation at any time during the period 
        specified pursuant to this subsection, agrees to make such 
        adjustments (consistent with the treatment of the corporation 
        as an S corporation) as may be required by the Secretary with 
        respect to such period,
then, notwithstanding the circumstances resulting in such 
ineffectiveness or termination, such corporation shall be treated as an 
S corporation during the period specified by the Secretary.''
    (b) Late Elections.--Subsection (b) of section 1362 is amended by 
adding at the end thereof the following new paragraph:
            ``(5) Authority to treat late elections as timely.--If--
                    ``(A) an election under subsection (a) is made for 
                any taxable year (determined without regard to 
                paragraph (3)) after the date prescribed by this 
                subsection for making such election for such taxable 
                year, and
                    ``(B) the Secretary determines that there was 
                reasonable cause for the failure to timely make such 
                election,
        the Secretary may treat such election as timely made for such 
        taxable year (and paragraph (3) shall not apply).''
    (c) Automatic Waivers.--The Secretary of the Treasury shall provide 
for an automatic waiver procedure under section 1362(f) of the Internal 
Revenue Code of 1986 in cases in which the Secretary determines 
appropriate.
    (d) Effective Date.--The amendments made by subsections (a) and (b) 
shall apply with respect to elections for taxable years beginning after 
December 31, 1982.

SEC. 212. AGREEMENT TO TERMINATE YEAR.

    Paragraph (2) of section 1377(a) (relating to pro rata share) is 
amended to read as follows:
            ``(2) Election to terminate year.--
                    ``(A) In general.--Under regulations prescribed by 
                the Secretary, if any shareholder terminates the 
                shareholder's interest in the corporation during the 
                taxable year and all affected shareholders agree to the 
                application of this paragraph, paragraph (1) shall be 
                applied to the affected shareholders as if the taxable 
                year consisted of 2 taxable years the first of which 
                ends on the date of the termination.
                    ``(B) Affected shareholders.--For purposes of 
                subparagraph (A), the term `affected shareholders' 
                means the shareholder whose interest is terminated and 
                all shareholders to whom such shareholder has 
                transferred shares during the taxable year. If such 
                shareholder has transferred shares to the corporation, 
                the term `affected shareholders' shall include all 
                persons who are shareholders during the taxable year.''

SEC. 213. EXPANSION OF POST-TERMINATION TRANSITION PERIOD.

    (a) In General.--Paragraph (1) of section 1377(b) (relating to 
post-termination transition period) is amended by striking ``and'' at 
the end of subparagraph (A), by redesignating subparagraph (B) as 
subparagraph (C), and by inserting after subparagraph (A) the following 
new subparagraph:
                    ``(B) the 120-day period beginning on the date of 
                any determination pursuant to an audit of the taxpayer 
                which follows the termination of the corporation's 
                election and which adjusts a subchapter S item of 
                income, loss, or deduction of the corporation arising 
                during the S period (as defined in section 1368(e)(2)), 
                and''.
    (b) Determination Defined.--Paragraph (2) of section 1377(b) is 
amended by striking subparagraphs (A) and (B), by redesignating 
subparagraph (C) as subparagraph (B), and by inserting before 
subparagraph (B) (as so redesignated) the following new subparagraph:
                    ``(A) a determination as defined in section 
                1313(a), or''.
    (c) Repeal of Special Audit Provisions for Subchapter S Items.--
            (1) General rule.--Subchapter D of chapter 63 (relating to 
        tax treatment of subchapter S items) is hereby repealed.
            (2) Consistent treatment required.--Section 6037 (relating 
        to return of S corporation), as amended by section 111(c)(2), 
        is amended by adding at the end the following new subsection:
    ``(d) Shareholder's Return Must Be Consistent With Corporate Return 
or Secretary Notified of Inconsistency.--
            ``(1) In general.--A shareholder of an S corporation shall, 
        on such shareholder's return, treat a subchapter S item in a 
        manner which is consistent with the treatment of such item on 
        the corporate return.
            ``(2) Notification of inconsistent treatment.--
                    ``(A) In general.--In the case of any subchapter S 
                item, if--
                            ``(i)(I) the corporation has filed a return 
                        but the shareholder's treatment on his return 
                        is (or may be) inconsistent with the treatment 
                        of the item on the corporate return, or
                            ``(II) the corporation has not filed a 
                        return, and
                            ``(ii) the shareholder files with the 
                        Secretary a statement identifying the 
                        inconsistency,
                paragraph (1) shall not apply to such item.
                    ``(B) Shareholder receiving incorrect 
                information.--A shareholder shall be treated as having 
                complied with clause (ii) of subparagraph (A) with 
                respect to a subchapter S item if the shareholder--
                            ``(i) demonstrates to the satisfaction of 
                        the Secretary that the treatment of the 
                        subchapter S item on the shareholder's return 
                        is consistent with the treatment of the item on 
                        the schedule furnished to the shareholder by 
                        the corporation, and
                            ``(ii) elects to have this paragraph apply 
                        with respect to that item.
            ``(3) Effect of failure to notify.--In any case--
                    ``(A) described in subparagraph (A)(i)(I) of 
                paragraph (2), and
                    ``(B) in which the shareholder does not comply with 
                subparagraph (A)(ii) of paragraph (2),
        any adjustment required to make the treatment of the items by 
        such shareholder consistent with the treatment of the items on 
        the corporate return shall be treated as arising out of 
        mathematical or clerical errors and assessed according to 
        section 6213(b)(1). Paragraph (2) of section 6213(b) shall not 
        apply to any assessment referred to in the preceding sentence.
            ``(4) Subchapter s item.--For purposes of this subsection, 
        the term `subchapter S item' means any item of an S corporation 
        to the extent that regulations prescribed by the Secretary 
        provide that, for purposes of this subtitle, such item is more 
        appropriately determined at the corporation level than at the 
        shareholder level.
            ``(5) Addition to tax for failure to comply 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.''
            (3) Conforming amendments.--
                    (A) Section 1366 is amended by striking subsection 
                (g).
                    (B) Subsection (b) of section 6233 is amended to 
                read as follows:
    ``(b) Similar Rules in Certain Cases.--If a partnership return is 
filed for any taxable year but it is determined that there is no entity 
for such taxable year, to the extent provided in regulations, rules 
similar to the rules of subsection (a) shall apply.''
                    (C) The table of subchapters for chapter 63 is 
                amended by striking the item relating to subchapter D.

SEC. 214. REPEAL OF EXCESSIVE PASSIVE INVESTMENT INCOME AS A 
              TERMINATION EVENT.

    (a) In General.--Section 1362(d) (relating to termination) is 
amended by striking paragraph (3).
    (b) Modification of Tax Imposed on Excessive Passive Investment 
Income.--
            (1) Increase in threshold.--Subsections (a)(2) and 
        (b)(1)(A)(i) of section 1375 (relating to tax imposed when 
        passive investment income of a corporation having subchapter C 
        earnings and profits exceeds 25 percent of gross receipts) are 
        each amended by striking ``25 percent'' and inserting ``50 
        percent''.
            (2) Tax rate increase after third consecutive year.--
        Section 1375 is amended by redesignating subsections (c) and 
        (d) as subsections (d) and (e), respectively, and by inserting 
        after subsection (b) the following new subsection:
    ``(c) Tax Rate Increase After Third Consecutive Year.--
            ``(1) In general.--If an S corporation is described in 
        subsection (a) for more than 3 consecutive taxable years, then 
        the rate of tax imposed under subsection (a) with respect to 
        each succeeding consecutive taxable year (if any) shall be 
        determined 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.
            ``(2) Years taken into account.--No tax shall be increased 
        under paragraph (1) for any taxable year beginning before 
        January 1, 1996.''
    (c) Conforming Amendments.--
            (1) Section 1362(f)(1) is amended by striking ``or (3)''.
            (2) Subsection (b) of section 1375 is amended by striking 
        paragraphs (3) and (4) and inserting the following new 
        paragraphs:
            ``(3) Subchapter c earnings and profits.--The term 
        `subchapter C earnings and profits' means earnings and profits 
        of any corporation for any taxable year with respect to which 
        an election under section 1362(a) (or under section 1372 of 
        prior law) was not in effect.
            ``(4) Gross receipts from sales of capital assets (other 
        than stock and securities).--In the case of dispositions of 
        capital assets (other than stock and securities), gross 
        receipts from such dispositions shall be taken into account 
        only to the extent of the capital gain net income therefrom.
            ``(5) Passive investment income defined.--
                    ``(A) In general.--Except as otherwise provided in 
                this paragraph, the term `passive investment income' 
                means gross receipts derived from royalties, rents, 
                dividends, interest, and annuities.
                    ``(B) Exception for interest on notes from sales of 
                inventory.--The term `passive investment income' shall 
                not include interest on any obligation acquired in the 
                ordinary course of the corporation's trade or business 
                from its sale of property described in section 1221(1).
                    ``(C) Treatment of certain lending or finance 
                companies.--If the S corporation meets the requirements 
                of section 542(c)(6) for the taxable year, the term 
                `passive investment income' shall not include gross 
                receipts for the taxable year which are derived 
                directly from the active and regular conduct of a 
                lending or finance business (as defined in section 
                542(d)(1)).
                    ``(D) Special rule for options and commodity 
                dealings.--
                            ``(i) In general.--In the case of any 
                        options dealer or commodities dealer, passive 
                        investment income shall be determined by not 
                        taking into account any gain or loss (in the 
                        normal course of the taxpayer's activity of 
                        dealing in or trading section 1256 contracts) 
                        from any section 1256 contract or property 
                        related to such a contract.
                            ``(ii) Definitions.--For purposes of this 
                        subparagraph--
                                    ``(I) Options dealer.--The term 
                                `options dealer' has the meaning given 
                                such term by section 1256(g)(8).
                                    ``(II) Commodities dealer.--The 
                                term `commodities dealer' means a 
                                person who is actively engaged in 
                                trading section 1256 contracts and is 
                                registered with a domestic board of 
                                trade which is designated as a contract 
                                market by the Commodities Futures 
                                Trading Commission.
                                    ``(III) Section 1256 contract.--The 
                                term `section 1256 contract' has the 
                                meaning given to such term by section 
                                1256(b).
                    ``(E) Coordination with section 1374.--The amount 
                of passive investment income shall be determined by not 
                taking into account any recognized built-in gain or 
                loss of the S corporation for any taxable year in the 
                recognition period. Terms used in the preceding 
                sentence shall have the same respective meaning as when 
                used in section 1374.''
            (3) The heading for section 1375 is amended by striking 
        ``25'' and inserting ``50''.
            (4) The table of sections for part III of subchapter S of 
        chapter 1 is amended by striking ``25'' in the item relating to 
        section 1375 and inserting ``50''.
            (5) Clause (i) of section 1042(c)(4)(A) is amended by 
        striking ``section 1362(d)(3)(D)'' and inserting ``section 
        1375(b)(5)''.

                      Subtitle C--Other Provisions

SEC. 221. S CORPORATIONS PERMITTED TO HOLD SUBSIDIARIES.

    (a) In General.--Paragraph (2) of section 1361(b) (defining 
ineligible corporation), as amended by section 112, is amended by 
striking subparagraph (A) and by redesignating subparagraphs (B), (C), 
(D), and (E) as subparagraphs (A), (B), (C), and (D), respectively.
    (b) Treatment of Certain Wholly Owned S Corporation Subsidiaries.--
Section 1361(b) (defining small business corporation) is amended by 
adding at the end thereof the following new subsection:
            ``(3) Treatment of certain wholly owned subsidiaries.--
                    ``(A) In general.--For purposes of this title--
                            ``(i) a corporation which is a qualified 
                        subchapter S subsidiary shall not be treated as 
                        a separate corporation, and
                            ``(ii) all assets, liabilities, and items 
                        of income, deduction, and credit of a qualified 
                        subchapter S subsidiary shall be treated as 
                        assets, liabilities, and such items (as the 
                        case may be) of the S corporation.
                    ``(B) Qualified subchapter s subsidiary.--For 
                purposes of this subsection, the term `qualified 
                subchapter S subsidiary' means any corporation 100 
                percent of the stock of which is held by an S 
                corporation as of the later of the effective date of 
                the S election of the S corporation or the acquisition 
                of the subsidiary, and at all times thereafter.
                    ``(C) Treatment of terminations of qualified 
                subchapter s subsidiary status.--For purposes of this 
                subtitle, if any corporation which was a qualified 
                subchapter S subsidiary ceases to meet the requirements 
                of subparagraph (B), such corporation shall be treated 
                as a new corporation acquiring all of its assets (and 
                assuming all of its liabilities) immediately before 
                such cessation from the S corporation in exchange for 
                its stock.''.
    (c) Certain Dividends Not Treated as Passive Investment Income.--
Section 1375(b)(5) (defining passive investment income), as added by 
section 214(c)(2), is amended by adding at the end the following new 
subparagraph:
                    ``(F) Treatment of certain dividends.--If an S 
                corporation holds stock in a C corporation meeting the 
                requirements of section 1504(a)(2), the term `passive 
                investment income' shall not include dividends from 
                such C corporation to the extent such dividends are 
                attributable to the earnings and profits of such C 
                corporation derived from the active conduct of a trade 
                or business.''
    (d) Conforming Amendments.--
            (1) Subsection (c) of section 1361, as amended by sections 
        111(a)(2) and 201(a), is amended by striking paragraph (6) and 
        redesignating paragraph (7) as paragraphs (6).
            (2) Subsection (b) of section 1504 (defining includible 
        corporation) is amended by adding at the end the following new 
        paragraph:
            ``(8) An S corporation.''

SEC. 222. TREATMENT OF DISTRIBUTIONS DURING LOSS YEARS.

    (a) Adjustments for Distributions Taken Into Account Before 
Losses.--
            (1) Subparagraph (A) of section 1366(d)(1) (relating to 
        losses and deductions cannot exceed shareholder's basis in 
        stock and debt) is amended by striking ``paragraph (1)'' and 
        inserting ``paragraphs (1) and (2)(A)''.
            (2) Subsection (d) of section 1368 (relating to certain 
        adjustments taken into account) is amended by adding at the end 
        the following new sentence:
``In the case of any distribution made during any taxable year, the 
adjusted basis of the stock shall be determined with regard to the 
adjustments provided in paragraph (1) of section 1367(a) for the 
taxable year.''
    (b) Accumulated Adjustments Account.--Paragraph (1) of section 
1368(e) (relating to accumulated adjustments account) is amended by 
adding at the end the following new subparagraph:
            ``(C) Net loss for year disregarded.--
                    ``(i) In general.--In applying this section to 
                distributions made during any taxable year, the amount 
                in the accumulated adjustments account as of the close 
                of such taxable year shall be determined without regard 
                to any net negative adjustment for such taxable year.
                    ``(ii) Net negative adjustment.--For purposes of 
                clause (i), the term `net negative adjustment' means, 
                with respect to any taxable year, the excess (if any) 
                of--
                            ``(I) the reductions in the account for the 
                        taxable year (other than for distributions), 
                        over
                            ``(II) the increases in such account for 
                        such taxable year.''
    (c) Conforming Amendments.--Subparagraph (A) of section 1368(e)(1) 
is amended--
            (1) by striking ``as provided in subparagraph (B)'' and 
        inserting ``as otherwise provided in this paragraph'', and
            (2) by striking ``section 1367(b)(2)(A)'' and inserting 
        ``section 1367(a)(2)''.

SEC. 223. CONSENT DIVIDEND FOR AAA BYPASS ELECTION.

    Section 1368(e)(3) (relating to election to distribute earnings 
first) is amended by adding at the end the following new subparagraph:
                    ``(C) Consent dividend.--Under regulations 
                prescribed by the Secretary, an S corporation may, 
                subject to the election under this paragraph, consent 
                to treat as a distribution the amount specified in such 
                consent, to the extent such amount does not exceed the 
                accumulated earnings and profits of such corporation. 
                The amount so specified shall be considered--
                            ``(i) as distributed in money by the 
                        corporation to its shareholders on the last day 
                        of the taxable year of the corporation and as 
                        contributed to the capital of the corporation 
                        by the shareholders on such day, and
                            ``(ii) if any such shareholder is an 
                        organization described in section 511(a)(2), as 
                        unrelated business taxable income (as defined 
                        in section 512) to such shareholder.''

SEC. 224. TREATMENT OF S CORPORATIONS UNDER SUBCHAPTER C.

    Subsection (a) of section 1371 (relating to application of 
subchapter C rules) is amended to read as follows:
    ``(a) Application of Subchapter C Rules.--Except as otherwise 
provided in this title, and except to the extent inconsistent with this 
subchapter, subchapter C shall apply to an S corporation and its 
shareholders.''
SEC. 225. ELIMINATION OF PRE-1983 EARNINGS AND PROFITS.

    (a) In General.--If--
            (1) a corporation was an electing small business 
        corporation under subchapter S of chapter 1 of the Internal 
        Revenue Code of 1986 for any taxable year beginning before 
        January 1, 1983, and
            (2) such corporation is an S corporation under subchapter S 
        of chapter 1 of such Code for its first taxable year beginning 
        after December 31, 1995,
the amount of such corporation's accumulated earnings and profits (as 
of the beginning of such first taxable year) shall be reduced by an 
amount equal to the portion (if any) of such accumulated earnings and 
profits which were accumulated in any taxable year beginning before 
January 1, 1983, for which such corporation was an electing small 
business corporation under such subchapter S.
    (b) Conforming Amendments.--
            (1)(A) Subsection (a) of section 1375 is amended by 
        striking ``subchapter C'' in paragraph (1) and inserting 
        ``accumulated''.
            (B) Subsection (b) of section 1375, as amended by section 
        214(c)(2), is amended by striking paragraph (3) and by 
        redesignating paragraphs (4) and (5) as paragraphs (3) and (4), 
        respectively.
            (C) The section heading for section 1375 is amended by 
        striking ``subchapter c'' and inserting ``accumulated''.
            (D) The table of sections for part III of subchapter S of 
        chapter 1 is amended by striking ``subchapter C'' in the item 
        relating to section 1375 and inserting ``accumulated''.
            (2) Clause (i) of section 1042(c)(4)(A), as amended by 
        section 214(c)(5), is amended by striking ``section 
        1375(b)(5)'' and inserting ``section 1375(b)(4)''.

SEC. 226. ALLOWANCE OF CHARITABLE CONTRIBUTIONS OF INVENTORY AND 
              SCIENTIFIC PROPERTY.

    (a) In General.--Section 170(e) (relating to certain contributions 
of ordinary income and capital gain property) is amended--
            (1) by striking ``(other than a corporation which is an S 
        corporation)'' in paragraph (3)(A), and
            (2) by striking clause (i) of paragraph (4)(D) and by 
        redesignating clauses (ii) and (iii) of such paragraph as 
        clauses (i) and (ii), respectively.
    (b) Stock Basis Adjustment.--Paragraph (1) of section 1367(a) 
(relating to adjustments to basis of stock of shareholders, etc.) is 
amended by striking ``and'' at the end of subparagraph (B), by striking 
the period at the end of subparagraph (C) and inserting ``, and'', and 
by adding at the end the following new subparagraph:
                    ``(D) the excess of the deductions for charitable 
                contributions over the basis of the property 
                contributed.''

SEC. 227. C CORPORATION RULES TO APPLY fOR FRINGE BENEFIT PURPOSES.

    (a) In General.--Section 1372 (relating to partnership rules to 
apply for fringe benefit purposes) is repealed.
    (b) Partnership Rules To Apply For Health Insurance Costs of 
Certain S Corporation Shareholders.--Paragraph (5) of section 162(l) is 
amended to read as follows:
            ``(5) Treatment of certain s corporation shareholders.--
                    ``(A) In general.--This subsection shall apply in 
                the case of any 2-percent shareholder of an S 
                corporation, except that--
                            ``(i) for purposes of this subsection, such 
                        shareholder's wages (as defined in section 
                        3121) from the S corporation shall be treated 
                        as such shareholder's earned income (within the 
                        meaning of section 401(c)(1)), and
                            ``(ii) there shall be such adjustments in 
                        the application of this subsection as the 
                        Secretary may by regulations prescribe.
                    ``(B) 2-percent shareholder defined.--For purposes 
                of this paragraph, the term `2-percent shareholder' 
                means any person who owns (or is considered as owning 
                within the meaning of section 318) on any day during 
                the taxable year of the S corporation more than 2 
                percent of the outstanding stock of such corporation or 
                stock possessing more than 2 percent of the total 
                combined voting power of all stock of such 
                corporation.''
    (b) Conforming Amendment.--The table of sections for part III of 
subchapter S of chapter 1 is amended by striking the item relating to 
section 1372.
           TITLE III--TAXATION OF S CORPORATION SHAREHOLDERS

SEC. 301. UNIFORM TREATMENT OF OWNER-EMPLOYEES UNDER PROHIBITED 
              TRANSACTION RULES.

    The last sentence of section 4975(d) (relating to exemptions from 
prohibited transactions) is amended by striking ``a shareholder-
employee (as defined in section 1379, as in effect on the day before 
the date of the enactment of the Subchapter S Revision Act of 1982),''.
SEC. 302. TREATMENT OF LOSSES TO SHAREHOLDERS.

    (a) Treatment of Losses in Liquidations.--Section 331 (relating to 
gain or loss to shareholders in corporate liquidations) is amended by 
redesignating subsection (c) as subsection (d) and by inserting after 
subsection (b) the following new subsection:
    ``(c) Losses on Liquidations of S Corporation.--
            ``(1) In general.--The portion of any loss recognized by a 
        shareholder of an S corporation (as defined in section 
        1361(a)(1)) on amounts received by such shareholder in a 
        distribution in complete liquidation of such S corporation 
        which does not exceed the ordinary income basis of stock of 
        such S corporation in the hands of such shareholder shall not 
        be treated as a loss from the sale or exchange of a capital 
        asset but shall be treated as an ordinary loss.
            ``(2) Ordinary income basis.--For purposes of this 
        subsection, the ordinary income basis of stock of an S 
        corporation in the hands of a shareholder of such S corporation 
        shall be an amount equal to the portion of such shareholder's 
        basis in such stock which is equal to the aggregate increases 
        in such basis under section 1367(a)(1) resulting from such 
        shareholder's pro rata share of ordinary income of such S 
        corporation attributable to the complete liquidation.''
    (b) Carryover of Disallowed Losses and Deductions Under At-Risk 
Rules Allowed.--Paragraph (3) of section 1366(d) (relating to carryover 
of disallowed losses and deductions to post-termination transition 
period) is amended by adding at the end the following new subparagraph:
                    ``(D) At-risk limitations.--To the extent that any 
                increase in adjusted basis described in subparagraph 
                (B) would have increased the shareholder's amount at 
                risk under section 465 if such increase had occurred on 
                the day preceding the commencement of the post-
                termination transition period, rules similar to the 
                rules described in subparagraphs (A) through (C) shall 
                apply to any losses disallowed by reason of section 
                465(a).''

                        TITLE IV--EFFECTIVE DATE

SEC. 401. EFFECTIVE DATE.

    (a) In General.--Except as otherwise provided in this Act, the 
amendments made by this Act shall apply to taxable years beginning 
after December 31, 1995.
    (b) Treatment of Certain Elections Under Prior Law.--For purposes 
of section 1362(g) of the Internal Revenue Code of 1986 (relating to 
election after termination), any termination or revocation under 
section 1362(d) of such Code (as in effect on the day before the date 
of the enactment of this Act) shall not be taken into account.
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