I

103D CONGRESS

2D SESSION H. R. 4056

To amend the Internal Revenue Code of 1986 to reform the rules regarding

subchapter S corporations.

IN THE HOUSE OF REPRESENTATIVES

MARCH 16, 1994

Mr. HOAGLAND (for himself, Mr. KOPETSKI, Mr. BREWSTER, Mr. ARCHER,

Mr. SHAW, Mr. PORTMAN, and Mr. MATSUI) 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 reform

the rules regarding subchapter S corporations.

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

6 ‘‘S Corporation Reform Act of 1993’’.

7 (b) AMENDMENT OF 1986 CODE.—Except as other8 wise expressly provided, whenever in this Act an amend9 ment or repeal is expressed in terms of an amendment

10 to, or repeal of, a section or other provision, the reference
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1 shall be considered to be made to a section or other provi2 sion of the Internal Revenue Code of 1986.

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

4 this Act 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 50 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. C corporation rules to apply for fringe benefit purposes.

Sec. 223. Treatment of distributions during loss years.

Sec. 224. Consent dividend for AAA bypass election.

Sec. 225. Treatment of S corporations under subchapter C.

Sec. 226. Elimination of pre-1983 earnings and profits.

Sec. 227. Allowance of charitable contributions of inventory and scientific

property.

TITLE III—TAXATION OF S CORPORATION SHAREHOLDERS

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

rules.
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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 50

6 SHAREHOLDERS.

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

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

9 shareholders’’ and inserting ‘‘50 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)—

19 ‘‘(i) except as provided in clause (ii),

20 a husband and wife (and their estates)

21 shall be treated as 1 shareholder, and

22 ‘‘(ii) in the case of a family with re23 spect to which an election is in effect
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1 under subparagraph (E), all members of

2 the family shall be treated as 1 share3 holder.

4 ‘‘(B) MEMBERS OF THE FAMILY.—For

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

6 ‘members of the family’ means the lineal de7 scendants of the common ancestor and the

8 spouses (or former spouses) of such lineal de9 scendants or common ancestor.

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

11 of this paragraph, an individual shall not be

12 considered a common ancestor if, as of the later

13 of the effective date of this paragraph or the

14 time the election under section 1362(a) is

15 made, the individual is more than 6 generations

16 removed from the youngest generation of share17 holders.

18 ‘‘(D) EFFECT OF ADOPTION, ETC.—In de19 termining whether any relationship specified in

20 subparagraph (B) or (C) exists, the rules of

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

22 ‘‘(E) ELECTION.—An election under sub23 paragraph (A)(ii)—

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

25 all shareholders,
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1 ‘‘(ii) shall remain in effect until termi2 nated, and

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

4 1 family in any corporation.’’

5 Subtitle B—Persons Allowed as

6 Shareholders

7 SEC. 111. CERTAIN EXEMPT ORGANIZATIONS.

8 (a) CERTAIN EXEMPT ORGANIZATIONS ALLOWED TO

9 BE SHAREHOLDERS.—

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

11 1361(b)(1) (defining small business corporation) is

12 amended to read as follows:

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

14 than an estate, a trust described in subsection

15 (c)(2), or an organization described in sub16 section (c)(7)) who is not an individual,’’.

17 (2) ELIGIBLE EXEMPT ORGANIZATIONS.—Sec18 tion 1361(c) (relating to special rules for applying

19 subsection (b)) is amended by adding at the end the

20 following new paragraph:

21 ‘‘(7) CERTAIN EXEMPT ORGANIZATIONS PER22 MITTED AS SHAREHOLDERS.—For purposes of sub23 section (b)(1)(B), an organization described in sec24 tion 401(a) or 501(c)(3) may be a shareholder in an

25 S corporation.’’.
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1 (b) CONTRIBUTIONS OF S CORPORATION STOCK.—

2 Section 170(e)(1) (relating to certain contributions of or3 dinary income and capital gain property) is amended by

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

5 of applying this paragraph in the case of a charitable con6 tribution of stock in an S corporation, rules similar to the

7 rules of section 751 shall apply in determining whether

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

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

10 (c) SPECIAL RULES APPLICABLE TO PARTNERSHIPS

11 AND S CORPORATIONS.—

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

13 512 (relating to unrelated business tax income) is

14 amended—

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

16 ‘‘partnership’’ each place it appears in para17 graphs (1) and (3),

18 (B) by inserting ‘‘or shareholder’’ after

19 ‘‘member’’ in paragraph (1), and

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

21 after ‘‘PARTNERSHIPS’’ in the heading.

22 (2) REPORTING REQUIREMENT.—Section 6037

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

24 adding at the end the following new subsection:
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1 ‘‘(c) SEPARATE STATEMENT OF ITEMS OF UNRE2 LATED BUSINESS TAXABLE INCOME.—In the case of any

3 S corporation regularly carrying on a trade or business

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

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

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

7 such information as is necessary to enable the shareholder

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

9 or loss from the trade or business in accordance with sec10 tion 512(a)(1), but without regard to the modifications de11 scribed in paragraphs (8) through (15) of section 512(b).’’

12 SEC. 112. FINANCIAL INSTITUTIONS.

13 Subparagraph (B) of section 1361(b)(2) (defining in14 eligible corporation) is amended to read as follows:

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

16 reserve method of accounting for bad debts de17 scribed in section 585 or 593,’’.

18 SEC. 113. NONRESIDENT ALIENS.

19 (a) NONRESIDENT ALIENS ALLOWED TO BE SHARE20 HOLDERS.—

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

22 1361(b) (defining small business corporation) is

23 amended—

24 (A) by adding ‘‘and’’ at the end of sub25 paragraph (B),
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1 (B) by striking subparagraph (C), and

2 (C) by redesignating subparagraph (D) as

3 subparagraph (C).

4 (2) CONFORMING AMENDMENTS.—Paragraphs

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

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

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

8 ‘‘subsection (b)(1)(C)’’.

9 (b) NONRESIDENT ALIEN SHAREHOLDER TREATED

10 AS ENGAGED IN TRADE OR BUSINESS WITHIN UNITED

11 STATES.—

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

13 (A) by striking ‘‘and’’ at the end of para14 graph (1),

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

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

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

18 paragraph:

19 ‘‘(3) a nonresident alien individual shall be con20 sidered as being engaged in a trade or business

21 within the United States if the S corporation of

22 which such individual is a shareholder is so en23 gaged.’’

24 (2) APPLICATION OF WITHHOLDING TAX ON

25 NONRESIDENT ALIEN SHAREHOLDERS.—Section
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1 1446 (relating to withholding tax on foreign part2 ners’ share of effectively connected income) is

3 amended by redesignating subsection (f) as sub4 section (g) and by inserting after subsection (e) the

5 following new subsection:

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

7 ETC.—For purposes of this section—

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

9 partnership,

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

11 be treated as partners of such partnership, and

12 ‘‘(3) any reference to section 704 shall be treat13 ed as a reference to section 1366.’’

14 (3) CONFORMING AMENDMENTS.—

15 (A) The heading of section 875 is amended

16 to read as follows:

17 ‘‘SEC. 875. PARTNERSHIPS; BENEFICIARIES OF ESTATES

18 AND TRUSTS; S CORPORATIONS.’’

19 (B) The heading of section 1446 is amend20 ed to read as follows:

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

22 AND S CORPORATE SHAREHOLDERS’ SHARE

23 OF EFFECTIVELY CONNECTED INCOME.’’

24 (4) CLERICAL AMENDMENTS.—
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1 (A) The item relating to section 875 in the

2 table of sections for subpart A of part II of

3 subchapter N of chapter 1 is amended to read

4 as follows:

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

5 (B) The item relating to section 1446 in

6 the table of sections for subchapter A of chap7 ter 3 is amended to read as follows:

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

share of effectively connected income.’’

8 (c) PERMANENT ESTABLISHMENT OF PARTNERS

9 AND S CORPORATION SHAREHOLDERS.—Section 894 (re10 lating to income affected by treaty) is amended by adding

11 at the end the following new subsection:

12 ‘‘(c) PERMANENT ESTABLISHMENT OF PARTNERS

13 AND S CORPORATION SHAREHOLDERS.—If a partnership

14 or S corporation has a permanent establishment in the

15 United States (within the meaning of a treaty to which

16 the United States is a party) at any time during a taxable

17 year of such entity, a nonresident alien individual or for18 eign corporation which is a partner in such partnership,

19 or a nonresident alien individual who is a shareholder in

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

21 establishment in the United States for purposes of such

22 treaty.’’
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1 SEC. 114. ELECTING SMALL BUSINESS TRUSTS.

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

3 1361(c)(2) (relating to certain trusts permitted as share4 holders) is amended by inserting after clause (iv) the fol5 lowing new clause:

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

7 (b) CURRENT BENEFICIARIES TREATED AS SHARE8 HOLDERS.—Subparagraph (B) of section 1361(c)(2) is

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

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

11 in clause (v) of subparagraph (A), each po12 tential current beneficiary of such trust

13 shall be treated as a shareholder; except

14 that, if for any period there is no potential

15 current beneficiary of such trust, such

16 trust shall be treated as the shareholder

17 during such period.’’

18 (c) ELECTING SMALL BUSINESS TRUST DEFINED.—

19 Section 1361 (defining S corporation) is amended by add20 ing at the end the following new subsection:

21 ‘‘(e) ELECTING SMALL BUSINESS TRUST DE22 FINED.—

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

24 purposes of this section—
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1 ‘‘(A) IN GENERAL.—Except as provided in

2 subparagraph (B), the term ‘electing small

3 business trust’ means any trust if—

4 ‘‘(i) such trust does not have as a

5 beneficiary any person other than an indi6 vidual, an estate, or an organization de7 scribed in section 401(a) or 501(c)(3),

8 ‘‘(ii) no interest in such trust was ac9 quired by purchase, and

10 ‘‘(iii) an election under this subsection

11 applies to such trust.

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

13 The term ‘electing small business trust’ shall

14 not include—

15 ‘‘(i) any qualified subchapter S trust

16 (as defined in subsection (d)(3)) if an elec17 tion under subsection (d)(2) applies to any

18 corporation the stock of which is held by

19 such trust, and

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

21 this subtitle.

22 ‘‘(C) PURCHASE.—For purposes of sub23 paragraph (A), the term ‘purchase’ means any

24 acquisition if the basis of the property acquired

25 is determined under section 1012.
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1 ‘‘(2) POTENTIAL CURRENT BENEFICIARY.—For

2 purposes of this section, the term ‘potential current

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

4 person who at any time during such period is enti5 tled to, or at the discretion of any person may re6 ceive, a distribution from the principal or income of

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

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

9 such corporation, the term ‘potential current bene10 ficiary’ does not include any person who first met

11 the requirements of the preceding sentence during

12 the 60-day period ending on the date of such dis13 position.

14 ‘‘(3) ELECTION.—An election under this sub15 section shall be made by the trustee in such manner

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

17 prescribe. Any such election shall apply to the tax18 able year of the trust for which made and all subse19 quent taxable years of such trust unless revoked

20 with the consent of the Secretary.

21 ‘‘(4) CROSS REFERENCE.—

‘‘For special treatment of electing small business

trusts, see section 641(d).’’

22 (d) TAXATION OF ELECTING SMALL BUSINESS

23 TRUSTS.—Section 641 (relating to imposition of tax on
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1 trusts) is amended by adding at the end the following new

2 subsection:

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

4 SMALL BUSINESS TRUSTS.—

5 ‘‘(1) IN GENERAL.—For purposes of this chap6 ter—

7 ‘‘(A) the portion of any electing small busi8 ness trust which consists of stock in l or more

9 S corporations shall be treated as a separate

10 trust, and

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

12 this chapter on such separate trust shall be de13 termined with the modifications of paragraph

14 (2).

15 ‘‘(2) MODIFICATIONS.—For purposes of para16 graph (1), the modifications of this paragraph are

17 the following:

18 ‘‘(A) Except as provided in section 1(h),

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

20 shall be determined by using the highest rate of

21 tax set forth in section 1(e).

22 ‘‘(B) The exemption amount under section

23 55(d) shall be zero.
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1 ‘‘(C) The only items of income, loss, deduc2 tion, or credit to be taken into account are the

3 following:

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

5 into account under section 1366.

6 ‘‘(ii) Any gain or loss from the dis7 position of stock in an S corporation.

8 ‘‘(iii) To the extent provided in regu9 lations, State or local income taxes or ad10 ministrative expenses to the extent alloca11 ble to items described in clauses (i) and

12 (ii).

13 No deduction or credit shall be allowed for any

14 amount not described in this paragraph, and no

15 item described in this paragraph shall be appor16 tioned to any beneficiary.

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

18 paragraph (1) or (2) of section 1211(b).

19 ‘‘(3) TREATMENT OF REMAINDER OF TRUST

20 AND DISTRIBUTIONS.—For purposes of determin21 ing—

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

23 this chapter on the portion of any electing small

24 business trust not treated as a separate trust

25 under paragraph (1), and
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1 ‘‘(B) the distributable net income of the

2 entire trust,

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

4 excluded. Except as provided in the preceding sen5 tence, this subsection shall not affect the taxation of

6 any distribution from the trust.

7 ‘‘(4) TREATMENT OF UNUSED DEDUCTIONS

8 WHERE TERMINATION OF SEPARATE TRUST.—If a

9 portion of an electing small business trust ceases to

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

11 any carryover or excess deduction of the separate

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

13 taken into account by the entire trust.

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

15 purposes of this subsection, the term ‘electing small

16 business trust’ has the meaning given such term by

17 section 1361(e)(1).’’

18 Subtitle C—Other Provisions

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

20 CERTAIN TRUSTS.

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

22 certain trusts permitted as shareholders) is amended—

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

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

25 period’’, and
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1 (2) by striking the last sentence in clause (ii).

2 TITLE II—QUALIFICATION AND

3 ELIGIBILITY REQUIREMENTS

4 FOR S CORPORATIONS

5 Subtitle A—One Class of Stock

6 SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.

7 (a) IN GENERAL.—Section 1361(c), as amended by

8 section 111(a)(2), is amended by adding at the end the

9 following new paragraph:

10 ‘‘(8) TREATMENT OF QUALIFIED PREFERRED

11 STOCK.—

12 ‘‘(A) IN GENERAL.—Notwithstanding sub13 section (b)(1)(D), an S corporation may issue

14 qualified preferred stock.

15 ‘‘(B) QUALIFIED PREFERRED STOCK DE16 FINED.—For purposes of this paragraph, the

17 term ‘qualified preferred stock’ means stock de18 scribed in section 1504(a)(4) which is issued to

19 a person eligible to hold common stock of an S

20 corporation.

21 ‘‘(C) DISTRIBUTIONS.—A distribution (not

22 in part or full payment in exchange for stock)

23 made by the corporation with respect to quali24 fied preferred stock shall be includible as inter25 est income of the holder and deductible to the
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1 corporation as interest expense in computing

2 taxable income under section 1363(b) in the

3 year such distribution is received.’’

4 (b) CONFORMING AMENDMENTS.—

5 (1) Subparagraph (C) of section 1361(b)(1), as

6 redesignated by section 113(a)(1)(C), is amended by

7 inserting ‘‘except as provided in paragraph (8),’’ be8 fore ‘‘have’’.

9 (2) Subsection (a) of section 1366 is amended

10 by adding at the end the following new paragraph:

11 ‘‘(3) ALLOCATION WITH RESPECT TO QUALI12 FIED PREFERRED STOCK.—The holders of qualified

13 preferred stock shall not, with respect to such stock,

14 be allocated any of the items described in paragraph

15 (1).’’

16 SEC. 202. FINANCIAL INSTITUTIONS PERMITTED TO HOLD

17 SAFE HARBOR DEBT.

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

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

20 clause (i) and by striking clauses (ii) and (iii) and insert21 ing the following:

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

23 such promise include a provision under

24 which the obligation to pay may be con25 verted (directly or indirectly) into stock of
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1 the corporation, such terms, taken as a

2 whole, are substantially the same as the

3 terms which could have been obtained on

4 the effective date of the promise from a

5 person which is not a related person (with6 in the meaning of section 465(b)(3)(C)) to

7 the S corporation or its shareholders, and

8 ‘‘(iii) the creditor is—

9 ‘‘(I) an individual,

10 ‘‘(II) an estate,

11 ‘‘(III) a trust described in para12 graph (2), or

13 ‘‘(IV) a person which is actively

14 and regularly engaged in the business

15 of lending money.’’

16 Subtitle B—Elections and

17 Terminations

18 SEC. 211. RULES RELATING TO INADVERTENT TERMI19 NATIONS AND INVALID ELECTIONS.

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

21 (relating to inadvertent terminations) is amended to read

22 as follows:

23 ‘‘(f) INADVERTENT INVALID ELECTIONS OR TERMI24 NATIONS.—If—
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1 ‘‘(1) an election under subsection (a) by any

2 corporation—

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

4 for which made (determined without regard to

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

6 the requirements of section 1361(b) or to ob7 tain shareholder consents, or

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

9 of subsection (d),

10 ‘‘(2) the Secretary determines that the cir11 cumstances resulting in such ineffectiveness or ter12 mination were inadvertent,

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

14 after discovery of the circumstances resulting in

15 such ineffectiveness or termination, steps were

16 taken—

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

18 business corporation, or

19 ‘‘(B) to acquire the required shareholder

20 consents, and

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

22 a shareholder in the corporation at any time during

23 the period specified pursuant to this subsection,

24 agrees to make such adjustments (consistent with

25 the treatment of the corporation as an S corpora-
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1 tion) as may be required by the Secretary with re2 spect to such period,

3 then, notwithstanding the circumstances resulting in such

4 ineffectiveness or termination, such corporation shall be

5 treated as an S corporation during the period specified

6 by the Secretary.’’

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

8 1362 is amended by adding at the end thereof the follow9 ing new paragraph:

10 ‘‘(5) AUTHORITY TO TREAT LATE ELECTIONS

11 AS TIMELY.—If—

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

13 made for any taxable year (determined without

14 regard to paragraph (3)) after the date pre15 scribed by this subsection for making such elec16 tion for such taxable year, and

17 ‘‘(B) the Secretary determines that there

18 was reasonable cause for the failure to timely

19 make such election,

20 the Secretary may treat such election as timely

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

22 not apply).’’

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

24 Treasury shall provide for an automatic waiver procedure

25 under section 1362(f) of the Internal Revenue Code of
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1 1986 in cases in which the Secretary determines appro2 priate.

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

4 subsection (a) and (b) shall apply with respect to elections

5 for taxable years beginning after December 31, 1982.

6 SEC. 212. AGREEMENT TO TERMINATE YEAR.

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

8 rata share) is amended to read as follows:

9 ‘‘(2) ELECTION TO TERMINATE YEAR.—

10 ‘‘(A) IN GENERAL.—Under regulations

11 prescribed by the Secretary, if any shareholder

12 terminates the shareholder’s interest in the cor13 poration during the taxable year and all af14 fected shareholders agree to the application of

15 this paragraph, paragraph (1) shall be applied

16 to the affected shareholders as if the taxable

17 year consisted of 2 taxable years the first of

18 which ends on the date of the termination.

19 ‘‘(B) AFFECTED SHAREHOLDERS.—For

20 purposes of subparagraph (A), the term ‘af21 fected shareholders’ means the shareholder

22 whose interest is terminated and all sharehold23 ers to whom such shareholder has transferred

24 shares during the taxable year. If such share25 holder has transferred shares to the corpora-
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1 tion, the term ‘affected shareholders’ shall in2 clude all persons who are shareholders during

3 the taxable year.’’

4 SEC. 213. EXPANSION OF POST-TERMINATION TRANSITION

5 PERIOD.

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

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

8 by striking ‘‘and’’ at the end of subparagraph (A), by re9 designating subparagraph (B) as subparagraph (C), and

10 by inserting after subparagraph (A) the following new sub11 paragraph:

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

13 date of any determination pursuant to an audit

14 of the taxpayer which follows the termination of

15 the corporation’s election and which adjusts a

16 subchapter S item of income, loss, or deduction

17 of the corporation arising during the S period

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

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

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

21 and (B), by redesignating subparagraph (C) as subpara22 graph (B), and by inserting before subparagraph (B) (as

23 so redesignated) the following new subparagraph:

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

25 1313(a), or’’.
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1 (c) REPEAL OF SPECIAL AUDIT PROVISIONS FOR

2 SUBCHAPTER S ITEMS.—

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

4 63 (relating to tax treatment of subchapter S items)

5 is hereby repealed.

6 (2) CONSISTENT TREATMENT REQUIRED.—Sec7 tion 6037 (relating to return of S corporation), as

8 amended by section 111(c)(2), is amended by adding

9 at the end the following new subsection:

10 ‘‘(d) SHAREHOLDER’S RETURN MUST BE CONSIST11 ENT WITH CORPORATE RETURN OR SECRETARY NOTI12 FIED OF INCONSISTENCY.—

13 ‘‘(1) IN GENERAL.—A shareholder of an S cor14 poration shall, on such shareholder’s return, treat a

15 subchapter S item in a manner which is consistent

16 with the treatment of such item on the corporate

17 return.

18 ‘‘(2) NOTIFICATION OF INCONSISTENT TREAT19 MENT.—

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

21 subchapter S item, if—

22 ‘‘(i)(I) the corporation has filed a re23 turn but the shareholder’s treatment on

24 his return is (or may be) inconsistent with
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1 the treatment of the item on the corporate

2 return, or

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

4 return, and

5 ‘‘(ii) the shareholder files with the

6 Secretary a statement identifying the in7 consistency,

8 paragraph (1) shall not apply to such item.

9 ‘‘(B) SHAREHOLDER RECEIVING INCOR10 RECT INFORMATION.—A shareholder shall be

11 treated as having complied with clause (ii) of

12 subparagraph (A) with respect to a subchapter

13 S item if the shareholder—

14 ‘‘(i) demonstrates to the satisfaction

15 of the Secretary that the treatment of the

16 subchapter S item on the shareholder’s re17 turn is consistent with the treatment of the

18 item on the schedule furnished to the

19 shareholder by the corporation, and

20 ‘‘(ii) elects to have this paragraph

21 apply with respect to that item.

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

23 case—

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

25 of paragraph (2), and
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1 ‘‘(B) in which the shareholder does not

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

3 (2),

4 any adjustment required to make the treatment of

5 the items by such shareholder consistent with the

6 treatment of the items on the corporate return shall

7 be treated as arising out of mathematical or clerical

8 errors and assessed according to section 6213(b)(1).

9 Paragraph (2) of section 6213(b) shall not apply

10 to any assessment referred to in the preceding

11 sentence.

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

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

14 any item of an S corporation to the extent that reg15 ulations prescribed by the Secretary provide that, for

16 purposes of this subtitle, such item is more appro17 priately determined at the corporation level than at

18 the shareholder level.

19 ‘‘(5) ADDITION TO TAX FOR FAILURE TO COM20 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.’’

21 (3) CONFORMING AMENDMENTS.—

22 (A) Section 1366 is amended by striking

23 subsection (g).
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1 (B) Subsection (b) of section 6233 is

2 amended to read as follows:

3 ‘‘(b) SIMILAR RULES IN CERTAIN CASES.—If a part4 nership return is filed for any taxable year but it is deter5 mined that there is no entity for such taxable year, to the

6 extent provided in regulations, rules similar to the rules

7 of subsection (a) shall apply.’’

8 (C) The table of subchapters for chapter

9 63 is amended by striking the item relating to

10 subchapter D.

11 SEC. 214. REPEAL OF EXCESSIVE PASSIVE INVESTMENT IN12 COME AS A TERMINATION EVENT.

13 (a) IN GENERAL.—Section 1362(d) (relating to ter14 mination) is amended by striking paragraph (3).

15 (b) MODIFICATION OF TAX IMPOSED ON EXCESSIVE

16 PASSIVE INVESTMENT INCOME.—

17 (1) INCREASE IN THRESHOLD.—Subsections

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

19 tax imposed when passive investment income of cor20 poration having subchapter C earnings and profits

21 exceeds 25 percent of gross receipts) are each

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

23 percent’’.

24 (2) TAX RATE INCREASE AFTER THIRD CON25 SECUTIVE YEAR.—Section 1375 is amended by re-
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1 designating subsections (c) and (d) as subsections

2 (d) and (e), respectively, and by inserting after sub3 section (b) the following new subsection:

4 ‘‘(c) TAX RATE INCREASE AFTER THIRD CONSECU5 TIVE YEAR.—

6 ‘‘(1) IN GENERAL.—If an S corporation is de7 scribed in subsection (a) for more than 3 consecutive

8 taxable years, then the rate of tax imposed under

9 subsection (a) with respect to each succeeding con10 secutive taxable year (if any) shall be determined

11 under the following table:

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

‘‘In the case of the— points:

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

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

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

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

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

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

13 shall be increased under paragraph (1) for any tax14 able year beginning before January 1, 1994.’’

15 (c) CONFORMING AMENDMENTS.—

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

17 ‘‘or (3)’’.

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

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

20 following new paragraphs:
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1 ‘‘(3) SUBCHAPTER C EARNINGS AND PROF2 ITS.—The term ‘subchapter C earnings and profits’

3 means earnings and profits of any corporation for

4 any taxable year with respect to which an election

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

6 prior law) was not in effect.

7 ‘‘(4) GROSS RECEIPTS FROM SALES OF CAPITAL

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

9 the case of dispositions of capital assets (other than

10 stock and securities), gross receipts from such dis11 positions shall be taken into account only to the ex12 tent of the capital gain net income therefrom.

13 ‘‘(5) PASSIVE INVESTMENT INCOME DE14 FINED.—

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

16 provided in this paragraph, the term ‘passive

17 investment income’ means gross receipts de18 rived from royalties, rents, dividends, interest,

19 and annuities.

20 ‘‘(B) EXCEPTION FOR INTEREST ON

21 NOTES FROM SALES OF INVENTORY.—The term

22 ‘passive investment income’ shall not include in23 terest on any obligation acquired in the ordi24 nary course of the corporation’s trade or busi-
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1 ness from its sale of property described in sec2 tion 1221(1).

3 ‘‘(C) TREATMENT OF CERTAIN LENDING

4 OR FINANCE COMPANIES.—If the S corporation

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

6 the taxable year, the term ‘passive investment

7 income’ shall not include gross receipts for the

8 taxable year which are derived directly from the

9 active and regular conduct of a lending or fi10 nance business (as defined in section

11 542(d)(1)).

12 ‘‘(D) SPECIAL RULE FOR OPTIONS AND

13 COMMODITY DEALINGS.—

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

15 options dealer or commodities dealer, pas16 sive investment income shall be determined

17 by not taking into account any gain or loss

18 (in the normal course of the taxpayer’ ac19 tivity of dealing in or trading section 1256

20 contracts) from any section 1256 contract

21 or property related to such a contract.

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

23 this subparagraph—

24 ‘‘(I) OPTIONS DEALER.—The

25 term ‘options dealer’ has the meaning
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1 given such term by section

2 1256(g)(8).

3 ‘‘(II) COMMODITIES DEALER.—

4 The term ‘commodities dealer’ means

5 a person who is actively engaged in

6 trading section 1256 contracts and is

7 registered with a domestic board of

8 trade which is designated as a con9 tract market by the Commodities Fu10 tures Trading Commission.

11 ‘‘(III) SECTION 1256 CON12 TRACT.—The term ‘section 1256 con13 tract’ has the meaning given to such

14 term by section 1256(b).

15 ‘‘(E) COORDINATION WITH SECTION

16 1374.—The amount of passive investment in17 come shall be determined by not taking into ac18 count any recognized built-in gain or loss of the

19 S corporation for any taxable year in the rec20 ognition period. Terms used in the preceding

21 sentence shall have the same respective mean22 ing as when used in section 1374.’’

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

24 striking ‘‘25’’ and inserting ‘‘50’’.
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1 (4) The table of sections for part III of sub2 chapter S of chapter 1 is amended by striking ‘‘25’’

3 in the item relating to section 1375 and inserting

4 ‘‘50’’.

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

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

7 inserting ‘‘section 1375(b)(5)’’.

8 Subtitle C—Other Provisions

9 SEC. 221. S CORPORATIONS PERMITTED TO HOLD SUBSIDI10 ARIES.

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

12 (defining ineligible corporation) is amended by striking

13 subparagraph (A) and by redesignating subparagraphs

14 (B), (C), (D), and (E) as subparagraphs (A), (B), (C),

15 and (D), respectively.

16 (b) CERTAIN DIVIDENDS NOT TREATED AS PASSIVE

17 INVESTMENT INCOME.—Section 1375(b)(5) (defining pas18 sive investment income), as added by section 214(c)(2),

19 is amended by adding at the end the following new sub20 paragraph:

21 ‘‘(F) TREATMENT OF CERTAIN DIVI22 DENDS.—If an S corporation holds stock in a

23 C corporation meeting the requirements of sec24 tion 1504(a)(2), the term ‘passive investment

25 income’ shall not include dividends from such C
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1 corporation to the extent such dividends are at2 tributable to the earnings and profits of such C

3 corporation derived from the active conduct of

4 a trade or business.’’

5 (c) CONFORMING AMENDMENTS.—

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

7 by sections 111 and 201, is amended by striking

8 paragraph (6) and redesignating paragraphs (7) and

9 (8) as paragraphs (6) and (7), respectively.

10 (2) Subsection (b) of section 1504 (defining in11 cludible corporation) is amended by adding at the

12 end the following new paragraph:

13 ‘‘(8) An S corporation.’’

14 SEC. 222. C CORPORATION RULES TO APPLY FOR FRINGE

15 BENEFIT PURPOSES.

16 (a) IN GENERAL.—Section 1372 (relating to partner17 ship rules to apply for fringe benefit purposes) is repealed.

18 (b) CONFORMING AMENDMENTS.—

19 (1) Section 162(l) is amended by striking para20 graph (5) and by redesignating paragraph (6) as

21 paragraph (5).

22 (2) The table of sections for part III of sub23 chapter S of chapter 1 is amended by striking the

24 item relating to section 1372.
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1 SEC. 223. TREATMENT OF DISTRIBUTIONS DURING LOSS

2 YEARS.

3 (a) ADJUSTMENTS FOR DISTRIBUTIONS TAKEN INTO

4 ACCOUNT BEFORE LOSSES.—

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

6 (relating to losses and deductions cannot exceed

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

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

9 (1) and (2)(A)’’.

10 (2) Subsection (d) of section 1368 (relating to

11 certain adjustments taken into account) is amended

12 by adding at the end the following new sentence:

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

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

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

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

17 (b) ACCUMULATED ADJUSTMENTS ACCOUNT.—Para18 graph (1) of section 1368(e) (relating to accumulated ad19 justments account) is amended by adding at the end the

20 following new subparagraph:

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

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

23 to distributions made during any taxable year,

24 the amount in the accumulated adjustments ac25 count as of the close of such taxable year shall
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1 be determined without regard to any net nega2 tive adjustment for such taxable year.

3 ‘‘(ii) NET NEGATIVE ADJUSTMENT.—For

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

5 adjustment’ means, with respect to any taxable

6 year, the excess (if any) of—

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

8 the taxable year (other than for distribu9 tions), over

10 ‘‘(II) the increases in such account for

11 such taxable year.’’

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

13 of section 1368(e)(1) is amended—

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

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

16 paragraph’’, and

17 (2) by striking ‘‘section 1367(b)(2)(A)’’ and in18 serting ‘‘section 1367(a)(2)’’.

19 SEC. 224. CONSENT DIVIDEND FOR AAA BYPASS ELECTION.

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

21 earnings first) is amended by adding at the end the follow22 ing new subparagraph:

23 ‘‘(C) CONSENT DIVIDEND.—Under regula24 tions prescribed by the Secretary, an S corpora25 tion may, subject to the election under this
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1 paragraph, consent to treat as a distribution

2 the amount specified in such consent, to the ex3 tent such amount does not exceed the accumu4 lated earnings and profits of such corporation.

5 The amount so specified shall be considered—

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

7 corporation to its shareholders on the last

8 day of the taxable year of the corporation

9 and as contributed to the capital of the

10 corporation by the shareholders on such

11 day, and

12 ‘‘(ii) if any such shareholder is an or13 ganization described in section 511(a)(2),

14 as unrelated business taxable income (as

15 defined in section 512) to such share16 holder.’’

17 SEC. 225. TREATMENT OF S CORPORATIONS UNDER SUB18 CHAPTER C.

19 Subsection (a) of section 1371 (relating to applica20 tion of subchapter C rules) is amended to read as follows:

21 ‘‘(a) APPLICATION OF SUBCHAPTER C RULES.—Ex22 cept as otherwise provided in this title, and except to the

23 extent inconsistent with this subchapter, subchapter C

24 shall apply to an S corporation and its shareholders.’’
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1 SEC. 226. ELIMINATION OF PRE-1983 EARNINGS AND

2 PROFITS.

3 (a) IN GENERAL.—If—

4 (1) a corporation was an electing small business

5 corporation under subchapter S of chapter 1 of the

6 Internal Revenue Code of 1986 for any taxable year

7 beginning before January 1, 1983, and

8 (2) such corporation is an S corporation under

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

10 taxable year beginning after December 31, 1993,

11 the amount of such corporation’s accumulated earnings

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

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

14 any) of such accumulated earnings and profits which were

15 accumulated in any taxable year beginning before January

16 1, 1983, for which such corporation was an electing small

17 business corporation under such subchapter S.

18 (b) CONFORMING AMENDMENTS.—

19 (1)(A) Subsection (a) of section 1375 is amend20 ed by striking ‘‘subchapter C’’ in paragraph (1) and

21 inserting ‘‘accumulated’’.

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

23 by section 214(c)(2), is amended by striking para24 graph (3) and by redesignating paragraphs (4) and

25 (5) as paragraphs (3) and (4), respectively.
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1 (C) The section heading for section 1375 is

2 amended by striking ‘‘SUBCHAPTER C’’ and insert3 ing ‘‘ACCUMULATED’’.

4 (D) The table of sections for part III of sub5 chapter S of chapter 1 is amended by striking ‘‘sub6 chapter C’’ in the item relating to section 1375 and

7 inserting ‘‘accumulated’’.

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

9 amended by section 214(c)(5), is amended by strik10 ing ‘‘section 1375(b)(5)’’ and inserting ‘‘section

11 1375(b)(4)’’.

12 SEC. 227. ALLOWANCE OF CHARITABLE CONTRIBUTIONS

13 OF INVENTORY AND SCIENTIFIC PROPERTY.

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

15 contributions of ordinary income and capital gain prop16 erty) is amended—

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

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

19 and

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

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

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

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

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

25 of shareholders, etc.) is amended by striking ‘‘and’’ at the
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1 end of subparagraph (B), by striking the period at the

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

3 adding at the end the following new subparagraph:

4 ‘‘(D) the excess of the deductions for char5 itable contributions over the basis of the prop6 erty contributed.’’

7 TITLE III—TAXATION OF S

8 CORPORATION SHAREHOLDERS

9 SEC. 301. UNIFORM TREATMENT OF OWNER-EMPLOYEES

10 UNDER PROHIBITED TRANSACTION RULES.

11 The last sentence of section 4975(d) (relating to ex12 emptions from prohibited transactions) is amended by

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

14 1379, as in effect on the day before the date of the enact15 ment of the Subchapter S Revision Act of 1982),’’.

16 SEC. 302. TREATMENT OF LOSSES TO SHAREHOLDERS.

17 (a) TREATMENT OF LOSSES IN LIQUIDATIONS.—Sec18 tion 331 (relating to gain or loss to shareholders in cor19 porate liquidations) is amended by redesignating sub20 section (c) as subsection (d) and by inserting after sub21 section (b) the following new subsection:

22 ‘‘(c) LOSSES ON LIQUIDATIONS OF S CORPORA23 TION.—

24 ‘‘(1) IN GENERAL.—The portion of any loss rec25 ognized by a shareholder of an S corporation (as de-
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1 fined in section 1361(a)(1)) on amounts received by

2 such shareholder in a distribution in complete liq3 uidation of such S corporation which does not exceed

4 the ordinary income basis of stock of such S cor5 poration in the hands of such shareholder shall not

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

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

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

9 of this subsection, the ordinary income basis of stock

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

11 such S corporation shall be an amount equal to the

12 portion of such shareholder’s basis in such stock

13 which is equal to the aggregate increases in such

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

15 shareholder’s pro rata share of ordinary income of

16 such S corporation attributable to the complete

17 liquidation.’’

18 (b) CARRYOVER OF DISALLOWED LOSSES AND DE19 DUCTIONS UNDER AT-RISK RULES ALLOWED.—Para20 graph (3) of section 1366(d) (relating to carryover of dis21 allowed losses and deductions to post-termination transi22 tion period) is amended by adding at the end the following

23 new subparagraph:

24 ‘‘(D) AT-RISK LIMITATIONS.—To the ex25 tent that any increase in adjusted basis de-
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1 scribed in subparagraph (B) would have in2 creased the shareholder’s amount at risk under

3 section 465 if such increase had occurred on

4 the day preceding the commencement of the

5 post-termination transition period, rules similar

6 to the rules described in subparagraphs (A)

7 through (C) shall apply to any losses disallowed

8 by reason of section 465(a).’’

9 TITLE IV—EFFECTIVE DATE

10 SEC. 401. EFFECTIVE DATE.

11 Except as otherwise provided in this Act, the amend12 ments made by this Act shall apply to taxable years begin13 ning after December 31, 1994.

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