II

106TH CONGRESS

1ST SESSION S. 875

To amend the Internal Revenue Code of 1986 to expand S corporation

eligibility for banks, and for other purposes.

IN THE SENATE OF THE UNITED STATES

APRIL 26, 1999

Mr. ALLARD (for himself, Mr. GRAMM, Mr. BENNETT, Mr. SHELBY, Mr.

ABRAHAM, Mr. HAGEL, Mr. ENZI, Mr. MACK, and Mr. GRAMS) introduced the following bill; which was read twice and referred to the Committee on Finance

A BILL

To amend the Internal Revenue Code of 1986 to expand

S corporation eligibility for banks, and for other purposes.

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

3 SECTION 1. SHORT TITLE.

4 This Act may be cited as the ‘‘Small Business and

5 Financial Institutions Tax Relief Act of 1999’’.

6 SEC. 2. EXPANSION OF S CORPORATION ELIGIBLE SHARE7 HOLDERS TO INCLUDE IRAS.

8 (a) IN GENERAL.—Section 1361(c)(2)(A) of the In9 ternal Revenue Code of 1986 (relating to certain trusts
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1 permitted as shareholders) is amended by inserting after

2 clause (v) the following:

3 ‘‘(vi) A trust which constitutes an in4 dividual retirement account under section

5 408(a), including one designated as a Roth

6 IRA under section 408A.’’

7 (b) TREATMENT AS SHAREHOLDER.—Section

8 1361(c)(2)(B) of the Internal Revenue Code of 1986 (re9 lating to treatment as shareholders) is amended by adding

10 at the end the following:

11 ‘‘(vi) In the case of a trust described

12 in clause (vi) of subparagraph (A), the in13 dividual for whose benefit the trust was

14 created shall be treated as a shareholder.’’

15 (c) SALE OF STOCK IN IRA RELATING TO S COR16 PORATION ELECTION EXEMPT FROM PROHIBITED

17 TRANSACTION RULES.—Section 4975(d) of the Internal

18 Revenue Code of 1986 (relating to exemptions) is amend19 ed by striking ‘‘or’’ at the end of paragraph (14), by strik20 ing the period at the end of paragraph (15) and inserting

21 ‘‘; or’’, and by adding at the end the following:

22 ‘‘(16) a sale of stock held by a trust which con23 stitutes an individual retirement account under sec24 tion 408(a) to the individual for whose benefit such
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1 account is established if such sale is pursuant to an

2 election under section 1362(a).’’

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

4 this section shall apply to taxable years beginning after

5 December 31, 1999.

6 SEC. 3. EXCLUSION OF INVESTMENT SECURITIES INCOME

7 FROM PASSIVE INCOME TEST FOR BANK S

8 CORPORATIONS.

9 (a) IN GENERAL.—Section 1362(d)(3)(C) of the In10 ternal Revenue Code of 1986 (defining passive investment

11 income) is amended by adding at the end the following:

12 ‘‘(v) EXCEPTION FOR BANKS; ETC.—

13 In the case of a bank (as defined in section

14 581), a bank holding company (as defined

15 in section 246A(c)(3)(B)(ii)), or a qualified

16 subchapter S subsidiary bank, the term

17 ‘passive investment income’ shall not

18 include—

19 ‘‘(I) interest income earned by

20 such bank, bank holding company, or

21 qualified subchapter S subsidiary

22 bank, or

23 ‘‘(II) dividends on assets required

24 to be held by such bank, bank holding

25 company, or qualified subchapter S
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1 subsidiary bank to conduct a banking

2 business, including stock in the Fed3 eral Reserve Bank, the Federal Home

4 Loan Bank, or the Federal Agricul5 tural Mortgage Bank or participation

6 certificates issued by a Federal Inter7 mediate Credit Bank.’’

8 (b) EFFECTIVE DATE.—The amendment made by

9 this section shall apply to taxable years beginning after

10 December 31, 1996.

11 SEC. 4. INCREASE IN NUMBER OF ELIGIBLE SHARE12 HOLDERS TO 150.

13 (a) IN GENERAL.—Section 1361(b)(1)(A) of the In14 ternal Revenue Code of 1986 (defining small business cor15 poration) is amended by striking ‘‘75’’ and inserting

16 ‘‘150’’.

17 (b) EFFECTIVE DATE.—The amendment made by

18 this section shall apply to taxable years beginning after

19 December 31, 1999.

20 SEC. 5. TREATMENT OF QUALIFYING DIRECTOR SHARES.

21 (a) IN GENERAL.—Section 1361 of the Internal Rev22 enue Code of 1986 is amended by adding at the end the

23 following:

24 ‘‘(f) TREATMENT OF QUALIFYING DIRECTOR

25 SHARES.—
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1 ‘‘(1) IN GENERAL.—For purposes of this

2 subchapter—

3 ‘‘(A) qualifying director shares shall not be

4 treated as a second class of stock, and

5 ‘‘(B) no person shall be treated as a share6 holder of the corporation by reason of holding

7 qualifying director shares.

8 ‘‘(2) QUALIFYING DIRECTOR SHARES DE9 FINED.—For purposes of this subsection, the term

10 ‘qualifying director shares’ means any shares of

11 stock in a bank (as defined in section 581) or in a

12 bank holding company registered as such with the

13 Federal Reserve System—

14 ‘‘(i) which are held by an individual

15 solely by reason of status as a director of

16 such bank or company or its controlled

17 subsidiary; and

18 ‘‘(ii) which are subject to an agree19 ment pursuant to which the holder is re20 quired to dispose of the shares of stock

21 upon termination of the holder’s status as

22 a director at the same price as the indi23 vidual acquired such shares of stock.

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

25 part or full payment in exchange for stock) made by
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1 the corporation with respect to qualifying director

2 shares shall be includible as ordinary income of the

3 holder and deductible to the corporation as an ex4 pense in computing taxable income under section

5 1363(b) in the year such distribution is received.’’

6 (b) CONFORMING AMENDMENTS.—

7 (1) Section 1361(b)(1) of the Internal Revenue

8 Code of 1986 is amended by inserting ‘‘, except as

9 provided in subsection (f),’’ before ‘‘which does not’’.

10 (2) Section 1366(a) of such Code is amended

11 by adding at the end the following:

12 ‘‘(3) ALLOCATION WITH RESPECT TO QUALI13 FYING DIRECTOR SHARES.—The holders of quali14 fying director shares (as defined in section 1361(f))

15 shall not, with respect to such shares of stock, be al16 located any of the items described in paragraph

17 (1).’’

18 (3) Section 1373(a) of such Code is amended

19 by striking ‘‘and’’ at the end of paragraph (1), by

20 striking the period at the end of paragraph (2) and

21 inserting ‘‘, and’’, and adding at the end the fol22 lowing:

23 ‘‘(3) no amount of an expense deductible under

24 this subchapter by reason of section 1361(f)(3) shall

25 be apportioned or allocated to such income.’’
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1 (c) EFFECTIVE DATE.—The amendments made by

2 this section shall apply to taxable years beginning after

3 December 31, 1996.

4 SEC. 6. BAD DEBT CHARGE OFFS IN YEARS AFTER ELEC5 TION YEAR TREATED AS ITEMS OF BUILT–IN

6 LOSS.

7 The Secretary of the Treasury shall modify Regula8 tion 1.1374–4(f) for S corporation elections made in tax9 able years beginning after December 31, 1996, with re10 spect to bad debt deductions under section 166 of the In11 ternal Revenue Code of 1986 to treat such deductions as

12 built-in losses under section 1374(d)(4) of such Code dur13 ing the entire period during which the bank recognizes

14 built-in gains from changing its accounting method for

15 recognizing bad debts from the reserve method under sec16 tion 585 of such Code to the charge-off method under sec17 tion 166 of such Code.

18 SEC. 7. INCLUSION OF BANKS IN 3-YEAR S CORPORATION

19 RULE FOR CORPORATE PREFERENCE ITEMS.

20 (a) IN GENERAL.—Section 1363(b) of the Internal

21 Revenue Code of 1986 (relating to computation of cor22 poration’s taxable income) is amended by adding at the

23 end the following new flush sentence:
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1 ‘‘Paragraph (4) shall apply to any bank whether such

2 bank is an S corporation or a qualified subchapter S sub3 sidiary.’’

4 (b) EFFECTIVE DATE.—The amendment made by

5 this section shall apply to taxable years beginning after

6 December 31, 1999.

7 SEC. 8. C CORPORATION RULES TO APPLY FOR FRINGE

8 BENEFIT PURPOSES.

9 (a) IN GENERAL.—Section 1372 of the Internal Rev10 enue Code of 1986 (relating to partnership rules to apply

11 for fringe benefit purposes) is repealed.

12 (b) PARTNERSHIP RULES TO APPLY FOR HEALTH

13 INSURANCE COSTS OF CERTAIN S CORPORATION SHARE14 HOLDERS.—Paragraph (5) of section 162(1) of the Inter15 nal Revenue Code of 1986 is amended to read as follows:

16 ‘‘(5) TREATMENT OF CERTAIN S CORPORATION

17 SHAREHOLDERS.—

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

19 apply in the case of any 2-percent shareholder

20 of an S corporation, except that—

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

22 such shareholder’s wages (as defined in

23 section 3121) from the S corporation shall

24 be treated as such shareholder’s earned in-
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1 come (within the meaning of section

2 401(c)(1)), and

3 ‘‘(ii) there shall be such adjustments

4 in the application of this subsection as the

5 Secretary may by regulations prescribe.

6 ‘‘(B) 2-PERCENT SHAREHOLDER DE7 FINED.—For purposes of this paragraph, the

8 term ‘2-percent shareholder’ means any person

9 who owns (or is considered as owning within

10 the meaning of section 318) on any day during

11 the taxable year of the S corporation more than

12 2 percent of the outstanding stock of such cor13 poration or stock possessing more than 2 per14 cent of the total combined voting power of all

15 stock of such corporation.’’

16 (c) CONFORMING AMENDMENT.—The table of sec17 tions for part III of subchapter S of chapter 1 of the Inter18 nal Revenue Code of 1986 is amended by striking the item

19 relating to section 1372.

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

21 this section shall apply to taxable years beginning after

22 December 31, 1999.
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1 SEC. 9. EXPANSION OF S CORPORATION ELIGIBLE SHARE2 HOLDERS TO INCLUDE FAMILY LIMITED

3 PARTNERSHIPS.

4 (a) IN GENERAL.—Section 1361(b)(1)(B) of the In5 ternal Revenue Code of 1986 (defining small business cor6 poration) is amended—

7 (1) by striking ‘‘or an organization’’ and insert8 ing ‘‘an organization’’, and

9 (2) by inserting ‘‘, or a family partnership de10 scribed in subsection (c)(8)’’ after ‘‘subsection

11 (c)(6)’’.

12 (b) FAMILY PARTNERSHIP.—Section 1361(c) of the

13 Internal Revenue Code of 1986 (relating to special rules

14 for applying subsection (b)), as amended by section 5, is

15 amended by adding at the end the following:

16 ‘‘(8) FAMILY PARTNERSHIPS.—

17 ‘‘(A) IN GENERAL.—For purposes of sub18 section (b)(1)(B), any partnership or limited li19 ability company may be a shareholder in an S

20 corporation if—

21 ‘‘(i) all partners or members are mem22 bers of 1 family as determined under sec23 tion 704(e)(3), and

24 ‘‘(ii) all of the partners or members

25 would otherwise be eligible shareholders of

26 an S corporation.
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1 ‘‘(B) TREATMENT AS SHAREHOLDERS.—

2 For purposes of subsection (b)(1)(A), in the

3 case of a partnership or limited liability com4 pany described in subparagraph (A), each part5 ner or member shall be treated as a share6 holder.’’

7 (c) EFFECTIVE DATE.—The amendments made by

8 this section shall apply to taxable years beginning after

9 December 31, 1999.

10 SEC. 10. ISSUANCE OF PREFERRED STOCK PERMITTED.

11 (a) IN GENERAL.—Section 1361 of the Internal Rev12 enue Code of 1986, as amended by section 5(a), is amend13 ed by adding at the end the following:

14 ‘‘(g) TREATMENT OF QUALIFIED PREFERRED

15 STOCK.—

16 ‘‘(1) IN GENERAL.—For purposes of this

17 subchapter—

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

19 treated as a second class of stock, and

20 ‘‘(B) no person shall be treated as a share21 holder of the corporation by reason of holding

22 qualified preferred stock.

23 ‘‘(2) QUALIFIED PREFERRED STOCK DE24 FINED.—For purposes of this subsection, the term

25 ‘qualified preferred stock’ means stock which meets
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1 the requirements of subparagraphs (A), (B), and (C)

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

3 treated as qualified preferred stock solely because it

4 is convertible into other stock.

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

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

7 the corporation with respect to qualified preferred

8 stock shall be includible as ordinary income of the

9 holder and deductible to the corporation as an ex10 pense in computing taxable income under section

11 1363(b) in the year such distribution is received.’’

12 (b) CONFORMING AMENDMENTS.—

13 (1) Section 1361(b)(1) of the Internal Revenue

14 Code of 1986, as amended by section 5(b)(1), is

15 amended by striking ‘‘subsection (f)’’ and inserting

16 ‘‘subsections (f) and (g)’’.

17 (2) Section 1366(a) of such Code, as amended

18 by section 5(b)(2), is amended by adding at the end

19 the following:

20 ‘‘(4) ALLOCATION WITH RESPECT TO QUALI21 FIED PREFERRED STOCK.—The holders of qualified

22 preferred stock (as defined in section 1361(g)) shall

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

24 the items described in paragraph (1).’’
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1 (3) Section 1373(a)(3) of such Code, as added

2 by section 5(b)(3), is amended by inserting ‘‘or

3 1361(g)(3)’’ after ‘‘section 1361(f)(3)’’.

4 (c) EFFECTIVE DATE.—The amendments made by

5 this section shall apply to taxable years beginning after

6 December 31, 1999.

7 SEC. 11. CONSENT TO ELECTIONS.

8 (a) 90 PERCENT OF SHARES REQUIRED FOR CON9 SENT TO ELECTION.—Section 1362(a)(2) of the Internal

10 Revenue Code of 1986 (relating to all shareholders must

11 consent to election) is amended—

12 (1) by striking ‘‘all persons who are share13 holders in’’ and inserting ‘‘shareholders holding at

14 least 90 percent of the shares of’’, and

15 (2) by striking ‘‘ALL SHAREHOLDERS’’ in the

16 heading and inserting ‘‘AT LEAST 90 PERCENT OF

17 SHARES’’.

18 (b) RULES FOR CONSENT.—Section 1362(a) of the

19 Internal Revenue Code of 1986 (relating to election) is

20 amended by adding at the end the following:

21 ‘‘(3) RULES FOR CONSENT.—For purposes of

22 making any consent required under paragraph (2) or

23 subsection (d)(1)(B)—

24 ‘‘(A) each joint owner of shares shall con25 sent with respect to such shares,
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1 ‘‘(B) the personal representative or other

2 fiduciary authorized to act on behalf of the es3 tate of a deceased individual shall consent for

4 the estate,

5 ‘‘(C) one parent, the custodian, the guard6 ian, or the conservator shall consent with re7 spect to shares owned by a minor or subject to

8 a custodianship, guardianship, conservatorship,

9 or similar arrangement,

10 ‘‘(D) the trustee of a trust shall consent

11 with respect to shares owned in trust,

12 ‘‘(E) the trustee of the estate of a bank13 rupt individual shall consent for shares owned

14 by a bankruptcy estate,

15 ‘‘(F) an authorized officer or the trustee of

16 an organization described in subsection (c)(6)

17 shall consent for the shares owned by such or18 ganization, and

19 ‘‘(G) in the case of a partnership or lim20 ited liability company described in subsection

21 (c)(8)—

22 ‘‘(i) all general partners shall consent

23 with respect to shares owned by such part24 nership,
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1 ‘‘(ii) all managers shall consent with

2 respect to shares owned by such company

3 if management of such company is vested

4 in 1 or more managers, and

5 ‘‘(iii) all members shall consent with

6 respect to shares owned by such company

7 if management of such company is vested

8 in the members.’’

9 (c) TREATMENT OF NONCONSENTING SHAREHOLDER

10 STOCK.—

11 (1) IN GENERAL.—Section 1361 of the Internal

12 Revenue Code of 1986, as amended by section 10(a),

13 is amended by adding at the end the following:

14 ‘‘(h) TREATMENT OF NONCONSENTING SHARE15 HOLDER STOCK.—

16 ‘‘(1) IN GENERAL.—For purposes of this

17 subchapter—

18 ‘‘(A) nonconsenting shareholder stock shall

19 not be treated as a second class of stock,

20 ‘‘(B) such stock shall be treated as C cor21 poration stock, and

22 ‘‘(C) the shareholder’s pro rata share

23 under section 1366(a)(1) with respect to such

24 stock shall be subject to tax paid by the S cor-
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1 poration at the highest rate of tax specified in

2 section 11(b).

3 ‘‘(2) NONCONSENTING SHAREHOLDER STOCK

4 DEFINED.—For purposes of this subsection, the

5 term ‘nonconsenting shareholder stock’ means stock

6 of an S corporation which is held by a shareholder

7 who did not consent to an election under section

8 1362(a) with respect to such S corporation.

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

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

11 the corporation with respect to nonconsenting share12 holder stock shall be includible as ordinary income

13 of the holder and deductible to the corporation as an

14 expense in computing taxable income under section

15 1363(b) in the year such distribution is received.’’

16 (2) CONFORMING AMENDMENT.—Section

17 1361(b)(1) of the Internal Revenue Code of 1986, as

18 amended by section 10(b)(1), is amended by striking

19 ‘‘subsections (f) and (g)’’ and inserting ‘‘subsections

20 (f), (g), and (h)’’.

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

22 this section shall apply to elections made in taxable years

23 beginning after December 31, 1999.
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1 SEC. 12. INFORMATION RETURNS FOR QUALIFIED SUB2 CHAPTER S SUBSIDIARIES.

3 (a) IN GENERAL.—Section 1361(b)(3)(A) of the In4 ternal Revenue Code of 1986 (relating to treatment of cer5 tain wholly owned subsidiaries) is amended by inserting

6 ‘‘and in the case of information returns required under

7 part III of subchapter A of chapter 61’’ after ‘‘Secretary’’.

8 (b) EFFECTIVE DATE.—The amendment made by

9 this section shall apply to taxable years beginning after

10 December 31, 1999.

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