I 

108TH CONGRESS 

2D SESSION H. R. 4137 

To amend the Internal Revenue Code of 1986 to provide for unified income 

taxation with respect to pass-thru entities. 

IN THE HOUSE OF REPRESENTATIVES 

APRIL 2, 2004 

Mr. HOUGHTON 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 unified income taxation with respect to pass-thru entities. 

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 ‘‘Small Business Tax Mod5 ernization Act of 2004’’. 

6 SEC. 2. UNIFIED PASS-THRU ENTITY REGIME. 

7 (a) TERMINATION OF S CORPORATION STATUS.— 

8 (1) NO NEW S CORPORATION ELECTIONS.— 

9 Subsection (a) of section 1362 of the Internal Rev-
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1 enue Code of 1986 is amended by adding at the end 

2 the following new paragraph: 

3 ‘‘(3) TERMINATION OF AUTHORITY TO MAKE

4 ELECTION.—No election may be made under para5 graph (1) for any taxable year beginning after De6 cember 31, 2004.’’. 

7 (2) TERMINATION OF STATUS.—Subsection (d) 

8 of section 1362 of such Code (relating to termi9 nation) is amended by adding at the end the fol10 lowing new paragraph: 

11 ‘‘(4) TREATMENT AS PARTNERSHIP AFTER

12 2014.—An election under subsection (a)— 

13 ‘‘(A) shall not be effective for any taxable 

14 year beginning after December 31, 2014, and 

15 ‘‘(B) shall be treated as an election under 

16 section 7701(a)(2)(B) for taxable years begin17 ning after such date.’’. 

18 (3) EFFECTIVE DATE.—The amendments made 

19 by this subsection shall apply to taxable years begin20 ning after December 31, 2004. 

21 (b) ELECTION BY CERTAIN CORPORATIONS TO BE

22 TAXED AS PARTNERSHIP.— 

23 (1) IN GENERAL.—Paragraph (2) of section 

24 7701(a) of such Code (defining partnership and 

25 partner) is amended to read as follows: 
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1 ‘‘(2) PARTNERSHIP AND PARTNER.— 

2 ‘‘(A) IN GENERAL.—The term ‘partner3 ship’ includes a syndicate, group, pool, joint 

4 venture, or other unincorporated organization, 

5 through or by means of which any business, fi6 nancial operation, or venture is carried on, and 

7 which is not, within the meaning of this title, 

8 a trust or estate or a corporation; and the term 

9 ‘partner’ includes a member in such a syn10 dicate, group, pool, joint venture, or organiza11 tion. 

12 ‘‘(B) ELECTION BY CORPORATION TO BE

13 TAXED AS PARTNERSHIP.— 

14 ‘‘(i) IN GENERAL.—An eligible cor15 poration may elect to be treated as a part16 nership for purposes of this title. 

17 ‘‘(ii) TAX TREATMENT.—Except as 

18 provided in section 1379A— 

19 ‘‘(I) no gain or loss shall be rec20 ognized to the corporation or the 

21 shareholders by reason of an election 

22 under clause (i), and 

23 ‘‘(II) except in the case of an 

24 election made by a S corporation after 

25 the end of the recognition period (as 
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1 defined in section 1374(d)(7) without 

2 regard to subparagraph (B) thereof), 

3 section 1374 shall apply to the entity 

4 after such election. 

5 ‘‘(iii) ELIGIBLE CORPORATION.—For 

6 purposes of clause (i), the term ‘eligible 

7 corporation’ means an entity— 

8 ‘‘(I) which, without regard to this 

9 subparagraph, is a domestic corpora10 tion no stock of which is readily 

11 tradable on an established securities 

12 market or otherwise, and 

13 ‘‘(II) which is not an ineligible 

14 corporation (as defined by section 

15 1361(b)(2)). 

16 ‘‘(iv) ELECTION AND TERMINATION.— 

17 For purposes of this subparagraph, rules 

18 similar to the rules of section 1362 (other 

19 than subsections (a)(3), (d)(3) and (4), 

20 and (e) thereof) shall apply. 

21 ‘‘(v) DISTRIBUTIONS, ETC.—Each 

22 partner shall include in gross income as a 

23 dividend, any amount that would have been 

24 so includible had the entity been an S cor25 poration during the period the entity was 
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1 treated as a partnership. Notwithstanding 

2 the preceding sentence, the provisions of 

3 subchapter K of chapter 1 shall apply to 

4 determine the basis of any property dis5 tributed and the basis of any interest in 

6 the partnership. 

7 ‘‘(vi) CROSS REFERENCE.—For tax 

8 treatment of S corporation electing unified 

9 pass-thru regime, see section 1379A.’’. 

10 (2) TAX TREATMENT OF S CORPORATION

11 ELECTING UNIFIED PASS-THRU REGIME.— 

12 (A) IN GENERAL.—Part IV of subchapter 

13 S of chapter 1 of such Code is amended by in14 serting after section 1379 the following new 

15 section: 

16 ‘‘SEC. 1379A. TAX TREATMENT OF S CORPORATION ELECT17 ING UNIFIED PASS-THRU REGIME. 

18 ‘‘In the case of an election under section 

19 7701(a)(2)(B) by an S corporation before January 1, 

20 2015, with respect to the corporation— 

21 ‘‘(1) the shareholders shall be treated as if the 

22 assets were distributed, on the date of such election, 

23 to the shareholders in exchange for their stock, 

24 ‘‘(2) any gain or loss recognized to the share25 holders by reason of paragraph (1) shall be taken 
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1 into account by the shareholders ratably over the 

2 taxable year in which the distribution is deemed to 

3 be made under paragraph (1) and the succeeding 4 

4 taxable years, and 

5 ‘‘(3) proper adjustments to the basis of inter6 ests in the entity shall be made.’’. 

7 (B) CLERICAL AMENDMENT.—The table of 

8 sections for part IV of subchapter S of chapter 

9 1 of such Code is amended by inserting after 

10 the item relating to section 1379 the following 

11 new item: 

‘‘Sec. 1379A. Tax treatment of S corporation electing unified pass-thru regime.’’. 

12 (3) MODIFICATION TO TREATMENT OF SECTION

13 1374 TAX FOR EARNINGS AND PROFITS PURPOSES.— 

14 Paragraph (2) of section 1366(f) of such Code is 

15 amended to read as follows: 

16 ‘‘(2) TREATMENT OF TAX IMPOSED ON BUILT17 IN GAINS.— 

18 ‘‘(A) IN GENERAL.—The amount of the 

19 items of the net recognized built-in gain taken 

20 into account under section 1374(b)(1) (reduced 

21 by any deduction allowed under section 

22 1374(b)(2)) shall not be taken into account 

23 under this section. 
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1 ‘‘(B) EARNINGS AND PROFITS.—The accu2 mulated earnings and profits of the corporation 

3 shall be increased at the beginning of the tax4 able year by the amount not taken into account 

5 under this section by reason of subparagraph 

6 (A) (determined without regard to section 

7 1374(b)(2)) reduced by the tax imposed by sec8 tion 1374 (net of credits allowed).’’. 

9 (4) EFFECT OF ELECTION ON RECOGNITION

10 PERIOD FOR PURPOSES OF TAX IMPOSED ON BUILT11 IN GAINS.—Paragraph (7) of section 1374(d) of 

12 such Code is amended to read as follows: 

13 ‘‘(7) RECOGNITION PERIOD.— 

14 ‘‘(A) IN GENERAL.—The term ‘recognition 

15 period’ means the 10-year period beginning 

16 with the 1st day of the 1st taxable year for 

17 which the corporation was an S corporation. 

18 For purposes of applying this section to any 

19 amount includible in income by reason of sec20 tion 593(e), the preceding sentence shall be ap21 plied without regard to the phrase ‘10-year’. 

22 ‘‘(B) SPECIAL RULE RELATING TO ELEC23 TION OF CORPORATION TO BE TAXED AS PART24 NERSHIP.— 
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1 ‘‘(i) IN GENERAL.—In the case of an 

2 election under section 7701(a)(2)(B), sub3 paragraph (A) shall be applied by sub4 stituting ‘25-year’ for ‘10-year’ both places 

5 it appears. 

6 ‘‘(ii) EXCEPTION WHERE 10-YEAR PE7 RIOD EXPIRED.—If, on the date of an elec8 tion referred to in clause (i) by a corpora9 tion, the 10-year period specified in sub10 paragraph (A) with respect to such cor11 poration has expired, clause (i) shall not 

12 apply to such corporation.’’. 

13 (5) EFFECTIVE DATES.—The amendments 

14 made by this subsection shall apply to taxable years 

15 beginning after December 31, 2004. 

16 (c) STEP TRANSACTION DOCTRINE NOT TO APPLY

17 TO PARTNERSHIP INCORPORATION FOLLOWED BY COR18 PORATE REORGANIZATION.— 

19 (1) IN GENERAL.—Section 351 of such Code is 

20 amended by redesignating subsection (h) as sub21 section (i) and by inserting after subsection (g) the 

22 following new subsection: 

23 ‘‘(h) SPECIAL RULE FOR PARTNERSHIPS WHICH IN24 CORPORATE AND SUBSEQUENTLY REORGANIZE.—The 

25 step transaction doctrine and any similar doctrine shall 
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1 not apply for purposes of determining whether the control 

2 requirement of subsection (a) is met in any case in 

3 which— 

4 ‘‘(1) a partnership engaged in an active trade 

5 or business transfers substantially all of the property 

6 used in carrying on such trade or business to a cor7 poration which is not publicly traded, and 

8 ‘‘(2) such corporation subsequently enters into 

9 a reorganization under this chapter.’’. 

10 (2) EFFECTIVE DATE.—The amendment made 

11 by this subsection shall apply to transactions after 

12 December 31, 2004. 

13 SEC. 3. PARTNERSHIP INCOME ATTRIBUTABLE TO CAPITAL 

14 EXCLUDED FROM NET EARNINGS FROM 

15 SELF-EMPLOYMENT. 

16 (a) IN GENERAL.—Paragraph (13) of section 

17 1402(a) of the Internal Revenue Code of 1986 is amended 

18 to read as follows: 

19 ‘‘(13) there shall be excluded the distributive 

20 share of net income of a partner attributable to cap21 ital;’’. 

22 (b) PARTNERSHIP INCOME ATTRIBUTABLE TO CAP23 ITAL.—Section 1402 of such Code is amended by adding 

24 at the end the following new subsection: 
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1 ‘‘(l) PARTNERSHIP INCOME ATTRIBUTABLE TO CAP2 ITAL.— 

3 ‘‘(1) IN GENERAL.—For purposes of subsection 

4 (a)(13), the following amounts shall be treated as in5 come attributable to capital— 

6 ‘‘(A) the amount, if any, in excess of what 

7 would constitute reasonable compensation for 

8 services rendered by such partner to the part9 nership, and 

10 ‘‘(B) an amount equal to a reasonable rate 

11 of return on unreturned capital of the partner 

12 determined as of the beginning of the taxable 

13 year. 

14 ‘‘(2) DEFINITIONS.—For purposes of paragraph 

15 (1)— 

16 ‘‘(A) UNRETURNED CAPITAL.—The term 

17 ‘unreturned capital’ means the excess of the ag18 gregate amount of money and the fair market 

19 value as of the date of contribution of other 

20 consideration (net of liabilities) contributed by 

21 the partner over the aggregate amount of 

22 money and the fair market value as of the date 

23 of distribution of other consideration (net of li24 abilities) distributed by the partnership to the 

25 partner, increased or decreased for the part-
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1 ner’s distributive share of all reportable items 

2 as determined in section 702. If the partner ac3 quires a partnership interest and the partner4 ship makes an election under section 754, the 

5 partner’s unreturned capital shall take into ac6 count appropriate adjustments under section 

7 743. 

8 ‘‘(B) REASONABLE RATE OF RETURN.—A 

9 reasonable rate of return on unreturned capital 

10 shall equal 150 percent (or such higher rate as 

11 is established in regulations) of the highest ap12 plicable Federal rate, as determined under sec13 tion 1274(d)(1), at the beginning of the part14 nership’s taxable year. 

15 ‘‘(3) REGULATIONS.—The Secretary shall pre16 scribe such regulations as may be necessary to carry 

17 out the purposes of this subsection.’’. 

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

19 this section shall apply with respect to services performed 

20 in taxable years beginning after December 31, 2004. 

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