II 

109TH CONGRESS 

2D SESSION S. 3838 

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

reform, and for other purposes. 

IN THE SENATE OF THE UNITED STATES 

AUGUST 3, 2006 

Mr. HATCH (for himself and Mrs. LINCOLN) 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 provide 

for S corporation reform, and for other purposes. 

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

3 SECTION 1. SHORT TITLE; REFERENCE; TABLE OF CON4 TENTS. 

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

6 Corporation Reform Act of 2006’’. 

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 for 

4 this Act is as follows: 

Sec. 1. Short title; reference; table of contents. 

TITLE I—ELIGIBLE SHAREHOLDERS OF AN S CORPORATION 

Sec. 101. Nonresident aliens allowed to be shareholders. 

Sec. 102. Expansion of S corporation eligible shareholders to include IRAS. 

TITLE II—QUALIFICATION AND ELIGIBILITY REQUIREMENTS OF 

S CORPORATIONS 

Sec. 201. Issuance of preferred stock permitted. 

Sec. 202. Safe harbor expanded to include convertible debt. 

Sec. 203. Repeal of excessive passive investment income as a termination event. 

Sec. 204. Modifications to passive income rules. 

Sec. 205. Adjustment to basis of s corporation stock for certain charitable contributions. 

TITLE III—TREATMENT OF S CORPORATION SHAREHOLDERS 

Sec. 301. Treatment of losses to shareholders. 

Sec. 302. Deductibility of interest expense incurred by an electing small business trust to acquire S corporation stock. 

Sec. 303. Back to back loans as indebtedness. 

TITLE IV—EXPANSION OF S CORPORATION ELIGIBILITY FOR 

BANKS 

Sec. 401. Treatment of qualifying director shares. 

Sec. 402. Recapture of bad debt reserves. 

TITLE V—QUALIFIED SUBCHAPTER S SUBSIDIARIES 

Sec. 501. Treatment of the sale of interest in a qualified subchapter S subsidiary. 

TITLE VI—ADDITIONAL PROVISIONS 

Sec. 601. Elimination of all earnings and profits attributable to pre-1983 years. 

Sec. 602. Repeal of LIFO recapture tax. 

Sec. 603. Expansion of post-termination transition period. 

Sec. 604. Reduction in tax rate on excess net passive income. 

Sec. 605. Increase in cap on qualified small issue bonds. 

Sec. 606. Special rules of application. 


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1 TITLE I—ELIGIBLE SHARE2 HOLDERS OF AN S CORPORA3 TION 

4 SEC. 101. NONRESIDENT ALIENS ALLOWED TO BE SHARE5 HOLDERS. 

6 (a) NONRESIDENT ALIENS ALLOWED TO BE SHARE7 HOLDERS.— 

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

9 1361(b) (defining small business corporation) is 

10 amended— 

11 (A) by adding ‘‘and’’ at the end of sub12 paragraph (B), 

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

14 (C) by redesignating subparagraph (D) as 

15 subparagraph (C). 

16 (2) CONFORMING AMENDMENTS.— 

17 (A) Paragraph (4) and (5)(A) of section 

18 1361(c) (relating to special rules for applying 

19 subsection (b)) are each amended by striking 

20 ‘‘subsection (b)(1)(D)’’ and inserting ‘‘sub21 section (b)(1)(C)’’. 

22 (B) Clause (i) of section 280G(b)(5)(A) 

23 (relating to general rule for exemption for small 

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1 ing ‘‘but without regard to paragraph (1)(C) 

2 thereof’’. 

3 (b) NONRESIDENT ALIEN SHAREHOLDER TREATED

4 AS ENGAGED IN TRADE OR BUSINESS WITHIN UNITED

5 STATES.— 

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

7 (A) by striking ‘‘and’’ at the end of para8 graph (1), 

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

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

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

12 paragraph: 

13 ‘‘(3) a nonresident alien individual shall be con14 sidered as being engaged in a trade or business 

15 within the United States if the S corporation of 

16 which such individual is a shareholder is so en17 gaged.’’. 

18 (2) PRO RATA SHARE OF S CORPORATION IN19 COME.—The last sentence of section 1441(b) (relat20 ing to income items) is amended to read as follows: 

21 ‘‘In the case of a nonresident alien individual who is 

22 a member of a domestic partnership or a share23 holder of an S corporation, the items of income re24 ferred to in subsection (a) shall be treated as refer25 ring to items specified in this subsection included in 


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1 his distributive share of the income of such partner2 ship or in his pro rata share of the income of such 

3 S corporation.’’. 

4 (3) APPLICATION OF WITHHOLDING TAX ON

5 NONRESIDENT ALIEN SHAREHOLDERS.—Section 

6 1446 (relating to withholding tax on foreign part7 ners’ share of effectively connected income) is 

8 amended by redesignating subsection (f) as sub9 section (g) and by inserting after subsection (e) the 

10 following new subsection: 

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

12 ETC.—For purposes of this section— 

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

14 partnership, 

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

16 be treated as partners of such partnership, 

17 ‘‘(3) any reference to section 704 shall be treat18 ed as a reference to section 1366, and 

19 ‘‘(4) no withholding tax under subsection (a) 

20 shall be required in the case of any income realized 

21 by such corporation and allocable to a shareholder 

22 which is an electing small business trust (as defined 

23 in section 1361(e)).’’. 

24 (4) CONFORMING AMENDMENTS.— 


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1 (A) The heading of section 875 is amended 

2 to read as follows: 

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

4 AND TRUSTS; S CORPORATIONS.’’. 

5 (B) The heading of section 1446 is amend6 ed to read as follows: 

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

8 AND S CORPORATION SHAREHOLDERS’

9 SHARE OF EFFECTIVELY CONNECTED IN10 COME.’’. 

11 (5) CLERICAL AMENDMENTS.— 

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

13 table of sections for subpart A of part II of 

14 subchapter N of chapter 1 is amended to read 

15 as follows: 

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

16 (B) The item relating to section 1446 in 

17 the table of sections for subchapter A of chap18 ter 3 is amended to read as follows: 

‘‘Sec. 1446 Withholding tax on foreign partners’ and S corporation shareholders’ share of effectively connected income.’’. 

19 (C) PERMANENT ESTABLISHMENT OF

20 PARTNERS AND S CORPORATION SHARE21 HOLDERS.—Section 894 (relating to income af22 fected by treaty) is amended by redesignating 

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1 ing after subsection (b) the following new sub2 section: 

3 ‘‘(c) PERMANENT ESTABLISHMENT OF PARTNERS

4 AND S CORPORATION SHAREHOLDERS.—If a partnership 

5 or S corporation has a permanent establishment in the 

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

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

8 year of such entity, a nonresident alien individual or for9 eign corporation which is a partner in such partnership, 

10 or a nonresident alien individual who is a shareholder in 

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

12 establishment in the United States for purposes of such 

13 treaty.’’. 

14 (c) APPLICATION OF OTHER WITHHOLDING TAX

15 RULES ON NONRESIDENT ALIEN SHAREHOLDERS.— 

16 (1) SECTION 1441.—Section 1441 (relating to 

17 withholding of tax on nonresident aliens) is amended 

18 by redesignating subsection (g) as subsection (h) 

19 and by inserting after subsection (f) the following 

20 new subsection: 

21 ‘‘(g) S CORPORATION TREATED AS PARTNERSHIP, 

22 ETC.—For purposes of this section— 

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

24 partnership, 


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

2 be treated as partners of such partnership, and 

3 ‘‘(3) no deduction or withholding under sub4 section (a) shall be required in the case of any item 

5 of income realized by such corporation and allocable 

6 to a shareholder which is an electing small business 

7 trust (as defined in section 1361(e)).’’. 

8 (2) SECTION 1445.—Section 1445(e) (relating 

9 to special rules relating to distributions, etc., by cor10 porations, partnerships, trusts, or estates) is amend11 ed by redesignating paragraph (6) as paragraph (7) 

12 and by inserting after paragraph (5) the following 

13 new paragraph: 

14 ‘‘(6) S CORPORATION TREATED AS PARTNER15 SHIP, ETC.—For purposes of this section— 

16 ‘‘(A) an S corporation shall be treated as 

17 a partnership, and 

18 ‘‘(B) the shareholders of such corporation 

19 shall be treated as partners of such partnership, 

20 and 

21 ‘‘(C) no deduction or withholding under 

22 subsection (a) shall be required in the case of 

23 any gain realized by such corporation and allo24 cable to a shareholder which is an electing small 

25 business trust (as defined in section 1361(e)).’’. 


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1 (d) ADDITIONAL CONFORMING AMENDMENTS.— 

2 (1) Section 1361(c)(2)(A)(i) is amended by 

3 striking ‘‘who is a citizen or resident of the United 

4 States’’. 

5 (2) Section 1361(d)(3)(B) is amended by strik6 ing ‘‘who is a citizen or resident of the United 

7 States’’. 

8 (3) Section 1361(e)(2) is amended by inserting 

9 ‘‘(including a nonresident alien)’’ after ‘‘person’’ the 

10 first place it appears. 

11 (e) EFFECTIVE DATE.—The amendments made by 

12 this section shall apply to taxable years beginning after 

13 December 31, 2006. 

14 SEC. 102. EXPANSION OF S CORPORATION ELIGIBLE 

15 SHAREHOLDERS TO INCLUDE IRAS. 

16 (a) IN GENERAL.—Clause (vi) of section 

17 1361(c)(2)(A) (relating to certain trusts permitted as 

18 shareholders) is amended to read as follows: 

19 ‘‘(vi) A trust which constitutes an in20 dividual retirement account under section 

21 408(a), including one designated as a Roth 

22 IRA under section 408A.’’. 

23 (b) SALE OF STOCK IN IRA RELATING TO S COR24 PORATION ELECTION EXEMPT FROM PROHIBITED

25 TRANSACTION RULES.—Paragraph (16) of section 


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1 4975(d) (relating to exemptions) is amended to read as 

2 follows: 

3 ‘‘(16) a sale of stock held by a trust which con4 stitutes an individual retirement account under sec5 tion 408(a) to the individual for whose benefit such 

6 account is established if 

7 ‘‘(A) such sale is pursuant to an election 

8 under section 1362(a) by the issuer of such 

9 stock, 

10 ‘‘(B) such sale is for fair market value at 

11 the time of sale (as established by an inde12 pendent appraiser) and the terms of the sale 

13 are otherwise at least as favorable to such trust 

14 as the terms that would apply on a sale to an 

15 unrelated party, 

16 ‘‘(C) such trust does not pay any commis17 sions, costs, or other expenses in connection 

18 with the sale, and 

19 ‘‘(D) the stock is sold in a single trans20 action for cash not later than 120 days after 

21 the S corporation election is made.’’. 

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

23 this section shall take effect on the date of the enactment 

24 of this Act. 


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1 TITLE II—QUALIFICATION AND 

2 ELIGIBILITY REQUIREMENTS 

3 OF S CORPORATIONS 

4 SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED. 

5 (a) IN GENERAL.—Section 1361 (defining S corpora6 tion) is amended by adding at the end the following new 

7 subsection: 

8 ‘‘(f) TREATMENT OF QUALIFIED PREFERRED

9 STOCK.— 

10 ‘‘(1) IN GENERAL.—For purposes of this sub11 chapter— 

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

13 treated as a second class of stock, and 

14 ‘‘(B) no person shall be treated as a share15 holder of the corporation by reason of holding 

16 qualified preferred stock. 

17 ‘‘(2) QUALIFIED PREFERRED STOCK DE18 FINED.—For purposes of this subsection, the term 

19 ‘qualified preferred stock’ means stock which meets 

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

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

22 treated as qualified preferred stock merely because 

23 it is convertible into other 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 qualified preferred 

2 stock 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) Paragraph (1) of section 1361(b) is amend8 ed by inserting ‘‘, except as provided in subsection 

9 (f),’’ before ‘‘which does not’’. 

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

11 by adding at the end the following new paragraph: 

12 ‘‘(3) ALLOCATION WITH RESPECT TO QUALI13 FIED PREFERRED STOCK.—The holders of qualified 

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

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

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

17 (3) So much of clause (ii) of section 

18 354(a)(2)(C) as precedes subclause (II) is amended 

19 to read as follows: 

20 ‘‘(ii) RECAPITALIZATION OF FAMILY21 OWNED CORPORATIONS AND S CORPORA22 TIONS.— 

23 ‘‘(I) IN GENERAL.—Clause (i) 

24 shall not apply in the case of a recapi25 talization under section 368(a)(I)(E) 


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1 of a family-owned corporation or S 

2 corporation.’’. 

3 (4) Subsection (a) of section 1373 is amended 

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

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

6 inserting ‘‘, and’’, and by adding at the end the fol7 lowing new paragraph: 

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

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

10 be apportioned or allocated to such income.’’. 

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

12 this section shall apply to taxable years beginning after 

13 December 31, 2006. 

14 SEC. 202. SAFE HARBOR EXPANDED TO INCLUDE CONVERT15 IBLE DEBT. 

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

17 1361(c)(5) (defining straight debt) is amended by striking 

18 clauses (ii) and (iii) and inserting the following new 

19 clauses: 

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

21 such promise include a provision under 

22 which the obligation to pay may be con23 verted (directly or indirectly) into stock of 

24 the corporation, such terms, taken as a 

25 whole, are substantially the same as the 


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1 terms which could have been obtained on 

2 the effective date of the promise from a 

3 person which is not a related person (with4 in the meaning of section 465(b)(3)(C)) to 

5 the S corporation or its shareholders, and 

6 ‘‘(iii) the creditor is— 

7 ‘‘(I) an individual, 

8 ‘‘(II) an estate, 

9 ‘‘(III) a trust described in para10 graph (2), 

11 ‘‘(IV) an exempt organization de12 scribed in paragraph (6), or 

13 ‘‘(V) a person which is actively 

14 and regularly engaged in the business 

15 of lending money.’’. 

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

17 this section shall apply to taxable years beginning after 

18 December 31, 2006. 

19 SEC. 203. REPEAL OF EXCESSIVE PASSIVE INVESTMENT IN20 COME AS A TERMINATION EVENT. 

21 (a) IN GENERAL.—Section 1362(d) (relating to ter22 mination) is amended by striking paragraph (3). 

23 (b) CONFORMING AMENDMENTS.— 

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

25 ‘‘or (3)’’. 


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1 (2) Clause (i) of section 1042(c)(4)(A) is 

2 amended by striking ‘‘section 1362(d)(3)(C)’’ and 

3 inserting ‘‘section 1375(b)(3)’’. 

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

5 this section shall apply to taxable years beginning after 

6 December 31, 2006. 

7 SEC. 204. MODIFICATIONS TO PASSIVE INCOME RULES. 

8 (a) INCREASED LIMIT.— 

9 (1) IN GENERAL.—Subsection (a)(2) of section 

10 1375 (relating to tax imposed when passive invest11 ment income of corporation having accumulated 

12 earnings and profits exceeds 25 percent of gross re13 ceipts) is amended by striking ‘‘25 percent’’ and in14 serting ‘‘60 percent’’. 

15 (2) CONFORMING AMENDMENTS.— 

16 (A) Subparagraph (J) of section 26(b)(2) 

17 is amended by striking ‘‘25 percent’’ and insert18 ing ‘‘60 percent’’. 

19 (B) Clause (i) of section 1375(b)(1)(A) is 

20 amended by striking ‘‘25 percent’’ and inserting 

21 ‘‘60 percent’’. 

22 (C) The heading for section 1375 is 

23 amended by striking ‘‘25 PERCENT’’ and in24 serting ‘‘60 PERCENT’’. 


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1 (D) The table of sections for part III of 

2 subchapter S of chapter 1 is amended by strik3 ing ‘‘25 percent’’ in the item relating to section 

4 1375 and inserting ‘‘60 percent’’. 

5 (b) REPEAL OF PASSIVE INCOME CAPITAL GAIN

6 CATEGORY.— 

7 (1) IN GENERAL.—Subsection (b) of section 

8 1375 (relating to tax imposed when passive invest9 ment income of corporation having accumulated 

10 earnings and profits exceeds 60 percent of gross re11 ceipts), as amended by subsection (a), is amended by 

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

13 following new paragraph: 

14 ‘‘(3) PASSIVE INVESTMENT INCOME DE15 FINED.— 

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

17 provided in this paragraph, the term ‘passive 

18 investment income’ means gross receipts de19 rived from royalties, rents, dividends, interest, 

20 and annuities. 

21 ‘‘(B) EXCEPTION FOR INTEREST ON

22 NOTES FROM SALES OF INVENTORY.—The term 

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1 ness from its sale of property described in sec2 tion 1221(a)(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) TREATMENT OF CERTAIN DIVI13 DENDS.—If an S corporation holds stock in a 

14 C corporation meeting the requirements of sec15 tion 1504(a)(2), the term ‘passive investment 

16 income’ shall not include dividends from such C 

17 corporation to the extent such dividends are at18 tributable to the earnings and profits of such C 

19 corporation derived from the active conduct of 

20 a trade or business. 

21 ‘‘(E) COORDINATION WITH SECTION

22 1374.—The amount of passive investment in23 come shall be determined by not taking into ac24 count any recognized built-in gain or loss of the 

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1 ognition period. Terms used in the preceding 

2 sentence shall have the same respective mean3 ing as when used in section 1374.’’. 

4 (2) CONFORMING AMENDMENTS.—Section 

5 1375(d) is amended by striking ‘‘subchapter C’’ both 

6 places it appears and inserting ‘‘accumulated’’. 

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

8 this section shall apply to taxable years beginning after 

9 December 31, 2006. 

10 SEC. 205. ADJUSTMENT TO BASIS OF S CORPORATION 

11 STOCK FOR CERTAIN CHARITABLE CON12 TRIBUTIONS. 

13 (a) IN GENERAL.—Paragraph (1) of section 1367(a) 

14 (relating to adjustments to basis of stock of shareholders, 

15 etc.) is amended by striking ‘‘and’’ at the end of subpara16 graph (B), by striking the period at the end of subpara17 graph (C) and inserting ‘‘, and’’, and by adding at the 

18 end the following new subparagraph: 

19 ‘‘(D) the excess of the amount of the 

20 shareholder’s proportionate share of any chari21 table contribution made by the S corporation 

22 over the shareholder’s proportionate share of 

23 the adjusted basis of the property contrib24 uted.’’. 


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1 (b) EFFECTIVE DATE.—The amendments made by 

2 this section shall apply to taxable years beginning after 

3 December 31, 2006. 

4 TITLE III—TREATMENT OF S 

5 CORPORATION SHAREHOLDERS 

6 SEC. 301. TREATMENT OF LOSSES TO SHAREHOLDERS. 

7 (a) LIQUIDATIONS.—Section 331 (relating to gain or 

8 loss to shareholders in corporate liquidations) is amended 

9 by redesignating subsection (c) as subsection (d) and by 

10 inserting after subsection (b) the following new subsection: 

11 ‘‘(c) LOSS ON LIQUIDATIONS OF S CORPORATION.— 

12 ‘‘(1) IN GENERAL.—The portion of any net loss 

13 recognized by a shareholder of an S corporation (as 

14 defined in section 1361(a)(1))— 

15 ‘‘(A) on amounts received by such share16 holder in a distribution in complete liquidation 

17 of such S corporation, or 

18 ‘‘(B) on an installment obligation received 

19 by such shareholder with respect to a sale or 

20 exchange by the corporation during the 12- 

21 month period beginning on the date a plan of 

22 complete liquidation is adopted if the liquida23 tion is completed during such 12-month period, 

24 which does not exceed the ordinary income 

25 basis of stock of such S corporation in the 


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1 hands of such shareholder shall not be treated 

2 as a loss from the sale or exchange of a capital 

3 asset but shall be treated as an ordinary loss. 

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

5 of this subsection, the ordinary income basis of stock 

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

7 such S corporation shall be an amount equal to the 

8 portion of such shareholder’s basis in such stock 

9 which is equal to the aggregate increases in such 

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

11 shareholder’s pro rata share of ordinary income of 

12 such S corporation attributable to the complete liq13 uidation.’’. 

14 (b) SUSPENDED PASSIVE ACTIVITY LOSSES.—Para15 graph (3) of section 1371(b) is amended to read as fol16 lows: 

17 ‘‘(3) TREATMENT OF S YEAR AS ELAPSED

18 YEAR; PASSIVE LOSSES.—Nothing in paragraphs (1) 

19 and (2) shall prevent treating a taxable year for 

20 which a corporation is an S corporation as a taxable 

21 year for purposes of determining the number of tax22 able years to which an item may be carried back or 

23 carried forward nor prevent the allowance of a pas24 sive activity loss deduction to the extent provided by 

25 section 469(g).’’. 


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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, 2006. 

4 SEC. 302. DEDUCTIBILITY OF INTEREST EXPENSE IN5 CURRED BY AN ELECTING SMALL BUSINESS 

6 TRUST TO ACQUIRE S CORPORATION STOCK. 

7 (a) IN GENERAL.—Subparagraph (C) of section 

8 641(c)(2) (relating to modifications) is amended by insert9 ing after clause (iii) the following new clause: 

10 ‘‘(iv) Any interest expense incurred to 

11 acquire stock in an S corporation.’’. 

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

13 this section shall apply to taxable years beginning after 

14 December 31, 2006. 

15 SEC. 303. BACK TO BACK LOANS AS INDEBTEDNESS. 

16 (a) IN GENERAL.—Section 1366(d) (relating to spe17 cial rules for losses and deductions) is amended by adding 

18 at the end the following new paragraph: 

19 ‘‘(4) LOANS INCLUDED IN INDEBTEDNESS OF

20 AN S CORPORATION.—For purposes of subsection 

21 (d), the indebtedness of an S corporation to the 

22 shareholder shall include any loans made or acquired 

23 (by purchase, gift, or distribution from another per24 son) by a shareholder to the S corporation, regard25 less of whether the funds loaned by the shareholder 


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1 to the S corporation were obtained by the share2 holder by means of a recourse loan from another 

3 person (whether related or unrelated to the share4 holder).’’. 

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

6 this section shall apply to taxable years beginning after 

7 December 31, 2006. 

8 TITLE IV—EXPANSION OF S COR9 PORATION ELIGIBILITY FOR 

10 BANKS 

11 SEC. 401. TREATMENT OF QUALIFYING DIRECTOR SHARES. 

12 (a) IN GENERAL.—Section 1361 (defining S corpora13 tion), as amended by section 201(a), is amended by adding 

14 at the end the following new subsection: 

15 ‘‘(g) TREATMENT OF QUALIFYING DIRECTOR

16 SHARES.— 

17 ‘‘(1) IN GENERAL.—For purposes of this sub18 chapter— 

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

20 treated as a second class of stock, and 

21 ‘‘(B) no person shall be treated as a share22 holder of the corporation by reason of holding 

23 qualifying director shares. 

24 ‘‘(2) QUALIFYING DIRECTOR SHARES DE25 FINED.—For purposes of this subsection, the term 


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1 ‘qualifying director shares’ means any shares of 

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

3 bank holding company registered as such with the 

4 Federal Reserve System— 

5 ‘‘(A) which are held by an individual solely 

6 by reason of status as a director of such bank 

7 or company or its controlled subsidiary; and 

8 ‘‘(B) which are subject to an agreement 

9 pursuant to which the holder is required to dis10 pose of the shares of stock upon termination of 

11 the holder’s status as a director at the same 

12 price as the individual acquired such shares of 

13 stock. 

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

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

16 the corporation with respect to qualifying director 

17 shares shall be includible as ordinary income of the 

18 holder and deductible to the corporation as an ex19 pense in computing taxable income under section 

20 1363(b) in the year such distribution is received.’’. 

21 (b) CONFORMING AMENDMENTS.— 

22 (1) Section 1361(b)(1), as amended by section 

23 201(b), is amended by striking ‘‘subsection (f)’’ and 

24 inserting ‘‘subsections (f) and (g)’’. 


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1 (2) Section 1366(a), as amended by section 

2 201(b), is amended by adding at the end the fol3 lowing new paragraph: 

4 ‘‘(4) ALLOCATION WITH RESPECT TO QUALI5 FYING DIRECTOR SHARES.—The holders of quali6 fying director shares (as defined in section 1361(g)) 

7 shall not, with respect to such shares of stock, be al8 located any of the items described in paragraph 

9 (1).’’. 

10 (3) Section 1373(a), as amended by section 

11 201(b), is amended by striking ‘‘and’’ at the end of 

12 paragraph (2), by striking the period at the end of 

13 paragraph (3) and inserting ‘‘, and’’, and adding at 

14 the end the following new paragraph: 

15 ‘‘(4) no amount of an expense deductible under 

16 this subchapter by reason of section 1361(g)(3) shall 

17 be apportioned or allocated to such income.’’. 

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

19 this section shall apply to taxable years beginning after 

20 December 31, 1996. 

21 SEC. 402. RECAPTURE OF BAD DEBT RESERVES. 

22 Notwithstanding section 481 of the Internal Revenue 

23 Code of 1986, with respect to any S corporation election 

24 made by any bank in taxable years beginning after Decem25 ber 31, 1996, such bank may recognize built-in gains from 


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1 changing its accounting method for recognizing bad debts 

2 from the reserve method under section 585 or 593 of such 

3 Code to the charge-off method under section 166 of such 

4 Code either in the taxable year ending with or beginning 

5 with such an election. 

6 TITLE V—QUALIFIED 

7 SUBCHAPTER S SUBSIDIARIES 

8 SEC. 501. TREATMENT OF THE SALE OF INTEREST IN A 

9 QUALIFIED SUBCHAPTER S SUBSIDIARY. 

10 (a) IN GENERAL.—Section 1361(b)(3) (relating to 

11 treatment of certain wholly owned subsidiaries) is amend12 ed by adding at the end the following new subparagraph: 

13 ‘‘(F) SPECIAL RULE ON TERMINATION.— 

14 The tax treatment of the disposition of the 

15 stock of the qualified subchapter S subsidiary 

16 shall be determined as if such disposition 

17 were— 

18 ‘‘(i) a sale of the undivided interest in 

19 the subsidiary’s assets based on the per20 centage of the stock transferred, and 

21 ‘‘(ii) followed by a deemed contribu22 tion by the S corporation and the trans23 feree in a section 351 transaction.’’. 


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

2 this section shall apply to taxable years beginning after 

3 December 31, 1996. 

4 TITLE VI—ADDITIONAL 

5 PROVISIONS 

6 SEC. 601. ELIMINATION OF ALL EARNINGS AND PROFITS 

7 ATTRIBUTABLE TO PRE-1983 YEARS. 

8 (a) IN GENERAL.—Subsection (a) of section 1311 of 

9 the Small Business Job Protection Act of 1996 is amend10 ed to read as follows: 

11 ‘‘(a) IN GENERAL.—If a corporation was an electing 

12 small business corporation under subchapter S of chapter 

13 1 of the Internal Revenue Code of 1986 for any taxable 

14 year beginning before January 1, 1983, the amount of 

15 such corporation’s accumulated earnings and profits (as 

16 of the beginning of any taxable year beginning after De17 cember 31, 1982) shall be reduced by an amount equal 

18 to the portion (if any) of such accumulated earnings and 

19 profits which were accumulated in any taxable year begin20 ning before January 1, 1983, for which such corporation 

21 was an electing small business corporation under such 

22 subchapter S.’’. 

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

24 this section shall apply to taxable years beginning after 

25 December 31, 1996. 


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1 SEC. 602. REPEAL OF LIFO RECAPTURE TAX. 

2 (a) IN GENERAL.—Section 1363 (relating to effect 

3 on election on corporations) is amended by striking sub4 section (d). 

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

6 this section shall apply to elections made after the date 

7 of the enactment of this Act. 

8 SEC. 603. EXPANSION OF POST-TERMINATION TRANSITION 

9 PERIOD. 

10 (a) IN GENERAL.—Clause (ii) of section 

11 1377(b)(1)(A) (defining post-termination transition pe12 riod) is amended to read as follows: 

13 ‘‘(ii) the date on which any refund or 

14 credit of any overpayment of tax with re15 spect to the return for such last year as an 

16 S corporation is prevented by the operation 

17 of any law or rule of law (including res ju18 dicata),’’. 

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

20 this section shall apply to periods beginning after the date 

21 of the enactment of this Act. 

22 SEC. 604. REDUCTION IN TAX RATE ON EXCESS NET PAS23 SIVE INCOME. 

24 (a) IN GENERAL.—Section 1375(a) (relating to tax 

25 imposed when passive investment income of corporation 

26 having accumulated earnings and profits exceeds 25 perVerDate Aug 31 2005 02:21 Aug 10, 2006 Jkt 049200 PO 00000 Frm 00027 Fmt 6652 Sfmt 6201 E:\BILLS\S3838.IS S3838

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1 cent of gross receipts) is amended by striking ‘‘computed 

2 by multiplying the excess net passive income by the high3 est rate of tax specified in section 11(b)’’ and inserting 

4 ‘‘15 percent of the excess net passive income’’. 

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

6 this section shall apply to taxable years beginning after 

7 December 31, 2006. 

8 SEC. 605. INCREASE IN CAP ON QUALIFIED SMALL ISSUE 

9 BONDS. 

10 (a) IN GENERAL.—Section 144(a)(4)(A)(i) (relating 

11 to general rule for $10,000,000 limit in certain cases) is 

12 amended by striking ‘‘$10,000,000’’ and inserting 

13 ‘‘$10,000,000($30,000,000 in the case of any bank (as de14 fined in section 581) or any depository institution holding 

15 company (as defined in section 3(w)(1) of the Federal De16 posit Insurance Act (12 U.S.C. 1813(w)(1)) which is an 

17 S corporation)’’. 

18 (b) ADJUSTMENT OF CAP FOR INFLATION.—Section 

19 144(a) (relating to qualified small issue bond) is amend20 ed— 

21 (1) by redesignating paragraph (12) as para22 graph (13); and 

23 (2) by inserting after paragraph (11) the fol24 lowing new paragraph: 

25 ‘‘(12) INFLATION ADJUSTMENT.— 


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1 ‘‘(A) IN GENERAL.—In the case of any cal2 endar year after 2006, the $30,000,000 amount 

3 contained in paragraph (4)(A)(i) shall be in4 creased by an amount equal to— 

5 ‘‘(i) such dollar amount, multiplied by 

6 ‘‘(ii) the cost-of-living adjustment de7 termined under section 1(f)(3) for such 

8 calendar year by substituting ‘calendar 

9 year 2005’ for ‘calendar year 1992’ in sub10 paragraph (B) thereof. 

11 ‘‘(B) ROUNDING.—Any increase under 

12 subparagraph (A) which is not a multiple of 

13 $100,000 shall be rounded to the next lowest 

14 multiple of $100,000.’’. 

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

16 this section shall apply to— 

17 (1) obligations issued after the date of the en18 actment of this Act; and 

19 (2) capital expenditures made after such date 

20 with respect to obligations issued on or before such 

21 date. 

22 SEC. 606. SPECIAL RULES OF APPLICATION. 

23 (a) WAIVER OF LIMITATIONS.—If refund or credit of 

24 any overpayment of tax resulting from the application of 

25 any amendment made by this Act is prevented at any time 


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1 before the close of the 1-year period beginning on the date 

2 of the enactment of this Act by the operation of any law 

3 or rule of law (including res judicata), such refund or cred4 it may nevertheless be made or allowed if claimed therefor 

5 is filed before the close of such period. 

6 (b) TREATMENT OF CERTAIN ELECTIONS UNDER

7 PRIOR LAW.—For purposes of section 1362(g) of the In8 ternal Revenue Code of 1986 (relating to election after 

9 termination), any termination or revocation under section 

10 1362(d) of such Code (as in effect on the day before enact11 ment of this Act) shall not be taken into account. 

Æ 


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