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[Congressional Bills 109th Congress]
[From the U.S. Government Publishing Office]
[S. 3838 Introduced in Senate (IS)]

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.

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

SECTION 1. SHORT TITLE; REFERENCE; TABLE OF CONTENTS.

    (a) Short Title.--This Act may be cited as the ``S Corporation 
Reform Act of 2006''.
    (b) Amendment of 1986 Code.--Except as otherwise expressly 
provided, whenever in this Act an amendment or repeal is expressed in 
terms of an amendment to, or repeal of, a section or other provision, 
the reference shall be considered to be made to a section or other 
provision of the Internal Revenue Code of 1986.
    (c) Table of Contents.--The table of contents for 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.

           TITLE I--ELIGIBLE SHAREHOLDERS OF AN S CORPORATION

SEC. 101. NONRESIDENT ALIENS ALLOWED TO BE SHAREHOLDERS.

    (a) Nonresident Aliens Allowed to Be Shareholders.--
            (1) In general.--Paragraph (1) of section 1361(b) (defining 
        small business corporation) is amended--
                    (A) by adding ``and'' at the end of subparagraph 
                (B),
                    (B) by striking subparagraph (C), and
                    (C) by redesignating subparagraph (D) as 
                subparagraph (C).
            (2) Conforming amendments.--
                    (A) Paragraph (4) and (5)(A) of section 1361(c) 
                (relating to special rules for applying subsection (b)) 
                are each amended by striking ``subsection (b)(1)(D)'' 
                and inserting ``subsection (b)(1)(C)''.
                    (B) Clause (i) of section 280G(b)(5)(A) (relating 
                to general rule for exemption for small business 
                corporations, etc.) is amended by striking ``but 
                without regard to paragraph (1)(C) thereof''.
    (b) Nonresident Alien Shareholder Treated as Engaged in Trade or 
Business Within United States.--
            (1) In general.--Section 875 is amended--
                    (A) by striking ``and'' at the end of paragraph 
                (1),
                    (B) by striking the period at the end of paragraph 
                (2) and inserting ``, and'', and
                    (C) by adding at the end the following new 
                paragraph:
            ``(3) a nonresident alien individual shall be considered as 
        being engaged in a trade or business within the United States 
        if the S corporation of which such individual is a shareholder 
        is so engaged.''.
            (2) Pro rata share of s corporation income.--The last 
        sentence of section 1441(b) (relating to income items) is 
        amended to read as follows: ``In the case of a nonresident 
        alien individual who is a member of a domestic partnership or a 
        shareholder of an S corporation, the items of income referred 
        to in subsection (a) shall be treated as referring to items 
        specified in this subsection included in his distributive share 
        of the income of such partnership or in his pro rata share of 
        the income of such S corporation.''.
            (3) Application of withholding tax on nonresident alien 
        shareholders.--Section 1446 (relating to withholding tax on 
        foreign partners' share of effectively connected income) is 
        amended by redesignating subsection (f) as subsection (g) and 
        by inserting after subsection (e) the following new subsection:
    ``(f) S Corporation Treated as Partnership, etc.--For purposes of 
this section--
            ``(1) an S corporation shall be treated as a partnership,
            ``(2) the shareholders of such corporation shall be treated 
        as partners of such partnership,
            ``(3) any reference to section 704 shall be treated as a 
        reference to section 1366, and
            ``(4) no withholding tax under subsection (a) shall be 
        required in the case of any income realized by such corporation 
        and allocable to a shareholder which is an electing small 
        business trust (as defined in section 1361(e)).''.
            (4) Conforming amendments.--
                    (A) The heading of section 875 is amended to read 
                as follows:

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

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

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

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

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

``Sec. 1446 Withholding tax on foreign partners' and S corporation 
                            shareholders' share of effectively 
                            connected income.''.
                    (C) Permanent establishment of partners and s 
                corporation shareholders.--Section 894 (relating to 
                income affected by treaty) is amended by redesignating 
                subsection (c) as subsection (d) and by inserting after 
                subsection (b) the following new subsection:
    ``(c) Permanent Establishment of Partners and S Corporation 
Shareholders.--If a partnership or S corporation has a permanent 
establishment in the United States (within the meaning of a treaty to 
which the United States is a party) at any time during a taxable year 
of such entity, a nonresident alien individual or foreign corporation 
which is a partner in such partnership, or a nonresident alien 
individual who is a shareholder in such S corporation, shall be treated 
as having a permanent establishment in the United States for purposes 
of such treaty.''.
    (c) Application of Other Withholding Tax Rules on Nonresident Alien 
Shareholders.--
            (1) Section 1441.--Section 1441 (relating to withholding of 
        tax on nonresident aliens) is amended by redesignating 
        subsection (g) as subsection (h) and by inserting after 
        subsection (f) the following new subsection:
    ``(g) S Corporation Treated as Partnership, etc.--For purposes of 
this section--
            ``(1) an S corporation shall be treated as a partnership,
            ``(2) the shareholders of such corporation shall be treated 
        as partners of such partnership, and
            ``(3) no deduction or withholding under subsection (a) 
        shall be required in the case of any item of income realized by 
        such corporation and allocable to a shareholder which is an 
        electing small business trust (as defined in section 
        1361(e)).''.
            (2) Section 1445.--Section 1445(e) (relating to special 
        rules relating to distributions, etc., by corporations, 
        partnerships, trusts, or estates) is amended by redesignating 
        paragraph (6) as paragraph (7) and by inserting after paragraph 
        (5) the following new paragraph:
            ``(6) S corporation treated as partnership, etc.--For 
        purposes of this section--
                    ``(A) an S corporation shall be treated as a 
                partnership, and
                    ``(B) the shareholders of such corporation shall be 
                treated as partners of such partnership, and
                    ``(C) no deduction or withholding under subsection 
                (a) shall be required in the case of any gain realized 
                by such corporation and allocable to a shareholder 
                which is an electing small business trust (as defined 
                in section 1361(e)).''.
    (d) Additional Conforming Amendments.--
            (1) Section 1361(c)(2)(A)(i) is amended by striking ``who 
        is a citizen or resident of the United States''.
            (2) Section 1361(d)(3)(B) is amended by striking ``who is a 
        citizen or resident of the United States''.
            (3) Section 1361(e)(2) is amended by inserting ``(including 
        a nonresident alien)'' after ``person'' the first place it 
        appears.
    (e) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

SEC. 102. EXPANSION OF S CORPORATION ELIGIBLE SHAREHOLDERS TO INCLUDE 
              IRAS.

    (a) In General.--Clause (vi) of section 1361(c)(2)(A) (relating to 
certain trusts permitted as shareholders) is amended to read as 
follows:
                            ``(vi) A trust which constitutes an 
                        individual retirement account under section 
                        408(a), including one designated as a Roth IRA 
                        under section 408A.''.
    (b) Sale of Stock in IRA Relating to S Corporation Election Exempt 
From Prohibited Transaction Rules.--Paragraph (16) of section 4975(d) 
(relating to exemptions) is amended to read as follows:
            ``(16) a sale of stock held by a trust which constitutes an 
        individual retirement account under section 408(a) to the 
        individual for whose benefit such account is established if
                    ``(A) such sale is pursuant to an election under 
                section 1362(a) by the issuer of such stock,
                    ``(B) such sale is for fair market value at the 
                time of sale (as established by an independent 
                appraiser) and the terms of the sale are otherwise at 
                least as favorable to such trust as the terms that 
                would apply on a sale to an unrelated party,
                    ``(C) such trust does not pay any commissions, 
                costs, or other expenses in connection with the sale, 
                and
                    ``(D) the stock is sold in a single transaction for 
                cash not later than 120 days after the S corporation 
                election is made.''.
    (c) Effective Date.--The amendments made by this section shall take 
effect on the date of the enactment of this Act.

 TITLE II--QUALIFICATION AND ELIGIBILITY REQUIREMENTS OF S CORPORATIONS

SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.

    (a) In General.--Section 1361 (defining S corporation) is amended 
by adding at the end the following new subsection:
    ``(f) Treatment of Qualified Preferred Stock.--
            ``(1) In general.--For purposes of this subchapter--
                    ``(A) qualified preferred stock shall not be 
                treated as a second class of stock, and
                    ``(B) no person shall be treated as a shareholder 
                of the corporation by reason of holding qualified 
                preferred stock.
            ``(2) Qualified preferred stock defined.--For purposes of 
        this subsection, the term `qualified preferred stock' means 
        stock which meets the requirements of subparagraphs (A), (B), 
        and (C) of section 1504(a)(4). Stock shall not fail to be 
        treated as qualified preferred stock merely because it is 
        convertible into other stock.
            ``(3) Distributions.--A distribution (not in part or full 
        payment in exchange for stock) made by the corporation with 
        respect to qualified preferred stock shall be includible as 
        ordinary income of the holder and deductible to the corporation 
        as an expense in computing taxable income under section 1363(b) 
        in the year such distribution is received.''.
    (b) Conforming Amendments.--
            (1) Paragraph (1) of section 1361(b) is amended by 
        inserting ``, except as provided in subsection (f),'' before 
        ``which does not''.
            (2) Subsection (a) of section 1366 is amended by adding at 
        the end the following new paragraph:
            ``(3) Allocation with respect to qualified preferred 
        stock.--The holders of qualified preferred stock (as defined in 
        section 1361(f)) shall not, with respect to such stock, be 
        allocated any of the items described in paragraph (1).''.
            (3) So much of clause (ii) of section 354(a)(2)(C) as 
        precedes subclause (II) is amended to read as follows:
                            ``(ii) Recapitalization of family-owned 
                        corporations and s corporations.--
                                    ``(I) In general.--Clause (i) shall 
                                not apply in the case of a 
                                recapitalization under section 
                                368(a)(I)(E) of a family-owned 
                                corporation or S corporation.''.
            (4) Subsection (a) of section 1373 is amended by striking 
        ``and'' at the end of paragraph (1), by striking the period at 
        the end of paragraph (2) and inserting ``, and'', and by adding 
        at the end the following new paragraph:
            ``(3) no amount of an expense deductible under this 
        subchapter by reason of section 1361(f)(3) shall be apportioned 
        or allocated to such income.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

SEC. 202. SAFE HARBOR EXPANDED TO INCLUDE CONVERTIBLE DEBT.

    (a) In General.--Subparagraph (B) of section 1361(c)(5) (defining 
straight debt) is amended by striking clauses (ii) and (iii) and 
inserting the following new clauses:
                            ``(ii) in any case in which the terms of 
                        such promise include a provision under which 
                        the obligation to pay may be converted 
                        (directly or indirectly) into stock of the 
                        corporation, such terms, taken as a whole, are 
                        substantially the same as the terms which could 
                        have been obtained on the effective date of the 
                        promise from a person which is not a related 
                        person (within the meaning of section 
                        465(b)(3)(C)) to the S corporation or its 
                        shareholders, and
                            ``(iii) the creditor is--
                                    ``(I) an individual,
                                    ``(II) an estate,
                                    ``(III) a trust described in 
                                paragraph (2),
                                    ``(IV) an exempt organization 
                                described in paragraph (6), or
                                    ``(V) a person which is actively 
                                and regularly engaged in the business 
                                of lending money.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2006.

SEC. 203. REPEAL OF EXCESSIVE PASSIVE INVESTMENT INCOME AS A 
              TERMINATION EVENT.

    (a) In General.--Section 1362(d) (relating to termination) is 
amended by striking paragraph (3).
    (b) Conforming Amendments.--
            (1) Section 1362(f)(1) is amended by striking ``or (3)''.
            (2) Clause (i) of section 1042(c)(4)(A) is amended by 
        striking ``section 1362(d)(3)(C)'' and inserting ``section 
        1375(b)(3)''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

SEC. 204. MODIFICATIONS TO PASSIVE INCOME RULES.

    (a) Increased Limit.--
            (1) In general.--Subsection (a)(2) of section 1375 
        (relating to tax imposed when passive investment income of 
        corporation having accumulated earnings and profits exceeds 25 
        percent of gross receipts) is amended by striking ``25 
        percent'' and inserting ``60 percent''.
            (2) Conforming amendments.--
                    (A) Subparagraph (J) of section 26(b)(2) is amended 
                by striking ``25 percent'' and inserting ``60 
                percent''.
                    (B) Clause (i) of section 1375(b)(1)(A) is amended 
                by striking ``25 percent'' and inserting ``60 
                percent''.
                    (C) The heading for section 1375 is amended by 
                striking ``25 percent'' and inserting ``60 percent''.
                    (D) The table of sections for part III of 
                subchapter S of chapter 1 is amended by striking ``25 
                percent'' in the item relating to section 1375 and 
                inserting ``60 percent''.
    (b) Repeal of Passive Income Capital Gain Category.--
            (1) In general.--Subsection (b) of section 1375 (relating 
        to tax imposed when passive investment income of corporation 
        having accumulated earnings and profits exceeds 60 percent of 
        gross receipts), as amended by subsection (a), is amended by 
        striking paragraphs (3) and (4) and inserting the following new 
        paragraph:
            ``(3) Passive investment income defined.--
                    ``(A) In general.--Except as otherwise provided in 
                this paragraph, the term `passive investment income' 
                means gross receipts derived from royalties, rents, 
                dividends, interest, and annuities.
                    ``(B) Exception for interest on notes from sales of 
                inventory.--The term `passive investment income' shall 
                not include interest on any obligation acquired in the 
                ordinary course of the corporation's trade or business 
                from its sale of property described in section 
                1221(a)(1).
                    ``(C) Treatment of certain lending or finance 
                companies.--If the S corporation meets the requirements 
                of section 542(c)(6) for the taxable year, the term 
                `passive investment income' shall not include gross 
                receipts for the taxable year which are derived 
                directly from the active and regular conduct of a 
                lending or finance business (as defined in section 
                542(d)(1)).
                    ``(D) Treatment of certain dividends.--If an S 
                corporation holds stock in a C corporation meeting the 
                requirements of section 1504(a)(2), the term `passive 
                investment income' shall not include dividends from 
                such C corporation to the extent such dividends are 
                attributable to the earnings and profits of such C 
                corporation derived from the active conduct of a trade 
                or business.
                    ``(E) Coordination with section 1374.--The amount 
                of passive investment income shall be determined by not 
                taking into account any recognized built-in gain or 
                loss of the S corporation for any taxable year in the 
                recognition period. Terms used in the preceding 
                sentence shall have the same respective meaning as when 
                used in section 1374.''.
            (2) Conforming amendments.--Section 1375(d) is amended by 
        striking ``subchapter C'' both places it appears and inserting 
        ``accumulated''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

SEC. 205. ADJUSTMENT TO BASIS OF S CORPORATION STOCK FOR CERTAIN 
              CHARITABLE CONTRIBUTIONS.

    (a) In General.--Paragraph (1) of section 1367(a) (relating to 
adjustments to basis of stock of shareholders, etc.) is amended by 
striking ``and'' at the end of subparagraph (B), by striking the period 
at the end of subparagraph (C) and inserting ``, and'', and by adding 
at the end the following new subparagraph:
                    ``(D) the excess of the amount of the shareholder's 
                proportionate share of any charitable contribution made 
                by the S corporation over the shareholder's 
                proportionate share of the adjusted basis of the 
                property contributed.''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

           TITLE III--TREATMENT OF S CORPORATION SHAREHOLDERS

SEC. 301. TREATMENT OF LOSSES TO SHAREHOLDERS.

    (a) Liquidations.--Section 331 (relating to gain or loss to 
shareholders in corporate liquidations) is amended by redesignating 
subsection (c) as subsection (d) and by inserting after subsection (b) 
the following new subsection:
    ``(c) Loss on Liquidations of S Corporation.--
            ``(1) In general.--The portion of any net loss recognized 
        by a shareholder of an S corporation (as defined in section 
        1361(a)(1))--
                    ``(A) on amounts received by such shareholder in a 
                distribution in complete liquidation of such S 
                corporation, or
                    ``(B) on an installment obligation received by such 
                shareholder with respect to a sale or exchange by the 
                corporation during the 12-month period beginning on the 
                date a plan of complete liquidation is adopted if the 
                liquidation is completed during such 12-month period, 
                which does not exceed the ordinary income basis of 
                stock of such S corporation in the hands of such 
                shareholder shall not be treated as a loss from the 
                sale or exchange of a capital asset but shall be 
                treated as an ordinary loss.
            ``(2) Ordinary income basis.--For purposes of this 
        subsection, the ordinary income basis of stock of an S 
        corporation in the hands of a shareholder of such S corporation 
        shall be an amount equal to the portion of such shareholder's 
        basis in such stock which is equal to the aggregate increases 
        in such basis under section 1367(a)(1) resulting from such 
        shareholder's pro rata share of ordinary income of such S 
        corporation attributable to the complete liquidation.''.
    (b) Suspended Passive Activity Losses.--Paragraph (3) of section 
1371(b) is amended to read as follows:
            ``(3) Treatment of s year as elapsed year; passive 
        losses.--Nothing in paragraphs (1) and (2) shall prevent 
        treating a taxable year for which a corporation is an S 
        corporation as a taxable year for purposes of determining the 
        number of taxable years to which an item may be carried back or 
        carried forward nor prevent the allowance of a passive activity 
        loss deduction to the extent provided by section 469(g).''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2006.

SEC. 302. DEDUCTIBILITY OF INTEREST EXPENSE INCURRED BY AN ELECTING 
              SMALL BUSINESS TRUST TO ACQUIRE S CORPORATION STOCK.

    (a) In General.--Subparagraph (C) of section 641(c)(2) (relating to 
modifications) is amended by inserting after clause (iii) the following 
new clause:
                            ``(iv) Any interest expense incurred to 
                        acquire stock in an S corporation.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2006.

SEC. 303. BACK TO BACK LOANS AS INDEBTEDNESS.

    (a) In General.--Section 1366(d) (relating to special rules for 
losses and deductions) is amended by adding at the end the following 
new paragraph:
            ``(4) Loans included in indebtedness of an s corporation.--
        For purposes of subsection (d), the indebtedness of an S 
        corporation to the shareholder shall include any loans made or 
        acquired (by purchase, gift, or distribution from another 
        person) by a shareholder to the S corporation, regardless of 
        whether the funds loaned by the shareholder to the S 
        corporation were obtained by the shareholder by means of a 
        recourse loan from another person (whether related or unrelated 
        to the shareholder).''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2006.

       TITLE IV--EXPANSION OF S CORPORATION ELIGIBILITY FOR BANKS

SEC. 401. TREATMENT OF QUALIFYING DIRECTOR SHARES.

    (a) In General.--Section 1361 (defining S corporation), as amended 
by section 201(a), is amended by adding at the end the following new 
subsection:
    ``(g) Treatment of Qualifying Director Shares.--
            ``(1) In general.--For purposes of this subchapter--
                    ``(A) qualifying director shares shall not be 
                treated as a second class of stock, and
                    ``(B) no person shall be treated as a shareholder 
                of the corporation by reason of holding qualifying 
                director shares.
            ``(2) Qualifying director shares defined.--For purposes of 
        this subsection, the term `qualifying director shares' means 
        any shares of stock in a bank (as defined in section 581) or in 
        a bank holding company registered as such with the Federal 
        Reserve System--
                    ``(A) which are held by an individual solely by 
                reason of status as a director of such bank or company 
                or its controlled subsidiary; and
                    ``(B) which are subject to an agreement pursuant to 
                which the holder is required to dispose of the shares 
                of stock upon termination of the holder's status as a 
                director at the same price as the individual acquired 
                such shares of stock.
            ``(3) Distributions.--A distribution (not in part or full 
        payment in exchange for stock) made by the corporation with 
        respect to qualifying director shares shall be includible as 
        ordinary income of the holder and deductible to the corporation 
        as an expense in computing taxable income under section 1363(b) 
        in the year such distribution is received.''.
    (b) Conforming Amendments.--
            (1) Section 1361(b)(1), as amended by section 201(b), is 
        amended by striking ``subsection (f)'' and inserting 
        ``subsections (f) and (g)''.
            (2) Section 1366(a), as amended by section 201(b), is 
        amended by adding at the end the following new paragraph:
            ``(4) Allocation with respect to qualifying director 
        shares.--The holders of qualifying director shares (as defined 
        in section 1361(g)) shall not, with respect to such shares of 
        stock, be allocated any of the items described in paragraph 
        (1).''.
            (3) Section 1373(a), as amended by section 201(b), is 
        amended by striking ``and'' at the end of paragraph (2), by 
        striking the period at the end of paragraph (3) and inserting 
        ``, and'', and adding at the end the following new paragraph:
            ``(4) no amount of an expense deductible under this 
        subchapter by reason of section 1361(g)(3) shall be apportioned 
        or allocated to such income.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 1996.

SEC. 402. RECAPTURE OF BAD DEBT RESERVES.

    Notwithstanding section 481 of the Internal Revenue Code of 1986, 
with respect to any S corporation election made by any bank in taxable 
years beginning after December 31, 1996, such bank may recognize built-
in gains from changing its accounting method for recognizing bad debts 
from the reserve method under section 585 or 593 of such Code to the 
charge-off method under section 166 of such Code either in the taxable 
year ending with or beginning with such an election.

              TITLE V--QUALIFIED SUBCHAPTER S SUBSIDIARIES

SEC. 501. TREATMENT OF THE SALE OF INTEREST IN A QUALIFIED SUBCHAPTER S 
              SUBSIDIARY.

    (a) In General.--Section 1361(b)(3) (relating to treatment of 
certain wholly owned subsidiaries) is amended by adding at the end the 
following new subparagraph:
                    ``(F) Special rule on termination.--The tax 
                treatment of the disposition of the stock of the 
                qualified subchapter S subsidiary shall be determined 
                as if such disposition were--
                            ``(i) a sale of the undivided interest in 
                        the subsidiary's assets based on the percentage 
                        of the stock transferred, and
                            ``(ii) followed by a deemed contribution by 
                        the S corporation and the transferee in a 
                        section 351 transaction.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 1996.

                    TITLE VI--ADDITIONAL PROVISIONS

SEC. 601. ELIMINATION OF ALL EARNINGS AND PROFITS ATTRIBUTABLE TO PRE-
              1983 YEARS.

    (a) In General.--Subsection (a) of section 1311 of the Small 
Business Job Protection Act of 1996 is amended to read as follows:
    ``(a) In General.--If a corporation was an electing small business 
corporation under subchapter S of chapter 1 of the Internal Revenue 
Code of 1986 for any taxable year beginning before January 1, 1983, the 
amount of such corporation's accumulated earnings and profits (as of 
the beginning of any taxable year beginning after December 31, 1982) 
shall be reduced by an amount equal to the portion (if any) of such 
accumulated earnings and profits which were accumulated in any taxable 
year beginning before January 1, 1983, for which such corporation was 
an electing small business corporation under such subchapter S.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 1996.

SEC. 602. REPEAL OF LIFO RECAPTURE TAX.

    (a) In General.--Section 1363 (relating to effect on election on 
corporations) is amended by striking subsection (d).
    (b) Effective Date.--The amendment made by this section shall apply 
to elections made after the date of the enactment of this Act.

SEC. 603. EXPANSION OF POST-TERMINATION TRANSITION PERIOD.

    (a) In General.--Clause (ii) of section 1377(b)(1)(A) (defining 
post-termination transition period) is amended to read as follows:
                            ``(ii) the date on which any refund or 
                        credit of any overpayment of tax with respect 
                        to the return for such last year as an S 
                        corporation is prevented by the operation of 
                        any law or rule of law (including res 
                        judicata),''.
    (b) Effective Date.--The amendment made by this section shall apply 
to periods beginning after the date of the enactment of this Act.

SEC. 604. REDUCTION IN TAX RATE ON EXCESS NET PASSIVE INCOME.

    (a) In General.--Section 1375(a) (relating to tax imposed when 
passive investment income of corporation having accumulated earnings 
and profits exceeds 25 percent of gross receipts) is amended by 
striking ``computed by multiplying the excess net passive income by the 
highest rate of tax specified in section 11(b)'' and inserting ``15 
percent of the excess net passive income''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after December 31, 2006.

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

    (a) In General.--Section 144(a)(4)(A)(i) (relating to general rule 
for $10,000,000 limit in certain cases) is amended by striking 
``$10,000,000'' and inserting ``$10,000,000($30,000,000 in the case of 
any bank (as defined in section 581) or any depository institution 
holding company (as defined in section 3(w)(1) of the Federal Deposit 
Insurance Act (12 U.S.C. 1813(w)(1)) which is an S corporation)''.
    (b) Adjustment of Cap for Inflation.--Section 144(a) (relating to 
qualified small issue bond) is amended--
            (1) by redesignating paragraph (12) as paragraph (13); and
            (2) by inserting after paragraph (11) the following new 
        paragraph:
            ``(12) Inflation adjustment.--
                    ``(A) In general.--In the case of any calendar year 
                after 2006, the $30,000,000 amount contained in 
                paragraph (4)(A)(i) shall be increased by an amount 
                equal to--
                            ``(i) such dollar amount, multiplied by
                            ``(ii) the cost-of-living adjustment 
                        determined under section 1(f)(3) for such 
                        calendar year by substituting `calendar year 
                        2005' for `calendar year 1992' in subparagraph 
                        (B) thereof.
                    ``(B) Rounding.--Any increase under subparagraph 
                (A) which is not a multiple of $100,000 shall be 
                rounded to the next lowest multiple of $100,000.''.
    (c) Effective Date.--The amendments made by this section shall 
apply to--
            (1) obligations issued after the date of the enactment of 
        this Act; and
            (2) capital expenditures made after such date with respect 
        to obligations issued on or before such date.

SEC. 606. SPECIAL RULES OF APPLICATION.

    (a) Waiver of Limitations.--If refund or credit of any overpayment 
of tax resulting from the application of any amendment made by this Act 
is prevented at any time before the close of the 1-year period 
beginning on the date of the enactment of this Act by the operation of 
any law or rule of law (including res judicata), such refund or credit 
may nevertheless be made or allowed if claimed therefor is filed before 
the close of such period.
    (b) Treatment of Certain Elections Under Prior Law.--For purposes 
of section 1362(g) of the Internal Revenue Code of 1986 (relating to 
election after termination), any termination or revocation under 
section 1362(d) of such Code (as in effect on the day before enactment 
of this Act) shall not be taken into account.
                                 <all>
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