I 

108TH CONGRESS 

1ST SESSION H. R. 714

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

eligibility for banks, and for other purposes. 

IN THE HOUSE OF REPRESENTATIVES 

FEBRUARY 12, 2003

Mr. MCINNIS (for himself, Mr. RAMSTAD, Mr. MATSUI, Mr. ENGLISH, Mr. 

POMEROY, Mr. FOLEY, Mr. BEAUPREZ, Mr. TANCREDO, Mr. GREEN of 

Wisconsin, Mr. UDALL of Colorado, Mrs. MUSGRAVE, and Ms. DEGETTE) 

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 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 2003’’. 

6 SEC. 2. EXPANSION OF BANK S CORPORATION ELIGIBLE 

7 SHAREHOLDERS 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 new clause: 

3 ‘‘(vi) In the case of a corporation 

4 which is a bank (as defined in section 

5 581), a trust which constitutes an indi6 vidual retirement account under section 

7 408(a), including one designated as a Roth 

8 IRA under section 408A, but only to the 

9 extent of the stock held by such trust in 

10 such bank as of the date of the enactment 

11 of this clause.’’. 

12 (b) TREATMENT AS SHAREHOLDER.—Section 

13 1361(c)(2)(B) of such Code (relating to treatment as 

14 shareholders) is amended by adding at the end the fol15 lowing new clause: 

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

17 in clause (vi) of subparagraph (A), the in18 dividual for whose benefit the trust was 

19 created shall be treated as a shareholder.’’. 

20 (c) SALE OF STOCK IN IRA RELATING TO S COR21 PORATION ELECTION EXEMPT FROM PROHIBITED

22 TRANSACTION RULES.—Section 4975(d) of such Code (re23 lating to exemptions) is amended by striking ‘‘or’’ at the 

24 end of paragraph (14), by striking the period at the end 
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1 of paragraph (15) and inserting ‘‘; or’’, and by adding at 

2 the end the following new paragraph: 

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 such sale is pursuant to an 

7 election under section 1362(a).’’. 

8 (d) CONFORMING AMENDMENT.—Section 512(e)(1) 

9 of such Code is amended by inserting ‘‘1361(c)(2)(A)(vi) 

10 or’’ before ‘‘1361(c)(6)’’. 

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

12 this section shall apply to trusts which constitute indi13 vidual retirement accounts on the date of the enactment 

14 of this Act. 

15 SEC. 3. EXCLUSION OF INVESTMENT SECURITIES INCOME 

16 FROM PASSIVE INCOME TEST FOR BANK S 

17 CORPORATIONS. 

18 (a) IN GENERAL.—Section 1362(d)(3)(C) of the In19 ternal Revenue Code of 1986 (defining passive invest20 ment income) is amended by adding at the end the fol21 lowing: 

22 ‘‘(v) EXCEPTION FOR BANKS; ETC.—

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

24 581) or a bank holding company (as de25 fined in section 246A(c)(3)(B)(ii)), the 
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1 term ‘passive investment income’ shall not 

2 include—

3 ‘‘(I) interest income earned by 

4 such bank or bank holding company, 

5 or 

6 ‘‘(II) dividends on assets required 

7 to be held by such bank or bank hold8 ing company to conduct a banking 

9 business, including stock in the Fed10 eral Reserve Bank, the Federal Home 

11 Loan Bank, or the Federal Agricul12 tural Mortgage Bank or participation 

13 certificates issued by a Federal Inter14 mediate Credit Bank.’’

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

16 this section shall apply to taxable years beginning after 

17 December 31, 2003. 

18 SEC. 4. INCREASE IN NUMBER OF ELIGIBLE SHARE19 HOLDERS TO 150. 

20 (a) IN GENERAL.—Section 1361(b)(1)(A) of the In21 ternal Revenue Code of 1986 (defining small business cor22 poration) is amended by striking ‘‘75 shareholders’’ and 

23 inserting ‘‘150 shareholders’’. 
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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, 2003.

4 SEC. 5. TREATMENT OF QUALIFYING DIRECTOR SHARES. 

5 (a) IN GENERAL.—Section 1361 of the Internal Rev6 enue Code of 1986 is amended by adding at the end the 

7 following: 

8 ‘‘(f) TREATMENT OF QUALIFYING DIRECTOR

9 SHARES.—

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

12 ‘‘(A) qualifying director shares 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 qualifying director shares. 

17 ‘‘(2) QUALIFYING DIRECTOR SHARES DE18 FINED.—For purposes of this subsection, the term 

19 ‘qualifying director shares’ means any shares of 

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

21 bank holding company registered as such with the 

22 Federal Reserve System—

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

24 solely by reason of status as a director of
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1 such bank or company or its controlled 

2 subsidiary; and 

3 ‘‘(ii) which are subject to an agree4 ment pursuant to which the holder is re5 quired to dispose of the shares of stock 

6 upon termination of the holder’s status as 

7 a director at the same price as the indi8 vidual acquired such shares of stock. 

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

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

11 the corporation with respect to qualifying director 

12 shares shall be includible as ordinary income of the 

13 holder and deductible to the corporation as an ex14 pense in computing taxable income under section 

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

16 (b) CONFORMING AMENDMENTS.—

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

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

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

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

21 by adding at the end the following: 

22 ‘‘(3) ALLOCATION WITH RESPECT TO QUALI23 FYING DIRECTOR SHARES.—The holders of quali24 fying director shares (as defined in section 1361(f)) 

25 shall not, with respect to such shares of stock, be al-
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1 located any of the items described in paragraph 

2 (1).’’ 

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

4 this section shall apply to taxable years beginning after 

5 December 31, 2003. 

6 SEC. 6. RECAPTURE OF BAD DEBT RESERVES. 

7 In the case of a bank which makes an S corporation 

8 election which first takes effect for a taxable year begin9 ning after December 31, 2003, the entire adjustment re10 quired by section 481 of the Internal Revenue Code of 

11 1986 by reason of changing its accounting method for rec12 ognizing bad debts from the reserve method under section 

13 585 or 593 of such Code to the charge-off method under 

14 section 166 of such Code may be taken into in the year 

15 of the change or the preceding taxable year (whichever is 

16 elected by the bank). 

17 SEC. 7. CLARIFICATION OF 3-YEAR S CORPORATION RULE 

18 FOR CORPORATE PREFERENCE ITEMS. 

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

20 Revenue Code of 1986 (relating to computation of cor21 poration’s taxable income) is amended by adding at the 

22 end the following new flush sentence: 

23 ‘‘Nothing in the preceding sentence shall be construed to 

24 apply section 291 to any taxable year which is more than 
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1 3 taxable years after the S corporation (or any prede2 cessor) was a C corporation.’’

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

4 this section shall apply to taxable years beginning after 

5 December 31, 2003. 

6 SEC. 8. MEMBERS OF FAMILY TREATED AS 1 SHARE7 HOLDER. 

8 (a) IN GENERAL.—Paragraph (1) of section 1361(c) 

9 of the Internal Revenue Code of 1986 (relating to special 

10 rules for applying subsection (b)) is amended to read as 

11 follows: 

12 ‘‘(1) MEMBERS OF FAMILY TREATED AS 1

13 SHAREHOLDER.—

14 ‘‘(A) IN GENERAL.—For purpose of sub15 section (b)(1)(A)—

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

17 a husband and wife (and their estates) 

18 shall be treated as 1 shareholder, and 

19 ‘‘(ii) in the case of a family with re20 spect to which an election is in effect 

21 under subparagraph (E), all members of 

22 the family shall be treated as 1 share23 holder. 

24 ‘‘(B) MEMBERS OF THE FAMILY.—For 

25 purpose of subparagraph (A)(ii), the term 
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1 ‘members of the family’ means the common an2 cestor, lineal descendants of the common ances3 tor and the spouses (or former spouses) of such 

4 lineal descendants or common ancestor. 

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

6 of this paragraph, an individual shall not be 

7 considered a common ancestor if, as of the later 

8 of the effective date of this paragraph or the 

9 time the election under section 1362(a) is 

10 made, the individual is more than 3 generations 

11 removed from the youngest generation of share12 holders. 

13 ‘‘(D) EFFECT OF ADOPTION, ETC.—In de14 termining whether any relationship specified in 

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

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

17 ‘‘(E) ELECTION.—An election under sub18 paragraph (A)(ii)—

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

20 shareholders (including those that are fam21 ily members) holding in the aggregate 

22 more than one-half of the shares of stock 

23 in the corporation on the day the election 

24 is made, 

25 ‘‘(ii) in the case of—
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1 ‘‘(I) an electing small business 

2 trust, shall be made by the trustee of 

3 the trust, and 

4 ‘‘(II) a qualified subchapter S 

5 trust, shall be made by the beneficiary 

6 of the trust, 

7 ‘‘(iii) under regulations, shall remain 

8 in effect until terminated, and 

9 ‘‘(iv) shall apply only with respect to 

10 1 family in any corporation.’’. 

11 (b) RELIEF FROM INADVERTENT INVALID ELECTION

12 OR TERMINATION.—Section 1362(f) of such Code (relat13 ing to inadvertent invalid elections or terminations) is 

14 amended—

15 (1) by inserting ‘‘or under section 

16 1361(c)(1)(A)(ii)’’ after ‘‘subsection (a)’’ in para17 graph (1), and 

18 (2) by inserting ‘‘or under section 

19 1361(c)(1)(E)(iii)’’ after ‘‘subsection (d)’’ in para20 graph (1)(B). 

21 (c) EFFECTIVE DATES.—

22 (1) SUBSECTION (a).—The amendment made by 

23 subsection (a) shall apply to taxable years beginning 

24 after December 31, 2003.
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1 (2) SUBSECTION (b).—The amendments made 

2 by subsection (b) shall apply to elections and termi3 nations made after December 31, 2003. 

4 SEC. 9. ISSUANCE OF PREFERRED STOCK PERMITTED. 

5 (a) IN GENERAL.—Section 1361 of the Internal Rev6 enue Code of 1986, as amended by section 5(a), is amend7 ed by adding at the end the following: 

8 ‘‘(g) 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 solely because it 

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

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

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

10 ‘‘subsections (f) and (g)’’. 

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

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

13 the following: 

14 ‘‘(4) ALLOCATION WITH RESPECT TO QUALI15 FIED PREFERRED STOCK.—The holders of qualified 

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

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

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

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

20 this section shall apply to taxable years beginning after 

21 December 31, 2003. 

22 SEC. 10. INFORMATION RETURNS FOR QUALIFIED SUB23 CHAPTER S SUBSIDIARIES. 

24 (a) IN GENERAL.—Section 1361(b)(3)(A) of the In25 ternal Revenue Code of 1986 (relating to treatment of cer-
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1 tain wholly owned subsidiaries) is amended by inserting 

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

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

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

5 this section shall apply to taxable years beginning after 

6 December 31, 2003. 

7 SEC. 11. ADJUSTMENT TO BASIS OF S CORPORATION 

8 STOCK FOR CERTAIN CHARITABLE CON9 TRIBUTIONS. 

10 (a) IN GENERAL.—Paragraph (2) of section 1367(a) 

11 of the Internal Revenue Code of 1986 (relating to adjust12 ments to basis of stock of shareholders, etc.) is amended 

13 by adding at the end the following new flush sentence: 

14 ‘‘The decrease under subparagraph (B) by reason of 

15 a charitable contribution (as defined in section 

16 170(c)) of property shall be the amount equal to the 

17 shareholder’s pro rata share of the adjusted basis of 

18 such property.’’. 

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

20 this section shall apply to taxable years beginning after 

21 December 31, 2003.

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