I 
109TH CONGRESS 
1ST SESSION H. R. 4421 
To amend the Internal Revenue Code of 1986 to provide for S corporation 
reform, and for other purposes. 
IN THE HOUSE OF REPRESENTATIVES 
NOVEMBER 18, 2005 
Mr. SHAW (for himself and Mr. RAMSTAD) 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 S corporation reform, and for other purposes. 
Be it enacted by the Senate and House of Representa-
tives of the United States of America in Congress assembled, 
SECTION 1. SHORT TITLE, REFERENCE. 
(a) SHORT TITLE.—This Act may be cited as the ‘‘S 
Corporation Reform Act of 2005’’. 
(b) AMENDMENT OF 1986 CODE.—Except as other-
wise expressly provided, whenever in this Act an amend-
ment 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 provi-
sion of the Internal Revenue Code of 1986. 
SEC. 2. REDUCED RECOGNITION PERIOD FOR BUILT-IN 
GAINS. 
(a) IN GENERAL.—Paragraph (7) of section 1374(d) 
(relating to definitions and special rules) is amended by 
striking ‘‘10-year’’ both places it appears and inserting 
‘‘7-year’’. 
(b) APPLICATION TO REGULATED INVESTMENT COM-
PANIES AND REAL ESTATE INVESTMENT TRUSTS.—For 
purposes of paragraph (1) of section 337(d) and the regu-
lations thereunder, any reference to the 10-year recogni-
tion period under section 1374 shall be applied as if the 
reference were to a 7-year recognition period. 
(c) EFFECTIVE DATE.— 
(1) GENERAL RULE.—The amendment made by 
this section shall apply to any recognition period in 
effect on or after the date of the enactment of this 
Act. 
(2) SPECIAL APPLICATION TO EXISTING PERI-
ODS EXCEEDING 7 YEARS.—Any recognition period 
(as defined in section 1374(d)(7) of the Internal 
Revenue Code of 1986) which is in effect on the 
date of the enactment of this Act and which is in 
the 8th, 9th, or 10th year after the beginning of
such period shall end on the date of the enactment 
of this Act. 
SEC. 3. ISSUANCE OF PREFERRED STOCK PERMITTED. 
(a) IN GENERAL.—Section 1361 (defining S corpora-
tion) is amended by adding at the end the following new 
subsection: 
‘‘(f) 
TREATMENT
OF
QUALIFIED
PREFERRED 
STOCK.— 
‘‘(1) IN GENERAL.—For purposes of this sub-
chapter— 
‘‘(A) qualified preferred stock shall not be 
treated as a second class of stock, and 
‘‘(B) no person shall be treated as a share-
holder of the corporation by reason of holding 
qualified preferred stock. 
‘‘(2) 
QUALIFIED
PREFERRED
STOCK
DE-
FINED.—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 ex-
pense 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 amend-
ed 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
QUALI-
FIED 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) thereof is 
amended to read as follows: 
‘‘(ii) RECAPITALIZATION OF FAMILY- 
OWNED
CORPORATIONS
AND
S
CORPORA-
TIONS.— 
‘‘(I) IN
GENERAL.—Clause (i) 
shall not apply in the case of a recapi-
talization 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 fol-
lowing 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, 2005. 
SEC. 4. SAFE HARBOR EXPANDED TO INCLUDE CONVERT-
IBLE 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 con-
verted (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 (with-
in 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 para-
graph (2), 
‘‘(IV) an exempt organization de-
scribed 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, 2005. 
SEC. 5. REPEAL OF EXCESSIVE PASSIVE INVESTMENT IN-
COME AS A TERMINATION EVENT. 
(a) IN GENERAL.—Section 1362(d) (relating to ter-
mination) 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, 2005. 
SEC. 6. MODIFICATIONS TO PASSIVE INCOME RULES. 
(a) INCREASED LIMIT.— 
(1) IN
GENERAL.—Paragraph (2) of section 
1375(a) (relating to tax imposed when passive in-
vestment income of corporation having accumulated 
earnings and profits exceeds 25 percent of gross re-
ceipts) is amended by striking ‘‘25 percent’’ and in-
serting ‘‘60 percent’’. 
(2) CONFORMING AMENDMENTS.— 
(A) Subparagraph (J) of section 26(b)(2) 
is amended by striking ‘‘25 percent’’ and insert-
ing ‘‘60 percent’’. 
(B) Clause (i) of section 1375(b)(1)(A) is 
amended by striking ‘‘25 percent’’ and inserting 
‘‘60 percent’’. 
(C) The table of sections for part III of 
subchapter S of chapter 1 is amended by strik-
ing ‘‘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 invest-
ment income of corporation having accumulated 
earnings and profits exceeds 60 percent of gross re-
ceipts), as amended by subsection (a), is amended by 
striking paragraphs (3) and (4) and inserting the 
following new paragraph: 
‘‘(3) 
PASSIVE
INVESTMENT
INCOME
DE-
FINED.— 
‘‘(A) IN GENERAL.—Except as otherwise 
provided in this paragraph, the term ‘passive 
investment income’ means gross receipts de-
rived 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 in-
terest on any obligation acquired in the ordi-
nary course of the corporation’s trade or busi-
ness from its sale of property described in sec-
tion 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 fi-
nance 
business 
(as 
defined 
in 
section 
542(d)(1)). 
‘‘(D) TREATMENT
OF
CERTAIN
DIVI-
DENDS.—If an S corporation holds stock in a 
C corporation meeting the requirements of sec-
tion 1504(a)(2), the term ‘passive investment 
income’ shall not include dividends from such C 
corporation to the extent such dividends are at-
tributable 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 in-
come shall be determined by not taking into ac-
count any recognized built-in gain or loss of the 
S corporation for any taxable year in the rec-
ognition period. Terms used in the preceding 
sentence shall have the same respective mean-
ing 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, 2005. 
SEC. 7. EXPANSION OF S CORPORATION ELIGIBLE SHARE-
HOLDERS 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 in-
dividual 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 COR-
PORATION
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 con-
stitutes an individual retirement account under sec-
tion 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 inde-
pendent 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 commis-
sions, costs, or other expenses in connection 
with the sale, and 
‘‘(D) the stock is sold in a single trans-
action 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. 
SEC. 8. 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 subpara-
graph (B), by striking the period at the end of subpara-
graph (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 chari-
table contribution made by the S corporation 
over the shareholder’s proportionate share of 
the adjusted basis of the property contrib-
uted.’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2005. 
SEC. 9. NONRESIDENT ALIENS ALLOWED TO BE SHARE-
HOLDERS. 
(a) NONRESIDENT ALIENS ALLOWED TO BE SHARE-
HOLDERS.— 
(1) IN
GENERAL.—Paragraph (1) of section 
1361(b) (defining small business corporation) is 
amended— 
(A) by adding ‘‘and’’ at the end of sub-
paragraph (B), 
(B) by striking subparagraph (C), and 
(C) by redesignating subparagraph (D) as 
subparagraph (C). 
(2) CONFORMING AMENDMENTS.—