amended by section 111(c)(2), is amended by adding
at the end the following new subsection:
‘‘(d) SHAREHOLDER’S RETURN MUST BE CONSIST-
ENT WITH CORPORATE RETURN OR SECRETARY NOTI-
FIED OF INCONSISTENCY.—
‘‘(1) IN GENERAL.—A shareholder of an S cor-
poration shall, on such shareholder’s return, treat a
subchapter S item in a manner which is consistent
with the treatment of such item on the corporate re-
turn.
‘‘(2) NOTIFICATION OF INCONSISTENT TREAT-
MENT.—
‘‘(A) IN
GENERAL.—In the case of any
subchapter S item, if—
‘‘(i)(I) the corporation has filed a re-
turn but the shareholder’s treatment on
his return is (or may be) inconsistent with
the treatment of the item on the corporate
return, or
‘‘(II) the corporation has not filed a
return, and
‘‘(ii) the shareholder files with the
Secretary a statement identifying the in-
consistency,
paragraph (1) shall not apply to such item.
‘‘(B) SHAREHOLDER
RECEIVING
INCOR-
RECT
INFORMATION.—A shareholder shall be
treated as having complied with clause (ii) of
subparagraph (A) with respect to a subchapter
S item if the shareholder—
‘‘(i) demonstrates to the satisfaction
of the Secretary that the treatment of the
subchapter S item on the shareholder’s re-
turn is consistent with the treatment of the
item on the schedule furnished to the
shareholder by the corporation, and
‘‘(ii) elects to have this paragraph
apply with respect to that item.
‘‘(3) EFFECT OF FAILURE TO NOTIFY.—In any
case—
‘‘(A) described in subparagraph (A)(i)(I)
of paragraph (2), and
‘‘(B) in which the shareholder does not
comply with subparagraph (A)(ii) of paragraph
(2),
any adjustment required to make the treatment of
the items by such shareholder consistent with the
treatment of the items on the corporate return shall
be treated as arising out of mathematical or clerical
errors and assessed according to section 6213(b)(1).
Paragraph (2) of section 6213(b) shall not apply to
any assessment referred to in the preceding sen-
tence.
‘‘(4) SUBCHAPTER S ITEM.—For purposes of
this subsection, the term ‘subchapter S item’ means
any item of an S corporation to the extent that reg-
ulations prescribed by the Secretary provide that, for
purposes of this subtitle, such item is more appro-
priately determined at the corporation level than at
the shareholder level.
‘‘(5) ADDITION TO TAX FOR FAILURE TO COM-
PLY WITH SECTION.—
‘‘For addition to tax in the case of a shareholder’s
negligence in connection with, or disregard of, the
requirements of this section, see part II of sub-
chapter A of chapter 68.’’
(3) CONFORMING AMENDMENTS.—
(A) Section 1366 is amended by striking
subsection (g).
(B) Subsection (b) of section 6233 is
amended to read as follows:
‘‘(b) SIMILAR RULES IN CERTAIN CASES.—If a part-
nership return is filed for any taxable year but it is deter-
mined that there is no entity for such taxable year, to the
extent provided in regulations, rules similar to the rules
of subsection (a) shall apply.’’
(C) The table of subchapters for chapter
63 is amended by striking the item relating to
subchapter D.
SEC. 214. 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) MODIFICATION OF TAX IMPOSED ON EXCESSIVE
PASSIVE INVESTMENT INCOME.—
(1) INCREASE
IN
THRESHOLD.—Subsections
(a)(2) and (b)(1)(A)(i) of section 1375 (relating to
tax imposed when passive investment income of a
corporation having subchapter C earnings and prof-
its exceeds 25 percent of gross receipts) are each
amended by striking ‘‘25 percent’’ and inserting ‘‘50
percent’’.
(2) TAX RATE INCREASE AFTER THIRD CON-
SECUTIVE YEAR.—Section 1375 is amended by re-
designating subsections (c) and (d) as subsections
(d) and (e), respectively, and by inserting after sub-
section (b) the following new subsection:
‘‘(c) TAX RATE INCREASE AFTER THIRD CONSECU-
TIVE YEAR.—
‘‘(1) IN GENERAL.—If an S corporation is de-
scribed in subsection (a) for more than 3 consecutive
taxable years, then the rate of tax imposed under
subsection (a) with respect to each succeeding con-
secutive taxable year (if any) shall be determined
under the following table:
‘‘In the case of the—
The rate of tax imposed under
subsection 
(a) 
shall 
be
equal to such rate of tax for
the 3rd taxable year, plus
the 
following 
percentage
points:
4th taxable year .......................................................................
5th taxable year .......................................................................
6th taxable year .......................................................................
7th taxable year .......................................................................
8th taxable year and thereafter ...............................................
50.
‘‘(2) YEARS
TAKEN
INTO
ACCOUNT.—No tax
shall be increased under paragraph (1) for any tax-
able year beginning before January 1, 1996.’’
(c) CONFORMING AMENDMENTS.—
(1) Section 1362(f)(1) is amended by striking
‘‘or (3)’’.
(2) Subsection (b) of section 1375 is amended
by striking paragraphs (3) and (4) and inserting the
following new paragraphs:
‘‘(3) SUBCHAPTER
C
EARNINGS
AND
PROF-
ITS.—The term ‘subchapter C earnings and profits’
means earnings and profits of any corporation for
any taxable year with respect to which an election
under section 1362(a) (or under section 1372 of
prior law) was not in effect.
‘‘(4) GROSS RECEIPTS FROM SALES OF CAPITAL
ASSETS (OTHER THAN STOCK AND SECURITIES).—In
the case of dispositions of capital assets (other than
stock and securities), gross receipts from such dis-
positions shall be taken into account only to the ex-
tent of the capital gain net income therefrom.
‘‘(5) 
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(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) SPECIAL
RULE
FOR
OPTIONS
AND
COMMODITY DEALINGS.—
‘‘(i) IN GENERAL.—In the case of any
options dealer or commodities dealer, pas-
sive investment income shall be determined
by not taking into account any gain or loss
(in the normal course of the taxpayer’s ac-
tivity of dealing in or trading section 1256
contracts) from any section 1256 contract
or property related to such a contract.
‘‘(ii) DEFINITIONS.—For purposes of
this subparagraph—
‘‘(I) 
OPTIONS
DEALER.—The
term ‘options dealer’ has the meaning
given 
such 
term 
by 
section
1256(g)(8).
‘‘(II) COMMODITIES
DEALER.—
The term ‘commodities dealer’ means
a person who is actively engaged in
trading section 1256 contracts and is
registered with a domestic board of
trade which is designated as a con-
tract market by the Commodities Fu-
tures Trading Commission.
‘‘(III) 
SECTION
1256
CON-
TRACT.—The term ‘section 1256 con-
tract’ has the meaning given to such
term by section 1256(b).
‘‘(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.’’
(3) The heading for section 1375 is amended by
striking ‘‘25’’ and inserting ‘‘50’’.
(4) The table of sections for part III of sub-
chapter S of chapter 1 is amended by striking ‘‘25’’
in the item relating to section 1375 and inserting
‘‘50’’.
(5) Clause (i) of section 1042(c)(4)(A) is
amended by striking ‘‘section 1362(d)(3)(D)’’ and
inserting ‘‘section 1375(b)(5)’’.
Subtitle C—Other Provisions
SEC. 221. S CORPORATIONS PERMITTED TO HOLD SUBSIDI-
ARIES.
(a) IN GENERAL.—Paragraph (2) of section 1361(b)
(defining ineligible corporation), as amended by section
112, is amended by striking subparagraph (A) and by re-
designating subparagraphs (B), (C), (D), and (E) as sub-
paragraphs (A), (B), (C), and (D), respectively.
(b) TREATMENT OF CERTAIN WHOLLY OWNED S
CORPORATION SUBSIDIARIES.—Section 1361(b) (defining
small business corporation) is amended by adding at the
end thereof the following new subsection:
‘‘(3) TREATMENT OF CERTAIN WHOLLY OWNED
SUBSIDIARIES.—
‘‘(A) IN GENERAL.—For purposes of this
title—
‘‘(i) a corporation which is a qualified
subchapter S subsidiary shall not be treat-
ed as a separate corporation, and
‘‘(ii) all assets, liabilities, and items of
income, deduction, and credit of a qualified
subchapter S subsidiary shall be treated as
assets, liabilities, and such items (as the
case may be) of the S corporation.
‘‘(B) QUALIFIED SUBCHAPTER S SUBSIDI-
ARY.—For purposes of this subsection, the term
‘qualified subchapter S subsidiary’ means any
corporation 100 percent of the stock of which
is held by an S corporation as of the later of
the effective date of the S election of the S cor-
poration or the acquisition of the subsidiary,
and at all times thereafter.
‘‘(C) TREATMENT
OF
TERMINATIONS
OF
QUALIFIED
SUBCHAPTER
S
SUBSIDIARY
STA-
TUS.—For purposes of this subtitle, if any cor-
poration which was a qualified subchapter S
subsidiary ceases to meet the requirements of
subparagraph (B), such corporation shall be
treated as a new corporation acquiring all of its
assets (and assuming all of its liabilities) imme-
diately before such cessation from the S cor-
poration in exchange for its stock.’’.
(c) CERTAIN DIVIDENDS NOT TREATED AS PASSIVE
INVESTMENT INCOME.—Section 1375(b)(5) (defining pas-
sive investment income), as added by section 214(c)(2),
is amended by adding at the end the following new sub-
paragraph:
‘‘(F) 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.’’
(d) CONFORMING AMENDMENTS.—
(1) Subsection (c) of section 1361, as amended
by sections 111(a)(2) and 201(a), is amended by
striking paragraph (6) and redesignating paragraph
(7) as paragraphs (6).
(2) Subsection (b) of section 1504 (defining in-
cludible corporation) is amended by adding at the
end the following new paragraph:
‘‘(8) An S corporation.’’
SEC. 222. TREATMENT OF DISTRIBUTIONS DURING LOSS
YEARS.
(a) ADJUSTMENTS FOR DISTRIBUTIONS TAKEN INTO
ACCOUNT BEFORE LOSSES.—
(1) Subparagraph (A) of section 1366(d)(1)
(relating to losses and deductions cannot exceed
shareholder’s basis in stock and debt) is amended by
striking ‘‘paragraph (1)’’ and inserting ‘‘paragraphs
(1) and (2)(A)’’.
(2) Subsection (d) of section 1368 (relating to
certain adjustments taken into account) is amended
by adding at the end the following new sentence:
‘‘In the case of any distribution made during any taxable
year, the adjusted basis of the stock shall be determined
with regard to the adjustments provided in paragraph (1)
of section 1367(a) for the taxable year.’’
(b) ACCUMULATED ADJUSTMENTS ACCOUNT.—Para-
graph (1) of section 1368(e) (relating to accumulated ad-
justments account) is amended by adding at the end the
following new subparagraph:
‘‘(C) NET LOSS FOR YEAR DISREGARDED.—
‘‘(i) IN GENERAL.—In applying this section
to distributions made during any taxable year,
the amount in the accumulated adjustments ac-
count as of the close of such taxable year shall
be determined without regard to any net nega-
tive adjustment for such taxable year.
‘‘(ii) NET
NEGATIVE
ADJUSTMENT.—For
purposes of clause (i), the term ‘net negative
adjustment’ means, with respect to any taxable
year, the excess (if any) of—
‘‘(I) the reductions in the account for
the taxable year (other than for distribu-
tions), over
corporation by the shareholders on such
day, and
‘‘(ii) if any such shareholder is an or-
ganization described in section 511(a)(2),
as unrelated business taxable income (as
defined in section 512) to such share-
holder.’’
SEC. 224. TREATMENT OF S CORPORATIONS UNDER SUB-
CHAPTER C.
Subsection (a) of section 1371 (relating to applica-
tion of subchapter C rules) is amended to read as follows:
‘‘(a) APPLICATION OF SUBCHAPTER C RULES.—Ex-
cept as otherwise provided in this title, and except to the
extent inconsistent with this subchapter, subchapter C
shall apply to an S corporation and its shareholders.’’
SEC. 225. ELIMINATION OF PRE-1983 EARNINGS AND
PROFITS.
(a) IN GENERAL.—If—
(1) 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, and
(2) such corporation is an S corporation under
subchapter S of chapter 1 of such Code for its first
taxable year beginning after December 31, 1995,
the amount of such corporation’s accumulated earnings
and profits (as of the beginning of such first taxable year)
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) CONFORMING AMENDMENTS.—
(1)(A) Subsection (a) of section 1375 is amend-
ed by striking ‘‘subchapter C’’ in paragraph (1) and
inserting ‘‘accumulated’’.
(B) Subsection (b) of section 1375, as amended
by section 214(c)(2), is amended by striking para-
graph (3) and by redesignating paragraphs (4) and
(5) as paragraphs (3) and (4), respectively.
(C) The section heading for section 1375 is
amended by striking ‘‘SUBCHAPTER C’’ and insert-
ing ‘‘ACCUMULATED’’.
(D) The table of sections for part III of sub-
chapter S of chapter 1 is amended by striking ‘‘sub-
chapter C’’ in the item relating to section 1375 and
inserting ‘‘accumulated’’.
(2) Clause (i) of section 1042(c)(4)(A), as
amended by section 214(c)(5), is amended by strik-
ing ‘‘section 1375(b)(5)’’ and inserting ‘‘section
1375(b)(4)’’.
SEC. 226. ALLOWANCE OF CHARITABLE CONTRIBUTIONS
OF INVENTORY AND SCIENTIFIC PROPERTY.
(a) IN GENERAL.—Section 170(e) (relating to certain
contributions of ordinary income and capital gain prop-
erty) is amended—
(1) by striking ‘‘(other than a corporation
which is an S corporation)’’ in paragraph (3)(A),
and
(2) by striking clause (i) of paragraph (4)(D)
and by redesignating clauses (ii) and (iii) of such
paragraph as clauses (i) and (ii), respectively.
(b) STOCK BASIS ADJUSTMENT.—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 deductions for char-
itable contributions over the basis of the prop-
erty contributed.’’
SEC. 227. C CORPORATION RULES TO APPLY fOR FRINGE
BENEFIT PURPOSES.
(a) IN GENERAL.—Section 1372 (relating to partner-
ship rules to apply for fringe benefit purposes) is repealed.
(b) PARTNERSHIP RULES TO APPLY FOR HEALTH
INSURANCE COSTS OF CERTAIN S CORPORATION SHARE-
HOLDERS.—Paragraph (5) of section 162(l) is amended
to read as follows:
‘‘(5) TREATMENT OF CERTAIN S CORPORATION
SHAREHOLDERS.—
‘‘(A) IN GENERAL.—This subsection shall
apply in the case of any 2-percent shareholder
of an S corporation, except that—
‘‘(i) for purposes of this subsection,
such shareholder’s wages (as defined in
section 3121) from the S corporation shall
be treated as such shareholder’s earned in-
come (within the meaning of section
401(c)(1)), and
‘‘(ii) there shall be such adjustments
in the application of this subsection as the
Secretary may by regulations prescribe.
‘‘(B) 
2-PERCENT
SHAREHOLDER
DE-
FINED.—For purposes of this paragraph, the
term ‘2-percent shareholder’ means any person
who owns (or is considered as owning within
the meaning of section 318) on any day during
the taxable year of the S corporation more than
2 percent of the outstanding stock of such cor-
poration or stock possessing more than 2 per-
cent of the total combined voting power of all
stock of such corporation.’’
(b) CONFORMING AMENDMENT.—The table of sec-
tions for part III of subchapter S of chapter 1 is amended
by striking the item relating to section 1372.
TITLE III—TAXATION OF S
CORPORATION SHAREHOLDERS
SEC. 301. UNIFORM TREATMENT OF OWNER-EMPLOYEES
UNDER PROHIBITED TRANSACTION RULES.
The last sentence of section 4975(d) (relating to ex-
emptions from prohibited transactions) is amended by
striking ‘‘a shareholder-employee (as defined in section
1379, as in effect on the day before the date of the enact-
ment of the Subchapter S Revision Act of 1982),’’.
SEC. 302. TREATMENT OF LOSSES TO SHAREHOLDERS.
(a) TREATMENT OF LOSSES IN LIQUIDATIONS.—Sec-
tion 331 (relating to gain or loss to shareholders in cor-
porate liquidations) is amended by redesignating sub-
section (c) as subsection (d) and by inserting after sub-
section (b) the following new subsection:
‘‘(c) LOSSES
ON LIQUIDATIONS
OF S CORPORA-
TION.—
‘‘(1) IN GENERAL.—The portion of any loss rec-
ognized by a shareholder of an S corporation (as de-
fined in section 1361(a)(1)) on amounts received by
such shareholder in a distribution in complete liq-
uidation of such S corporation which does not exceed
the ordinary income basis of stock of such S cor-
poration 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 liq-
uidation.’’
(b) CARRYOVER OF DISALLOWED LOSSES AND DE-
DUCTIONS UNDER AT-RISK RULES ALLOWED.—Para-
graph (3) of section 1366(d) (relating to carryover of dis-
allowed losses and deductions to post-termination transi-
tion period) is amended by adding at the end the following
new subparagraph:
‘‘(D) AT-RISK LIMITATIONS.—To the ex-
tent that any increase in adjusted basis de-
scribed in subparagraph (B) would have in-
creased the shareholder’s amount at risk under
section 465 if such increase had occurred on
the day preceding the commencement of the
post-termination transition period, rules similar
to the rules described in subparagraphs (A)
through (C) shall apply to any losses disallowed
by reason of section 465(a).’’
TITLE IV—EFFECTIVE DATE
SEC. 401. EFFECTIVE DATE.
(a) IN GENERAL.—Except as otherwise provided in
this Act, the amendments made by this Act shall apply
to taxable years beginning after December 31, 1995.
(b) TREATMENT OF CERTAIN ELECTIONS UNDER
PRIOR LAW.—For purposes of section 1362(g) of the In-
ternal 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 the
date of the enactment of this Act) shall not be taken into
account.
Æ
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