shall be considered to be made to a section or other provi-
sion of the Internal Revenue Code of 1986.
(c) TABLE OF CONTENTS.—The table of contents of
this Act is as follows:
Sec. 1. Short title; amendment of 1986 Code; table of contents.
TITLE I—ELIGIBLE SHAREHOLDERS OF S CORPORATION
Subtitle A—Number of Shareholders
Sec. 101. S corporations permitted to have 50 shareholders.
Sec. 102. Members of family treated as 1 shareholder.
Subtitle B—Persons Allowed as Shareholders
Sec. 111. Certain exempt organizations.
Sec. 112. Financial institutions.
Sec. 113. Nonresident aliens.
Sec. 114. Electing small business trusts.
Subtitle C—Other Provisions
Sec. 121. Expansion of post-death qualification for certain trusts.
TITLE II—QUALIFICATION AND ELIGIBILITY REQUIREMENTS
FOR S CORPORATIONS
Subtitle A—One Class of Stock
Sec. 201. Issuance of preferred stock permitted.
Sec. 202. Financial institutions permitted to hold safe harbor debt.
Subtitle B—Elections and Terminations
Sec. 211. Rules relating to inadvertent terminations and invalid elections.
Sec. 212. Agreement to terminate year.
Sec. 213. Expansion of post-termination transition period.
Sec. 214. Repeal of excessive passive investment income as a termination event.
Subtitle C—Other Provisions
Sec. 221. S corporations permitted to hold subsidiaries.
Sec. 222. C corporation rules to apply for fringe benefit purposes.
Sec. 223. Treatment of distributions during loss years.
Sec. 224. Consent dividend for AAA bypass election.
Sec. 225. Treatment of S corporations under subchapter C.
Sec. 226. Elimination of pre-1983 earnings and profits.
Sec. 227. Allowance of charitable contributions of inventory and scientific
property.
TITLE III—TAXATION OF S CORPORATION SHAREHOLDERS
Sec. 301. Uniform treatment of owner-employees under prohibited transaction
rules.
Sec. 302. Treatment of losses to shareholders.
TITLE IV—EFFECTIVE DATE
Sec. 401. Effective date.
TITLE I—ELIGIBLE SHAREHOLD-
ERS OF S CORPORATION
Subtitle A—Number of
Shareholders
SEC. 101. S CORPORATIONS PERMITTED TO HAVE 50
SHAREHOLDERS.
Subparagraph (A) of section 1361(b)(1) (defining
small business corporation) is amended by striking ‘‘35
shareholders’’ and inserting ‘‘50 shareholders’’.
SEC. 102. MEMBERS OF FAMILY TREATED AS 1 SHARE-
HOLDER.
Paragraph (1) of section 1361(c) (relating to special
rules for applying subsection (b)) is amended to read as
follows:
‘‘(1) MEMBERS
OF
FAMILY
TREATED
AS
SHAREHOLDER.—
‘‘(A) IN GENERAL.—For purposes of sub-
section (b)(1)(A)—
‘‘(i) except as provided in clause (ii),
a husband and wife (and their estates)
shall be treated as 1 shareholder, and
‘‘(ii) in the case of a family with re-
spect to which an election is in effect
under subparagraph (E), all members of
the family shall be treated as 1 share-
holder.
‘‘(B) MEMBERS
OF
THE
FAMILY.—For
purposes of subparagraph (A)(ii), the term
‘members of the family’ means the lineal de-
scendants of the common ancestor and the
spouses (or former spouses) of such lineal de-
scendants or common ancestor.
‘‘(C) COMMON ANCESTOR.—For purposes
of this paragraph, an individual shall not be
considered a common ancestor if, as of the later
of the effective date of this paragraph or the
time the election under section 1362(a) is
made, the individual is more than 6 generations
removed from the youngest generation of share-
holders.
‘‘(D) EFFECT OF ADOPTION, ETC.—In de-
termining whether any relationship specified in
subparagraph (B) or (C) exists, the rules of
section 152(b)(2) shall apply.
‘‘(E) ELECTION.—An election under sub-
paragraph (A)(ii)—
‘‘(i) must be made with the consent of
all shareholders,
‘‘(ii) shall remain in effect until termi-
nated, and
‘‘(iii) shall apply only with respect to
1 family in any corporation.’’
Subtitle B—Persons Allowed as
Shareholders
SEC. 111. CERTAIN EXEMPT ORGANIZATIONS.
(a) CERTAIN EXEMPT ORGANIZATIONS ALLOWED TO
BE SHAREHOLDERS.—
(1) IN GENERAL.—Subparagraph (B) of section
1361(b)(1) (defining small business corporation) is
amended to read as follows:
‘‘(B) have as a shareholder a person (other
than an estate, a trust described in subsection
(c)(2), or an organization described in sub-
section (c)(7)) who is not an individual,’’.
(2) ELIGIBLE EXEMPT ORGANIZATIONS.—Sec-
tion 1361(c) (relating to special rules for applying
subsection (b)) is amended by adding at the end the
following new paragraph:
‘‘(7) CERTAIN
EXEMPT
ORGANIZATIONS
PER-
MITTED AS SHAREHOLDERS.—For purposes of sub-
section (b)(1)(B), an organization described in sec-
tion 401(a) or 501(c)(3) may be a shareholder in an
S corporation.’’.
(b) CONTRIBUTIONS OF S CORPORATION STOCK.—
Section 170(e)(1) (relating to certain contributions of or-
dinary income and capital gain property) is amended by
adding at the end the following sentence: ‘‘For purposes
of applying this paragraph in the case of a charitable con-
tribution of stock in an S corporation, rules similar to the
rules of section 751 shall apply in determining whether
gain on such stock would have been long-term capital gain
if such stock were sold by the taxpayer.’’
(c) SPECIAL RULES APPLICABLE TO PARTNERSHIPS
AND S CORPORATIONS.—
(1) IN
GENERAL.—Subsection (c) of section
512 (relating to unrelated business tax income) is
amended—
(A) by inserting ‘‘or S corporation’’ after
‘‘partnership’’ each place it appears in para-
graphs (1) and (3),
(B) by inserting ‘‘or shareholder’’ after
‘‘member’’ in paragraph (1), and
(C) by inserting ‘‘AND S CORPORATIONS’’
after ‘‘PARTNERSHIPS’’ in the heading.
(2) REPORTING REQUIREMENT.—Section 6037
(relating to return of S corporation) is amended by
adding at the end the following new subsection:
‘‘(c) SEPARATE STATEMENT OF ITEMS OF UNRE-
LATED BUSINESS TAXABLE INCOME.—In the case of any
S corporation regularly carrying on a trade or business
(within the meaning of section 512(c)(1)), the information
required under subsection (b) to be furnished to any
shareholder described in section 1361(c)(7) shall include
such information as is necessary to enable the shareholder
to compute its pro rata share of the corporation’s income
or loss from the trade or business in accordance with sec-
tion 512(a)(1), but without regard to the modifications de-
scribed in paragraphs (8) through (15) of section 512(b).’’
SEC. 112. FINANCIAL INSTITUTIONS.
Subparagraph (B) of section 1361(b)(2) (defining in-
eligible corporation) is amended to read as follows:
‘‘(B) a financial institution which uses the
reserve method of accounting for bad debts de-
scribed in section 585 or 593,’’.
SEC. 113. NONRESIDENT ALIENS.
(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.—Paragraphs
(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) 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 para-
graph (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 con-
sidered 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 en-
gaged.’’
(2) APPLICATION
OF
WITHHOLDING
TAX
ON
NONRESIDENT
ALIEN
SHAREHOLDERS.—Section
1446 (relating to withholding tax on foreign part-
ners’ share of effectively connected income) is
amended by redesignating subsection (f) as sub-
section (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, and
‘‘(3) any reference to section 704 shall be treat-
ed as a reference to section 1366.’’
(3) 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 amend-
ed to read as follows:
‘‘SEC. 1446. WITHHOLDING TAX ON FOREIGN PARTNERS’
AND S CORPORATE SHAREHOLDERS’ SHARE
OF EFFECTIVELY CONNECTED INCOME.’’
(4) 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 chap-
ter 3 is amended to read as follows:
‘‘Sec. 1446. Withholding tax on foreign partners’ and S corporate shareholders’
share of effectively connected income.’’
(c) PERMANENT ESTABLISHMENT
OF PARTNERS
AND S CORPORATION SHAREHOLDERS.—Section 894 (re-
lating to income affected by treaty) is amended by adding
at the end 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 for-
eign 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.’’
SEC. 114. ELECTING SMALL BUSINESS TRUSTS.
(a) GENERAL RULE.—Subparagraph (A) of section
1361(c)(2) (relating to certain trusts permitted as share-
holders) is amended by inserting after clause (iv) the fol-
lowing new clause:
‘‘(v) An electing small business trust.’’
(b) CURRENT BENEFICIARIES TREATED AS SHARE-
HOLDERS.—Subparagraph (B) of section 1361(c)(2) is
amended by adding at the end the following new clause:
‘‘(v) In the case of a trust described
in clause (v) of subparagraph (A), each po-
tential current beneficiary of such trust
shall be treated as a shareholder; except
that, if for any period there is no potential
current beneficiary of such trust, such
trust shall be treated as the shareholder
during such period.’’
(c) ELECTING SMALL BUSINESS TRUST DEFINED.—
Section 1361 (defining S corporation) is amended by add-
ing at the end the following new subsection:
‘‘(e) ELECTING
SMALL
BUSINESS
TRUST
DE-
FINED.—
‘‘(1) ELECTING SMALL BUSINESS TRUST.—For
purposes of this section—
‘‘(A) IN GENERAL.—Except as provided in
subparagraph (B), the term ‘electing small
business trust’ means any trust if—
‘‘(i) such trust does not have as a
beneficiary any person other than an indi-
vidual, an estate, or an organization de-
scribed in section 401(a) or 501(c)(3),
‘‘(ii) no interest in such trust was ac-
quired by purchase, and
‘‘(iii) an election under this subsection
applies to such trust.
‘‘(B) CERTAIN TRUSTS NOT ELIGIBLE.—
The term ‘electing small business trust’ shall
not include—
‘‘(i) any qualified subchapter S trust
(as defined in subsection (d)(3)) if an elec-
tion under subsection (d)(2) applies to any
corporation the stock of which is held by
such trust, and
‘‘(ii) any trust exempt from tax under
this subtitle.
‘‘(C) PURCHASE.—For purposes of sub-
paragraph (A), the term ‘purchase’ means any
acquisition if the basis of the property acquired
is determined under section 1012.
‘‘(2) POTENTIAL CURRENT BENEFICIARY.—For
purposes of this section, the term ‘potential current
beneficiary’ means, with respect to any period, any
person who at any time during such period is enti-
tled to, or at the discretion of any person may re-
ceive, a distribution from the principal or income of
the trust. If a trust disposes of all of the stock which
it holds in an S corporation, then, with respect to
such corporation, the term ‘potential current bene-
ficiary’ does not include any person who first met
the requirements of the preceding sentence during
the 60-day period ending on the date of such dis-
position.
‘‘(3) ELECTION.—An election under this sub-
section shall be made by the trustee in such manner
and form, and at such time, as the Secretary may
prescribe. Any such election shall apply to the tax-
able year of the trust for which made and all subse-
quent taxable years of such trust unless revoked
with the consent of the Secretary.
‘‘(4) CROSS REFERENCE.—
‘‘For special treatment of electing small business
trusts, see section 641(d).’’
(d) TAXATION
OF
ELECTING
SMALL
BUSINESS
TRUSTS.—Section 641 (relating to imposition of tax on
trusts) is amended by adding at the end the following new
subsection:
‘‘(d) SPECIAL RULES FOR TAXATION OF ELECTING
SMALL BUSINESS TRUSTS.—
‘‘(1) IN GENERAL.—For purposes of this chap-
ter—
‘‘(A) the portion of any electing small busi-
ness trust which consists of stock in l or more
S corporations shall be treated as a separate
trust, and
‘‘(B) the amount of the tax imposed by
this chapter on such separate trust shall be de-
termined with the modifications of paragraph
(2).
‘‘(2) MODIFICATIONS.—For purposes of para-
graph (1), the modifications of this paragraph are
the following:
‘‘(A) Except as provided in section 1(h),
the amount of the tax imposed by section 1(e)
shall be determined by using the highest rate of
tax set forth in section 1(e).
‘‘(B) The exemption amount under section
55(d) shall be zero.
‘‘(C) The only items of income, loss, deduc-
tion, or credit to be taken into account are the
following:
‘‘(i) The items required to be taken
into account under section 1366.
‘‘(ii) Any gain or loss from the dis-
position of stock in an S corporation.
‘‘(iii) To the extent provided in regu-
lations, State or local income taxes or ad-
ministrative expenses to the extent alloca-
ble to items described in clauses (i) and
(ii).
No deduction or credit shall be allowed for any
amount not described in this paragraph, and no
item described in this paragraph shall be appor-
tioned to any beneficiary.
‘‘(D) No amount shall be allowed under
paragraph (1) or (2) of section 1211(b).
‘‘(3) TREATMENT
OF
REMAINDER
OF
TRUST
AND
DISTRIBUTIONS.—For purposes of determin-
ing—
‘‘(A) the amount of the tax imposed by
this chapter on the portion of any electing small
business trust not treated as a separate trust
under paragraph (1), and
‘‘(B) the distributable net income of the
entire trust,
the items referred to in paragraph (2)(C) shall be
excluded. Except as provided in the preceding sen-
tence, this subsection shall not affect the taxation of
any distribution from the trust.
‘‘(4) TREATMENT
OF
UNUSED
DEDUCTIONS
WHERE TERMINATION OF SEPARATE TRUST.—If a
portion of an electing small business trust ceases to
be treated as a separate trust under paragraph (1),
any carryover or excess deduction of the separate
trust which is referred to in section 642(h) shall be
taken into account by the entire trust.
‘‘(5) ELECTING SMALL BUSINESS TRUST.—For
purposes of this subsection, the term ‘electing small
business trust’ has the meaning given such term by
section 1361(e)(1).’’
Subtitle C—Other Provisions
SEC. 121. EXPANSION OF POST-DEATH QUALIFICATION FOR
CERTAIN TRUSTS.
Subparagraph (A) of section 1361(c)(2) (relating to
certain trusts permitted as shareholders) is amended—
(1) by striking ‘‘60-day period’’ each place it
appears in clauses (ii) and (iii) and inserting ‘‘2-year
period’’, and
(2) by striking the last sentence in clause (ii).
TITLE II—QUALIFICATION AND
ELIGIBILITY REQUIREMENTS
FOR S CORPORATIONS
Subtitle A—One Class of Stock
SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.
(a) IN GENERAL.—Section 1361(c), as amended by
section 111(a)(2), is amended by adding at the end the
following new paragraph:
‘‘(8) TREATMENT
OF
QUALIFIED
PREFERRED
STOCK.—
‘‘(A) IN GENERAL.—Notwithstanding sub-
section (b)(1)(D), an S corporation may issue
qualified preferred stock.
‘‘(B) QUALIFIED PREFERRED STOCK DE-
FINED.—For purposes of this paragraph, the
term ‘qualified preferred stock’ means stock de-
scribed in section 1504(a)(4) which is issued to
a person eligible to hold common stock of an S
corporation.
‘‘(C) DISTRIBUTIONS.—A distribution (not
in part or full payment in exchange for stock)
made by the corporation with respect to quali-
fied preferred stock shall be includible as inter-
est income of the holder and deductible to the
corporation as interest expense in computing
taxable income under section 1363(b) in the
year such distribution is received.’’
(b) CONFORMING AMENDMENTS.—
(1) Subparagraph (C) of section 1361(b)(1), as
redesignated by section 113(a)(1)(C), is amended by
inserting ‘‘except as provided in paragraph (8),’’ be-
fore ‘‘have’’.
(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 shall not, with respect to such stock,
be allocated any of the items described in paragraph
(1).’’
SEC. 202. FINANCIAL INSTITUTIONS PERMITTED TO HOLD
SAFE HARBOR DEBT.
Subparagraph (B) of section 1361(c)(5) (defining
straight debt) is amended by adding ‘‘and’’ at the end of
clause (i) and by striking clauses (ii) and (iii) and insert-
ing the following:
‘‘(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), or
‘‘(IV) a person which is actively
and regularly engaged in the business
of lending money.’’
Subtitle B—Elections and
Terminations
SEC. 211. RULES RELATING TO INADVERTENT TERMI-
NATIONS AND INVALID ELECTIONS.
(a) GENERAL RULE.—Subsection (f) of section 1362
(relating to inadvertent terminations) is amended to read
as follows:
‘‘(f) INADVERTENT INVALID ELECTIONS OR TERMI-
NATIONS.—If—
‘‘(1) an election under subsection (a) by any
corporation—
‘‘(A) was not effective for the taxable year
for which made (determined without regard to
subsection (b)(2)) by reason of a failure to meet
the requirements of section 1361(b) or to ob-
tain shareholder consents, or
‘‘(B) was terminated under paragraph (2)
of subsection (d),
‘‘(2) the Secretary determines that the cir-
cumstances resulting in such ineffectiveness or ter-
mination were inadvertent,
‘‘(3) no later than a reasonable period of time
after discovery of the circumstances resulting in
such ineffectiveness or termination, steps were
taken—
‘‘(A) so that the corporation is a small
business corporation, or
‘‘(B) to acquire the required shareholder
consents, and
‘‘(4) the corporation, and each person who was
a shareholder in the corporation at any time during
the period specified pursuant to this subsection,
agrees to make such adjustments (consistent with
the treatment of the corporation as an S corpora-
tion) as may be required by the Secretary with re-
spect to such period,
then, notwithstanding the circumstances resulting in such
ineffectiveness or termination, such corporation shall be
treated as an S corporation during the period specified
by the Secretary.’’
(b) LATE ELECTIONS.—Subsection (b) of section
1362 is amended by adding at the end thereof the follow-
ing new paragraph:
‘‘(5) AUTHORITY TO TREAT LATE ELECTIONS
AS TIMELY.—If—
‘‘(A) an election under subsection (a) is
made for any taxable year (determined without
regard to paragraph (3)) after the date pre-
scribed by this subsection for making such elec-
tion for such taxable year, and
‘‘(B) the Secretary determines that there
was reasonable cause for the failure to timely
make such election,
the Secretary may treat such election as timely
made for such taxable year (and paragraph (3) shall
not apply).’’
(c) AUTOMATIC WAIVERS.—The Secretary of the
Treasury shall provide for an automatic waiver procedure
under section 1362(f) of the Internal Revenue Code of
1986 in cases in which the Secretary determines appro-
priate.
(d) EFFECTIVE DATE.—The amendments made by
subsection (a) and (b) shall apply with respect to elections
for taxable years beginning after December 31, 1982.
SEC. 212. AGREEMENT TO TERMINATE YEAR.
Paragraph (2) of section 1377(a) (relating to pro
rata share) is amended to read as follows:
‘‘(2) ELECTION TO TERMINATE YEAR.—
‘‘(A) IN
GENERAL.—Under regulations
prescribed by the Secretary, if any shareholder
terminates the shareholder’s interest in the cor-
poration during the taxable year and all af-
fected shareholders agree to the application of
this paragraph, paragraph (1) shall be applied
to the affected shareholders as if the taxable
year consisted of 2 taxable years the first of
which ends on the date of the termination.
‘‘(B) 
AFFECTED
SHAREHOLDERS.—For
purposes of subparagraph (A), the term ‘af-
fected shareholders’ means the shareholder
whose interest is terminated and all sharehold-
ers to whom such shareholder has transferred
shares during the taxable year. If such share-
holder has transferred shares to the corpora-
tion, the term ‘affected shareholders’ shall in-
clude all persons who are shareholders during
the taxable year.’’
SEC. 213. EXPANSION OF POST-TERMINATION TRANSITION
PERIOD.
(a) IN GENERAL.—Paragraph (1) of section 1377(b)
(relating to post-termination transition period) is amended
by striking ‘‘and’’ at the end of subparagraph (A), by re-
designating subparagraph (B) as subparagraph (C), and
by inserting after subparagraph (A) the following new sub-
paragraph:
‘‘(B) the 120-day period beginning on the
date of any determination pursuant to an audit
of the taxpayer which follows the termination of
the corporation’s election and which adjusts a
subchapter S item of income, loss, or deduction
of the corporation arising during the S period
(as defined in section 1368(e)(2)), and’’.
(b) DETERMINATION DEFINED.—Paragraph (2) of
section 1377(b) is amended by striking subparagraphs (A)
and (B), by redesignating subparagraph (C) as subpara-
graph (B), and by inserting before subparagraph (B) (as
so redesignated) the following new subparagraph:
‘‘(A) a determination as defined in section
1313(a), or’’.
(c) REPEAL OF SPECIAL AUDIT PROVISIONS FOR
SUBCHAPTER S ITEMS.—
(1) GENERAL RULE.—Subchapter D of chapter
63 (relating to tax treatment of subchapter S items)
is hereby repealed.
(2) CONSISTENT TREATMENT REQUIRED.—Sec-
tion 6037 (relating to return of S corporation), as
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
return.
‘‘(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
sentence.
‘‘(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 cor-
poration having subchapter C earnings and profits
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:
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
‘‘In the case of the—
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, 1994.’’
(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’ 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) is amended by striking
subparagraph (A) and by redesignating subparagraphs
(B), (C), (D), and (E) as subparagraphs (A), (B), (C),
and (D), respectively.
(b) 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.’’
(c) CONFORMING AMENDMENTS.—
(1) Subsection (c) of section 1361, as amended
by sections 111 and 201, is amended by striking
paragraph (6) and redesignating paragraphs (7) and
(8) as paragraphs (6) and (7), respectively.
(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. 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) CONFORMING AMENDMENTS.—
(1) Section 162(l) is amended by striking para-
graph (5) and by redesignating paragraph (6) as
paragraph (5).
(2) The table of sections for part III of sub-
chapter S of chapter 1 is amended by striking the
item relating to section 1372.
SEC. 223. 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
‘‘(II) the increases in such account for
such taxable year.’’
(c) CONFORMING AMENDMENTS.—Subparagraph (A)
of section 1368(e)(1) is amended—
(1) by striking ‘‘as provided in subparagraph
(B)’’ and inserting ‘‘as otherwise provided in this
paragraph’’, and
(2) by striking ‘‘section 1367(b)(2)(A)’’ and in-
serting ‘‘section 1367(a)(2)’’.
SEC. 224. CONSENT DIVIDEND FOR AAA BYPASS ELECTION.
Section 1368(e)(3) (relating to election to distribute
earnings first) is amended by adding at the end the follow-
ing new subparagraph:
‘‘(C) CONSENT DIVIDEND.—Under regula-
tions prescribed by the Secretary, an S corpora-
tion may, subject to the election under this
paragraph, consent to treat as a distribution
the amount specified in such consent, to the ex-
tent such amount does not exceed the accumu-
lated earnings and profits of such corporation.
The amount so specified shall be considered—
‘‘(i) as distributed in money by the
corporation to its shareholders on the last
day of the taxable year of the corporation
and as contributed to the capital of the
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. 225. 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. 226. 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, 1993,
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.
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.’’
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
liquidation.’’
(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.
Except as otherwise provided in this Act, the amend-
ments made by this Act shall apply to taxable years begin-
ning after December 31, 1994.
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