account is established if such sale is pursuant to an 
election under section 1362(a).’’. 
(d) CONFORMING AMENDMENT.—Section 512(e)(1) 
is amended by inserting ‘‘1361(c)(2)(A)(vi) or’’ before 
‘‘1361(c)(6)’’. 
(e) EFFECTIVE DATE.—The amendments made by 
this section shall apply to trusts which constitute indi-
vidual retirement accounts on the date of the enactment 
of this Act. 
SEC. 104. INCREASE IN NUMBER OF ELIGIBLE SHARE-
HOLDERS TO 150. 
(a) IN GENERAL.—Section 1361(b)(1)(A) (defining 
small business corporation) is amended by striking ‘‘75’’ 
and inserting ‘‘150’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
TITLE II—QUALIFICATION AND 
ELIGIBILITY REQUIREMENTS 
OF S CORPORATIONS 
SEC. 201. 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) 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, 2003. 
SEC. 202. 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, 2003. 
SEC. 203. 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)(4)’’.
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
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 invest-
ment 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 heading for section 1375 is 
amended by striking ‘‘25 PERCENT’’ and in-
serting ‘‘60 PERCENT’’. 
(D) 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, 2003.
SEC. 205. ADJUSTMENT TO BASIS OF S CORPORATION 
STOCK 
FOR 
CERTAIN 
CHARITABLE 
CON-
TRIBUTIONS. 
(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, 2003.
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 share-
holder 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 liquida-
tion 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 treat-
ed 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) SUSPENDED PASSIVE ACTIVITY LOSSES.—Para-
graph (3) of section 1371(b) is amended to read as fol-
lows: 
‘‘(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 tax-
able years to which an item may be carried back or 
carried forward nor prevent the allowance of a pas-
sive 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, 2003.
SEC. 302. TRANSFER OF SUSPENDED LOSSES INCIDENT TO 
DIVORCE. 
(a) IN GENERAL.—Section 1366(d) (relating to spe-
cial rules for losses and deductions) is amended by adding 
at the end the following new paragraph: 
‘‘(4) TRANSFER OF SUSPENDED LOSSES AND 
DEDUCTIONS WHEN STOCK IS TRANSFERRED INCI-
DENT TO DIVORCE.—For purposes of paragraph (2), 
the transfer of any shareholder’s stock in an S cor-
poration incident to a decree of divorce shall include 
any loss or deduction described in such paragraph 
attributable to such stock.’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to transfers made after the date 
of the enactment of this Act. 
SEC. 303. USE OF PASSIVE ACTIVITY LOSS AND AT-RISK 
AMOUNTS BY QUALIFIED SUBCHAPTER S 
TRUST INCOME BENEFICIARIES. 
(a) IN GENERAL.—Section 1361(d)(1) (relating to 
special rule for qualified subchapter S trust) is amended—
(1) by striking ‘‘and’’ at the end of subpara-
graph (A), 
(2) by striking the period at the end of sub-
paragraph (B) and inserting ‘‘, and’’, and 
(3) by adding at the end the following new sub-
paragraph:
‘‘(C) for purposes of applying sections 465 
and 469(g) to the beneficiary of the trust, the 
disposition of the S corporation stock by the 
trust shall be treated as a disposition by such 
beneficiary.’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to transfers made after the date 
of the enactment of this Act. 
SEC. 304. DEDUCTIBILITY OF INTEREST EXPENSE IN-
CURRED 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 insert-
ing 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, 2003. 
SEC. 305. DISREGARD OF UNEXERCISED POWERS OF AP-
POINTMENT IN DETERMINING POTENTIAL 
CURRENT BENEFICIARIES OF ESBT. 
(a) IN GENERAL.—Section 1361(e)(2) (defining po-
tential current beneficiary) is amended—
(1) by inserting ‘‘(determined without regard to 
any unexercised (in whole or in part) power of ap-
pointment during such period)’’ after ‘‘of the trust’’ 
in the first sentence, and 
(2) by striking ‘‘60-day’’ in the second sentence 
and inserting ‘‘1-year’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 306. CLARIFICATION OF ELECTING SMALL BUSINESS 
TRUST DISTRIBUTION RULES. 
(a) IN GENERAL.—Section 641(c)(1) (relating to spe-
cial rules for taxation of electing small business trusts) 
is amended—
(1) by striking ‘‘and’’ at the end of subpara-
graph (A), 
(2) by redesignating subparagraph (B) as sub-
paragraph (C), and 
(3) by inserting after subparagraph (A) the fol-
lowing new subparagraph:
‘‘(B) any distribution attributable to the 
portion treated as a separate trust shall be 
treated separately from any distribution attrib-
utable to the portion not so treated, and’’.
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 1996. 
SEC. 307. ALLOWANCE OF CHARITABLE CONTRIBUTIONS 
DEDUCTION FOR ELECTING SMALL BUSINESS 
TRUSTS. 
(a) IN GENERAL.—Section 641(c)(2)(C) (relating to 
modifications), as amended by section 304(a), is amended 
by inserting after clause (iv) the following new clause: 
‘‘(v) Deductions described in section 
642(c)(1).’’. 
(b) CONFORMING AMENDMENT.—Section 512(e) (re-
lating to special rules applicable to S corporations) is 
amended by redesignating subparagraph (3) as subpara-
graph (4) and by inserting after subparagraph (2) the fol-
lowing new subparagraph: 
‘‘(3) AMOUNTS RECEIVED FROM AN ELECTING 
SMALL
BUSINESS
TRUST.—Notwithstanding any 
other provision of this part, amounts received by an 
organization described in section 511(a)(2) from an 
electing small business trust (as defined in section 
1361(e)) shall be taken into account in computing 
the unrelated business taxable income of such orga-
nization to the extent such amount is deducted by 
such trust under section 641(c)(2)(C)(v).’’.
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 308. SHAREHOLDER BASIS NOT INCREASED BY IN-
COME DERIVED FROM CANCELLATION OF S 
CORPORATION’S DEBT. 
(a) IN GENERAL.—Section 1366(a)(1) (relating to 
determination of shareholder’s tax liability) is amended by 
inserting ‘‘but not including income excludable from gross 
income under section 108’’ after ‘‘tax-exempt income’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to discharges of indebtedness oc-
curring after December 31, 2002. 
SEC. 309. BACK TO BACK LOANS AS INDEBTEDNESS. 
(a) IN GENERAL.—Section 1366(d) (relating to spe-
cial 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 sub-
section (d), the indebtedness of an S corpora-
tion to the shareholder shall include any loans 
made or acquired (by purchase, gift, or dis-
tribution from another person) by a shareholder 
to the S corporation, regardless of whether the 
funds loaned by the shareholder to the S cor-
poration were obtained by the shareholder by 
means of a recourse loan from another person 
(whether related or unrelated to the share-
holder).’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
TITLE IV—EXPANSION OF S COR-
PORATION ELIGIBILITY FOR 
BANKS 
SEC. 401. EXCLUSION OF INVESTMENT SECURITIES INCOME 
FROM PASSIVE INCOME TEST FOR BANK S 
CORPORATIONS. 
(a) IN GENERAL.—Section 1375(b)(3) (defining pas-
sive investment income), as amended by section 204, is 
amended by adding at the end the following new subpara-
graph: 
‘‘(F) EXCEPTION
FOR
BANKS; ETC.—In 
the case of a bank (as defined in section 581), 
a bank holding company (as defined in section 
246A(c)(3)(B)(ii)), or a qualified subchapter S 
subsidiary which is a bank, the term ‘passive 
investment income’ shall not include—
‘‘(i) interest income earned by such 
bank, bank holding company, or qualified 
subchapter S subsidiary, or 
‘‘(ii) dividends on assets required to 
be held by such bank, bank holding com-
pany, or qualified subchapter S subsidiary 
to conduct a banking business, including 
stock in the Federal Reserve Bank, the 
Federal Home Loan Bank, or the Federal 
Agricultural Mortgage Bank or participa-
tion certificates issued by a Federal Inter-
mediate Credit Bank.’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to taxable years beginning after 
December 31, 1996. 
SEC. 402. TREATMENT OF QUALIFYING DIRECTOR SHARES. 
(a) IN GENERAL.—Section 1361 (defining S corpora-
tion), 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 sub-
chapter—
‘‘(A) qualifying director shares 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 
qualifying director shares. 
‘‘(2) 
QUALIFYING
DIRECTOR
SHARES
DE-
FINED.—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—
‘‘(i) which are held by an individual 
solely by reason of status as a director of 
such bank or company or its controlled 
subsidiary; and 
‘‘(ii) which are subject to an agree-
ment pursuant to which the holder is re-
quired to dispose of the shares of stock 
upon termination of the holder’s status as 
a director at the same price as the indi-
vidual 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 ex-
pense in computing taxable income under section 
1363(b) in the year such distribution is received.’’. 
(b) CONFORMING AMENDMENTS.—
(1) Section 1361(b)(1) is amended by inserting 
‘‘, except as provided in subsection (g),’’ before 
‘‘which does not’’. 
(2) Section 1366(a) is amended by adding at 
the end the following new paragraph: 
‘‘(3) ALLOCATION
WITH
RESPECT
TO
QUALI-
FYING
DIRECTOR
SHARES.—The holders of quali-
fying director shares (as defined in section 1361(g)) 
shall not, with respect to such shares of stock, be al-
located any of the items described in paragraph 
(1).’’. 
(3) Section 1373(a) 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 adding at the end the following new 
paragraph: 
‘‘(3) 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. 403. 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 Decem-
ber 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. RELIEF FROM INADVERTENTLY INVALID QUALI-
FIED SUBCHAPTER S SUBSIDIARY ELECTIONS 
AND TERMINATIONS. 
(a) IN GENERAL.—Section 1362(f) (relating to inad-
vertent invalid elections or terminations) is amended—
(1) 
by 
inserting 
‘‘or 
under 
section 
1361(b)(3)(B)(ii)’’ after ‘‘subsection (a)’’ in para-
graph (1), 
(2) 
by 
inserting 
‘‘or 
under 
section 
1361(b)(3)(C)’’ after ‘‘subsection (d)’’ in paragraph 
(1)(B), 
(3) by inserting ‘‘or a qualified subchapter S 
subsidiary, as the case may be’’ after ‘‘small busi-
ness corporation’’ in paragraph (3)(A),
(4) by inserting ‘‘or a qualified subchapter S 
subsidiary, as the case may be’’ after ‘‘S corpora-
tion’’ in paragraph (4), and 
(5) by inserting ‘‘or a qualified subchapter S 
subsidiary, as the case may be’’ after ‘‘S corpora-
tion’’ in the matter following paragraph (4). 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 1996. 
SEC. 502. INFORMATION RETURNS FOR QUALIFIED SUB-
CHAPTER S SUBSIDIARIES. 
(a) IN GENERAL.—Section 1361(b)(3)(A) (relating 
to treatment of certain wholly owned subsidiaries) is 
amended by inserting ‘‘and in the case of information re-
turns required under part III of subchapter A of chapter 
61’’ after ‘‘Secretary’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to taxable years beginning after 
December 31, 2003.
SEC. 503. 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 amend-
ed by adding at the end the following new subparagraph:
‘‘(E) 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 per-
centage of the stock transferred, and 
‘‘(ii) followed by a deemed contribu-
tion by the S corporation and the trans-
feree in a section 351 transaction.’’. 
(b) EFFECTIVE DATE.—The amendment made by 
this section shall apply to taxable years beginning after 
December 31, 1996. 
SEC. 504. EXCEPTION TO APPLICATION OF STEP TRANS-
ACTION DOCTRINE FOR RESTRUCTURING IN 
CONNECTION WITH MAKING QUALIFIED SUB-
CHAPTER S SUBSIDIARY ELECTIONS. 
(a) IN GENERAL.—Section 1361(b)(3) (relating to 
treatment of certain wholly owned subsidiaries), as amend-
ed by section 503, is amended by redesignating subpara-
graphs (C), (D), and (E), as subparagraphs (D), (E), and 
(F), respectively, and by inserting after subparagraph (B) 
the following new subparagraph:
‘‘(C) TREATMENT
OF
ELECTION.—The 
election under subparagraph (B)(ii) shall be 
treated as a liquidation of the qualified sub-
chapter S subsidiary to which section 332 ap-
plies.’’. 
(b) EFFECTIVE DATE.—The amendments made by 
this section shall apply to elections effective after Decem-
ber 31, 2003. 
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 amend-
ed 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 De-
cember 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 begin-
ning 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. NO GAIN OR LOSS ON DEFERRED INTERCOMPANY 
TRANSACTIONS BECAUSE OF CONVERSION 
TO S CORPORATION OR QUALIFIED S COR-
PORATION SUBSIDIARY. 
With respect to taxable years beginning before, on, 
or after July 12, 1995, the regulations under section 1502 
of the Internal Revenue Code of 1986 shall not cause gain 
or loss to be recognized by reason of an election under 
section 1361(b)(3)(B) or 1362(a) of such Code. 
SEC. 603. TREATMENT OF CHARITABLE CONTRIBUTION 
AND 
FOREIGN 
TAX 
CREDIT 
CARRYFORWARDS. 
(a) 
CHARITABLE
CONTRIBUTION 
CARRYFORWARDS.—The 
last 
sentence 
of 
section 
1374(b)(2) (relating to net operating loss carryforwards 
from C years allowed) is amended by inserting ‘‘or a chari-
table contribution carryforward under section 170(d)(2)’’ 
after ‘‘capital loss carryforward’’. 
(b) FOREIGN TAX CREDIT CARRYFORWARDS.—The 
last sentence of section 1374(b)(3)(B) (relating to busi-
ness credit carryforwards from C years allowed) is amend-
ed by inserting ‘‘and the foreign tax credit carryforward 
under section 904’’ after ‘‘section 53’’. 
(c) 
TREATMENT
OF
ADDITIONAL 
CARRYFORWARDS.—Section 1374(b) (relating to amount 
of tax) is amended by adding at the end the following new 
paragraph: 
‘‘(5) 
TREATMENT
OF
ADDITIONAL 
CARRYFORWARDS.—The Secretary under regulations 
shall provide treatment similar to the preceding 
paragraphs 
of 
this 
subsection 
for 
other 
carryforwards attributable to taxable years for which 
an S corporation was a C corporation.’’. 
(d) EFFECTIVE DATE.—The amendments made by 
this section shall apply to taxable years beginning after 
December 31, 2003. 
SEC. 604. DISTRIBUTIONS BY AN S CORPORATION TO AN 
EMPLOYEE STOCK OWNERSHIP PLAN. 
(a) IN GENERAL.—Section 1368 (relating to distribu-
tions) is amended by adding at the end the following new 
subsection: 
‘‘(f) DISTRIBUTIONS BY AN S CORPORATION TO AN 
EMPLOYEE STOCK OWNERSHIP PLAN.—Any distribution 
described in subsection (a) to an employee stock ownership
plan (as defined in section 4975(e)(7)) shall be treated 
as a dividend under section 404(k)(2)(A).’’. 
(b) TECHNICAL AMENDMENT.—Section 404(a)(9)(C) 
(relating to S corporations) is amended to read as follows: 
‘‘(C) S CORPORATIONS.—The deduction 
provided in this paragraph shall not apply to an 
S corporation.’’. 
(c) EFFECTIVE DATE.—The amendments made by 
this section shall apply to distributions received after the 
date of the enactment of this Act. 
SEC. 605. 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 cred-
it 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 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 enact-
ment of this Act) shall not be taken into account.
Æ