To amend the Internal Revenue Code of 1986 to provide for unified income taxation with respect to pass-thru entities.

SECTION 1. SHORT TITLE.

    This Act may be cited as ``Small Business Tax Modernization Act of 
2004''.

SEC. 2. UNIFIED PASS-THRU ENTITY REGIME.

    (a) Termination of S Corporation Status.--
            (1) No new s corporation elections.--Subsection (a) of 
        section 1362 of the Internal Revenue Code of 1986 is amended by 
        adding at the end the following new paragraph:
            ``(3) Termination of authority to make election.--No 
        election may be made under paragraph (1) for any taxable year 
        beginning after December 31, 2004.''.
            (2) Termination of status.--Subsection (d) of section 1362 
        of such Code (relating to termination) is amended by adding at 
        the end the following new paragraph:
            ``(4) Treatment as partnership after 2014.--An election 
        under subsection (a)--
                    ``(A) shall not be effective for any taxable year 
                beginning after December 31, 2014, and
                    ``(B) shall be treated as an election under section 
                7701(a)(2)(B) for taxable years beginning after such 
                date.''.
            (3) Effective date.--The amendments made by this subsection 
        shall apply to taxable years beginning after December 31, 2004.
    (b) Election by Certain Corporations to Be Taxed as Partnership.--
            (1) In general.--Paragraph (2) of section 7701(a) of such 
        Code (defining partnership and partner) is amended to read as 
        follows:
            ``(2) Partnership and partner.--
                    ``(A) In general.--The term `partnership' includes 
                a syndicate, group, pool, joint venture, or other 
                unincorporated organization, through or by means of 
                which any business, financial operation, or venture is 
                carried on, and which is not, within the meaning of 
                this title, a trust or estate or a corporation; and the 
                term `partner' includes a member in such a syndicate, 
                group, pool, joint venture, or organization.
                    ``(B) Election by corporation to be taxed as 
                partnership.--
                            ``(i) In general.--An eligible corporation 
                        may elect to be treated as a partnership for 
                        purposes of this title.
                            ``(ii) Tax treatment.--Except as provided 
                        in section 1379A--
                                    ``(I) no gain or loss shall be 
                                recognized to the corporation or the 
                                shareholders by reason of an election 
                                under clause (i), and
                                    ``(II) except in the case of an 
                                election made by a S corporation after 
                                the end of the recognition period (as 
                                defined in section 1374(d)(7) without 
                                regard to subparagraph (B) thereof), 
                                section 1374 shall apply to the entity 
                                after such election.
                            ``(iii) Eligible corporation.--For purposes 
                        of clause (i), the term `eligible corporation' 
                        means an entity--
                                    ``(I) which, without regard to this 
                                subparagraph, is a domestic corporation 
                                no stock of which is readily tradable 
                                on an established securities market or 
                                otherwise, and
                                    ``(II) which is not an ineligible 
                                corporation (as defined by section 
                                1361(b)(2)).
                            ``(iv) Election and termination.--For 
                        purposes of this subparagraph, rules similar to 
                        the rules of section 1362 (other than 
                        subsections (a)(3), (d)(3) and (4), and (e) 
                        thereof) shall apply.
                            ``(v) Distributions, etc.--Each partner 
                        shall include in gross income as a dividend, 
                        any amount that would have been so includible 
                        had the entity been an S corporation during the 
                        period the entity was treated as a partnership. 
                        Notwithstanding the preceding sentence, the 
                        provisions of subchapter K of chapter 1 shall 
                        apply to determine the basis of any property 
                        distributed and the basis of any interest in 
                        the partnership.
                            ``(vi) Cross reference.--For tax treatment 
                        of S corporation electing unified pass-thru 
                        regime, see section 1379A.''.
            (2) Tax treatment of s corporation electing unified pass-
        thru regime.--
                    (A) In general.--Part IV of subchapter S of chapter 
                1 of such Code is amended by inserting after section 
                1379 the following new section:

``SEC. 1379A. TAX TREATMENT OF S CORPORATION ELECTING UNIFIED PASS-THRU 
              REGIME.

    ``In the case of an election under section 7701(a)(2)(B) by an S 
corporation before January 1, 2015, with respect to the corporation--
            ``(1) the shareholders shall be treated as if the assets 
        were distributed, on the date of such election, to the 
        shareholders in exchange for their stock,
            ``(2) any gain or loss recognized to the shareholders by 
        reason of paragraph (1) shall be taken into account by the 
        shareholders ratably over the taxable year in which the 
        distribution is deemed to be made under paragraph (1) and the 
        succeeding 4 taxable years, and
            ``(3) proper adjustments to the basis of interests in the 
        entity shall be made.''.
                    (B) Clerical amendment.--The table of sections for 
                part IV of subchapter S of chapter 1 of such Code is 
                amended by inserting after the item relating to section 
                1379 the following new item:

``Sec. 1379A. Tax treatment of S corporation electing unified pass-thru 
                            regime.''.
            (3) Modification to treatment of section 1374 tax for 
        earnings and profits purposes.--Paragraph (2) of section 
        1366(f) of such Code is amended to read as follows:
            ``(2) Treatment of tax imposed on built-in gains.--
                    ``(A) In general.--The amount of the items of the 
                net recognized built-in gain taken into account under 
                section 1374(b)(1) (reduced by any deduction allowed 
                under section 1374(b)(2)) shall not be taken into 
                account under this section.
                    ``(B) Earnings and profits.--The accumulated 
                earnings and profits of the corporation shall be 
                increased at the beginning of the taxable year by the 
                amount not taken into account under this section by 
                reason of subparagraph (A) (determined without regard 
                to section 1374(b)(2)) reduced by the tax imposed by 
                section 1374 (net of credits allowed).''.
            (4) Effect of election on recognition period for purposes 
        of tax imposed on built-in gains.--Paragraph (7) of section 
        1374(d) of such Code is amended to read as follows:
            ``(7) Recognition period.--
                    ``(A) In general.--The term `recognition period' 
                means the 10-year period beginning with the 1st day of 
                the 1st taxable year for which the corporation was an S 
                corporation. For purposes of applying this section to 
                any amount includible in income by reason of section 
                593(e), the preceding sentence shall be applied without 
                regard to the phrase `10-year'.
                    ``(B) Special rule relating to election of 
                corporation to be taxed as partnership.--
                            ``(i) In general.--In the case of an 
                        election under section 7701(a)(2)(B), 
                        subparagraph (A) shall be applied by 
                        substituting `25-year' for `10-year' both 
                        places it appears.
                            ``(ii) Exception where 10-year period 
                        expired.--If, on the date of an election 
                        referred to in clause (i) by a corporation, the 
                        10-year period specified in subparagraph (A) 
                        with respect to such corporation has expired, 
                        clause (i) shall not apply to such 
                        corporation.''.
            (5) Effective dates.--The amendments made by this 
        subsection shall apply to taxable years beginning after 
        December 31, 2004.
    (c) Step Transaction Doctrine not to Apply to Partnership 
Incorporation Followed by Corporate Reorganization.--
            (1) In general.--Section 351 of such Code is amended by 
        redesignating subsection (h) as subsection (i) and by inserting 
        after subsection (g) the following new subsection:
    ``(h) Special Rule for Partnerships Which Incorporate and 
Subsequently Reorganize.--The step transaction doctrine and any similar 
doctrine shall not apply for purposes of determining whether the 
control requirement of subsection (a) is met in any case in which--
            ``(1) a partnership engaged in an active trade or business 
        transfers substantially all of the property used in carrying on 
        such trade or business to a corporation which is not publicly 
        traded, and
            ``(2) such corporation subsequently enters into a 
        reorganization under this chapter.''.
            (2) Effective date.--The amendment made by this subsection 
        shall apply to transactions after December 31, 2004.

SEC. 3. PARTNERSHIP INCOME ATTRIBUTABLE TO CAPITAL EXCLUDED FROM NET 
              EARNINGS FROM SELF-EMPLOYMENT.

    (a) In General.--Paragraph (13) of section 1402(a) of the Internal 
Revenue Code of 1986 is amended to read as follows:
            ``(13) there shall be excluded the distributive share of 
        net income of a partner attributable to capital;''.
    (b) Partnership Income Attributable to Capital.--Section 1402 of 
such Code is amended by adding at the end the following new subsection:
    ``(l) Partnership Income Attributable to Capital.--
            ``(1) In general.--For purposes of subsection (a)(13), the 
        following amounts shall be treated as income attributable to 
        capital--
                    ``(A) the amount, if any, in excess of what would 
                constitute reasonable compensation for services 
                rendered by such partner to the partnership, and
                    ``(B) an amount equal to a reasonable rate of 
                return on unreturned capital of the partner determined 
                as of the beginning of the taxable year.
            ``(2) Definitions.--For purposes of paragraph (1)--
                    ``(A) Unreturned capital.--The term `unreturned 
                capital' means the excess of the aggregate amount of 
                money and the fair market value as of the date of 
                contribution of other consideration (net of 
                liabilities) contributed by the partner over the 
                aggregate amount of money and the fair market value as 
                of the date of distribution of other consideration (net 
                of liabilities) distributed by the partnership to the 
                partner, increased or decreased for the partner's 
                distributive share of all reportable items as 
                determined in section 702. If the partner acquires a 
                partnership interest and the partnership makes an 
                election under section 754, the partner's unreturned 
                capital shall take into account appropriate adjustments 
                under section 743.
                    ``(B) Reasonable rate of return.--A reasonable rate 
                of return on unreturned capital shall equal 150 percent 
                (or such higher rate as is established in regulations) 
                of the highest applicable Federal rate, as determined 
                under section 1274(d)(1), at the beginning of the 
                partnership's taxable year.
            ``(3) Regulations.--The Secretary shall prescribe such 
        regulations as may be necessary to carry out the purposes of 
        this subsection.''.
    (c) Effective Date.--The amendments made by this section shall 
apply with respect to services performed in taxable years beginning 
after December 31, 2004.

Summary: Small Business Modernization Act of 2004 - Amends the Internal Revenue Code to: (1) terminate subchapter S corporation elections after 2004 and subchapter S status after 2014 and to allow privately-held domestic corporations, in lieu of electing subchapter S treatment, to elect to be treated as partnerships for tax purposes; (2) set forth rules for the tax treatment of former subchapter S corporations electing partnership status; and (3) exclude from net earnings from self-employment partnership income attributable to capital.