To amend the Internal Revenue Code of 1986 to provide for S corporation reform, and for other purposes.

SECTION 1. SHORT TITLE, REFERENCE.

    (a) Short Title.--This Act may be cited as the ``S Corporation 
Modernization Act of 2007''.
    (b) Amendment of 1986 Code.--Except as otherwise expressly 
provided, whenever in this Act an amendment or repeal is expressed in 
terms of an amendment to, or repeal of, a section or other provision, 
the reference shall be considered to be made to a section or other 
provision of the Internal Revenue Code of 1986.

SEC. 2. REDUCED RECOGNITION PERIOD FOR BUILT-IN GAINS.

    (a) In General.--Paragraph (7) of section 1374(d) (relating to 
definitions and special rules) is amended as follows:
            ``(7) Recognition period.--The term `recognition period' 
        means the 7-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 distributions to shareholders pursuant 
        to section 593(e), the preceding sentence shall be applied 
        without regard to the duration of the recognition period in 
        effect on the date of such distribution.''.
    (b) Effective Date.--The amendment made by this section--
            (1) shall apply for purposes of determining the recognition 
        period with respect to 1st days referred to in section 
        1374(d)(7) of the Internal Revenue Code of 1986 occurring 
        before, on, or after the date of the enactment of this Act, but
            (2) shall not apply for purposes of determining the tax 
        imposed by section 1374 of such Code for taxable years ending 
        before such date.

SEC. 3. EXPANSION OF QUALIFYING BENEFICIARIES OF AN ELECTING SMALL 
              BUSINESS TRUST.

    (a) No Look Through for Eligibility Purposes.--Clause (v) of 
section 1361(c)(2)(B) (relating to treatment as shareholders) is 
amended by adding at the end the following new sentence: ``This clause 
shall not apply for purposes of subsection (b)(1)(C).''.
    (b) Effective Date.--The amendment made by this section shall take 
effect on the date of the enactment of this Act.

SEC. 4. REPEAL OF EXCESSIVE PASSIVE INVESTMENT INCOME AS A TERMINATION 
              EVENT.

    (a) In General.--Section 1362(d) (relating to termination) is 
amended by striking paragraph (3).
    (b) Conforming Amendments.--
            (1) Section 1362(f)(1) is amended by striking ``or (3)''.
            (2) Clause (i) of section 1042(c)(4)(A) is amended by 
        striking ``section 1362(d)(3)(C)'' and inserting ``section 
        1375(b)(3)''.
    (c) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2007.

SEC. 5. MODIFICATIONS TO PASSIVE INCOME RULES.

    (a) Increased Limit.--
            (1) In general.--Paragraph (2) of section 1375(a) (relating 
        to tax imposed when passive investment income of corporation 
        having accumulated earnings and profits exceeds 25 percent of 
        gross receipts) is amended by striking ``25 percent'' and 
        inserting ``60 percent''.
            (2) Conforming amendments.--
                    (A) Subparagraph (J) of section 26(b)(2) is amended 
                by striking ``25 percent'' and inserting ``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 inserting ``60 percent''.
                    (D) The table of sections for part III of 
                subchapter S of chapter 1 is amended by striking ``25 
                percent'' in the item relating to section 1375 and 
                inserting ``60 percent''.
    (b) Effective Date.--The amendments made by this section shall 
apply to taxable years beginning after December 31, 2007.

SEC. 6. EXPANSION OF S CORPORATION ELIGIBLE SHAREHOLDERS TO INCLUDE 
              IRAS.

    (a) In General.--Clause (vi) of section 1361(c)(2)(A) (relating to 
certain trusts permitted as shareholders) is amended to read as 
follows:
                            ``(vi) A trust which constitutes an 
                        individual retirement account under section 
                        408(a), including one designated as a Roth IRA 
                        under section 408A.''.
    (b) Sale of Stock in IRA Relating to S Corporation Election Exempt 
From Prohibited Transaction Rules.--Paragraph (16) of section 4975(d) 
(relating to exemptions) is amended to read as follows:
            ``(16) a sale of stock held by a trust which constitutes an 
        individual retirement account under section 408(a) to the 
        individual for whose benefit such account is established if--
                    ``(A) such sale is pursuant to an election under 
                section 1362(a) by the issuer of such stock,
                    ``(B) such sale is for fair market value at the 
                time of sale (as established by an independent 
                appraiser) and the terms of the sale are otherwise at 
                least as favorable to such trust as the terms that 
                would apply on a sale to an unrelated party,
                    ``(C) such trust does not pay any commissions, 
                costs, or other expenses in connection with the sale, 
                and
                    ``(D) the stock is sold in a single transaction for 
                cash not later than 120 days after the S corporation 
                election is made.''.
    (c) Effective Date.--The amendments made by this section shall take 
effect on the date of the enactment of this Act.

SEC. 7. ALLOWANCE OF DEDUCTION FOR CHARITABLE CONTRIBUTIONS FOR 
              ELECTING SMALL BUSINESS TRUSTS.

    (a) In General.--Section 641(c)(2)(C) (relating to modifications) 
is amended by adding at the end the following new sentence: ``The 
deduction for charitable contributions allowed under clause (i) shall 
be determined without regard to section 642(c), and the limitations 
imposed by section 170(b)(1) on the amount of the deduction shall be 
applied to the electing small business trust as if it were an 
individual.''.
    (b) Effective Date.--The amendment made by this section shall apply 
to taxable years beginning after the date of the enactment of this Act.

SEC. 8. ENTITY NEUTRALITY STUDY.

    Not later than December 31, 2009, the Comptroller General of the 
United States shall conduct a study on entity neutrality under the 
Internal Revenue Code of 1986 and shall submit a report to the 
Committee on Ways and Means of the House of Representatives which--
            (1) discusses the challenges to providing equal treatment 
        between S corporations and limited liability companies under 
        the Internal Revenue Code of 1986,
            (2) identifies the differences under the Internal Revenue 
        Code of 1986 between the various pass-through entity rules, and
            (3) discusses why entities would prefer one set of rules 
        over another.

Summary: S Corporation Modernization Act of 2007 - Amends the Internal Revenue Code to revise the tax treatment of S corporations, including by: (1) reducing from 10 to 7 years the period during which S corporation built-in gains are subject to tax; (2) allowing nonresident aliens to qualify as beneficiaries of an electing small business trust (ESBT); (3) repealing mandatory termination of S corporation elections for excessive passive investment income; (4) allowing S corporations to increase passive investment income from 25 to 60% without incurring additional tax; (5) allowing individual retirement accounts to be S corporation shareholders; and (6) allowing ESBTs to claim expanded charitable tax deductions.

Directs the Comptroller General to study and report to Congress on entity neutrality under the Internal Revenue Code with respect to S corporations, limited liability companies, and other pass-through entities.