H.R. 4056 (103rd): S Corporation Reform Act of 1993

103rd Congress, 1993–1994. Text as of Mar 16, 1994 (Introduced).

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HR 4056 IH

103d CONGRESS

2d Session

H. R. 4056

To amend the Internal Revenue Code of 1986 to reform the rules regarding subchapter S corporations.

IN THE HOUSE OF REPRESENTATIVES

March 16, 1994

Mr. HOAGLAND (for himself, Mr. KOPETSKI, Mr. BREWSTER, Mr. ARCHER, Mr. SHAW, Mr. PORTMAN, and Mr. MATSUI) introduced the following bill; which was referred to the Committee on Ways and Means


A BILL

To amend the Internal Revenue Code of 1986 to reform the rules regarding subchapter S corporations.

    Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

SECTION 1. SHORT TITLE; AMENDMENT OF 1986 CODE; TABLE OF CONTENTS.

    (a) SHORT TITLE- This Act may be cited as the ‘S Corporation Reform Act of 1993’.

    (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.

    (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 SHAREHOLDERS 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 SHAREHOLDER.

    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 1 SHAREHOLDER-

        ‘(A) IN GENERAL- For purposes of subsection (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 respect to which an election is in effect under subparagraph (E), all members of the family shall be treated as 1 shareholder.

        ‘(B) MEMBERS OF THE FAMILY- For purposes of subparagraph (A)(ii), the term ‘members of the family’ means the lineal descendants of the common ancestor and the spouses (or former spouses) of such lineal descendants 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 shareholders.

        ‘(D) EFFECT OF ADOPTION, ETC- In determining whether any relationship specified in subparagraph (B) or (C) exists, the rules of section 152(b)(2) shall apply.

        ‘(E) ELECTION- An election under subparagraph (A)(ii)--

          ‘(i) must be made with the consent of all shareholders,

          ‘(ii) shall remain in effect until terminated, 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 subsection (c)(7)) who is not an individual,’.

      (2) ELIGIBLE EXEMPT ORGANIZATIONS- Section 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 PERMITTED AS SHAREHOLDERS- For purposes of subsection (b)(1)(B), an organization described in section 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 ordinary 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 contribution 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 paragraphs (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 UNRELATED 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 section 512(a)(1), but without regard to the modifications described in paragraphs (8) through (15) of section 512(b).’

SEC. 112. FINANCIAL INSTITUTIONS.

    Subparagraph (B) of section 1361(b)(2) (defining ineligible corporation) is amended to read as follows:

        ‘(B) a financial institution which uses the reserve method of accounting for bad debts described in section 585 or 593,’.

SEC. 113. NONRESIDENT ALIENS.

    (a) NONRESIDENT ALIENS ALLOWED TO BE SHAREHOLDERS-

      (1) IN GENERAL- Paragraph (1) of section 1361(b) (defining small business corporation) is amended--

        (A) by adding ‘and’ at the end of subparagraph (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 paragraph (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 considered 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 engaged.’

      (2) APPLICATION OF WITHHOLDING TAX ON NONRESIDENT ALIEN SHAREHOLDERS- Section 1446 (relating to withholding tax on foreign partners’ share of effectively connected income) is amended by redesignating subsection (f) as subsection (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 treated 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 amended 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 chapter 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 (relating 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 foreign 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 shareholders) is amended by inserting after clause (iv) the following new clause:

          ‘(v) An electing small business trust.’

    (b) CURRENT BENEFICIARIES TREATED AS SHAREHOLDERS- 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 potential 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 adding at the end the following new subsection:

    ‘(e) ELECTING SMALL BUSINESS TRUST DEFINED-

      ‘(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 individual, an estate, or an organization described in section 401(a) or 501(c)(3),

          ‘(ii) no interest in such trust was acquired 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 election 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 subparagraph (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 entitled to, or at the discretion of any person may receive, 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 beneficiary’ 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 disposition.

      ‘(3) ELECTION- An election under this subsection 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 taxable year of the trust for which made and all subsequent 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 chapter--

        ‘(A) the portion of any electing small business 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 determined with the modifications of paragraph (2).

      ‘(2) MODIFICATIONS- For purposes of paragraph (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, deduction, 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 disposition of stock in an S corporation.

          ‘(iii) To the extent provided in regulations, State or local income taxes or administrative expenses to the extent allocable 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 apportioned 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 determining--

        ‘(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 sentence, 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 subsection (b)(1)(D), an S corporation may issue qualified preferred stock.

        ‘(B) QUALIFIED PREFERRED STOCK DEFINED- For purposes of this paragraph, the term ‘qualified preferred stock’ means stock described 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 qualified preferred stock shall be includible as interest 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),’ before ‘have’.

      (2) Subsection (a) of section 1366 is amended by adding at the end the following new paragraph:

      ‘(3) ALLOCATION WITH RESPECT TO QUALIFIED 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 inserting the following:

          ‘(ii) in any case in which the terms of such promise include a provision under which the obligation to pay may be converted (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 (within 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 paragraph (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 TERMINATIONS 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 TERMINATIONS- 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 obtain shareholder consents, or

        ‘(B) was terminated under paragraph (2) of subsection (d),

      ‘(2) the Secretary determines that the circumstances resulting in such ineffectiveness or termination 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 corporation) as may be required by the Secretary with respect 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 following 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 prescribed by this subsection for making such election 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 appropriate.

    (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 corporation during the taxable year and all affected 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 ‘affected shareholders’ means the shareholder whose interest is terminated and all shareholders to whom such shareholder has transferred shares during the taxable year. If such shareholder has transferred shares to the corporation, the term ‘affected shareholders’ shall include 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 redesignating subparagraph (B) as subparagraph (C), and by inserting after subparagraph (A) the following new subparagraph:

        ‘(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 subparagraph (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- Section 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 CONSISTENT WITH CORPORATE RETURN OR SECRETARY NOTIFIED OF INCONSISTENCY-

      ‘(1) IN GENERAL- A shareholder of an S corporation 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 TREATMENT-

        ‘(A) IN GENERAL- In the case of any subchapter S item, if--

          ‘(i)(I) the corporation has filed a return 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 inconsistency,

        paragraph (1) shall not apply to such item.

        ‘(B) SHAREHOLDER RECEIVING INCORRECT 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 return 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 regulations prescribed by the Secretary provide that, for purposes of this subtitle, such item is more appropriately determined at the corporation level than at the shareholder level.

      ‘(5) ADDITION TO TAX FOR FAILURE TO COMPLY 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 subchapter 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 partnership return is filed for any taxable year but it is determined 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 INCOME AS A TERMINATION EVENT.

    (a) IN GENERAL- Section 1362(d) (relating to termination) 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 corporation 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 CONSECUTIVE YEAR- Section 1375 is amended by redesignating subsections (c) and (d) as subsections (d) and (e), respectively, and by inserting after subsection (b) the following new subsection:

    ‘(c) TAX RATE INCREASE AFTER THIRD CONSECUTIVE YEAR-

      ‘(1) IN GENERAL- If an S corporation is described in subsection (a) for more than 3 consecutive taxable years, then the rate of tax imposed under subsection (a) with respect to each succeeding consecutive 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

--10

5th taxable year

--20

6th taxable year

--30

7th taxable year

--40

8th taxable year and thereafter

--50.

      ‘(2) YEARS TAKEN INTO ACCOUNT- No tax shall be increased under paragraph (1) for any taxable 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 PROFITS- 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 dispositions shall be taken into account only to the extent of the capital gain net income therefrom.

      ‘(5) PASSIVE INVESTMENT INCOME DEFINED-

        ‘(A) IN GENERAL- Except as otherwise provided in this paragraph, the term ‘passive investment income’ means gross receipts derived 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 interest on any obligation acquired in the ordinary course of the corporation’s trade or business from its sale of property described in section 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 finance 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, passive investment income shall be determined by not taking into account any gain or loss (in the normal course of the taxpayer’ activity 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 contract market by the Commodities Futures Trading Commission.

            ‘(III) SECTION 1256 CONTRACT- The term ‘section 1256 contract’ has the meaning given to such term by section 1256(b).

        ‘(E) COORDINATION WITH SECTION 1374- The amount of passive investment income shall be determined by not taking into account any recognized built-in gain or loss of the S corporation for any taxable year in the recognition period. Terms used in the preceding sentence shall have the same respective meaning 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 subchapter 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 SUBSIDIARIES.

    (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 passive investment income), as added by section 214(c)(2), is amended by adding at the end the following new subparagraph:

        ‘(F) TREATMENT OF CERTAIN DIVIDENDS- If an S corporation holds stock in a C corporation meeting the requirements of section 1504(a)(2), the term ‘passive investment income’ shall not include dividends from such C corporation to the extent such dividends are attributable 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 includible 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 partnership rules to apply for fringe benefit purposes) is repealed.

    (b) CONFORMING AMENDMENTS-

      (1) Section 162(l) is amended by striking paragraph (5) and by redesignating paragraph (6) as paragraph (5).

      (2) The table of sections for part III of subchapter 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- Paragraph (1) of section 1368(e) (relating to accumulated adjustments 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 account as of the close of such taxable year shall be determined without regard to any net negative 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 distributions), 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 inserting ‘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 following new subparagraph:

        ‘(C) CONSENT DIVIDEND- Under regulations prescribed by the Secretary, an S corporation may, subject to the election under this paragraph, consent to treat as a distribution the amount specified in such consent, to the extent such amount does not exceed the accumulated 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 organization described in section 511(a)(2), as unrelated business taxable income (as defined in section 512) to such shareholder.’

SEC. 225. TREATMENT OF S CORPORATIONS UNDER SUBCHAPTER C.

    Subsection (a) of section 1371 (relating to application of subchapter C rules) is amended to read as follows:

    ‘(a) APPLICATION OF SUBCHAPTER C RULES- Except 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 amended 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 paragraph (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 inserting ‘accumulated’.

      (D) The table of sections for part III of subchapter S of chapter 1 is amended by striking ‘subchapter 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 striking ‘section 1375(b)(5)’ and inserting ‘section 1375(b)(4)’.

SEC. 227. 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 property) 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 charitable contributions over the basis of the property 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 exemptions 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 enactment of the Subchapter S Revision Act of 1982),’.

SEC. 302. TREATMENT OF LOSSES TO SHAREHOLDERS.

    (a) TREATMENT OF LOSSES IN 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) LOSSES ON LIQUIDATIONS OF S CORPORATION-

      ‘(1) IN GENERAL- The portion of any loss recognized by a shareholder of an S corporation (as defined in section 1361(a)(1)) on amounts received by such shareholder in a distribution in complete liquidation of such S corporation 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 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 DEDUCTIONS UNDER AT-RISK RULES ALLOWED- Paragraph (3) of section 1366(d) (relating to carryover of disallowed losses and deductions to post-termination transition period) is amended by adding at the end the following new subparagraph:

        ‘(D) AT-RISK LIMITATIONS- To the extent that any increase in adjusted basis described in subparagraph (B) would have increased 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 amendments made by this Act shall apply to taxable years beginning after December 31, 1994.

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