[Congressional Bills 105th Congress]
[From the U.S. Government Publishing Office]
[H.R. 4285 Introduced in House (IH)]







105th CONGRESS
  2d Session
                                H. R. 4285

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


_______________________________________________________________________


                    IN THE HOUSE OF REPRESENTATIVES

                             July 21, 1998

     Mr. Shaw (for himself, Mr. Matsui, Mr. Portman,  Mr. Neal of 
Massachusetts, Mr. Camp, Ms. Dunn, Mr. Herger, Mr. Bunning, Mr. Levin, 
Mr. Thomas, Mr. Houghton, Mr. Hall of Texas, Mr. Kleczka, Mr. Watkins, 
 and Mr. Ensign) 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 provide for S corporation 
                    reform, and for other purposes.

    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 ``Subchapter S 
Revision Act of 1998''.
    (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 is as follows:

Sec. 1. Short title; amendment of 1986 Code; table of contents.
                    TITLE I--SUBCHAPTER S EXPANSION

         Subtitle A--Eligible Shareholders of an S Corporation

Sec. 101. Members of a family treated as one shareholder.
Sec. 102. Nonresident aliens.
      Subtitle B--Qualification and Eligibility Requirements of S 
                              Corporations

Sec. 111. Issuance of preferred stock permitted.
Sec. 112. Safe harbor debt expanded to include convertible debt.
Sec. 113. Repeal of excessive passive investment income as termination 
                            event.
Sec. 114. Repeal passive income capital gain category.
Sec. 115. Allowance of charitable contributions of inventory and 
                            scientific property.
Sec. 116. C corporation rules to apply for fringe benefit purposes.
           Subtitle C--Taxation of S Corporation Shareholders

Sec. 120. Treatment of losses to shareholders.
                       Subtitle D--Effective Date

Sec. 130. Effective Date.
       TITLE II--SENSE OF THE HOUSE OF REPRESENTATIVES RESOLUTION

Sec. 201. Sense of the House of Representatives resolution opposing the 
                            administration's proposal to treat 
                            Subchapter S elections as taxable 
                            liquidations of C corporations.

                    TITLE I--SUBCHAPTER S EXPANSION

         Subtitle A--Eligible Shareholders of an S Corporation

SEC. 101. 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 purpose 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 purpose 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.''.

SEC. 102. NONRESIDENT ALIENS ALLOWED TO BE SHAREHOLDERS.

    (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.--Paragraph (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 CORPORATION 
              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 of 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 redesignating 
                subsection 894(c) as subsection 894(d) and inserting 
                the following new subsection after subsection 894(b):
    ``(c) Permanent Establishment of Partners and S Corporation 
Shareholders.--If a partnership of 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.''

      Subtitle B--Qualification and Eligibility Requirements of S 
                              Corporations

SEC. 111. ISSUANCE OF PREFERRED STOCK PERMITTED.

    (a) In General.--Section 1361 is amended by adding at the end the 
following new subsection:
    ``(f) Treatment of Qualified Preferred Stock.--
            ``(1) In general.--For purposes of this subchapter--
                    ``(A) qualified preferred stock shall not be 
                treated as a second class of stock, and
                    ``(B) no person shall be treated as a shareholder 
                of the corporation by reason of holding qualified 
                preferred stock.
            ``(2) Qualified preferred stock defined.--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 expense 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 amended 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 qualified 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) The title to clause (ii) to subparagraph (C) of section 
        354(a)(2) and part I of such clause (ii) are amended to read as 
        follows:
                            ``(ii) Recapitalization of family-owned 
                        corporations and s corporations.--
                                    (I) In general.--Clause (I) shall 
                                not apply in the case of a 
                                recapitalization 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), striking the period at the 
        end of paragraph (2) and inserting ``, and'' in its place, and 
        adding at the end the following 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.''

SEC. 112. SAFE HARBOR EXPANDED TO INCLUDE CONVERTIBLE 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 cases 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.''

SEC. 113. 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)(D)'' and inserting ``section 
        1375(b)(5)''.

SEC. 114. REPEAL PASSIVE INCOME CAPITAL GAIN CATEGORY.

    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) 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) 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 extend such dividends are 
                attributable to the earnings and profits of such C 
                corporations derived from the active conduct of a trade 
                or business.
                    ``(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.''

SEC. 115. 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 subparagraphs (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.''

SEC. 116. 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) Partnership Rules To Apply for Health Insurance Costs of 
Certain S Corporation Shareholders.--Paragraph (5) of section 162(1) is 
amended to read as follows:
            ``(5) Treatment of certain s corporation shareholders.--
                    ``(A) In general.--This subsection shall apply in 
                the case of any 2-percent shareholder of an S 
                corporation, except that--
                            ``(i) for purposes of this subsection, such 
                        shareholder's wages (as defined in section 
                        3121) from the S corporation shall be treated 
                        as such shareholder's earned income (within the 
                        meaning of section 401(c)(1)), and
                            ``(ii) there shall be such adjustments in 
                        the application of this subsection as the 
                        Secretary may by regulations prescribe.
                    ``(B) 2-percent shareholder defined.--For purposes 
                of this paragraph, the term `2-percent shareholder' 
                means any person who owns (or is considered as owning 
                within the meaning of section 318) on any day during 
                the taxable year of the S corporation more than 2 
                percent of the outstanding stock of such corporation or 
                stock possessing more than 2 percent of the total 
                combined voting power of all stock of such 
                corporation.''
    (b) Conforming Amendment.--The table of sections for part III of 
subchapter S of chapter 1 is amended by striking the item relating to 
section 1372.

           Subtitle C--Taxation of S Corporation Shareholders

SEC. 120. 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 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) Suspended Passive Activity Losses.--Paragraph (3) of section 
1371(b) is amended to read as follows:
            ``(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 taxable years to which an item may be carried back or 
        carried forward nor prevent the allowance of a passive activity 
        loss deduction to the extent provided by section 469(g).''

                       Subtitle D--Effective Date

SEC. 130. EFFECTIVE DATE.

    (a) In General.--Except as otherwise provided in this Act, and in 
section 1362(g) relating to elections after termination, the amendments 
made by this Act shall apply to taxable years beginning after December 
31, 1998.
    (b) Treatment of Certain Elections Under Prior Law.--For purposes 
of section 1362(g) of the Internal 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 enactment 
of this Act) shall not be taken into account.

       TITLE II--SENSE OF THE HOUSE OF REPRESENTATIVES RESOLUTION

SEC. 201. SENSE OF THE HOUSE OF REPRESENTATIVES RESOLUTION OPPOSING THE 
              ADMINISTRATION'S PROPOSAL TO TREAT SUBCHAPTER S ELECTIONS 
              AS TAXABLE LIQUIDATIONS.

    To express the sense of the House of Representatives that the 
proposal in the President's Fiscal Year 1999 budget to treat the 
conversion of certain ``large'' C corporations into S corporations as 
taxable liquidations would be harmful to the business community, would 
effectively prohibit many businesses from making S elections in the 
future, and should be rejected.
    Whereas, the President's proposal would impose a ``liquidation 
tax'' upon C to S corporation conversions.
    Whereas, the President's proposal would undermine the S corporation 
reform provisions included in the Small Business Job Protection Act of 
1996.
    Whereas, the President's proposal would curtail future conversion 
of businesses from C to S status.
    Whereas, S corporations function as an integral and productive part 
of our domestic economy and their formation and use should be 
encouraged.
    Resolved, That it is the sense of the House of Representatives that 
the President's ``liquidation tax'' proposal upon the conversion of C 
corporations to S status is ill-advised and should be rejected.
                                 <all>