[Congressional Bills 107th Congress]
[From the U.S. Government Publishing Office]
[S. 1201 Introduced in Senate (IS)]
107th CONGRESS
1st Session
S. 1201
To amend the Internal Revenue Code of 1986 to provide for S corporation
reform, and for other purposes.
_______________________________________________________________________
IN THE SENATE OF THE UNITED STATES
July 19, 2001
Mr. Hatch (for himself, Mr. Breaux, Mrs. Lincoln, Mr. Allard, Mr.
Thompson, and Mr. Gramm) introduced the following bill; which was read
twice and referred to the Committee on Finance
_______________________________________________________________________
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
Modernization Act of 2001''.
(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--ELIGIBLE SHAREHOLDERS OF AN S CORPORATION
Sec. 101. Members of family treated as 1 shareholder.
Sec. 102. Nonresident aliens allowed to be shareholders.
Sec. 103. Expansion of bank S corporation eligible shareholders to
include IRAs.
Sec. 104. Increase in number of eligible shareholders to 150.
TITLE II--QUALIFICATION AND ELIGIBILITY REQUIREMENTS OF S CORPORATIONS
Sec. 201. Issuance of preferred stock permitted.
Sec. 202. Safe harbor expanded to include convertible debt.
Sec. 203. Repeal of excessive passive investment income as a
termination event.
Sec. 204. Modifications to passive income rules.
Sec. 205. Adjustment to basis of S corporation stock for certain
charitable contributions.
TITLE III--TREATMENT OF S CORPORATION SHAREHOLDERS
Sec. 301. Treatment of losses to shareholders.
Sec. 302. Transfer of suspended losses incident to divorce.
Sec. 303. Use of passive activity loss and at-risk amounts by qualified
subchapter S trust income beneficiaries.
Sec. 304. Deductibility of interest expense incurred by an electing
small business trust to acquire S
corporation stock.
Sec. 305. Disregard of unexercised powers of appointment in determining
potential current beneficiaries of ESBT.
Sec. 306. Clarification of electing small business trust distribution
rules.
Sec. 307. Allowance of charitable contributions deduction for electing
small business trusts.
Sec. 308. Shareholder basis not increased by income derived from
cancellation of S corporation's debt.
Sec. 309. Back to back loans as indebtedness.
TITLE IV--EXPANSION OF S CORPORATION ELIGIBILITY FOR BANKS.
Sec. 401. Exclusion of investment securities income from passive income
test for bank S corporations.
Sec. 402. Treatment of qualifying director shares.
Sec. 403. Recapture of bad debt reserves.
TITLE V--QUALIFIED SUBCHAPTER S SUBSIDIARIES
Sec. 501. Relief from inadvertently invalid qualified subchapter S
subsidiary elections and terminations.
Sec. 502. Information returns for qualified subchapter S subsidiaries.
Sec. 503. Treatment of the sale of interest in a qualified subchapter S
subsidiary.
Sec. 504. Exception to application of step transaction doctrine for
restructuring in connection with making
qualified subchapter S subsidiary
elections.
TITLE VI--ADDITIONAL PROVISIONS
Sec. 601. Elimination of all earnings and profits attributable to pre-
1983 years.
Sec. 602. No gain or loss on deferred intercompany transactions because
of conversion to S corporation or qualified
S corporation subsidiary.
Sec. 603. Treatment of charitable contribution and foreign tax credit
carryforwards.
Sec. 604. Distributions by an S corporation to an employee stock
ownership plan.
Sec. 605. Special rules of application.
TITLE I--ELIGIBLE SHAREHOLDERS OF AN S CORPORATION
SEC. 101. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.
(a) In General.--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 common ancestor, 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
shareholders (including those that are family
members) holding in the aggregate more than
one-half of the shares of stock in the
corporation on the day the election is made,
``(ii) in the case of--
``(I) an electing small business
trust, shall be made by the trustee of
the trust, and
``(II) a qualified subchapter S
trust, shall be made by the beneficiary
of the trust,
``(iii) under regulations, shall remain in
effect until terminated, and
``(iv) shall apply only with respect to 1
family in any corporation.''.
(b) Relief From Inadvertent Invalid Election or Termination.--
Section 1362(f) (relating to inadvertent invalid elections or
terminations), as amended by section 501, is amended--
(1) by inserting ``or under section 1361(c)(1)(A)(ii)''
after ``section 1361(b)(3)(B)(ii)'' in paragraph (1), and
(2) by inserting ``or under section 1361(c)(1)(E)(iii)''
after ``section 1361(b)(3)(C)'' in paragraph (1)(B).
(c) Effective Dates.--
(1) Subsection (a).--The amendment made by subsection (a)
shall apply to taxable years beginning after December 31, 2001.
(2) Subsection (b).--The amendments made by subsection (b)
shall apply to elections and terminations made after December
31, 2001.
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,
``(3) any reference to section 704 shall be treated as a
reference to section 1366, and
``(4) no withholding tax under subsection (a) shall be
required in the case of any income realized by such corporation
and allocable to a shareholder which is an electing small
business trust (as defined in section 1361(e)).''.
(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 on foreign partners' and S corporation
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 (c) as subsection (d) and by inserting after
subsection (b) 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.''.
(c) Application of Other Withholding Tax Rules on Nonresident Alien
Shareholders.--
(1) Section 1441.--Section 1441 (relating to withholding of
tax on nonresident aliens) is amended by redesignating
subsection (g) as subsection (h) and by inserting after
subsection (f) the following new subsection:
``(g) 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) no deduction or withholding under subsection (a)
shall be required in the case of any item of income realized by
such corporation and allocable to a shareholder which is an
electing small business trust (as defined in section
1361(e)).''.
(2) Section 1445.--Section 1445(e) (relating to special
rules relating to distributions, etc., by corporations,
partnerships, trusts, or estates) is amended by redesignating
paragraph (6) as paragraph (7) and by inserting after paragraph
(5) the following new paragraph:
``(6) S corporation treated as partnership, etc.--For
purposes of this section--
``(A) an S corporation shall be treated as a
partnership, and
``(B) the shareholders of such corporation shall be
treated as partners of such partnership, and
``(C) no deduction or withholding under subsection
(a) shall be required in the case of any gain realized
by such corporation and allocable to a shareholder
which is an electing small business trust (as defined
in section 1361(e)).''.
(d) Conforming Amendment.--Section 1361(e)(2) is amended by
inserting ``(including a nonresident alien)'' after ``person'' the
first place it appears.
(e) Effective Date.--The amendments made by this section shall
apply to taxable years beginning after December 31, 2001.
SEC. 103. EXPANSION OF BANK S CORPORATION ELIGIBLE SHAREHOLDERS TO
INCLUDE IRAS.
(a) In General.--Section 1361(c)(2)(A) (relating to certain trusts
permitted as shareholders) is amended by inserting after clause (v) the
following new clause:
``(vi) In the case of a corporation which
is a bank (as defined in section 581), a trust
which constitutes an individual retirement
account under section 408(a), including one
designated as a Roth IRA under section 408A,
but only to the extent of the stock held by
such trust in such bank as of the date of the
enactment of this clause.''.
(b) Treatment as Shareholder.--Section 1361(c)(2)(B) (relating to
treatment as shareholders) is amended by adding at the end the
following new clause:
``(vi) In the case of a trust described in
clause (vi) of subparagraph (A), the individual
for whose benefit the trust was created shall
be treated as a shareholder.''.
(c) Sale of Stock in IRA Relating to S Corporation Election Exempt
From Prohibited Transaction Rules.--Section 4975(d) (relating to
exemptions) is amended by striking ``or'' at the end of paragraph (14),
by striking the period at the end of paragraph (15) and inserting ``;
or'', and by adding at the end the following new paragraph:
``(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
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 individual retirement accounts on the
date of the enactment of this Act.
SEC. 104. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS 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, 2001.
TITLE II--QUALIFICATION AND ELIGIBILITY REQUIREMENTS OF S CORPORATIONS
SEC. 201. ISSUANCE OF PREFERRED STOCK PERMITTED.
(a) In General.--Section 1361 (defining S corporation) 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) 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 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), by striking the period at
the end of paragraph (2) and inserting ``, and'', and by 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.''.
(c) Effective Date.--The amendments made by this section shall
apply to taxable years beginning after December 31, 2001.
SEC. 202. SAFE HARBOR EXPANDED TO INCLUDE CONVERTIBLE 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 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),
``(IV) an exempt organization
described 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, 2001.
SEC. 203. 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)(4)''.
(c) Effective Date.--The amendments made by this section shall
apply to taxable years beginning after December 31, 2001.
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 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) Repeal of Passive Income Capital Gain Category.--
(1) In general.--Subsection (b) of section 1375 (relating
to tax imposed when passive investment income of corporation
having accumulated earnings and profits exceeds 60 percent of
gross receipts), as amended by subsection (a), is amended by
striking paragraphs (3) and (4) and inserting the following new
paragraph:
``(3) 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(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 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 extent such dividends are
attributable 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 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.''.
(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, 2001.
SEC. 205. ADJUSTMENT TO BASIS OF S CORPORATION STOCK FOR CERTAIN
CHARITABLE CONTRIBUTIONS.
(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 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 amount of the shareholder's
proportionate share of any charitable contribution made
by the S corporation over the shareholder's
proportionate share of the adjusted basis of the
property contributed.''.
(b) Effective Date.--The amendments made by this section shall
apply to taxable years beginning after December 31, 2001.
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 shareholder 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
liquidation 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 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).''.
(c) Effective Date.--The amendments made by this section shall
apply to taxable years beginning after December 31, 2001.
SEC. 302. TRANSFER OF SUSPENDED LOSSES INCIDENT TO DIVORCE.
(a) In General.--Section 1366(d) (relating to special 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 incident to divorce.--For purposes of
paragraph (2), the transfer of any shareholder's stock in an S
corporation 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 subparagraph (A),
(2) by striking the period at the end of subparagraph (B)
and inserting ``, and'', and
(3) by adding at the end the following new subparagraph:
``(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 INCURRED 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 inserting 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, 2001.
SEC. 305. DISREGARD OF UNEXERCISED POWERS OF APPOINTMENT IN DETERMINING
POTENTIAL CURRENT BENEFICIARIES OF ESBT.
(a) In General.--Section 1361(e)(2) (defining potential current
beneficiary) is amended--
(1) by inserting ``(determined without regard to any
unexercised (in whole or in part) power of appointment 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, 2001.
SEC. 306. CLARIFICATION OF ELECTING SMALL BUSINESS TRUST DISTRIBUTION
RULES.
(a) In General.--Section 641(c)(1) (relating to special rules for
taxation of electing small business trusts) is amended--
(1) by striking ``and'' at the end of subparagraph (A),
(2) by redesignating subparagraph (B) as subparagraph (C),
and
(3) by inserting after subparagraph (A) the following new
subparagraph:
``(B) any distribution attributable to the portion
treated as a separate trust shall be treated separately
from any distribution attributable 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) (relating to special
rules applicable to S corporations) is amended by redesignating
subparagraph (3) as subparagraph (4) and by inserting after
subparagraph (2) the following 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 organization 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, 2001.
SEC. 308. SHAREHOLDER BASIS NOT INCREASED BY INCOME 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 occurring after December 31, 2000.
SEC. 309. BACK TO BACK LOANS AS INDEBTEDNESS.
(a) In General.--Section 1366(d) (relating to special 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 subsection (d), the
indebtedness of an S corporation to the shareholder
shall include any loans made or acquired (by purchase,
gift, or distribution from another person) by a
shareholder to the S corporation, regardless of whether
the funds loaned by the shareholder to the S
corporation were obtained by the shareholder by means
of a recourse loan from another person (whether related
or unrelated to the shareholder).''.
(b) Effective Date.--The amendment made by this section shall apply
to taxable years beginning after December 31, 2001.
TITLE IV--EXPANSION OF S CORPORATION ELIGIBILITY FOR BANKS.
SEC. 401. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM PASSIVE INCOME
TEST FOR BANK S CORPORATIONS.
(a) In General.--Section 1374(b)(3) (defining passive investment
income) is amended by adding at the end the following new subparagraph:
``(E) 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 company, 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 participation certificates issued by a
Federal Intermediate 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 corporation), 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 subchapter--
``(A) qualifying director shares 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 qualifying
director shares.
``(2) Qualifying director shares defined.--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 agreement
pursuant to which the holder is required to
dispose of the shares of stock upon termination
of the holder's status as a director at the
same price as the individual 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 expense 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 (f),'' before ``which does not''.
(2) Section 1366(a) is amended by adding at the end the
following new paragraph:
``(3) Allocation with respect to qualifying director
shares.--The holders of qualifying director shares (as defined
in section 1361(f)) shall not, with respect to such shares of
stock, be allocated 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(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, 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 December 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 QUALIFIED SUBCHAPTER S
SUBSIDIARY ELECTIONS AND TERMINATIONS.
(a) In General.--Section 1362(f) (relating to inadvertent invalid
elections or terminations) is amended--
(1) by inserting ``or under section 1361(b)(3)(B)(ii)''
after ``subsection (a)''in paragraph (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 business corporation'' in
paragraph (3)(A),
(4) by inserting ``or a qualified subchapter S subsidiary,
as the case may be'' after ``S corporation'' in paragraph (4),
and
(5) by inserting ``or a qualified subchapter S subsidiary,
as the case may be'' after ``S corporation'' 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 SUBCHAPTER 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 returns 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, 2001.
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 amended 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 percentage
of the stock transferred, and
``(ii) followed by a deemed contribution by
the S corporation and the transferee 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 TRANSACTION DOCTRINE FOR
RESTRUCTURING IN CONNECTION WITH MAKING QUALIFIED
SUBCHAPTER S SUBSIDIARY ELECTIONS.
(a) In General.--Section 1361(b)(3) (relating to treatment of
certain wholly owned subsidiaries), as amended by section 503, is
amended by redesignating subparagraphs (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 subchapter S subsidiary to which
section 332 applies.''.
(b) Effective Date.--The amendments made by this section shall
apply to elections effective after December 31, 2001.
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 amended 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 December 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 beginning 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 CORPORATION
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 charitable 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 business credit carryforwards from C years
allowed) is amended 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, 2001.
SEC. 604. DISTRIBUTIONS BY AN S CORPORATION TO AN EMPLOYEE STOCK
OWNERSHIP PLAN.
(a) In General.--Section 1368(f) (relating to distributions) 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 credit
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 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.
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