[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.
                                 <all>