[Congressional Record Volume 141, Number 113 (Thursday, July 13, 1995)]
[Extensions of Remarks]
[Pages E1433-E1435]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]


                  THE S CORPORATION REFORM ACT OF 1995

                                 ______


                         HON. E. CLAY SHAW, JR.

                               of florida

                    in the house of representatives

                        Thursday, July 13, 1995
  Mr. SHAW. Mr. Speaker, I rise today to introduce legislation to 
strengthen small and family-owned businesses. Recently we have grown 
more aware of the burdens that regulations and tax complexities place 
on small and family-owned businesses. It is time for us to enact 
legislation to help the businesses that are the driving force of the 
American economy. The S Corporation Reform Act of 1995 will provide 
such support. Today almost 1.9 million businesses pay taxes as S 
corporations and the vast majority of these are small businesses. The S 
Corporation Reform Act of 1995 is targeted to growing these small 
businesses by improving their access to capital, by preserving family-
owned businesses, and by simplifying many of the outdated, unnecessary, 
and complex rules for S corporations.
  Under current law, S corporations face obstacles and limitations not 
imposed on other forms of entities. The rules governing S corporations 
need to be modernized to bring them more on par with partnerships and C 
corporations. For instance, S corporations are unable to turn to 
nontraditional sources of financing such as venture capitalists and 
pension funds because they are unable to offer inducements that 
partnerships or C corporations can offer. This has greatly hindered 
their growth as traditional sources of debt financing, such as 
commercial bank loans, can at times be hard to get, especially for 
smaller businesses. This bill would expand S corporations access to 
capital by increasing the number of permitted shareholders from 35 to 
75, by permitting tax-exempt entities to be shareholders, and by 
allowing nonresident aliens to own S corporation stock. More 
importantly, S corporations would be allowed to issue convertible 
preferred stock opening the door to the venture capital market.
  Additionally, the bill helps preserve family-owned businesses by 
counting all family members as one shareholder for purposes of S 
corporation eligibility and better enabling families to establish 
trusts funded by S corporation shares. Under current law, multi-
generational family businesses are threatened by the artificial 35 
shareholder limit which counts each family member as one shareholder. S 
corporations also do not have access to the same estate planning 
techniques available to C corporation owners since there are 
restrictions on the types of trusts permitted to be shareholders of an 
S corporation.
  Another important feature of this bill is the flexibility it would 
offer to S corporations and their shareholders in structuring their 
business operations. Under the bill, S corporations would be allowed to 
hold wholly-owned corporate subsidiaries that would for Federal tax 
purposes be effectively treated as a division or branch of the parent 
company. From a compliance perspective, only one tax return would be 
filed by the corporations, which would significantly simplify the 
compliance burden imposed by present law.
  Further, the bill would eradicate a number of outmoded and arcane 
provisions some of which date back to enactment of the S corporation in 
1958. For example, S corporations 

[[Page E 1434]]
would be given the opportunity under the bill to clean up invalid or 
untimely S corporation elections.
  I encourage my colleagues to support this important and badly needed 
legislation that is vital to small and family-owned businesses' ability 
to grow and compete in the next century. I am submitting a section-by-
section summary of the legislation and I ask unanimous consent that the 
text of the bill be printed in the Record.
            TITLE I--ELIGIBLE SHAREHOLDERS OF A CORPORATION

                   Subtitle A--Number of Shareholders

       Sec. 101. S corporations permitted to have 75 
     shareholders--The maximum number of eligible shareholders 
     would be increased from 35 to 75. Increasing the number of 
     eligible shareholders would help S corporations stay within 
     multi-generational families, and the expanded number would 
     offer opportunity for additional cyclical investors.
       Sec. 102. Members of family treated as one shareholder--All 
     family members within seven generations who own stock could 
     elect to be treated as one shareholder. The election would be 
     made available to only one family per corporation, must be 
     made with the consent of all shareholders of the corporation 
     and would remain in effect until terminated. This provision 
     is intended to keep S corporations within families that might 
     span several generations.

              Subtitle B--Persons Allowed As Shareholders

       Sec. 111. Certain exempt organizations--A new source of 
     financing would be provided to S corporations by allowing 
     certain exempt organizations including pensions, profit 
     sharing plans, and employee stock ownership plans (ESOPs) to 
     acquire S corporation stock. S corporation income that flows 
     through to these organizations would be treated as unrelated 
     business income (UBI) to the organization or entity. In 
     addition, charities would be allowed as shareholders of an S 
     corporation for purposes of allowing more flexibility in 
     estate planning.
       Sec. 112. Financial institutions--Under the bill, financial 
     institutions that do not use the reserve method of accounting 
     for bad debts would be eligible to elect S corporation 
     status.
       Sec. 113. Nonresident aliens--This provision would provide 
     the opportunity for aliens to invest in domestic S 
     corporations and S corporations to operate abroad with a 
     foreign shareholder by allowing nonresident aliens 
     (individuals only) to own S corporation stock. Any 
     effectively-connected U.S. income allocable to the 
     nonresident alien would be subject to the withholding rules 
     that currently apply to foreign partners in a partnership.
       Sec. 114. Electing small business trusts--Trust eligibility 
     rules would be expanded by allowing stock in an S corporation 
     to be held by certain trusts (``electing small business 
     trusts'') provided
      that all beneficiaries of the trust are individuals, estates 
     or exempt organizations. Each potential current 
     beneficiary of the trust would be counted as a shareholder 
     under the counting conventions of the maximum number of 
     shareholder rules. In a situation where there are no 
     potential current beneficiaries, the trust would be 
     treated as a shareholder. For taxation purposes, the 
     portion of the trust consisting of S corporation stock 
     would be treated as a separate taxpayer and would pay tax 
     at the highest individual tax rate.

                      Subtitle C--Other Provisions

       Sec. 121. Expansion of post-death qualification for certain 
     trusts--The bill would extend the holding period for all 
     testamentary trusts to two years.

TITLE II--QUALIFICATION AND ELIGIBILITY REQUIREMENTS FOR S CORPORATIONS

                     Subtitle A--One Class of Stock

       Sec. 201. Issuance of preferred stock permitted--An S 
     corporation would be allowed to issue either convertible or 
     plain vanilla preferred stock. Holders of preferred stock 
     would not be treated as shareholders, thus, ineligible 
     shareholders like corporations or partnerships could own 
     preferred stock interests in S corporations. Payments to 
     owners of the preferred stock would be deemed as interest 
     rather than a dividend and would provide an interest 
     deduction to the S corporation. This provision would afford S 
     corporations and their shareholders more flexibility in 
     estate planning and in capitalizing the S corporation by 
     giving it access to venture capital.
       Sec. 202. Financial institutions permitted to hold safe 
     harbor debt--An S corporation is not considered to have more 
     than one class of stock if outstanding debt obligations to 
     shareholders meet the ``straight debt'' safe harbor. 
     Currently, the safe harbor provides that straight debt cannot 
     be convertible into stock. However, the legislation would 
     permit a convertibility provision so long as that provision 
     is the same as one that could have been obtained by a person 
     not related to the S corporation or S corporation 
     shareholders. Additionally, the straight debt safe harbor 
     would be amended to allow creditors who are persons actively 
     and regularly engaged in the business of lending money to 
     hold such debentures.

                 Subtitle B--Elections and Terminations

       Sec. 211. Rules relating to inadvertent terminations and 
     invalid elections--The legislation would provide the IRS with 
     the authority to extend its current automatic waiver 
     procedure for inadvertent terminations due to defective 
     elections. Additionally, the IRS would be allowed to treat a 
     late Subchapter S election as timely if the Service 
     determines that there was reasonable cause for the failure to 
     make the election timely. The provision would apply to 
     taxable years beginning after December 31, 1982.
       Sec. 212. Agreement to terminate year--The bill provides 
     that the election to close the books of the S corporation 
     upon the termination of a shareholder's interest would be 
     made by, and apply to, all affected shareholders rather than 
     by all shareholders.
       Sec. 213. Expansion of post-termination transition period--
     The post-termination period would be expanded to include the 
     120-day period beginning on the date of any determination 
     pursuant to an audit of the taxpayer that follows the 
     termination of the S corporation's election and that adjust a 
     subchapter S item of income, loss or deduction of the S 
     corporation during the S period. In addition, the bill would 
     repeal the TEFRA audit provisions applicable to S 
     corporations and would provide other rules to require 
     consistency between the returns of the S corporation and its 
     shareholder.
       Sec. 214. Repeal of excessive passive investment income as 
     a termination event--This provision would repeal the current 
     rule that terminates S corporation status for certain 
     corporations that have both subchapter C earnings and profits 
     and that derive more than 25 percent of their gross receipts 
     from passive sources for three consecutive years. The 
     legislation would not repeal the rule that imposes a tax on 
     those corporations possessing excess net passive investment 
     income. It would liberalize this tax by raising the threshold 
     triggering the tax to 50% of passive receipts from passive 
     income sources rather the present law 25% threshold. The rate 
     of the passive income tax would be increased if applicable.

                      Subtitle C--Other Provisions

       Sec. 221. S corporations permitted to hold subsidiaries--
     The legislation would repeal the current rule that disallows 
     an S corporation from being a member of an affiliated group 
     of corporations, thus enabling an S corporation to own up to 
     100 percent of a C corporation's stock. It does preclude, 
     however, an S corporation from being included in a group 
     filing a consolidated tax return. In addition, S corporations 
     would be permitted to own wholly-owned S corporation 
     subsidiaries. Thus, a parent S corporation and its wholly-
     owned subsidiary would be treated as one corporation and 
     would file one tax return. This provision offers tremendous 
     structuring flexibility to existing S corporations by 
     allowing them to put operations into wholly-owned 
     subsidiaries and be treated as one S corporation.
       Sec. 222. Treatment of distributions during loss years--
     Basis adjustments for distributions made by an S corporation 
     during a taxable year would be taken into account before 
     applying the loss limitation for the year. This would result 
     in distributions during the year reducing adjusted stock 
     basis for purposes of determining the tax status of the 
     distributions made during that year before determining the 
     allowable loss for the year. A similar concept would apply in 
     computing adjustments to the accumulated adjustments account.
       Sec. 223. Consent divided for AAA bypass elections--The 
     bill codifies a Treasury regulation which allows an election 
     to by-pass the AAA to apply to deemed dividends.
       Sec. 224. Treatment of S corporations under subchapter C--
     The current rule treating an S corporation as an individual 
     in its status as a shareholder of another corporation would 
     be repealed, permitting IRC Section 332 liquidations and IRC 
     Section 338 elections. These rules effectively expand an S 
     corporation's ability to participate in tax-free structuring 
     transactions.
       Sec. 225. Elimination of pre-1983 earnings and profits--S 
     corporation earnings and profits attributable to taxable 
     years prior to 1983 would be eliminated. This change will 
     simplify distributions for those S corporations in existence 
     prior to 1983.
       Sec. 226. Allowance of charitable contributions of 
     inventory and scientific property--This provision would allow 
     the same deduction for charitable contributions of inventory 
     and scientific property used to care for the ill, needy or 
     infants for subchapter S as for subchapter C corporations. In 
     addition, S corporations are no longer disqualified from 
     making ``qualified research contributions'' (charitable 
     contributions of inventory property to educational 
     institutions or scientific research organizations) for use in 
     research or experimentation. The S corporation's shareholders 
     would also be permitted to increase the basis of their stock 
     by the excess of deductions for charitable over the basis of 
     the property contributed by the S corporation.
       Sec. 227. C corporation rules to apply for fringe benefit 
     purposes--The current rule that limits the ability of ``more-
     than-two-percent'' S corporation shareholder-employees to 
     exclude certain fringe benefits from wages would be repealed 
     for benefits other than health insurance. Under the bill, 
     fringe benefits such as group-term life insurance would 
     become excludable from wages for these shareholders. However, 
     health care benefits would remain taxable (please note that 
     on April 11, 1995, President Clinton signed into law P.L. 
     104-7, which provides in years 1995 and thereafter a 30% 
     deduction for health insurance costs of the self-employed 
     which partially offsets taxable health insurance benefits). 

[[Page E 1435]]


           TITLE III--TAXATION OF S CORPORATION SHAREHOLDERS

       Sec. 301. Uniform treatment of owner-employees under 
     prohibited transaction rules--Provides that subchapter-S 
     shareholder-employees no longer will be deemed to be owner-
     employees under the rules prohibiting loans to owner-
     employees from qualified retirement plans.
       Sec. 302. Treatment of losses to shareholders--Loss 
     recognized by a shareholder in complete liquidation of an S 
     corporation would be treated as ordinary loss to the extent 
     the shareholder's adjusted basis in the S corporation stock 
     is attributable to ordinary income that was recognized as a 
     result of the liquidation.

                        TITLE V--EFFECTIVE DATE

       Sec. 401. Effective date--Except as otherwise provided, the 
     amendments made by this Act shall apply to taxable years 
     beginning after December 31, 1995.
     

                          ____________________