[Congressional Record Volume 147, Number 72 (Wednesday, May 23, 2001)]
[Senate]
[Pages S5544-S5547]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. ALLARD (for himself, Mr. Johnson, and Mr. Thomas):
  S. 936. A bill to amend the Internal Revenue Code of 1986 to expand S 
corporation eligibility for banks, and for other purposes; to the 
Committee on Finance.
  Mr. ALLARD. Mr. President, today I am pleased to introduce 
legislation that will expand and improve Subchapter S of the Internal 
Revenue Code. I am joined in this effort by Senators Tim Johnson and 
Craig Thomas. I have introduced this legislation over the last few 
years and I am hopeful that this year we can get this important tax 
legislation enacted.
  The Subchapter S provision of the Internal Revenue Code reflect the 
desire of Congress to eliminate the double tax burden on small business 
corporations. Pursuant to that desire, Subchapter S has been 
liberalized a number of times, most recently in 1996. This legislation 
contains several provisions that will make the Subchapter S election 
more widely available to small businesses in all sectors. It also 
contains several provisions of particular benefit to community banks 
that may be contemplating a conversion to Subchapter S. Financial 
institutions were first made eligible for the Subchapter S election in 
1996. This legislation builds on and clarifies the Subchapter S 
provisions applicable to financial institutions.
  I ask unanimous consent that the text of the bill and an explanation 
of

[[Page S5545]]

the provisions of the bill be printed in the Record.
  There being no objection, the additional material was ordered to be 
printed in the Record, as follows:

                                 S. 936

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

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Small Business and Financial 
     Institutions Tax Relief Act of 2001''.

     SEC. 2. EXPANSION OF S CORPORATION ELIGIBLE SHAREHOLDERS TO 
                   INCLUDE IRAS.

       (a) In General.--Section 1361(c)(2)(A) of the Internal 
     Revenue Code of 1986 (relating to certain trusts permitted as 
     shareholders) is amended by inserting after clause (v) the 
     following:
       ``(vi) A trust which constitutes an individual retirement 
     account under section 408(a), including one designated as a 
     Roth IRA under section 408A.''.
       (b) Treatment as Shareholder.--Section 1361(c)(2)(B) of the 
     Internal Revenue Code of 1986 (relating to treatment as 
     shareholders) is amended by adding at the end the following:
       ``(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) of 
     the Internal Revenue Code of 1986 (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:
       ``(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) of the 
     Internal Revenue Code of 1986 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 in taxable 
     years beginning after December 31, 2001.

     SEC. 3. EXCLUSION OF INVESTMENT SECURITIES INCOME FROM 
                   PASSIVE INCOME TEST FOR BANK S CORPORATIONS.

       (a) In General.--Section 1362(d)(3)(C) of the Internal 
     Revenue Code of 1986 (defining passive investment income) is 
     amended by adding at the end the following:
       ``(v) 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 bank, the term `passive investment income' shall 
     not include--

       ``(I) interest income earned by such bank, bank holding 
     company, or qualified subchapter S subsidiary bank, or
       ``(II) dividends on assets required to be held by such 
     bank, bank holding company, or qualified subchapter S 
     subsidiary bank 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. 4. INCREASE IN NUMBER OF ELIGIBLE SHAREHOLDERS TO 150.

       (a) In General.--Section 1361(b)(1)(A) of the Internal 
     Revenue Code of 1986 (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.

     SEC. 5. TREATMENT OF QUALIFYING DIRECTOR SHARES.

       (a) In General.--Section 1361 of the Internal Revenue Code 
     of 1986 (defining s corporation) is amended by adding at the 
     end the following:
       ``(f) 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) of the Internal Revenue Code of 1986 
     is amended by inserting ``, except as provided in subsection 
     (f),'' before ``which does not''.
       (2) Section 1366(a) of such Code is amended by adding at 
     the end the following:
       ``(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) of such Code 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:
       ``(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. 6. BAD DEBT CHARGE OFFS IN YEARS AFTER ELECTION YEAR 
                   TREATED AS ITEMS OF BUILT-IN LOSS.

       The Secretary of the Treasury shall modify Regulation 
     1.1374-4(f) for S corporation elections made in taxable years 
     beginning after December 31, 1996, with respect to bad debt 
     deductions under section 166 of the Internal Revenue Code of 
     1986 to treat such deductions as built-in losses under 
     section 1374(d)(4) of such Code during the entire period 
     during which the bank recognizes built-in gains from changing 
     its accounting method for recognizing bad debts from the 
     reserve method under section 585 of such Code to the charge-
     off method under section 166 of such Code.

     SEC. 7. INCLUSION OF BANKS IN 3-YEAR S CORPORATION RULE FOR 
                   CORPORATE PREFERENCE ITEMS.

       (a) In General.--Section 1363(b) of the Internal Revenue 
     Code of 1986 (relating to computation of corporation's 
     taxable income) is amended by adding at the end the following 
     new flush sentence:

     ``Paragraph (4) shall apply to any bank whether such bank is 
     an S corporation or a qualified subchapter S subsidiary.''.
       (b) Effective Date.--The amendment made by this section 
     shall apply to taxable years beginning after December 31, 
     2001.

     SEC. 8. C CORPORATION RULES TO APPLY FOR FRINGE BENEFIT 
                   PURPOSES.

       (a) In General.--Section 1372 of the Internal Revenue Code 
     of 1986 (relating to partnership rules to apply for fringe 
     benefit purposes) is repealed.
       (b) Partnership Rules To Apply for Health Insurance Costs 
     of Certain S Corporation Shareholders.--Paragraph (5) of 
     section 162(l) of the Internal Revenue Code of 1986 (relating 
     to special rules for health insurance costs of self-employed 
     individuals) is amended to read as follows:
       ``(5) Treatment of certain s corporation shareholders.--
       ``(A) In general.--This subsection shall apply in the case 
     of any 2-percent shareholder of an S corporation, except 
     that--
       ``(i) for purposes of this subsection, such shareholder's 
     wages (as defined in section 3121) from the S corporation 
     shall be treated as such shareholder's earned income (within 
     the meaning of section 401(c)(1)), and
       ``(ii) there shall be such adjustments in the application 
     of this subsection as the Secretary may by regulations 
     prescribe.
       ``(B) 2-percent shareholder defined.--For purposes of this 
     paragraph, the term `2-percent shareholder' means any person 
     who owns (or is considered as owning within the meaning of 
     section 318) on any day during the taxable year of the S 
     corporation more than 2 percent of the outstanding stock of 
     such corporation or stock possessing more than 2 percent of 
     the total combined voting power of all stock of such 
     corporation.''.
       (c) Conforming Amendment.--The table of sections for part 
     III of subchapter S of chapter 1 of the Internal Revenue Code 
     of 1986 is amended by striking the item relating to section 
     1372.
       (d) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2001.

     SEC. 9. EXPANSION OF S CORPORATION ELIGIBLE SHAREHOLDERS TO 
                   INCLUDE FAMILY LIMITED PARTNERSHIPS.

       (a) In General.--Section 1361(b)(1)(B) of the Internal 
     Revenue Code of 1986 (defining small business corporation) is 
     amended--
       (1) by striking ``or an organization'' and inserting ``an 
     organization'', and
       (2) by inserting ``, or a family partnership described in 
     subsection (c)(7)'' after ``subsection (c)(6)''.
       (b) Family Partnership.--Section 1361(c) of the Internal 
     Revenue Code of 1986 (relating to special rules for applying 
     subsection (b)) is amended by adding at the end the 
     following:
       ``(7) Family partnerships.--
       ``(A) In general.--For purposes of subsection (b)(1)(B), 
     any partnership or limited liability company may be a 
     shareholder in an S corporation if--
       ``(i) all partners or members are members of 1 family as 
     determined under section 704(e)(3), and
       ``(ii) all of the partners or members would otherwise be 
     eligible shareholders of an S corporation.
       ``(B) Treatment as shareholders.--For purposes of 
     subsection (b)(1)(A), in the case

[[Page S5546]]

     of a partnership or limited liability company described in 
     subparagraph (A), each partner or member shall be treated as 
     a shareholder.''.
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2001.

     SEC. 10. ISSUANCE OF PREFERRED STOCK PERMITTED.

       (a) In General.--Section 1361 of the Internal Revenue Code 
     of 1986 (defining s corporation), as amended by section 5(a), 
     is amended by adding at the end the following:
       ``(g) 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 solely 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) Section 1361(b)(1) of the Internal Revenue Code of 
     1986, as amended by section 5(b)(1), is amended by striking 
     ``subsection (f)'' and inserting ``subsections (f) and (g)''.
       (2) Section 1366(a) of such Code, as amended by section 
     5(b)(2), is amended by adding at the end the following:
       ``(4) Allocation with respect to qualified preferred 
     stock.--The holders of qualified preferred stock (as defined 
     in section 1361(g)) shall not, with respect to such stock, be 
     allocated any of the items described in paragraph (1).''.
       (3) Section 1373(a)(3) of such Code, as added by section 
     5(b)(3), is amended by inserting ``or 1361(g)(3)'' after 
     ``section 1361(f)(3)''.
       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2001.

     SEC. 11. CHARITABLE CONTRIBUTIONS STOCK BASIS ADJUSTMENT.

       (a) Stock Basis Adjustment.--Paragraph (1) of section 
     1367(a) of the Internal Revenue Code of 1986 (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:
       ``(D) the excess of the deductions for charitable 
     contributions over the basis of the property contributed.''.
       (b) Effective Date.--The amendment made by this section 
     shall apply to taxable years beginning after December 31, 
     2001.

     SEC. 12. CONSENT TO ELECTIONS.

       (a) 90 Percent of Shares Required for Consent to 
     Election.--Section 1362(a)(2) of the Internal Revenue Code of 
     1986 (relating to all shareholders must consent to election) 
     is amended--
       (1) by striking ``all persons who are shareholders in'' and 
     inserting ``shareholders holding at least 90 percent of the 
     shares of'', and
       (2) by striking ``All shareholders'' in the heading and 
     inserting ``At least 90 percent of shares''.
       (b) Rules for Consent.--Section 1362(a) of the Internal 
     Revenue Code of 1986 (relating to election) is amended by 
     adding at the end the following:
       ``(3) Rules for consent.--For purposes of making any 
     consent required under paragraph (2) or subsection 
     (d)(1)(B)--
       ``(A) each joint owner of shares shall consent with respect 
     to such shares,
       ``(B) the personal representative or other fiduciary 
     authorized to act on behalf of the estate of a deceased 
     individual shall consent for the estate,
       ``(C) one parent, the custodian, the guardian, or the 
     conservator shall consent with respect to shares owned by a 
     minor or subject to a custodianship, guardianship, 
     conservatorship, or similar arrangement,
       ``(D) the trustee of a trust shall consent with respect to 
     shares owned in trust,
       ``(E) the trustee of the estate of a bankrupt individual 
     shall consent for shares owned by a bankruptcy estate,
       ``(F) an authorized officer or the trustee of an 
     organization described in subsection (c)(6) shall consent for 
     the shares owned by such organization, and
       ``(G) in the case of a partnership or limited liability 
     company described in subsection (c)(8)--
       ``(i) all general partners shall consent with respect to 
     shares owned by such partnership,
       ``(ii) all managers shall consent with respect to shares 
     owned by such company if management of such company is vested 
     in 1 or more managers, and
       ``(iii) all members shall consent with respect to shares 
     owned by such company if management of such company is vested 
     in the members.''.
       (c) Treatment of Nonconsenting Shareholder Stock.--
       (1) In general.--Section 1361 of the Internal Revenue Code 
     of 1986 (defining s corporation), as amended by section 
     10(a), is amended by adding at the end the following:
       ``(h) Treatment of Nonconsenting Shareholder Stock.--
       ``(1) In general.--For purposes of this subchapter--
       ``(A) nonconsenting shareholder stock shall not be treated 
     as a second class of stock,
       ``(B) such stock shall be treated as C corporation stock, 
     and
       ``(C) the shareholder's pro rata share under section 
     1366(a)(1) with respect to such stock shall be subject to tax 
     paid by the S corporation at the highest rate of tax 
     specified in section 11(b).
       ``(2) Nonconsenting shareholder stock defined.--For 
     purposes of this subsection, the term `nonconsenting 
     shareholder stock' means stock of an S corporation which is 
     held by a shareholder who did not consent to an election 
     under section 1362(a) with respect to such S corporation.
       ``(3) Distributions.--A distribution (not in part or full 
     payment in exchange for stock) made by the corporation with 
     respect to nonconsenting shareholder 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.''.
       (2) Conforming amendment.--Section 1361(b)(1) of the 
     Internal Revenue Code of 1986, as amended by section 
     10(b)(1), is amended by striking ``subsections (f) and (g)'' 
     and inserting ``subsections (f), (g), and (h)''.
       (d) Effective Date.--The amendments made by this section 
     shall apply to elections made in taxable years beginning 
     after December 31, 2001.

     SEC. 13. INFORMATION RETURNS FOR QUALIFIED SUBCHAPTER S 
                   SUBSIDIARIES.

       (a) In General.--Section 1361(b)(3)(A) of the Internal 
     Revenue Code of 1986 (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.
                                  ____


   Small Business and Financial Institutions Tax Relief Act of 2001--
                                Summary

       This legislation expands Subchapter S of the IRS Code. 
     Subchapter S corporations do not pay corporate income taxes, 
     earnings are passed through to the shareholders where income 
     taxes are paid, eliminating the double taxation of 
     corporations. By contrast, Subchapter C corporations pay 
     corporate income taxes on earnings, and shareholders pay 
     income taxes again on those same earnings when they pass 
     through as dividends. Subchapter S of the IRS Code was 
     enacted in 1958 to reduce the tax burden on small business. 
     The Subchapter S provisions have been liberalized a number of 
     times over the last two decades, significantly in 1982, and 
     again in 1996. This reflects a desire on the part of Congress 
     to reduce taxes on small business.
       This S corporation legislation would benefit many small 
     businesses, but its provisions are particularly applicable to 
     banks. Congress made S corporation status available to small 
     banks for the first time in the 1996 ``Small Business Job 
     Protection Act'' but many banks are having trouble qualifying 
     under the current rules. The proposed legislation:
       Permits S corporation shares to be held as Individual 
     Retirement Accounts (IRAs), and permit IRA shareholders to 
     purchase their shares from the IRA in order to facilitate a 
     Subchapter S election.
       Clarifies that interest and dividends on investments 
     maintained by a bank for liquidity and safety and soundness 
     purposes shall not be ``passive'' income. This is necessary 
     because S corporations are restricted in the amount of 
     passive investment income they may generate.
       Increases the number of S corporation eligible shareholders 
     from 75 to 150.
       Provides that any stock that bank directors must hold under 
     banking regulations shall not be a disqualifying second class 
     of stock. This is necessary because S corporations are 
     permitted only one class of stock.
       Permits banks to treat bad debt charge offs as items of 
     built in loss over the same number of years that the 
     accumulated bad debt reserve must be recaptured (four years) 
     for built in gains tax purposes. This provision is necessary 
     to properly match built in gains and losses relating to 
     accounting for bad debts. Banks that are converting to S 
     corporations must convert from the reserve method of 
     accounting to the specific charge off method and the 
     recapture of the accumulated bad debt reserve is built in 
     gain. Presently the presumption that a bad debt charge off is 
     a built in loss applies only to the first S corporation year.
       Clarifies that the general 3 Year S corporation rule for 
     certain ``preference'' items applies to interest deductions 
     by S corporation banks, thereby providing equitable treatment 
     for S corporation banks. S corporations that convert from C 
     corporations are denied certain interest deductions 
     preference items for up to 3 years after the conversion, at 
     the end of 3 years the deductions are allowed.
       Provides that non-health care related fringe benefits such 
     as group-term life insurance will be excludable from wages 
     for ``more-than-two-percent'' shareholders. Current law taxes 
     the fringe benefits of these shareholders. Health care 
     related benefits are not included because their deductibility

[[Page S5547]]

     would increase the revenue impact of the legislation.
       Permits Family Limited Partnerships to be shareholders in 
     subchapter S corporations. Many family owned small businesses 
     are organized as Family Limited Partnerships or controlled by 
     Family Limited Partnerships for a variety of reasons. A 
     number of small banks have Family Limited Partnership 
     shareholders, and this legislation would for the first time 
     permit those partnerships to be S corporation shareholders.
       Permits S corporations to issue preferred stock in addition 
     to common. Prohibited under current law which permits S 
     corporations to have only one class of stock. Because of 
     limitations on the number of common shareholders, banks need 
     to be able to issue preferred stock in order to have adequate 
     access to equity.
       Facilitates charitable giving by S corporation shareholders 
     by providing a basis increase for the excess of the 
     charitable contribution deduction over the basis of property 
     contributed. Current law penalizes a shareholder who makes a 
     charitable contribution through an S corporation by limiting 
     the charitable deduction that flows through to the 
     shareholder to the basis of the donated property. This means 
     that the shareholder is unable to benefit from the full fair 
     market value deduction when the basis does not reflect the 
     appreciation in the property. This differs from the full 
     value deduction afforded the taxpayer who donates property in 
     an individual capacity or through a partnership, instead of 
     through an S corporation.
       Reduces the required level of shareholder consent to 
     convert to an S corporation from unanimous to 90 percent of 
     shares.
       Clarifies that Qualified Subchapter S Subsidiaries (QSSS) 
     provide information returns under their own tax id number. 
     This can help avoid confusion by depositors and other parties 
     over the insurance of deposits and the payer of salaries and 
     interest.
                                 ______