I
109th CONGRESS
1st Session
H. R. 4421
IN THE HOUSE OF REPRESENTATIVES
November 18, 2005
Mr. Shaw (for himself and Mr. Ramstad) introduced the following bill; which was referred to the Committee on Ways and Means
A BILL
To amend the Internal Revenue Code of 1986 to provide for S corporation reform, and for other purposes.
Short title, reference
Short title
This Act may be cited as the S Corporation Reform Act of 2005
.
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.
Reduced recognition period for built-in gains
In General
Paragraph (7) of section 1374(d) (relating to definitions and special rules) is amended by striking 10-year
both places it appears and inserting 7-year
.
Application to regulated investment companies and real estate investment trusts
For purposes of paragraph (1) of section 337(d) and the regulations thereunder, any reference to the 10-year recognition period under section 1374 shall be applied as if the reference were to a 7-year recognition period.
Effective date
General rule
The amendment made by this section shall apply to any recognition period in effect on or after the date of the enactment of this Act.
Special application to existing periods exceeding 7 years
Any recognition period (as defined in section 1374(d)(7) of the Internal Revenue Code of 1986) which is in effect on the date of the enactment of this Act and which is in the 8th, 9th, or 10th year after the beginning of such period shall end on the date of the enactment of this Act.
Issuance of preferred stock permitted
In general
Section 1361 (defining S corporation) is amended by adding at the end the following new subsection:
Treatment of Qualified Preferred Stock
In general
For purposes of this subchapter—
qualified preferred stock shall not be treated as a second class of stock, and
no person shall be treated as a shareholder of the corporation by reason of holding qualified preferred stock.
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.
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.
.
Conforming amendments
Paragraph (1) of section 1361(b) is amended by inserting , except as provided in subsection (f),
before which does not
.
Subsection (a) of section 1366 is amended by adding at the end the following new paragraph:
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).
.
So much of clause (ii) of section 354(a)(2)(C) as precedes subclause (II) thereof is amended to read as follows:
Recapitalization of family-owned corporations and S corporations
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.
.
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:
no amount of an expense deductible under this subchapter by reason of section 1361(f)(3) shall be apportioned or allocated to such income.
.
Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.
Safe harbor expanded to include convertible debt
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:
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
the creditor is—
an individual,
an estate,
a trust described in paragraph (2),
an exempt organization described in paragraph (6), or
a person which is actively and regularly engaged in the business of lending money.
.
Effective date
The amendment made by this section shall apply to taxable years beginning after December 31, 2005.
Repeal of excessive passive investment income as a termination event
In general
Section 1362(d) (relating to termination) is amended by striking paragraph (3).
Conforming amendments
Section 1362(f)(1) is amended by striking or (3)
.
Clause (i) of section 1042(c)(4)(A) is amended by striking section 1362(d)(3)(C)
and inserting section 1375(b)(3)
.
Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.
Modifications to passive income rules
Increased limit
In general
Paragraph (2) of section 1375(a) (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
.
Conforming amendments
Subparagraph (J) of section 26(b)(2) is amended by striking 25 percent
and inserting 60 percent
.
Clause (i) of section 1375(b)(1)(A) is amended by striking 25 percent
and inserting 60 percent
.
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
.
Repeal of passive income capital gain category
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:
Passive investment income defined
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.
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).
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)).
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.
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.
.
Conforming amendments
Section 1375(d) is amended by striking subchapter C
both places it appears and inserting accumulated
.
Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.
Expansion of S corporation eligible shareholders to include IRAS
In general
Clause (vi) of section 1361(c)(2)(A) (relating to certain trusts permitted as shareholders) is amended to read as follows:
A trust which constitutes an individual retirement account under section 408(a), including one designated as a Roth IRA under section 408A.
.
Sale of stock in IRA relating to S corporation election exempt from prohibited transaction rules
Paragraph (16) of section 4975(d) (relating to exemptions) is amended to read as follows:
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) by the issuer of such stock,
such sale is for fair market value at the time of sale (as established by an independent appraiser) and the terms of the sale are otherwise at least as favorable to such trust as the terms that would apply on a sale to an unrelated party,
such trust does not pay any commissions, costs, or other expenses in connection with the sale, and
the stock is sold in a single transaction for cash not later than 120 days after the S corporation election is made.
.
Effective date
The amendments made by this section shall take effect on the date of the enactment of this Act.
Adjustment to basis of S corporation stock for certain charitable contributions
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:
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.
.
Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.
Nonresident aliens allowed to be shareholders
Nonresident aliens allowed to be shareholders
In general
Paragraph (1) of section 1361(b) (defining small business corporation) is amended—
by adding and
at the end of subparagraph (B),
by striking subparagraph (C), and
by redesignating subparagraph (D) as subparagraph (C).
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)
.
Clause (i) of section 280G(b)(5)(A) (relating to general rule for exemption for small business corporations, etc.) is amended by striking but without regard to paragraph (1)(C) thereof
.
Nonresident Alien Shareholder Treated as Engaged in Trade or Business Within United States
In general
Section 875 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:
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.
.
Pro rata share of S corporation income
The last sentence of section 1441(b) (relating to income items) is amended to read as follows: In the case of a nonresident alien individual who is a member of a domestic partnership or a shareholder of an S corporation, the items of income referred to in subsection (a) shall be treated as referring to items specified in this subsection included in his distributive share of the income of such partnership or in his pro rata share of the income of such S corporation.
.
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:
S corporation treated as partnership, etc
For purposes of this section—
an S corporation shall be treated as a partnership,
the shareholders of such corporation shall be treated as partners of such partnership,
any reference to section 704 shall be treated as a reference to section 1366, and
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)).
.
Conforming amendments
The heading of section 875 is amended to read as follows:
Partnerships; beneficiaries of estates and trusts; s corporations
.
The heading of section 1446 is amended to read as follows:
Withholding tax on foreign partners’ and s corporation shareholders’ share of effectively connected income
.
Clerical amendments
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
.
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
.
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:
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.
.
Application of other withholding tax rules on nonresident alien shareholders
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:
S corporation treated as partnership, etc
For purposes of this section—
an S corporation shall be treated as a partnership,
the shareholders of such corporation shall be treated as partners of such partnership, and
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)).
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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:
S corporation treated as partnership, etc
For purposes of this section—
an S corporation shall be treated as a partnership, and
the shareholders of such corporation shall be treated as partners of such partnership, and
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)).
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Additional conforming amendments
Section 1361(c)(2)(A)(i) is amended by striking who is a citizen or resident of the United States
.
Section 1361(d)(3)(B) is amended by striking who is a citizen or resident of the United States
.
Section 1361(e)(2) is amended by inserting (including a nonresident alien)
after person
the first place it appears.
Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.
Inadvertent invalid elections or terminations
In general
Subsection (f) of section 1362 (relating to inadvertent invalid elections or terminations) is amended to read as follows:
Inadvertent invalid elections or terminations
In general
If—
an election under subsection (a), section 1361(b)(3)(B)(ii), or section 1361(c)(1)(A)(ii) by any corporation—
was not effective for the taxable year for which made (determined without regard to subsection (b)(2)) by reason of a failure to meet the requirements of section 1361(b) or to obtain shareholder consents, or
was terminated under paragraph (2) or (3) of subsection (d), section 1361(b)(3)(C), or section 1361(c)(1)(D)(iii),
the Secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent, and
such circumstances occurred in a taxable year for which a claim for credit or refund under section 6511 has expired as of the date of discovery referred to in subparagraph (C),
no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination, steps were taken—
so that the corporation for which the election was made or the termination occurred is a small business corporation or a qualified subchapter S subsidiary, as the case may be, or
to acquire the required shareholder consents, and
the corporation for which the election was made or the termination occurred, and each person who was a shareholder in such corporation at any time during the period specified pursuant to this subsection, makes all adjustments (necessary and consistent with the treatment of such corporation as an S corporation or a qualified subchapter S subsidiary, as the case may be)—
for purposes of subparagraph (B)(i), as may be required by the Secretary with respect to such period, or
for purposes of subparagraph (B)(ii), as if the corporation was a S corporation or a qualified subchapter S subsidiary for each taxable year for which a claim for credit or refund pursuant to section 6511 has not expired at the time of the discovery in paragraph (3) of this subsection,
Period for which treated as S corporation
If this paragraph applies to a corporation by reason of paragraph (1), such corporation shall be treated as an S corporation or a qualified subchapter S subsidiary, as the case may be—
for purposes of paragraph (1)(B)(i), during the period specified by the Secretary, and
for purposes of paragraph (1)(B)(ii), for each taxable year for which a claim for credit or return pursuant to section 6511 has not expired at the time of the discovery referred to in paragraph (1)(C).
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Effective date
The amendments made by this section shall apply to taxable years beginning after December 31, 2005.