To amend the Internal Revenue Code of 1986 to expand S corporation eligibility for banks, and for other purposes.

April 10, 2003

Mr. ALLARD introduced the following bill; which was read twice and referred to the Committee on Finance

To amend the Internal Revenue Code of 1986 to expand S corporation eligibility for banks, 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.

This Act may be cited as the `Small Business and Financial Institutions Tax Relief Act of 2003'.

SEC. 2. EXPANSION OF BANK 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 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) of such Code (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) of such Code (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) of such Code 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. 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) or a bank holding company (as defined in section 246A(c)(3)(B)(ii)), the term `passive investment income' shall not include--

`(I) interest income earned by such bank or bank holding company, or

`(II) dividends on assets required to be held by such bank or bank holding company 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, 2003.

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 shareholders' and inserting `150 shareholders'.

(b) EFFECTIVE DATE- The amendment made by this section shall apply to taxable years beginning after December 31, 2003.

SEC. 5. TREATMENT OF QUALIFYING DIRECTOR SHARES.

(a) IN GENERAL- Section 1361 of the Internal Revenue Code of 1986 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).'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2003.

SEC. 6. RECAPTURE OF BAD DEBT RESERVES.

In the case of a bank which makes an S corporation election which first takes effect for a taxable year beginning after December 31, 2003, the entire adjustment required by section 481 of the Internal Revenue Code of 1986 by reason of 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 may be taken into in the year of the change or the preceding taxable year (whichever is elected by the bank).

SEC. 7. CLARIFICATION OF 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:

`Nothing in the preceding sentence shall be construed to apply section 291 to any taxable year which is more than 3 taxable years after the S corporation (or any predecessor) was a C corporation.'

(b) EFFECTIVE DATE- The amendment made by this section shall apply to taxable years beginning after December 31, 2003.

SEC. 8. MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER.

(a) IN GENERAL- Paragraph (1) of section 1361(c) of the Internal Revenue Code of 1986 (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 3 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) of such Code (relating to inadvertent invalid elections or terminations) is amended--

(1) by inserting `or under section 1361(c)(1)(A)(ii)' after `subsection (a)' in paragraph (1), and

(2) by inserting `or under section 1361(c)(1)(E)(iii)' after `subsection (d)' 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, 2003.

(2) SUBSECTION (b)- The amendments made by subsection (b) shall apply to elections and terminations made after December 31, 2003.

SEC. 9. ISSUANCE OF PREFERRED STOCK PERMITTED.

(a) IN GENERAL- Section 1361 of the Internal Revenue Code of 1986, 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).'

(c) EFFECTIVE DATE- The amendments made by this section shall apply to taxable years beginning after December 31, 2003.

SEC. 10. 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, 2003.

SEC. 11. ADJUSTMENT TO BASIS OF S CORPORATION STOCK FOR CERTAIN CHARITABLE CONTRIBUTIONS.

(a) IN GENERAL- Paragraph (2) of section 1367(a) of the Internal Revenue Code of 1986 (relating to adjustments to basis of stock of shareholders, etc.) is amended by adding at the end the following new flush sentence:

`The decrease under subparagraph (B) by reason of a charitable contribution (as defined in section 170(c)) of property shall be the amount equal to the shareholder's pro rata share of the adjusted basis of such property.'.

(b) EFFECTIVE DATE- The amendment made by this section shall apply to taxable years beginning after December 31, 2003.

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