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

May 23, 2001

Mr. ALLARD (for himself, Mr. JOHNSON, and Mr. THOMAS) 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 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 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.

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