S Corp Bill Introduced in the Senate

July 24, 2019

On July 18, Sens. John Thune (R-S.D.) and Ben Cardin (D-Md.), both members of the Senate Finance Committee, reintroduced the S Corporation Modernization Act (S. 2156), legislation that would make several pro-growth reforms to help S corporations operate more easily, which would improve their ability to raise capital. Among the items, the bill would: provide meaningful relief from the so-called “sting tax” passive income rules; expand the ability of IRAs to invest in S corporation banks; and level the tax-treatment of asset sales with sales of S corporation stock.

Subchapter S of the Internal Revenue Code (S corporations) was enacted in 1958 to provide entrepreneurs the advantage of corporate protection from liability, along with the single level of taxation enjoyed by partnerships and limited liability companies. This type of business has grown in popularity, particularly among small businesses, because of its simplicity and flexibility. However, the S corporation statute contains a variety of limitations and restrictions. Even though some very important improvements have been made over the years, more needs to be done to bring the tax treatment of these important businesses into the twenty-first century.

Some of the specific provisions included in S. 2156 would:

Modifications to Passive Income Rules: The tax code includes an additional tax on S corporations that have previously converted from C corporations if more than 25 percent of the S corporation’s income is passive in nature (such as rents, royalties, and interest). The provision implements a 2001 recommendation by the Joint Committee on Taxation (JCT) that this threshold be increased to 60 percent and that the rules be altered so that an S corporation paying this tax does not lose its S corporation status.

S Corporation IRA Shareholders: This provision permits any S corporation bank to have IRA shareholders. Current law limits IRA ownership of S corporation banks to only those S corporation banks with stock held by an IRA as of October 22, 2004. As under current law, the IRA would be required to pay Unrelated Business Income Tax on its share of S corporation income. A significant percentage of banks are currently organized as S corporations.

Basis Parity for S Corporation Assets: This provision would provide a basis adjustment for S corporation assets, but do so in a way that would not require tracking the basis of individual assets, which would be complex and time consuming. Instead, upon the death of a shareholder, the S corporation would get a 15-year amortization deduction attributable to the percentage of S corporation assets owned by the deceased owner.

Unfortunately, our federal tax code has not kept up with the increasingly important role that S corporations play. Thus, NSBA is pleased that the S Corporation Modernization Act contains much-needed changes to the tax treatment of S corporations, allowing them to better attract capital, and create jobs, making them more competitive.