John Thune (R-S.D.) and Ben Cardin (D-Md.), members of the tax-writing Senate Finance Committee, introduced the S Corporation Modernization Act of 2016 (S. 3181), legislation that would make several pro-growth reforms to help S corporations operate more easily, which would improve their ability to raise capital. S corporations were created in 1958, must be domestically owned, and are limited to 100 shareholders. This type of business has grown in popularity, particularly among small businesses, because of its simplicity and flexibility. S corporations are the most common form of business structure in America, with more than 4 million in existence today. Despite their popularity, relatively few reforms have been made to S corporations since their creation, which is why the Thune-Cardin bill would help modernize this part of the tax code.
“Family owned small businesses are the backbone of the U.S. economy and can be located in every corner of the country,” said Thune. “Small towns and rural communities are oftentimes the ideal location for these small- and medium-sized businesses, which is why making these common-sense reforms to S corporations is so important to South Dakota. There’s broad bipartisan agreement that our tax code is wildly outdated, and making these kinds of incremental changes is an important step in the right direction.”
“S corporation businesses are critical to the well-being of the Maryland economy and account for more than half of our state’s private-sector workforce,” said Cardin. “Unfortunately, our federal tax code has not kept up with the increasingly important role that these types of companies play,” said Cardin. “The S Corporation Modernization Act contains much-needed changes to the tax treatment of S corporations, allowing them to better attract capital, create jobs, and make charitable investments in their communities.”
This is the first time since 2009 that the S Corporation Modernization Act, of which Sen. Pat Roberts (R-Kan.) is also a cosponsor, has been introduced in the Senate. U.S. Reps. Dave Reichert (R-Wash) and Ron Kind (D-Wis.) have introduced companion legislation in the House of Representatives.
Highlights of the S Corporation Modernization Act:
Expansion of Qualifying Beneficiaries of an Electing Small Business Trust: This provision allows a non-resident alien to be a qualified beneficiary of an Electing Small Business Trust (ESBT), which is a certain type of trust allowed to own shares in an S corporation. Currently, only U.S. citizens or U.S. residents can own S corporation shares. This provision does not change the direct ownership requirement, but it allows a non-resident alien to get the benefits of S corporation ownership by being a beneficiary of the ESBT, while ensuring that any applicable taxes are collected by the ESBT.
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 than 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.
Charitable Contributions for Electing Small Business Trusts: ESBTs are allowed to own S corporation stock, but are not allowed a charitable deduction for certain donations to charitable organizations. Individual S corporation owners are allowed the charitable deduction. This provision would allow ESBTs to claim the deduction.
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.