Good news on a hot day in July! The 2016 version of the “S Corporation Modernization Act” has been introduced the House and the Senate. Led by Senators Thune (R-SD) and Cardin (D-MD) and Representatives Reichert (R-WA) and Kind (D-WI), the bill includes a half-dozen provisions designed to improve the rules that govern S corporations.
- You can see the entire bill here
- You can see the section-by-section analysis here
- You can see the S-Corp press release here
Yesterday’s introduction of companion bills is the first time in a while that the S corporation community has had this important legislation being championed in both bodies, and we really appreciate the hard work the members and their staffs put in to get the provisions just right.
Of particular note is the fact that Senator Thune is taking on the leadership of the bill from Finance Committee Chair and longtime S corporation advocate Senator Orrin Hatch (R-UT). South Dakota has a ton of S corporations and ranks second nationally in pass-through employment, so this effort is important to Senator Thune and his state and we look forward to his enthusiastic leadership. As he noted at the introduction:
Family owned small businesses are the backbone of the U.S. economy and can be located in every corner of the country. 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.
Senator Ben Cardin added:
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. 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.
Key changes in this version relative to past efforts include:
- Dropping the two provisions – BIG and charitable – that were made a permanent part of the Tax Code last December
- Moving the Nonresident Alien provision up to the top slot – it is time for direct foreign investment to be available to S corporations; and
- Including the new internal basis adjustment provision to ensure that S corporation assets receive similar treatment as partnerships.
So your S-Corp team has a new bill, new champions, and new priorities to accomplish in the coming months and years. The legislative outlook is uncertain, with Congress preparing to break for the party conventions and then, after a short fall session, the November elections. That doesn’t leave us much time, but as always we will be looking for opportunities to get something done. With a terrific bipartisan set of advocates on the Hill, we are in a good position to do just that.
S-Corp Concerns Dominate 385 Comments
The comment period is closed and the verdict is in – just take S corps out. That’s what numerous trade associations and other groups recommended to Treasury regarding the pending section 385 regulations. Here’s what the National Association of Manufacturers had to say:
The proposed regulations also significantly impede the ability of businesses organized as subchapter S corporations to utilize their cash effectively. In particular, the bifurcation rule in the proposed regulations, which allows the IRS to treat a debt instrument as part debt and part stock, could cause a subchapter S corporation to lose its S status and become taxed as a C corporation.
In order to qualify as an S corporation, an entity must have only one class of stock (identical rights to distribution and liquidation proceeds) and must be owned only by eligible shareholders (examples of ineligible shareholders include C corporations, foreign corporations, partnerships, insurance companies and non-resident aliens). The reclassification to stock, or part stock, could inadvertently create an ineligible S corporation shareholder (e.g., if the debt reclassified to stock was held by a C corporation, the C corporation would become an ineligible S corporation shareholder); and/or the reclassification to stock could create a second class of stock via preferred return consideration on the debt instrument….
The proposed regulations do not apply to corporations filing a consolidated tax return. S corporations under common ownership, however, are not permitted to file a consolidated tax return and thus, the proposed regulations apply to commonly-owned S corporations, even those with solely domestic activity. The NAM strongly recommends that subchapter S corporations be exempted from the final regulations.
Other groups made similar arguments and their conclusions were just as strong. Here’s just a sample:
Exclude S corporations from the expanded group.
We recommend that S corporations be exempted from the application of the regulations.
American Institute of Certified Public Accountants
Provide exceptions to ensure that S corporations do not inadvertently terminate their status when debt is reclassified as equity.
The rules should exempt S corporations which clearly cannot be a focus for the issues of concern regarding the Proposed Rules.
Exclude S corporations, as well as certain other entities, from the ambit of the proposed regulations (i.e., revise Prop. Treas. Reg. § 1.385-1(b)(3)(i)(A) so that it only “turns off” paragraph (3) of section 1504(b)).
The IRS is holding a public hearing on the proposed rules today. Of the 18 speakers listed, many of them are from groups that support excluding S corporations from the rule. We’ll be watching closely to what, if any, reaction there is from the Treasury and IRS officials in attendance. More to come.