S Corporation Modernization Act of 2013

On February 28, 2013, House Ways & Means Committee members Dave Reichert (R-WA) and Ron Kind (D-WI) introduced the S Corporation Modernization Act of 2013 (“H.R. 892”). The bill is the most recent iteration of S corporation reform to be introduced in Congress. A prior version of the bill (H.R. 1478) was introduced in 2011 as the S Corporation Modernization Act of 2011. The bipartisan S corporation tax reform bill was touted by its sponsors as “a commonsense update to the tax code that will give S corporations the ability to grow and prosper especially in this tough economic environment.” The bill has wide support from industry organizations that in a joint support letter to Congress indicated that the bill would ensure the continued success of S corporations by “increasing access to capital by reducing S corporation ownership restrictions; easing punitive restrictions that apply to converted S corporations and punish the unwary; and encouraging philanthropy by S corporations.” Industry groups joining in support of the bill include the American Council of Engineering Companies, the American Institute of Architects, the American Supply Association, Associated Builders & Contractors, Associated General Contracts of America, Independent Community Bankers of America, and various other industry organizations.

The reforms included in the bill amend provisions of Subchapter S of the Internal Revenue Code (the “Code”) related to the built-in gains tax on S corporations, the excess passive income rules, the rules governing electing small business trusts (“ESBTs”), shareholder eligibility rules, and the treatment of charitable contributions made by S corporations.

The bipartisan bill proposes significant legislativechanges to Subchapter S to allow for greater access to capital and greater flexibility for S corporations. However, given the current climate in Congress and the tendency towards so-called “legislation by crisis,” it is unlikely that the bill will be taken up by the house this term. Regardless, the bill has become a framework for outlining effective tax reforms for S corporations that may in the future become part of a push for more comprehensive tax reforms. On March 12, 2013, the House Ways & Means Committee released a tax reform discussion draft for
implementation of structural reforms to the taxation of passthrough entities such as S corporations and partnerships. This discussion draft outlines two options for implementing reforms. Option 1 which proposes targeted reforms to both Subchapter S and Subchapter K (taxation of partnerships) draws heavily from the ideas proposed in H.R. 892. Option 2 goes even further, essentially restructuring both Subchapter S and Subchapter K into a single set of rules for the taxation of all nonpublicly traded passthroughs and some publicly traded passthrough entities. This past summer House Ways & Means Committee Chairman Dave Camp and Senate Finance Committee Chairman Max Baucus toured the country in an attempt to solicit feedback on the Small Business and Passthrough Entities reform and other proposals to generate support for comprehensive reforms to the Code. It is clear that support for comprehensive tax reform is slowly building. The question, however, is whether it can overcome the perpetual gridlock that has become commonplace in Congress.

Regardless of the hurdles to passage of the bill, the reforms proposed in H.R. 892 are instructive as to the possibilities for reforming the S corporation and also present an opportunity to review important aspects of Subchapter S for new or existing S corporations.

For more specifics on what the bill accomplishes and to read a detailed legislative summary on the Act please contact Patrick J. Kennedy, Jr.

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