Institute calls for fewer limits on S corporations. (Highlights).

A bill pending in the House of Representatives would modernize the laws that govern subchapter S of the Internal Revenue Code, Robert A. Zarzar, CPA and chairman of the AICPA tax executive committee, told the House Ways and Means subcommittee on select revenue measures in June. The Small Business Job Protection Act of 1996 and other laws passed in recent years have facilitated entrepreneurs' access to S corporations, he said, but more liberal reform is necessary to broaden and ease entry into these entities, which offer a limited number of investors--currently not more than 75--protection from corporate creditors, the ability to deduct business losses on shareholders' individual tax returns and freedom from double taxation.

Zarzar told subcommittee members that while the Institute had some minor reservations about a few provisions in the bill, the AICPA generally supported HR 1896, the Subchapter S Modernization Act of 2003, which addresses many, but not all, of the improvements needed. Still, the AICPA recommends certain changes in the bill, including

* Recognizing and removing anticompetitive limitations on the growth of existing S corporations. The Institute strongly supports section 205 of the pending bill allowing a stock basis increase for appreciated property an S corporation contributes to charity. Currently, the IRS requires an S corporation shareholder to reduce his or her stock basis by the amount of any charitable contribution deduction flowing from an S corporation to the shareholder. So if an S corporation claims a fair-market-value deduction for a contribution of appreciated property, the shareholder must reduce his or her basis in the S corporation by that amount. But for partnerships, the IRS requires a partner's basis in his or her partnership interest be reduced by his or her pro rata share of the partnership's basis in the property contributed. The AICPA believes partnerships and S corporations should be treated similarly in this context, and this provision would preserve the intended benefit of a fair-market-value deduction for the contributed appreciated property without recognizing the appreciation when the stock is later sold. Section 205 would encourage charitable giving and protect taxpayers who don't realize gifting appreciated property through an S corporation results in recognition of the gain inherent in the property when the S corporation stock eventually is disposed of in a taxable transaction.

* Clarifying or correcting existing S-corporation-related laws. The pending bill eliminates a major concern regarding the use of electing small business trusts (ESBTs) for succession planning in family-owned S corporations by disregarding unexercised powers of appointment in determining the trust's eligibility as an S corporation shareholder. However, because ESBTs are taxed at the highest marginal rate (that is, 35%) and thus are minimally susceptible to abuse, the Institute believes the bill should go further and eliminate most other eligibility restrictions on ESBTs.