§ 1378. Taxable year of S corporation

Legislative history

Reconstructed from this section’s Code source credit and amendment notes, resolved against the local Statutes at Large. Editorial notes are evidence, not the law that made the change.

1. 1982

   Subchapter S Revision Act of 1982

   Pub. L. 97–354 § 2 · 96 Stat. 1669

   Enacted · 26 U.S.C. § 1378

   Added Pub. L. 97–354, § 2, Oct. 19, 1982, 96 Stat. 1685

   Source evidence

   Code source credit
   Added Pub. L. 97–354, § 2, Oct. 19, 1982, 96 Stat. 1685

   Enacted provision · exact public law section
   SEC. 2. AMENDMENT OF SUBCHAPTER S. Subchapter S of chapter 1 is amended to read as follows: “Subchapter S— Tax Treatment of S Corporations and Their Shareholders “Part I. In general. “Part II. Tax treatment of shareholders. “Part III. Special rules. “Part IV. Definitions; miscellaneous. “PART I— IN GENERAL “Sec. 1361. S corporation defined. “Sec. 1362. Election; revocation; termination. “Sec. 1363. Effect of election on corporation. “SEC. 1361. S CORPORATION DEFINED. “(a) S Corporation Defined.— “(1) In general.— For purposes of this title, the term ‘S corporation’ means, with respect to any taxable year, a small business corporation for which an election under section 1362(a) is in effect for such year. “(2) C corporation.— For purposes of this title, the term ‘C corporation’ means, with respect to any taxable year, a corporation which is not an S corporation for such year. “(b) Small Business Corporation.— “(1) In general.— For purposes of this subchapter, the term ‘small business corporation’ means a domestic corporation which is not an ineligible corporation and which does not— “(A) have more than 35 shareholders, “(B) have as a shareholder a person (other than an estate and other than a trust described in subsection (c)(2)) who is not an individual, “(C) have a nonresident alien as a shareholder, and “(D) have more than 1 class of stock. “(2) Ineligible corporation defined.— For purposes of paragraph (1), the term ‘ineligible corporation’ means any corporation which is— “(A) a member of an affiliated group (determined under section 1504 without regard to the exceptions contained in subsection (b) thereof), “(B) a financial institution to which section 585 or 593 applies, “(C) an insurance company subject to tax under subchapter L, 26 USC 801. “(D) a corporation to which an election under section 936 applies, or “(E) a DISC or former DISC. “(c) Special Rules for Applying Subsection (b).— “(1) Husband and wife treated as 1 shareholder— For purposes of subsection (b)(1)(A), a husband and wife (and their estates) shall be treated as 1 shareholder. “(2) Certain trusts permitted as shareholders.— “(A) In general.— For purposes of subsection (b)(1)(B), the following trusts may be shareholders: “(i) A trust all of which is treated (under subpart E of part I of subchapter J of this chapter) as owned by an 26 USC 671. individual who is a citizen or resident of the United States. “(ii) A trust which was described in clause (i) immediately before the death of the deemed owner and which continues in existence after such death, but only for the 60-day period beginning on the day of the deemed owner’s death. If a trust is described in the preceding sentence and if the entire corpus of the trust is includible in the gross estate of the deemed owner, the preceding sentence shall be applied by substituting ‘2-year period’ for ‘60-day period’. “(iii) A trust with respect to stock transferred to it pursuant to the terms of a will, but only for the 60-day period beginning on the day on which such stock is transferred to it. “(iv) A trust created primarily to exercise the voting power of stock transferred to it. This subparagraph shall not apply to any foreign trust. “(B) Treatment as shareholders.— For purposes of subsection (b)(1)— “(i) In the case of a trust described in clause (i) of subparagraph (A), the deemed owner shall be treated as the shareholder. “(ii) In the case of a trust described in clause (ii) of subparagraph (A), the estate of the deemed owner shall be treated as the shareholder. “(iii) In the case of a trust described in clause (iii) of subparagraph (A), the estate of the testator shall be treated as the shareholder. “(iv) In the case of a trust described in clause (iv) of subparagraph (A), each beneficiary of the trust shall be treated as a shareholder. “(3) Estate of individual in bankruptcy may be shareholder.— For purposes of subsection (b)(1)(B), the term ‘estate’ includes the estate of an individual in a case under title 11 of the United States Code. 11 USC 101 et seq. “(4) Differences in common stock voting rights disregarded.— For purposes of subsection (b)(1)(D), a corporation shall not be treated as having more than 1 class of stock solely because there are differences in voting rights among the shares of common stock. “(5) Straight debt safe harbor.— “(A) In general.— For purposes of subsection (b)(1)(D), straight debt shall not be treated as a second class of stock. “(B) Straight debt defined.— For purposes of this paragraph, the term ‘straight debt’ means any written unconditional promise to pay on demand or on a specified date a sum certain in money if— “(i) the interest rate (and interest payment dates) are not contingent on profits, the borrower’s discretion, or similar factors, “(ii) there is no convertibility (directly or indirectly) into stock, and “(iii) the creditor is an individual (other than a nonresident alien), an estate, or a trust described in paragraph (2). “(C) Regulations.— The Secretary shall prescribe such regulations as may be necessary or appropriate to provide for the proper treatment of straight debt under this subchapter and for the coordination of such treatment with other provisions of this title. “(6) Ownership of stock in certain inactive corporations.— For purposes of subsection (b)(2)(A), a corporation shall not be treated as a member of an affiliated group at any time during any taxable year by reason of the ownership of stock in another corporation if such other corporation— “(A) has not begun business at any time on or after the date of its incorporation and before the close of such taxable year, and “(B) does not have taxable income for the period included within such taxable year. “(d) Special Rule for Qualified Subchapter S Trust.— “(1) In general.— In the case of a qualified subchapter S trust with respect to which a beneficiary makes an election under paragraph (2)— “(A) such trust shall be treated as a trust described in subsection (c)(2)(A)(i), and “(B) for purposes of section 678(a), the beneficiary of such trust shall be treated as the owner of that portion of the trust which consists of stock in an S corporation with respect to which the election under paragraph (2) is made. “(2) Election.— “(A) In general.— A beneficiary of a qualified subchapter S trust (or his legal representative) may elect to have this subsection apply. “(B) Manner and time of election.— “(i) Separate election with respect to each S corporation.— An election under this paragraph shall be made separately with respect to each S corporation the stock of which is held by the trust. “(ii) Elections with respect to successive income beneficiaries.— If there is an election under this paragraph with respect to any beneficiary, an election under this paragraph shall be treated as made by each successive beneficiary unless such beneficiary affirmatively refuses to consent to such election. “(iii) Time, manner, and form of election.— Any election, or refusal, under this paragraph shall be made in such manner and form, and at such time, as the Secretary may prescribe. “(C) Election irrevocable.— An election under this paragraph, once made, may be revoked only with the consent of the Secretary. “(D) Grace period.— An election under this paragraph shall be effective up to 60 days before the date of the election. “(3) Qualified subchapter s trust.— For purposes of this subsection, the term ‘qualified subchapter S trust’ means a trust— “(A) which owns stock in 1 or more S corporations, “(B) all of the income (within the meaning of section 643(b)) of which is distributed (or required to be distributed) currently to 1 individual who is a citizen or resident of the United States, and “(C) the terms of which require that— “(i) during the life of the current income beneficiary there shall be only 1 income beneficiary of the trust, “(ii) any corpus distributed during the life of the current income beneficiary may be distributed only to such beneficiary, “(iii) the income interest of the current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s death or the termination of the trust, and “(iv) upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary. “(4) Trust ceasing to be qualified.— If a qualified subchapter S trust ceases to meet any requirement under paragraph (3), the provisions of this subsection shall not apply to such trust as of the date it ceases to meet such requirements. “SEC. 1362. ELECTION; REVOCATION; TERMINATION. “(a) Election.— “(1) In general.— Except as provided in subsection (g), a small business corporation may elect, in accordance with the provisions of this section, to be an S corporation. “(2) All shareholders must consent to election.— An election under this subsection shall be valid only if all persons who are shareholders in such corporation on the day on which such election is made consent to such election. “(b) When Made.— “(1) In general.— An election under subsection (a) may be made by a small business corporation for any taxable year— “(A) at any time during the preceding taxable year, or “(B) at any time during the taxable year and on or before the 15th day of the 3d month of the taxable year. “(2) Certain elections made during 1st 2½ months treated as made for next taxable year.— If— “(A) an election under subsection (a) is made for any taxable year during such year and on or before the 15th day of the 3d month of such year, but “(B) either— “(i) on 1 or more days in such taxable year before the day on which the election was made the corporation did not meet the requirements of subsection (b) of section 1361, or Ante, p. 1669. “(ii) 1 or more of the persons who held stock in the corporation during such taxable year and before the election was made did not consent to the election, then such election shall be treated as made for the following taxable year. “(3) Election made after 1st 2½ months treated as made for following taxable year.— If— “(A) a small business corporation makes an election under subsection (a) for any taxable year, and “(B) such election is made after the 15th day of the 3d month of the taxable year and on or before the last day of such taxable year, then such election shall be treated as made for the following taxable year. “(c) Years for Which Effective.— An election under subsection (a) shall be effective for the taxable year of the corporation for which it is made and for all succeeding taxable years of the corporation, until such election is terminated under subsection (d). “(d) Termination.— “(1) By revocation.— “(A) In general.— An election under subsection (a) may be terminated by revocation. “(B) More than one-half of shares must consent to revocation.— An election may be revoked only if shareholders holding more than one-half of the shares of stock of the corporation on the day on which the revocation is made consent to the revocation. “(C) When effective.— Except as provided in subparagraph (D)— “(i) a revocation made during the taxable year and on or before the 15th day of the 3d month thereof shall be effective on the 1st day of such taxable year, and “(ii) a revocation made during the taxable year but after such 15th day shall be effective on the 1st day of the following taxable year. “(D) Revocation may specify prospective date.— If the revocation specifies a date for revocation which is on or after the day on which the revocation is made, the revocation shall be effective on and after the date so specified. “(2) By corporation ceasing to be small business corporation.— “(A) In general.— An election under subsection (a) shall be terminated whenever (at any time on or after the 1st day of the 1st taxable year for which the corporation is an S corporation) such corporation ceases to be a small business corporation. “(B) When effective.— Any termination under this paragraph shall be effective on and after the date of cessation. “(3) Where passive investment income exceeds 25 percent of gross receipts for 3 consecutive taxable years and corporation has subchapter c earnings and profits.— “(A) Termination.— “(i) In general.— An election under subsection (a) shall be terminated whenever the corporation— “(I) has subchapter C earnings and profits at the 26 USC 301. close of each of 3 consecutive taxable years, and “(II) has gross receipts for each of such taxable years more than 25 percent of which are passive investment income. “(ii) When effective.— Any termination under this paragraph shall be effective on and after the first day of the first taxable year beginning after the third consecutive taxable year referred to in clause (i). “(iii) Years taken into account.— A prior taxable year shall not be taken into account under clause (i) unless— “(I) such taxable year began after December 31, 1981, and “(II) the corporation was an S corporation for such taxable year. “(B) Subchapter c earnings and profits.— For purposes of subparagraph (A), the term ‘subchapter C earnings and profits’ means earnings and profits of any corporation for any taxable year with respect to which an election under section 1362(a) (or under section 1372 of prior law) was not Ante, p. 1672. in effect. “(C) Gross receipts from sales of capital assets (other than stock and securities).— For purposes of this paragraph, in the case of dispositions of capital assets (other than stock and securities), gross receipts from such dispositions shall be taken into account only to the extent of the capital gain net income therefrom. “(D) Passive investment income defined.— For purposes of this paragraph— “(i) In general.— Except as otherwise provided in this subparagraph, the term ‘passive investment income’ means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities (gross receipts from such sales or exchanges being taken into account for purposes of this paragraph only to the extent of gains therefrom). “(ii) Exception for interest on notes from sales of inventory.— The term ‘passive investment income’ shall not include interest on any obligation acquired in the ordinary course of the corporation’s trade or business from its sale of property described in section 1221(1). “(iii) Treatment of certain lending or finance companies.— If the S corporation meets the requirements of section 542(c)(6) for the taxable year, the term ‘passive investment income’ shall not include gross receipts for the taxable year which are derived directly from the active and regular conduct of a lending or finance business (as defined in section 542(d)(1)). “(iv) Treatment of certain liquidations.— Gross receipts derived from sales or exchanges of stock or securities shall not include amounts received by an S corporation which are treated under section 331 (relating to corporate liquidations) as payments in exchange for stock where the S corporation owned more than 50 percent of each class of stock of the liquidating corporation. “(e) Treatment of S Termination Year.— “(1) In general.— In the case of an S termination year, for purposes of this title— “(A) S short year.— The portion of such year ending before the 1st day for which the termination is effective shall be treated as a short taxable year for which the corporation is an S corporation. “(B) C short year.— The portion of such year beginning on such 1st day shall be treated as a short taxable year for which the corporation is a C corporation. “(2) Pro rata allocation.— Except as provided in paragraph (3), the determination of which items are to be taken into account for each of the short taxable years referred to in paragraph (1) shall be made— “(A) first by determining for the S termination year— “(i) the amount of each of the items of income, loss, deduction, or credit described in section 1366(a)(1)(A), Post, p. 1677. and “(ii) the amount of the nonseparately computed income or loss, and “(B) then by assigning an equal portion of each amount determined under subparagraph (A) to each day of the S termination year. “(3) Election to have items assigned to each short taxable year under normal tax accounting rules.— “(A) In general.— A corporation may elect to have paragraph (2) not apply. “(B) All shareholders must consent to election.— An election under this paragraph shall be valid only if all persons who are shareholders in the corporation at any time during the S termination year consent to such election. “(4) S termination year.— For purposes of this subsection, the term ‘S termination year’ means any taxable year of a corporation (determined without regard to this subsection) in which a termination of an election made under subsection (a) takes effect (other than on the 1st day thereof). “(5) Tax for c short year determined on annualized basis.— “(A) In general.— The taxable income for the short year described in subparagraph (B) of paragraph (1) shall be placed on an annual basis by multiplying the taxable income for such short year by the number of days in the S termination year and by dividing the result by the number of days in the short year. The tax shall be the same part of the tax computed on the annual basis as the number of days in such short year is of the number of days in the S termination year. “(B) Section 443(d)(2) to apply.— Subsection (d)(2) of section 443 shall apply to the short taxable year described in subparagraph (B) of paragraph (1). “(6) Other special rules.— For purposes of this title— “(A) Short years treated as 1 year for carryover purposes.— The short taxable year described in subparagraph (A) of paragraph (1) shall not be taken into account for purposes of determining the number of taxable years to which any item may be carried back or carried forward by the corporation. “(B) Due date for s year.— The due date for filing the return for the short taxable year described in subparagraph (A) of paragraph (1) shall be the same as the due date for filing the return for the short taxable year described in subparagraph (B) of paragraph (1) (including extensions thereof). “(f) Inadvertent Terminations.— If— “(1) an election under subsection (a) by any corporation was terminated under paragraph (2) or (3) of subsection (d), “(2) the Secretary determines that the termination was inadvertent, “(3) no later than a reasonable period of time after discovery of the event resulting in such termination, steps were taken so that the corporation is once more a small business corporation, and “(4) the corporation, and each person who was a shareholder of the corporation at any time during the period specified pursuant to this subsection, agrees to make such adjustments (consistent with the treatment of the corporation as an S corporation) as may be required by the Secretary with respect to such period, then, notwithstanding the terminating event, such corporation shall be treated as continuing to be an S corporation during the period specified by the Secretary. “(g) Election After Termination.— If a small business corporation has made an election under subsection (a) and if such election has been terminated under subsection (d), such corporation (and any successor corporation) shall not be eligible to make an election under subsection (a) for any taxable year before its 5th taxable year which begins after the 1st taxable year for which such termination is effective, unless the Secretary consents to such election. “SEC. 1363. EFFECT OF ELECTION ON CORPORATION. “(a) General Rule.— Except as otherwise provided in this subchapter and in section 58(d), an S corporation shall not be subject to the taxes imposed by this chapter. “(b) Computation of Corporation’s Taxable Income.— The taxable income of an S corporation shall be computed in the same manner as in the case of an individual, except that— “(1) the items described in section 1366(a)(1)(A) shall be separately Ante, p. 1677. stated, “(2) the deductions referred to in section 703(a)(2) shall not be allowed to the corporation, and “(3) section 248 shall apply. “(c) Elections of the S Corporation.— “(1) In general.— Except as provided in paragraph (2), any election affecting the computation of items derived from an S corporation shall be made by the corporation. “(2) Exceptions.— In the case of an S corporation, elections under the following provisions shall be made by each shareholder separately— “(A) subsection (b)(5) or (d)(4) of section 108 (relating to income from discharge of indebtedness), “(B) section 163(d) (relating to limitation on interest on investment indebtedness), “(C) section 617 (relating to deduction and recapture of certain mining exploration expenditures), and “(D) section 901 (relating to taxes of foreign countries and possessions of the United States). “(d) Distributions of Appreciated Property.— If— “(1) an S corporation makes a distribution of property (other than an obligation of such corporation) with respect to its stock, and “(2) the fair market value of such property exceeds its adjusted basis in the hands of the S corporation, then, notwithstanding any other provision of this subtitle, gain shall be recognized to the S corporation on the distribution in the same manner as if it had sold such property to the distributee at its fair market value. “PART II— TAX TREATMENT OF SHAREHOLDERS “Sec. 1366. Pass-thru of items to shareholders. “Sec. 1367. Adjustments to basis of stock of shareholders, etc. “Sec. 1368. Distributions. “SEC. 1366. PASS-THRU OF ITEMS TO SHAREHOLDERS. “(a) Determination of Shareholder’s Tax Liability.— “(1) In general.— In determining the tax under this chapter of a shareholder for the shareholder’s taxable year in which the taxable year of the S corporation ends (or for the final taxable year of a shareholder who dies before the end of the corporation’s taxable year), there shall be taken into account the shareholder’s pro rata share of the corporation’s— “(A) items of income (including tax-exempt income), loss, deduction, or credit the separate treatment of which could affect the liability for tax of any shareholder, and “(B) nonseparately computed income or loss. For purposes of the preceding sentence, the items referred to in subparagraph (A) shall include amounts described in paragraph (4) or (6) of section 702(a). “(2) Nonseparately computed income or loss defined.— For purposes of this subchapter, the term ‘nonseparately computed income or loss’ means gross income minus the deductions allowed to the corporation under this chapter, determined by excluding all items described in paragraph (1)(A). “(b) Character Passed Thru.— The character of any item included in a shareholder’s pro rata share under paragraph (1) of subsection (a) shall be determined as if such item were realized directly from the source from which realized by the corporation, or incurred in the same manner as incurred by the corporation. “(c) Gross Income of a Shareholder.— In any case where it is necessary to determine the gross income of a shareholder for purposes of this title, such gross income shall include the shareholder’s pro rata share of the gross income of the corporation. “(d) Special Rules for Losses and Deductions.— “(1) Cannot exceed shareholder’s basis in stock and debt.— The aggregate amount of losses and deductions taken into account by a shareholder under subsection (a) for any taxable year shall not exceed the sum of— “(A) the adjusted basis of the shareholder’s stock in the S corporation (determined with regard to paragraph (1) of section 1367(a) for the taxable year), and “(B) the shareholder’s adjusted basis of any indebtedness of the S corporation to the shareholder (determined without regard to any adjustment under paragraph (2) of section 1367(b) for the taxable year). “(2) Indefinite carryover of disallowed losses and deductions.— Any loss or deduction which is disallowed for any taxable year by reason of paragraph (1) shall be treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder. “(3) Carryover of disallowed losses and deductions to post-termination transition period.— “(A) In general.— If for the last taxable year of a corporation for which it was an S corporation a loss or deduction was disallowed by reason of paragraph (1), such loss or deduction shall be treated as incurred by the shareholder on the last day of any post-termination transition period. “(B) Cannot exceed shareholder’s basis in stock.— The aggregate amount of losses and deductions taken into account by a shareholder under subparagraph (A) shall not exceed the adjusted basis of the shareholder’s stock in the corporation (determined at the close of the last day of the post-termination transition period and without regard to this paragraph). “(C) Adjustment in basis of stock.— The shareholder’s basis in the stock of the corporation shall be reduced by the amount allowed as a deduction by reason of this paragraph. “(e) Treatment of Family Group.— If an individual who is a member of the family (within the meaning of section 704(e)(3)) of one or more shareholders of an S corporation renders services for the corporation or furnishes capital to the corporation without receiving reasonable compensation therefor, the Secretary shall make such adjustments in the items taken into account by such individual and such shareholders as may be necessary in order to reflect the value of such services or capital. “(f) Special Rules.— “(1) Subsection (a) not to apply to credit allowable under section 39.— Subsection (a) shall not apply with respect to any credit allowable under section 39 (relating to certain uses of gasoline, special fuels, and lubricating oil). “(2) Reduction in pass-thru for tax imposed on capital gain.— If any tax is imposed under section 56 or 1374 for any Post, p. 1683. taxable year on an S corporation, for purposes of subsection (a)— “(A) the amount of the corporation’s long-term capital gains for the taxable year shall be reduced by the amount of such tax, and “(B) if the amount of such tax exceeds the amount of such long-term capital gains, the corporation’s gains from sales or exchanges of property described in section 1231 shall be reduced by the amount of such excess. For purposes of the preceding sentence, the term ‘long-term “Long-term capital gain.” capital gain’ shall not include any gain from the sale or exchange of property described in section 1231. “(3) Reduction in pass-thru for tax imposed on excess net passive income.— If any tax is imposed under section 1375 for Post, p. 1684. any taxable year on an S corporation, for purposes of subsection (a), each item of passive investment income shall be reduced by an amount which bears the same ratio to the amount of such tax as— “(A) the amount of such item, bears to “(B) the total passive investment income for the taxable year. “(g) Cross Reference.— “For rules relating to procedures for determining the tax treatment of subchapter S items, see subchapter D of chapter 63. “SEC. 1367. ADJUSTMENTS TO BASIS OF STOCK OF SHAREHOLDERS, ETC. “(a) General Rule.— “(1) Increases in basis.— The basis of each shareholder’s stock in an S corporation shall be increased for any period by the sum of the following items determined with respect to that shareholder for such period: “(A) the items of income described in subparagraph (A) of section 1366(a)(1), Ante, p. 1677. “(B) any nonseparately computed income determined under subparagraph (B) of section 1366(a)(1), and “(C) the excess of the deductions for depletion over the basis of the property subject to depletion. “(2) Decreases in basis.— The basis of each shareholder’s stock in an S corporation shall be decreased for any period (but not below zero) by the sum of the following items determined with respect to the shareholder for such period: “(A) distributions by the corporation which were not includible in the income of the shareholder by reason of section 1368, “(B) the items of loss and deduction described in subparagraph (A) of section 1366(a)(1), “(C) any nonseparately computed loss determined under subparagraph (B) of section 1366(a)(1), “(D) any expense of the corporation not deductible in computing its taxable income and not properly chargeable to capital account, and “(E) the amount of the shareholder’s deduction for depletion under section 611 with respect to oil and gas wells. “(b) Special Rules.— “(1) Income items.— An amount which is required to be included in the gross income of a shareholder and shown on his return shall be taken into account under subparagraph (A) or (B) of subsection (a)(1) only to the extent such amount is included in the shareholder’s gross income on his return, in-creased or decreased by any adjustment of such amount in a redetermination of the shareholder’s tax liability. “(2) Adjustments in basis of indebtedness.— “(A) Reduction of basis.— If for any taxable year the amounts specified in subparagraphs (B), (C), (D), and (E) of subsection (a)(2) exceed the amount which reduces the shareholder’s basis to zero, such excess shall be applied to reduce (but not below zero) the shareholder’s basis in any indebtedness of the S corporation to the shareholder. “(B) Restoration of basis.— If for any taxable year there is a reduction under subparagraph (A) in the shareholder’s basis in the indebtedness of an S corporation to a shareholder, any net increase (after the application of paragraphs (1) and (2) of subsection (a)) for any subsequent taxable year shall be applied to restore such reduction in basis before any of it may be used to increase the shareholder’s basis in the stock of the S corporation. “(3) Coordination with section 165(g).— This section and section 1366 shall be applied before the application of section Ante, p. 1677. 165(g) to any taxable year of the shareholder or the corporation in which the stock becomes worthless. “SEC. 1368. DISTRIBUTIONS. “(a) General Rule.— A distribution of property made by an S corporation with respect to its stock to which (but for this subsection) section 301(c) would apply shall be treated in the manner provided in subsection (b) or (c), whichever applies. “(b) S Corporation Having No Earnings and Profits.— In the case of a distribution described in subsection (a) by an S corporation which has no accumulated earnings and profits— “(1) Amount applied against basis.— The distribution shall not be included in gross income to the extent that it does not exceed the adjusted basis of the stock. “(2) Amount in excess of basis.— If the amount of the distribution exceeds the adjusted basis of the stock, such excess shall be treated as gain from the sale or exchange of property. “(c) S Corporation Having Earnings and Profits.— In the case of a distribution described in subsection (a) by an S corporation which has accumulated earnings and profits— “(1) Accumulated adjustments account.— That portion of the distribution which does not exceed the accumulated adjustments account shall be treated in the manner provided by subsection (b). “(2) Dividend.— That portion of the distribution which remains after the application of paragraph (1) shall be treated as a dividend to the extent it does not exceed the accumulated earnings and profits of the S corporation. “(3) Treatment of remainder.— Any portion of the distribution remaining after the application of paragraph (2) of this subsection shall be treated in the manner provided by subsection (b). “(d) Certain Adjustments Taken Into Account.— Subsections (b) and (c) shall be applied by taking into account (to the extent proper)— “(1) the adjustments to the basis of the shareholder’s stock described in section 1367, and Ante, p. 1679. “(2) the adjustments to the accumulated adjustments account which are required by subsection (e)(1). “(e) Definitions and Special Rules.— For purposes of this section— “(1) Accumulated adjustments account.— “(A) In general.— Except as provided in subparagraph (B), the term ‘accumulated adjustments account’ means an account of the S corporation which is adjusted for the S period in a manner similar to the adjustments under section 1367 (except that no adjustment shall be made for Ante, p. 1679. income which is exempt from tax under this title and no adjustment shall be made for any expense not deductible in computing the corporation’s taxable income and not properly chargeable to capital account). “(B) Amount of adjustment in the case of redemptions.— In the case of any redemption which is treated as an exchange under section 302(a) or 303(a), the adjustment in the accumulated adjustments account shall be an amount which bears the same ratio to the balance in such account as the number of shares redeemed in such redemption bears to the number of shares of stock in the corporation immediately before such redemption. “(2) S period.— The term ‘S period’ means the most recent continuous period during which the corporation has been an S corporation. Such period shall not include any taxable year beginning before January 1, 1983. “PART III— SPECIAL RULES “Sec. 1371. Coordination with subchapter C. “Sec. 1372. Partnership rules to apply for fringe benefit purposes. “Sec. 1373. Foreign income. “Sec. 1374. Tax imposed on certain capital gains. “Sec. 1375. Tax imposed when passive investment income of corporation having subchapter C earnings and profits exceeds 25 percent of gross receipts. “SEC. 1371. COORDINATION WITH SUBCHAPTER C. “(a) Application of Subchapter C Rules.— “(1) In general.— Except as otherwise provided in this title, and except to the extent inconsistent with this subchapter, subchapter C shall apply to an S corporation and its shareholders. “(2) S corporation as shareholder treated like individual.— For purposes of subchapter C, an S corporation in its capacity as a shareholder of another corporation shall be treated as an individual. “(b) No Carryover Between C Year and S Year.— “(1) From c year to s year.— No carryforward, and no carryback, arising for a taxable year for which a corporation is a C corporation may be carried to a taxable year for which such corporation is an S corporation. “(2) No carryover from s year.— No carryforward, and no carryback, shall arise at the corporate level for a taxable year for which a corporation is an S corporation. “(3) Treatment of s year as elapsed year.— Nothing in paragraphs (1) and (2) shall prevent treating a taxable year for which a corporation is an S corporation as a taxable year for purposes of determining the number of taxable years to which an item may be carried back or carried forward. “(c) Earnings and Profits.— “(1) In general.— Except as provided in paragraphs (2) and (3), no adjustment shall be made to the earnings and profits of an S corporation. “(2) Adjustments for redemptions, liquidations, reorganizations, divisives, etc.— In the case of any transaction involving the application of subchapter C to any S corporation, proper 26 USC 301. adjustment to any accumulated earnings and profits of the corporation shall be made. “(3) Adjustments in case of distributions treated as dividends under section 1368(c)(2).— Paragraph (1) shall not apply with respect to that portion of a distribution which is treated as a dividend under section 1368(c)(2). Ante, p. 1680. “(d) Coordination With Investment Credit Recapture.— “(1) No recapture by reason of election.— Any election under section 1362 shall be treated as a mere change in the Ante, p. 1672. form of conducting a trade or business for purposes of the second sentence of section 47(b). “(2) Corporation continues to be liable.— Notwithstanding an election under section 1362, an S corporation shall continue to be liable for any increase in tax under section 47 attributable to credits allowed for taxable years for which such corporation was not an S corporation. “(e) Cash Distributions During Post-Termination Transition Period.— Any distribution of money by a corporation with respect to its stock during a post-termination transition period shall be applied against and reduce the adjusted basis of the stock, to the extent that the amount of the distribution does not exceed the accumulated adjustments account. “SEC. 1372. PARTNERSHIP RULES TO APPLY FOR FRINGE BENEFIT PURPOSES. “(a) General Rule.— For purposes of applying the provisions of this subtitle which relate to employee fringe benefits— “(1) the S corporation shall be treated as a partnership, and “(2) any 2-percent shareholder of the S corporation shall be treated as a partner of such partnership. “(b) 2-Percent Shareholder Defined.— For purposes of this section, the term ‘2-percent shareholder’ means any person who owns (or is considered as owning within the meaning of section 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation. “SEC. 1373. FOREIGN INCOME. “(a) S Corporation Treated as Partnership, Etc.— For purposes of subparts A and F of part III, and part V, of subchapter N (relating 26 USC 901, 951. 26 USC 999. to income from sources without the United States)— “(1) an S corporation shall be treated as a partnership, and “(2) the shareholders of such corporation shall be treated as partners of such partnership. “(b) Recapture of Overall Foreign Loss.— For purposes of section 904(f) (relating to recapture of overall foreign loss), the making or termination of an election to be treated as an S corporation shall be treated as a disposition of the business. “SEC. 1374. TAX IMPOSED ON CERTAIN CAPITAL GAINS. “(a) General Rule.— If for a taxable year of an S corporation— “(1) the net capital gain of such corporation exceeds $25,000, and exceeds 50 percent of its taxable income for such year, and “(2) the taxable income of such corporation for such year exceeds $25,000, there is hereby imposed a tax (computed under subsection (b)) on the income of such corporation. “(b) Amount of Tax.— The tax imposed by subsection (a) shall be the lower of— “(1) an amount equal to the tax, determined as provided in section 1201(a), on the amount by which the net capital gain of the corporation for the taxable year exceeds $25,000, or “(2) an amount equal to the tax which would be imposed by section 11 on the taxable income of the corporation for the taxable year if the corporation were not an S corporation. No credit shall be allowable under part IV of subchapter A of this chapter (other than under section 39) against the tax imposed by 26 USC 31. subsection (a). “(c) Exceptions.— “(1) In general.— Subsection (a) shall not apply to an S corporation for any taxable year if the election under section 1362(a) which is in effect with respect to such corporation for Ante, p. 1672. such taxable year has been in effect for the 3 immediately preceding taxable years. “(2) New corporations.— Subsection (a) shall not apply to an S corporation if— “(A) it (and any predecessor corporation) has been in existence for less than 4 taxable years, and “(B) an election under section 1362(a) has been in effect with respect to such corporation for each of its taxable years. “(3) Property with substituted basis.— If— “(A) but for paragraph (1) or (2), subsection (a) would apply for the taxable year, “(B) any long-term capital gain is attributable to property acquired by the S corporation during the period beginning 3 years before the first day of the taxable year and ending on the last day of the taxable year, and “(C) the basis of such property is determined in whole or in part by reference to the basis of any property in the hands of another corporation which was not an S corporation throughout all of the period described in subparagraph (B) before the transfer by such other corporation and during which such other corporation was in existence, then subsection (a) shall apply for the taxable year, but the amount of the tax determined under subsection (b) shall not exceed a tax, determined as provided in section 1201(a), on the net capital gain attributable to property acquired as provided in subparagraph (B) and having a basis described in subparagraph (C). “(d) Determination of Taxable Income.— For purposes of subsections (a)(2) and (b)(2), taxable income of the corporation shall be determined under section 63(a) without regard to— “(1) the deduction allowed by section 172 (relating to net operating loss deduction), and “(2) the deductions allowed by part VIII of subchapter B 26 USC 241. (other than the deduction allowed by section 248, relating to organization expenditures). “SEC. 1375. TAX IMPOSED WHEN PASSIVE INVESTMENT INCOME OF CORPORATION HAVING SUBCHAPTER C EARNINGS AND PROFITS EXCEEDS 25 PERCENT OF GROSS RECEIPTS. “(a) General Rule.— If for the taxable year an S corporation has— “(1) subchapter C earnings and profits at the close of such 26 USC 341. taxable year, and “(2) gross receipts more than 25 percent of which are passive investment income, then there is hereby imposed a tax on the income of such corporation for such taxable year. Such tax shall be computed by multiplying the excess net passive income by the highest rate of tax specified in section 11(b). “(b) Definitions.— For purposes of this section— “(1) Excess net passive income.— “(A) In general.— Except as provided in subparagraph (B), the term ‘excess net passive income’ means an amount which bears the same ratio to the net passive income for the taxable year as— “(i) the amount by which the passive investment income for the taxable year exceeds 25 percent of the gross receipts for the taxable year, bears to “(ii) the passive investment income for the taxable year. “(B) Limitation.— The amount of the excess net passive income for any taxable year shall not exceed the corporation’s taxable income for the taxable year (determined in accordance with section 1374(d)). Ante, p. 1683. “(2) Net passive income.— The term ‘net passive income’ means— “(A) passive investment income, reduced by “(B) the deductions allowable under this chapter which are directly connected with the production of such income (other than deductions allowable under section 172 and part VIII of subchapter B). “(3) Passive investment income; etc.— The terms ‘subchapter C earnings and profits’, ‘passive investment income’, and ‘gross receipts’ shall have the same respective meanings as when used in paragraph (3) of section 1362(d). Ante, p. 1672. “(c) Special Rules.— “(1) Disallowance of credit.— No credit shall be allowed under part IV of subchapter A of this chapter (other than 26 USC 31. section 39) against the tax imposed by subsection (a). “(2) Coordination with section 1374.— If any gain— “(A) is taken into account in determining passive income for purposes of this section, and “(B) is taken into account under section 1374, the amount of such gain taken into account under section 1374 shall be reduced by the portion of the excess net passive income for the taxable year which is attributable (on a pro rata basis) to such gain. “PART IV— DEFINITIONS; MISCELLANEOUS “Sec. 1377. Definitions and special rule. “Sec. 1378. Taxable year of S corporation. “Sec. 1379. Transitional rules on enactment. “SEC. 1377. DEFINITIONS AND SPECIAL RULE. “(a) Pro Rata Share.— For purposes of this subchapter— “(1) In general.— Except as provided in paragraph (2), each shareholder’s pro rata share of any item for any taxable year shall be the sum of the amounts determined with respect to the shareholder— “(A) by assigning an equal portion of such item to each day of the taxable year, and “(B) then by dividing that portion pro rata among the shares outstanding on such day. “(2) Election to terminate year.— Under regulations prescribed by the Secretary, if any shareholder terminates his interest in the corporation during the taxable year and all persons who are shareholders during the taxable year agree to the application of this paragraph, paragraph (1) shall be applied as if the taxable year consisted of 2 taxable years the first of which ends on the date of the termination. “(b) Post-Termination Transition Period.— “(1) In general.— For purposes of this subchapter, the term ‘post-termination transition period’ means— “(A) the period beginning on the day after the last day of the corporation’s last taxable year as an S corporation and ending on the later of— “(i) the day which is 1 year after such last day, or “(ii) the due date for filing the return for such last year as an S corporation (including extensions), and “(B) the 120-day period beginning on the date of a determination that the corporation’s election under section 1362(a) had terminated for a previous taxable year. “(2) Determination defined.— For purposes of paragraph (1), the term ‘determination’ means— “(A) a court decision which becomes final, “(B) a closing agreement, or “(C) an agreement between the corporation and the Secretary that the corporation failed to qualify as an S corporation. “(c) Manner of Making Elections, Etc.— Any election under this subchapter, and any revocation under section 1362(d)(1), shall Ante, p. 1672. be made in such manner as the Secretary shall by regulations prescribe. “SEC. 1378. TAXABLE YEAR OF S CORPORATION. “(a) General Rule.— For purposes of this subtitle— “(1) an S corporation shall not change its taxable year to any accounting period other than a permitted year, and “(2) no corporation may make an election under section 1362(a) for any taxable year unless such taxable year is a permitted year. “(b) Permitted Year Defined.— For purposes of this section, the term ‘permitted year’ means a taxable year which— “(1) is a year ending December 31, or “(2) is any other accounting period for which the corporation establishes a business purpose to the satisfaction of the Secretary. “(c) Existing S Corporations Required To Use Permitted Year After 50-Percent Shift in Ownership.— “(1) In general.— A corporation which is an S corporation for a taxable year which includes December 31, 1982, shall not be treated as an S corporation for any subsequent taxable year beginning after the first day on which more than 50 percent of the stock is newly owned stock unless such subsequent taxable year is a permitted year. “(2) Newly owned stock.— For purposes of paragraph (1), the stock held by any person on any day shall be treated as newly owned stock to the extent that— “(A) the percentage of the stock of such corporation owned by such person on such day, exceeds “(B) the percentage of the stock of such corporation owned by such person on December 31, 1982. “(3) Stock acquired by reason of death, gift from family member, etc.— “(A) In general.— For purposes of paragraph (2), if— “(i) a person acquired stock in the corporation after December 31, 1982, and “(ii) such stock was acquired by such person— “(I) by reason of the death of a qualified transferor, “(II) by reason of a gift from a qualified transferor who is a member of such person’s family, or “(III) by reason of a qualified buy-sell agreement from a qualified transferor (or his estate) who was a member of such person’s family, then such stock shall be treated as held on December 31, 1982, by the person described in clause (i). “(B) Qualified transferor.— For purposes of subparagraph (A), the term ‘qualified transferor’ means a person— “(i) who held the stock in the corporation (or predecessor stock) on December 31, 1982, or “(ii) who acquired the stock in an acquisition which meets the requirements of subparagraph (A). “(C) Family.— For purposes of subparagraph (A), the term ‘family’ has the meaning given such term by section 267(c)(4). “(D) Qualified buy-sell agreement.— For purposes of subparagraph (A), the term ‘qualified buy-sell agreement’ means any agreement which— “(i) has been continuously in existence since September 28, 1982, and “(ii) provides that on the death of any party to such agreement, the stock in the S corporation held by such party will be sold to surviving parties to such agreement who were parties to such agreement on September 28, 1982. “SEC. 1379. TRANSITIONAL RULES ON ENACTMENT. “(a) Old Elections.— Any election made under section 1372(a) (as in effect before the enactment of the Subchapter S Revision Act of 1982) shall be treated as an election made under section 1362. “(b) References to Prior Law Included.— In applying this subchapter to any taxable year beginning after December 31, 1982, any reference in this subchapter to another provision of this subchapter shall, to the extent not inconsistent with the purposes of this subchapter, include a reference to the corresponding provision as in effect before the enactment of the Subchapter S Revision Act of 1982. “(c) Distributions of Undistributed Taxable Income.— If a corporation was an electing small business corporation for the last preenactment year, subsections (f) and (d) of section 1375 (as in effect before the enactment of the Subchapter S Revision Act of 1982) shall continue to apply with respect to distributions of undistributed taxable income for any taxable year beginning before January 1, 1983. “(d) Carryforwards.— If a corporation was an electing small business corporation for the last preenactment year and is an S corporation for the 1st postenactment year, any carryforward to the 1st postenactment year which arose in a taxable year for which the corporation was an electing small business corporation shall be treated as arising in the 1st postenactment year. “(e) Preenactment and Postenactment Years Defined.— For purposes of this subsection— “(1) Last Preenactment Year.— The term ‘last preenactment year’ means the last taxable year of a corporation which begins before January 1, 1983. “(2) 1st Postenactment Year.— The term ‘1st postenactment year’ means the 1st taxable year of a corporation which begins after December 31, 1982.”

2. 1984

   Tax Reform Act of 1984

   Pub. L. 98–369 § 721(m) · 98 Stat. 494

   Substituted · 26 U.S.C. § 1378(c)(1)

   Pub. L. 98–369, § 721(m), substituted “which includes December 31, 1982 (or which is an S corporation for a taxable year beginning during 1983 by reason of an election made on or before October 19, 1982)” for “which includes December 31, 1982”

   Source evidence

   Code amendment note
   Subsec. (c)(1). Pub. L. 98–369, § 721(m), substituted “which includes December 31, 1982 (or which is an S corporation for a taxable year beginning during 1983 by reason of an election made on or before October 19, 1982)” for “which includes December 31, 1982”.

   Enacted provision · exact public law section
   (m) Taxable Year of Existing S Corporations.— Paragraph (1) of section 1378(c) (relating to existing S corporations required to use permitted year after 50-percent 26 USC 1378. shift in ownership) is amended by striking out “which includes December 31, 1982” and inserting in lieu thereof “which includes December 31, 1982 (or which is an S corporation for a taxable year beginning during 1983 by reason of an election made on or before October 19, 1982)”.

3. 1984

   Tax Reform Act of 1984

   Pub. L. 98–369 § 721(q) · 98 Stat. 494

   Substituted · 26 U.S.C. § 1378(c)(3)(B)(i)

   Pub. L. 98–369, § 721(q), substituted “who (or whose estate) held” for “who held”

   Source evidence

   Code amendment note
   Subsec. (c)(3)(B)(i). Pub. L. 98–369, § 721(q), substituted “who (or whose estate) held” for “who held”.

   Enacted provision · exact public law section
   (q) Treatment of Stock Held by Estate of Qualified Transferor.— Clause (i) of section 1378(c)(3)(B) (relating to existing S corporations required to use permitted year after 50-percent shift in ownership) is amended by striking out “who held” and inserting in lieu thereof “who (or whose estate) held”.

4. 1986

   Tax Reform Act of 1986

   Pub. L. 99–514 § 806(b)(1) · 100 Stat. 2085

   Amended · 26 U.S.C. § 1378(a)

   Pub. L. 99–514, § 806(b)(1), amended subsec. (a) generally. Prior to amendment, subsec. (a) read as follows: “For purposes of this subtitle—

   Source evidence

   Code amendment note
   Subsec. (a). Pub. L. 99–514, § 806(b)(1), amended subsec. (a) generally. Prior to amendment, subsec. (a) read as follows: “For purposes of this subtitle—

   “(1) an S corporation shall not change its taxable year to any accounting period other than a permitted year, and “(2) no corporation may make an election under section 1362(a) for any taxable year unless such taxable year is a permitted year.”

   Enacted provision · exact public law section
   (B) such change shall be treated as having been made with the consent of the Secretary, and

   Effective date note
   Pub. L. 99–514, title VIII, § 806(e), Oct. 22, 1986, 100 Stat. 2364, as amended by Pub. L. 100–647, title I, § 1008(e)(7), (8), (10), Nov. 10, 1988, 102 Stat. 3441, provided that:

5. 1986

   Tax Reform Act of 1986

   Pub. L. 99–514 § 806(b)(2) · 100 Stat. 2085

   Inserted · 26 U.S.C. § 1378(b)

   Pub. L. 99–514, § 806(b)(2), inserted at end “For purposes of paragraph (2), any deferral of income to shareholders shall not be treated as a business purpose.”

   Source evidence

   Code amendment note
   Subsec. (b). Pub. L. 99–514, § 806(b)(2), inserted at end “For purposes of paragraph (2), any deferral of income to shareholders shall not be treated as a business purpose.”

   Enacted provision · exact public law section
   (B) such change shall be treated as having been made with the consent of the Secretary, and

   Effective date note
   Pub. L. 99–514, title VIII, § 806(e), Oct. 22, 1986, 100 Stat. 2364, as amended by Pub. L. 100–647, title I, § 1008(e)(7), (8), (10), Nov. 10, 1988, 102 Stat. 3441, provided that:

6. 1986

   Tax Reform Act of 1986

   Pub. L. 99–514 § 806(b)(3) · 100 Stat. 2085

   Struck · 26 U.S.C. § 1378(c)

   Pub. L. 99–514, § 806(b)(3), struck out subsec. (c) which required existing S corporations to use permitted year after 50-percent shift in ownership

   Source evidence

   Code amendment note
   Subsec. (c). Pub. L. 99–514, § 806(b)(3), struck out subsec. (c) which required existing S corporations to use permitted year after 50-percent shift in ownership.

   Enacted provision · exact public law section
   (B) such change shall be treated as having been made with the consent of the Secretary, and

   Effective date note
   Pub. L. 99–514, title VIII, § 806(e), Oct. 22, 1986, 100 Stat. 2364, as amended by Pub. L. 100–647, title I, § 1008(e)(7), (8), (10), Nov. 10, 1988, 102 Stat. 3441, provided that:

6 of 6 references resolved to an enrolled provision