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'S' Corporation Bill Quite Likely To Succeed In US Senate

by Mike Godfrey, Tax-News.com, New York

28 August 2001

In the US, 'S' Corporations are much used as 'pass-through' entities comparable to limited partnerships for investment and many other purposes, but a recent Supreme Court decision confirmed them in one advantage that legislators never could have intended: when an 'S' Corporation goes bust, its debts die with it and don't revert to its owners.

This decision makes it quite likely that legislation introduced recently by Senator Orrin Hatch (R - Utah) to reform 'S' Corporation rules will be successful.

Led by Senator Hatch, a bi-partisan group of senators introduced S.1201 'A bill to amend the Internal Revenue Code of 1986 to provide for S corporation reform, and for other purposes'.

The bill would ease the tax rules for "S" corporations and put them on a more competitive playing field with other businesses. It would also make S corporation status easier to elect and more attractive for small banks.

Said the senator: "Many people do not realize it, but there are over 2.5 million businesses in this nation that are organized as S corporations. The current S corporation rules create special tax barriers and complexities for these entities that often get in the way of them being competitive with larger companies, attracting capital or even staying in business."

Apart from dealing with the bankruptcy issue highlighted by the Supreme Court decision, the "Subchapter S Modernization Act of 2001" would provide a significant boost for small businesses by:

  • easing the requirements for electing S corporation status;
  • improving S corporations' access to capital;
  • making S corporation status more attractive for small banks;
  • simplifying the rules and removing traps for the unwary.

S corporations are primarily small businesses with 75 or fewer shareholders that choose to be taxed in a manner similar to partnerships rather than as regular corporations. A major provision of the bill would double the permitted size to 150 shareholders.

"The biggest advantage of the S corporation election for most businesses is that they pay only one level of tax - at the shareholder level," Hatch noted. "Regular corporations must pay tax at two levels - the company level and the shareholder level. This puts an extra strain on smaller corporations, particularly those that compete with partnerships or limited liability companies that also pay just one level of tax."

Hatch's bill builds on S corporation reforms that were enacted in 1996, which were also authored by Hatch. "Despite the 1996 reforms, the tax laws that currently govern S corporations remain too restrictive, complex and burdensome, particularly in comparison with the laws that are imposed on other entities. As a result, many small businesses . . . . are unable to attract sufficient capital to grow to their full potential or are stifled by the unnecessary restrictions in the tax law. This bill will ease these rules to help level the playing field for small businesses," Hatch added.

The bill has been referred to the Finance Committee; its sponsoring group hopes to have the bill included in a small business tax relief package that is expected to debated in the Senate in September.

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