S corporation proposal includes interesting step-up provision
Similar to step-up currently available to partnerships
TAX ALERT |
Legislators included an interesting provision in the 2016 version of the S Corporation Modernization Act (the Act), which was introduced July 13 in the House and the Senate. For the first time, the Act includes a proposal that would give shareholders who receive their shares from a decedent the ability to adjust the inside basis of the S corporation’s assets to reflect the assets’ fair market value.
This proposal is similar to the basis adjustment provision that currently exists for partners in a partnership, although it would be much more limited—only applying in situations where the shareholder receives the shares from a decedent. The partnership provision applies in most sale or exchange situations.
At this point, the legislation has simply been introduced, and there is no certainty that legislators will act upon it. Furthermore, there would be many logistical issues that Treasury likely would need to wrestle with in order to implement such a change for S corporation shareholders. Nonetheless, it is noteworthy that they have added it to the Act. Prior versions of the Act have included provisions that Congress ultimately has enacted, including the shortened five-year built-in gain recognition period enacted last year.
The legislation also includes several other proposals that have been included in prior versions of the Act, including:
- Taking some of the sting out of the so-called ‘sting tax.’ S corporations currently must pay a tax and they also risk continued qualification as an S corporation when more than 25 percent of their receipts are from passive sources (rents, royalties, interest, dividends and annuities.) The legislation would increase the threshold to 60 percent and eliminate the chance that the entity would lose its S corporation status.
- Enabling foreign ownership of S corporations through electing-small business trusts (ESBTs). Nonresident aliens cannot be owners of an S corporation. Similarly, a trust with nonresident alien beneficiaries will not qualify as a shareholder. The legislation would modify this rule, allowing trusts that otherwise qualify as an ESBT to have nonresident alien beneficiaries.
- Adding IRAs to the list of qualifying S corporation shareholders.
Again, these are simply proposals. They do, however, provide some insight into areas where there may be changes within the S corporation community—either this year or sometime in the future.