Small Business Act: S Corporation Relief and Pension Plan Reform

Journal of Accountancy, November 1996 | Go to article overview

Small Business Act: S Corporation Relief and Pension Plan Reform


The Small Business Job Protection Act of 1996 (HR 3448), signed into law August 20, includes a number of provisions to help small businesses stay competitive by providing both tax relief and pension plan reform. The new law, commonly known as the minimum wage bill? significantly liberalizes subchapter S corporation rules, clarifies certain worker classification rules and simplifies and expands retirement plan benefits.

Looser S corporation rules

The 1996 act lifts many of the prohibitive restraints in subchapter S corporation rules dating back to 1958 and expands the availability of S corporation status to many closely held corporations that previously were ineligible. For example, before the passage of HR 3448, S corporations were prohibited from having more than 35 shareholders and from owning subsidiaries and generally were allowed to have only one class of outstanding stock. Entities other than individuals, estates and certain trusts were not allowed to own stock in S corporations.

The new law helps alleviate these restrictions by increasing the maximum number of shareholders to 75 and expanding the types of trusts eligible to hold S corporation stock. "This change will make it easier for S corporation owners to plan for their estates," said Laura M. MacDonough, a tax principal of Ernst & Young in Washington, D.C. "Many of the common estate planning vehicles available to C corporations and partnerships are now available to S corporations." MacDonough also said the increase in the number of shareholders will make it easier both to transfer ownership to multiple generations within a family for estate planning purposes and to provide incentives to employees through stock ownership.

The 1996 act expands the straight-debt safe harbor to include qualifying debt held by financial institutions, making it easier for many S corporations to obtain conventional financing without jeopardizing their subchapter S status. The new law also permits an S corporation to be a member of an affiliated group as a result of its ownership of another corporation. MacDonough said that this allows an S corporation to hold a foreign corporation as a wholly owned subsidiary, making it easier for small businesses that are expanding overseas. She also said certain banks may elect S corporation status under the act. All of these provisions will be effective for tax years after December 31, 1996. For tax years beginning after December 31, 1997, the new law allows certain tax-exempt organizations to own S corporation stock.

The 1996 act eases S corporation termination and election rules. Prior to the 1996 act, a corporation that terminated a subchapter S election could not reelect the status for five years without the consent of the Internal Revenue Service. Now, corporations that terminate their subchapter S status during or before 1996 no longer need IRS consent. Also under the new law, the IRS has the authority to waive the consequences of an invalid election, and it can treat late S corporation elections as timely when there is reasonable cause for the late filing. This provision is retroactive to tax years beginning after December 31, 1982.

Employee or independent contractor?

The 1996 act contains a number of modifications to section 530 of the Revenue Act of 1978, which was intended to provide some relief to employers by prohibiting the IRS from reclassifying an independent contractor as an employee if the employer reasonably treated the individual as an independent contractor. …

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