S 2017119th CongressIntroduced

S Corporation Modernization Act of 2025

Introduced: Jun 10, 2025

Economy & Taxes

Standard Summary

Comprehensive overview in 1-2 paragraphs

The S Corporation Modernization Act of 2025 would overhaul several core S corporation rules in the Internal Revenue Code. Key changes include creating a new framework for taxing S corporation “built-in gains” upon the death of a shareholder (with a 15-year amortization and potential acceleration of deductions on dispositions), raising the allowable share of passive investment income (from 25% to 60%) and removing passive income as a trigger to terminate an S election, permitting nonresident aliens to own S corporation stock with new withholding and effectively connected income rules, treating employees as a single shareholder for purposes of the 100-shareholder limit, expanding eligible S corporation shareholders to include IRAs, and various other related provisions (including transfers at death, repeal of 409A nonqualified deferred compensation, and changes to related tax rules). The bill would apply on different effective dates for each provision, generally stretching from 2024 through 2026 and beyond. Introduced in the Senate on June 10, 2025 by Senator Sheehy, the bill aims to broaden ownership, recalibrate how S corporations handle gains and passive income, and modernize several administrative and compliance aspects of S corporations and related compensation arrangements.

Key Points

1Sec. 1369: Treatment of S corporation built-in gain amount upon death of shareholder
2- Creates a new deduction for the decedent’s S corporation built-in gain amount, amortized over 15 years, with special rules for property dispositions (amortizable vs nonamortizable built-in gain property) and a mechanism to recharacterize excess deductions as ordinary income on dispositions.
3- Sets up detailed definitions (e.g., “S corporation built-in gain amount,” “amortizable” vs “non-amortizable” property) and special transfer rules on death, gifts, spousal transfers, estates, and trusts.
4- Applies to decedents dying after enactment; affects taxable years ending after enactment.
5Sec. 3: Modifications to S corporation passive investment income rules
6- Increases the passive investment income limit from 25% to 60%.
7- Repeals the rule that excessive passive income terminates an S election (i.e., no longer a hard stop based on passive income level).
8- Broadens and refines the definition of “passive investment income” with several detailed exceptions (e.g., certain interest on notes, active lending/finance activities, dividends from certain C corporations, banks/depository institutions, and rules for dispositions of capital assets).
9- Aligns coordination with section 1374 (built-in gains) and updates several cross-references.
10- Applies to taxable years beginning after December 31, 2024.
11Sec. 4: Nonresident alien individuals permitted as S corporation shareholders
12- Expands eligible S corporation shareholders to include nonresident aliens.
13- Adds a new 1447 withholding framework: S corporations must withhold tax on nonresident aliens’ pro rata shares of effectively connected income, with credits allowed to the shareholder and special distribution timing rules.
14- Defines “effectively connected income” for this context and provides special rules for disposition-related withholding.
15- Applies to years beginning after December 31, 2024 (with certain disposition rules applying to sales after that date).
16Sec. 5: Employees of a firm counted as a single shareholder toward the shareholder limit
17- Treats all employees (and their estates) of a corporation and its wholly owned entities as one shareholder for purposes of the S-corp 100-shareholder limit.
18- Applies to taxable years beginning after December 31, 2024.
19Sec. 6: Expansion of S corporation eligible shareholders to include IRAs
20- Adds IRAs (including Roth IRAs) as eligible S corporation shareholders.
21- Adjusts related prohibited transaction rules to accommodate stock in IRAs.
22- Effective date: January 1, 2026.
23(Additional related items in other sections include transfers on death, repeal of 409A nonqualified deferred compensation, and related conforming amendments, but the five bullets above capture the most substantive changes.)

Impact Areas

Primary group/area affected- S corporation shareholders and the S corporation itself (including family-owned businesses and professional service firms). Major changes include death-related built-in-gain treatment, the counting of employees as a single shareholder, and broader eligibility of investors (IRAs and NRAs).Secondary group/area affected- Estate planning and heirs of S corporation owners (due to built-in gain deductions at death and transfer rules).- Investors and retirement accounts (IRAs) seeking to own S corporation stock, with implications for prohibited transactions and tax planning.- Nonresident aliens with U.S. trade or business activities in S corporations, due to withholding and effectively connected income rules.Additional impacts- Tax planning and administrator considerations for firms with substantial passive income or ownership structures that previously risked terminating S status.- Compensation planning and payroll/tax compliance changes stemming from the repeal of 409A, altering deferred compensation arrangements.- Financial services, banking, and lending businesses may see nuanced effects from the expanded “passive income” definitions and related cross-references.- Treasury/IRS guidance and regulation will be needed to implement withholding, credit administration, and the updated cross-references.2024-12-31 onward for many provisions (Sec. 3, Sec. 4, Sec. 5) with varying specifics.2025-12-31 onward for repeal of 409A (Sec. 8) (tax years beginning after 2025).2026-01-01 for IRA eligibility (Sec. 6).Sec. 2’s built-in gain death provisions apply to decedents dying after enactment.

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