The bill creates a new section 1369 that lets beneficiaries (or other transferees treated as shareholders) amortize an S‑corporation built‑in gain amount created by a basis step‑up at death over 15 years, with special rules for dispositions and reporting. It also raises the S‑corporation passive investment income threshold from 25% to 60%, eliminates termination of S status for excessive passive income, permits nonresident aliens and IRAs (including Roth IRAs) to be S shareholders, and repeals Internal Revenue Code section 409A (nonqualified deferred compensation rules).
These changes shift estate‑planning outcomes, widen who can hold S stock, and alter the line between active S‑corp businesses and passive investment entities. Compliance and withholding obligations are added (including a new withholding regime for effectively connected income allocated to nonresident shareholders), and multiple cross‑references in the Code receive conforming edits—so tax administrators, advisers, and S‑corporations will need to revise reporting, election, and valuation practices if the bill becomes law.
At a Glance
What It Does
Creates a 15‑year amortizable deduction for S‑corporation built‑in gain arising from a decedent’s basis step‑up; raises the passive investment income safe harbor from 25% to 60% and removes passive‑income termination; authorizes nonresident alien individuals and IRAs as S shareholders; and repeals section 409A. It also adds withholding and reporting rules tied to nonresident shareholders and stock dispositions.
Who It Affects
Estate executors, beneficiaries, and family trusts holding S stock; S corporations with sizable unrealized built‑in gains; private companies with high passive receipts; tax advisors/accounting shops that prepare basis valuations and K‑1 reporting; nonresident alien investors and custodians of IRAs that hold company stock.
Why It Matters
It changes how post‑death S‑corp wealth is taxed (moving from an immediate capital gain exposure to a timed amortization), broadens the investor pool for S elections, and relaxes passive‑income constraints—each of which affects entity choice, M&A pricing for closely held companies, estate and succession planning, and compliance workloads at both taxpayer and IRS levels.
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What This Bill Actually Does
Section 2 of the bill inserts a new Internal Revenue Code section (1369) that addresses how S‑corporation built‑in gain is treated when a shareholder dies and the decedent’s stock basis is stepped up under section 1014. The core idea: the beneficiary (the person whose basis is determined under 1014) may claim a deduction equal to the S‑corporation built‑in gain amount and must amortize the amortizable portion over 15 years beginning the month that includes the applicable valuation date.
The provision separates company property into amortizable (depreciable) and non‑amortizable categories, allocates the built‑in gain amount pro rata to each, and provides different acceleration or additional deduction rules when the S corporation disposes of those properties. The bill also requires reporting of the relevant pro rata amounts to shareholders for K‑1 purposes.
Disposition rules are designed to pull deductions forward: if the S corporation disposes of amortizable built‑in gain property, a pro rata share of recognized gain can accelerate the available deduction; dispositions of non‑amortizable property permit an additional deduction up to the non‑amortizable built‑in gain amount. However, the overall deductions cannot exceed the computed built‑in gain amount for that stock.
If stock or covered property that was the subject of deductions is later sold at a gain, the bill recharacterizes an amount of that gain as ordinary income to the extent of prior deductions under 1369. The deduction terminates if the S election is terminated or the shareholder transfers the stock (with special rules for distributions from estates/trusts, gifts, transfers to spouses, and transfers to trusts).Section 3 alters the passive investment income rules by increasing the tested threshold from 25% to 60% of gross receipts and removing excessive passive income as an automatic S‑status termination event.
The bill refines how passive receipts are measured—limiting the inclusion of certain sales, dividends, interest and providing carve‑outs for banks, financing businesses that meet existing tests, and dividends from C corporations whose earnings derive from active business operations. It coordinates with the recognized built‑in gain rules so recognized built‑in gains during a recognition period are not counted as passive receipts.Section 4 allows nonresident alien individuals to hold S stock and adds a new framework to tax and collect U.S. tax on their share of effectively connected income.
It creates section 864(c)(9) treating some gains on sale of S stock by nonresident aliens as effectively connected to the extent of the share of underlying U.S. effectively connected income, and it adds a new chapter‑3 withholding section (1447) requiring an S corporation to withhold an amount equal to the top individual tax rate times the aggregate pro rata effectively connected income allocated to nonresident shareholders. The transferee of S stock must withhold 10% of the amount realized on a taxable disposition if part of the gain is treated as effectively connected; rules similar to section 1446(f) apply for certifications and exemptions.Other changes: Section 5 treats all employees (and their estates) of a corporation and certain wholly owned entities as a single shareholder for the S‑shareholder count; Section 6 permits IRAs, including Roth IRAs, to be S shareholders and adjusts prohibited‑transaction rules so sales of S stock held in IRAs are not automatically treated as disallowed transactions; Section 7 allows suspended S‑corporation losses to be transferred incident to death; and Section 8 repeals Code section 409A (the nonqualified deferred compensation inclusion and penalty regime) and makes a number of conforming edits.
The bill contains staggered effective dates—several amendments apply to taxable years beginning after December 31, 2024, some to sales or dispositions after that date, and the IRA change and section 409A repeal take effect in 2026 and for years after December 31, 2025, respectively.
The Five Things You Need to Know
New section 1369 permits a beneficiary whose stock basis is stepped up under section 1014 to amortize the computed S‑corporation built‑in gain amount over a 15‑year period beginning with the applicable valuation month.
The bill raises the passive investment income threshold used for S‑corporation tests from 25% to 60% of gross receipts and removes excessive passive income as a statutory S‑termination event.
Nonresident alien individuals may be S shareholders; the bill adds section 864(c)(9) treating certain gains on S‑stock sales by NRAs as effectively connected and creates section 1447 requiring S corporations to withhold an amount equal to the top individual rate times the NRA shareholders’ pro rata effectively connected income.
The legislation treats all employees (and their estates) of a firm and designated wholly owned entities as a single shareholder for the S‑shareholder limit, and it expressly allows IRAs (including Roth IRAs) to hold S stock effective January 1, 2026.
The Act repeals Internal Revenue Code section 409A (nonqualified deferred compensation rules) for taxable years beginning after December 31, 2025, and makes extensive conforming amendments across the Code.
Section-by-Section Breakdown
Every bill we cover gets an analysis of its key sections.
Amortization of built‑in gain after a shareholder’s death
This provision creates a statutory mechanism for beneficiaries to recover a computed built‑in gain amount via a deduction amortized over 15 years when stock basis is stepped up at death under section 1014. It distinguishes amortizable (depreciable) and non‑amortizable property; allocates the built‑in gain pro rata; and provides both acceleration and additional deduction rules tied to S‑corp dispositions. The section imposes limitations so aggregate deductions for a share cannot exceed the computed built‑in gain amount, requires reporting under section 6037, and contains rules to recharacterize later gains as ordinary income to the extent prior deductions reduced taxable income.
Passive investment income tests and coordination with built‑in gain rules
This change increases the passive income trigger from 25% to 60% and eliminates excessive passive income as a ground for terminating S status. The bill rewrites the definition of passive investment income to clarify inclusion/exclusion rules (interest on inventory notes, certain lending businesses, bank-specific carve‑outs, and dividend exceptions tied to active C‑corp earnings) and limits sales proceeds to net capital gain treatment. It explicitly excludes recognized built‑in gains or losses during recognition periods from passive receipts, and it updates cross‑references in the tax code to reflect the new threshold.
Permitting nonresident aliens as S shareholders and new withholding rules
The bill removes the prohibition on nonresident alien individual shareholders and adds a new paragraph to section 864 treating certain gain or loss on S‑stock sales by NRAs as effectively connected with a U.S. trade or business to the extent of the shareholder’s pro rata share of deemed asset‑level gain. To secure U.S. tax on effectively connected income allocated to NRAs, it creates section 1447, requiring S corporations to withhold an amount equal to the top individual tax rate multiplied by the aggregate NRA pro rata effectively connected income. The provision also requires transferee withholding of 10% of the amount realized on stock dispositions when part of the gain is treated as effectively connected and adopts rules similar to section 1446(f) for certifications and exceptions.
Employees counted as one shareholder for the shareholder limit
This short amendment treats all employees (and their estates) of a corporation and its wholly owned business entities as a single shareholder for purposes of the S‑corporation shareholder count. The bill references the definition of employee under section 3121(d) and leaves the Secretary the authority to determine which entities are wholly owned. Practically, this reduces the administrative barrier to S status for businesses that issue equity‑based compensation to large employee groups but shifts recordkeeping responsibility to companies that previously counted many employee owners.
Allowing IRAs (including Roths) to hold S stock; prohibited transaction changes
The bill adds trusts that are individual retirement accounts under section 408(a), explicitly including Roth IRAs, to the list of permitted S shareholders. It adjusts the prohibited transaction rules (section 4975) to exempt certain sales of S‑stock held by IRAs from automatic disqualification treatment and updates conforming language so the issuer is used in place of an older reference. The effective date is January 1, 2026, giving custodians, plan administrators, and issuers time to adjust procedures for IRA ownership of closely held business stock.
Transfers of suspended S losses at death and repeal of 409A
Section 7 allows suspended S‑corporation losses to transfer incident to death, updating the loss‑utilization rules that previously applied only to transfers under section 1041. Section 8 repeals Code section 409A—the specialized income inclusion and penalty regime for nonqualified deferred compensation—and makes numerous conforming edits across the Code (including to reporting statutes and related provisions like 430, 457A, and 877A). The repeal applies to taxable years beginning after December 31, 2025, and will require plan sponsors and advisers to re‑evaluate deferred‑comp arrangements and associated tax reporting frameworks.
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Explore Finance in Codify Search →Who Benefits and Who Bears the Cost
Every bill creates winners and losers. Here's who stands to gain and who bears the cost.
Who Benefits
- Beneficiaries and estates of deceased S‑shareholders — the new 15‑year amortization and the ability to transfer suspended losses incident to death smooths estate tax and income tax consequences and can preserve value for heirs by spreading tax recognition.
- Closely held S corporations with high passive receipts — raising the passive income threshold to 60% and removing passive‑income termination preserves S status for companies with elevated investment or rental receipts and reduces the risk of unintended conversion to C status.
- retirement account holders and plan beneficiaries — permitting IRAs (including Roth IRAs) to hold S stock creates another tax‑preferred vehicle for owning private company equity and may increase liquidity options for retirement savers.
- Nonresident alien individuals who wish to acquire U.S. private company equity — allowing NRA individuals to be S shareholders opens a new investor class for small‑cap and family businesses that previously could not accept such investors.
- Shareholders and acquirers concerned with post‑death transitions — the combination of amortization, reporting, and transfer rules gives more predictable tax treatment for succession planning and M&A pricing discussions.
Who Bears the Cost
- S corporations and their tax preparers — new bookkeeping, valuation, and K‑1 reporting requirements (allocation of amortizable/non‑amortizable built‑in gain amounts, tracking amortization schedules) will increase compliance workload and potentially require systems upgrades.
- Transferees and purchasers of S stock — the new 10% transferee withholding on dispositions where some gain is effectively connected introduces a closing‑stage withholding obligation that may slow or complicate transactions.
- Nonresident shareholders — while allowed to hold S stock, NRAs face new effectively‑connected tax attribution rules and may be subject to corporate withholding that creates cash‑flow and filing burdens in the U.S.
- The IRS and Treasury — the agency must issue forms, regulations, and guidance for elections under the new elective S‑corporation rules, valuation practices, the interplay with section 1014, and for administering the new withholding section 1447.
- Employers and plan sponsors of deferred‑compensation arrangements — repeal of section 409A removes the special inclusion/penalty regime but creates legal uncertainty and transitional tax planning burdens for firms that used 409A frameworks to design deferred‑comp plans.
Key Issues
The Core Tension
The central dilemma is between expanding flexibility for small and family businesses, heirs, and investors (reducing barriers to ownership, softening estate‑time tax hits, and preserving S status) and the countervailing risks of added complexity, compliance burdens, revenue leakage, and new avenues for timing or character arbitrage; the bill eases practical problems but simultaneously raises collection, valuation, and anti‑avoidance questions that regulatory and enforcement policy must then resolve.
The bill solves specific estate and ownership problems but creates several implementation challenges. Section 1369 depends on a reliable valuation date and a clear allocation of the built‑in gain amount between depreciable and non‑depreciable assets; contested valuations could produce litigation and delay claimable deductions.
The elective nature—an S corporation must elect the application of the new section with respect to a shareholder—introduces governance frictions: companies and executors will need to coordinate elections across estates, trusts, and later transferees, and the Secretary is authorized to prescribe forms and timing, which may materially change how the rules operate in practice. Reporting under section 6037 is extended to include amounts tied to 1369, which increases K‑1 complexity and the potential for mismatch between corporate calculations and beneficiary returns.
Permitting nonresident individuals as shareholders improves capital access but raises source‑of‑income and collection problems. The new withholding regime (section 1447) shifts collection responsibility to S corporations and transferees; the fixed‑rate multiplier (the top individual tax rate) may under‑ or over‑withhold relative to the NRA’s actual tax liability, and the 10% transferee withholding rule could chill secondary market trades in closely held stock or require escrow mechanics at closing.
Repealing section 409A removes a long‑standing penalties framework but leaves unanswered questions about which existing practices must change and how transitional liabilities are treated; conforming edits help but meaningful regulatory guidance will be necessary to avoid disruption.
Finally, the passive income threshold increase improves S‑status stability for asset‑heavy companies but reduces a structural distinction between active pass‑through businesses and passive investment vehicles that historically justified C‑corporation treatment. That shift could alter corporate form decisions, generate revenue consequences, and create opportunities to shift income from C corporations into pass‑throughs—issues the bill addresses in part by excluding recognized built‑in gains from passive receipts but not fully resolving the broader tax‑base tradeoffs.
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