text: SECTION 1. SHORT TITLE.
  
      This Act may be cited as ``Small Business Tax Modernization Act of 
  2004''.
  
  SEC. 2. UNIFIED PASS-THRU ENTITY REGIME.
  
      (a) Termination of S Corporation Status.--
              (1) No new s corporation elections.--Subsection (a) of 
          section 1362 of the Internal Revenue Code of 1986 is amended by 
          adding at the end the following new paragraph:
              ``(3) Termination of authority to make election.--No 
          election may be made under paragraph (1) for any taxable year 
          beginning after December 31, 2004.''.
              (2) Termination of status.--Subsection (d) of section 1362 
          of such Code (relating to termination) is amended by adding at 
          the end the following new paragraph:
              ``(4) Treatment as partnership after 2014.--An election 
          under subsection (a)--
                      ``(A) shall not be effective for any taxable year 
                  beginning after December 31, 2014, and
                      ``(B) shall be treated as an election under section 
                  7701(a)(2)(B) for taxable years beginning after such 
                  date.''.
              (3) Effective date.--The amendments made by this subsection 
          shall apply to taxable years beginning after December 31, 2004.
      (b) Election by Certain Corporations to Be Taxed as Partnership.--
              (1) In general.--Paragraph (2) of section 7701(a) of such 
          Code (defining partnership and partner) is amended to read as 
          follows:
              ``(2) Partnership and partner.--
                      ``(A) In general.--The term `partnership' includes 
                  a syndicate, group, pool, joint venture, or other 
                  unincorporated organization, through or by means of 
                  which any business, financial operation, or venture is 
                  carried on, and which is not, within the meaning of 
                  this title, a trust or estate or a corporation; and the 
                  term `partner' includes a member in such a syndicate, 
                  group, pool, joint venture, or organization.
                      ``(B) Election by corporation to be taxed as 
                  partnership.--
                              ``(i) In general.--An eligible corporation 
                          may elect to be treated as a partnership for 
                          purposes of this title.
                              ``(ii) Tax treatment.--Except as provided 
                          in section 1379A--
                                      ``(I) no gain or loss shall be 
                                  recognized to the corporation or the 
                                  shareholders by reason of an election 
                                  under clause (i), and
                                      ``(II) except in the case of an 
                                  election made by a S corporation after 
                                  the end of the recognition period (as 
                                  defined in section 1374(d)(7) without 
                                  regard to subparagraph (B) thereof), 
                                  section 1374 shall apply to the entity 
                                  after such election.
                              ``(iii) Eligible corporation.--For purposes 
                          of clause (i), the term `eligible corporation' 
                          means an entity--
                                      ``(I) which, without regard to this 
                                  subparagraph, is a domestic corporation 
                                  no stock of which is readily tradable 
                                  on an established securities market or 
                                  otherwise, and
                                      ``(II) which is not an ineligible 
                                  corporation (as defined by section 
                                  1361(b)(2)).
                              ``(iv) Election and termination.--For 
                          purposes of this subparagraph, rules similar to 
                          the rules of section 1362 (other than 
                          subsections (a)(3), (d)(3) and (4), and (e) 
                          thereof) shall apply.
                              ``(v) Distributions, etc.--Each partner 
                          shall include in gross income as a dividend, 
                          any amount that would have been so includible 
                          had the entity been an S corporation during the 
                          period the entity was treated as a partnership. 
                          Notwithstanding the preceding sentence, the 
                          provisions of subchapter K of chapter 1 shall 
                          apply to determine the basis of any property 
                          distributed and the basis of any interest in 
                          the partnership.
                              ``(vi) Cross reference.--For tax treatment 
                          of S corporation electing unified pass-thru 
                          regime, see section 1379A.''.
              (2) Tax treatment of s corporation electing unified pass-
          thru regime.--
                      (A) In general.--Part IV of subchapter S of chapter 
                  1 of such Code is amended by inserting after section 
                  1379 the following new section:
  
  ``SEC. 1379A. TAX TREATMENT OF S CORPORATION ELECTING UNIFIED PASS-THRU 
                REGIME.
  
      ``In the case of an election under section 7701(a)(2)(B) by an S 
  corporation before January 1, 2015, with respect to the corporation--
              ``(1) the shareholders shall be treated as if the assets 
          were distributed, on the date of such election, to the 
          shareholders in exchange for their stock,
              ``(2) any gain or loss recognized to the shareholders by 
          reason of paragraph (1) shall be taken into account by the 
          shareholders ratably over the taxable year in which the 
          distribution is deemed to be made under paragraph (1) and the 
          succeeding 4 taxable years, and
              ``(3) proper adjustments to the basis of interests in the 
          entity shall be made.''.
                      (B) Clerical amendment.--The table of sections for 
                  part IV of subchapter S of chapter 1 of such Code is 
                  amended by inserting after the item relating to section 
                  1379 the following new item:
  
  ``Sec. 1379A. Tax treatment of S corporation electing unified pass-thru 
                              regime.''.
              (3) Modification to treatment of section 1374 tax for 
          earnings and profits purposes.--Paragraph (2) of section 
          1366(f) of such Code is amended to read as follows:
              ``(2) Treatment of tax imposed on built-in gains.--
                      ``(A) In general.--The amount of the items of the 
                  net recognized built-in gain taken into account under 
                  section 1374(b)(1) (reduced by any deduction allowed 
                  under section 1374(b)(2)) shall not be taken into 
                  account under this section.
                      ``(B) Earnings and profits.--The accumulated 
                  earnings and profits of the corporation shall be 
                  increased at the beginning of the taxable year by the 
                  amount not taken into account under this section by 
                  reason of subparagraph (A) (determined without regard 
                  to section 1374(b)(2)) reduced by the tax imposed by 
                  section 1374 (net of credits allowed).''.
              (4) Effect of election on recognition period for purposes 
          of tax imposed on built-in gains.--Paragraph (7) of section 
          1374(d) of such Code is amended to read as follows:
              ``(7) Recognition period.--
                      ``(A) In general.--The term `recognition period' 
                  means the 10-year period beginning with the 1st day of 
                  the 1st taxable year for which the corporation was an S 
                  corporation. For purposes of applying this section to 
                  any amount includible in income by reason of section 
                  593(e), the preceding sentence shall be applied without 
                  regard to the phrase `10-year'.
                      ``(B) Special rule relating to election of 
                  corporation to be taxed as partnership.--
                              ``(i) In general.--In the case of an 
                          election under section 7701(a)(2)(B), 
                          subparagraph (A) shall be applied by 
                          substituting `25-year' for `10-year' both 
                          places it appears.
                              ``(ii) Exception where 10-year period 
                          expired.--If, on the date of an election 
                          referred to in clause (i) by a corporation, the 
                          10-year period specified in subparagraph (A) 
                          with respect to such corporation has expired, 
                          clause (i) shall not apply to such 
                          corporation.''.
              (5) Effective dates.--The amendments made by this 
          subsection shall apply to taxable years beginning after 
          December 31, 2004.
      (c) Step Transaction Doctrine not to Apply to Partnership 
  Incorporation Followed by Corporate Reorganization.--
              (1) In general.--Section 351 of such Code is amended by 
          redesignating subsection (h) as subsection (i) and by inserting 
          after subsection (g) the following new subsection:
      ``(h) Special Rule for Partnerships Which Incorporate and 
  Subsequently Reorganize.--The step transaction doctrine and any similar 
  doctrine shall not apply for purposes of determining whether the 
  control requirement of subsection (a) is met in any case in which--
              ``(1) a partnership engaged in an active trade or business 
          transfers substantially all of the property used in carrying on 
          such trade or business to a corporation which is not publicly 
          traded, and
              ``(2) such corporation subsequently enters into a 
          reorganization under this chapter.''.
              (2) Effective date.--The amendment made by this subsection 
          shall apply to transactions after December 31, 2004.
  
  SEC. 3. PARTNERSHIP INCOME ATTRIBUTABLE TO CAPITAL EXCLUDED FROM NET 
                EARNINGS FROM SELF-EMPLOYMENT.
  
      (a) In General.--Paragraph (13) of section 1402(a) of the Internal 
  Revenue Code of 1986 is amended to read as follows:
              ``(13) there shall be excluded the distributive share of 
          net income of a partner attributable to capital;''.
      (b) Partnership Income Attributable to Capital.--Section 1402 of 
  such Code is amended by adding at the end the following new subsection:
      ``(l) Partnership Income Attributable to Capital.--
              ``(1) In general.--For purposes of subsection (a)(13), the 
          following amounts shall be treated as income attributable to 
          capital--
                      ``(A) the amount, if any, in excess of what would 
                  constitute reasonable compensation for services 
                  rendered by such partner to the partnership, and
                      ``(B) an amount equal to a reasonable rate of 
                  return on unreturned capital of the partner determined 
                  as of the beginning of the taxable year.
              ``(2) Definitions.--For purposes of paragraph (1)--
                      ``(A) Unreturned capital.--The term `unreturned 
                  capital' means the excess of the aggregate amount of 
                  money and the fair market value as of the date of 
                  contribution of other consideration (net of 
                  liabilities) contributed by the partner over the 
                  aggregate amount of money and the fair market value as 
                  of the date of distribution of other consideration (net 
                  of liabilities) distributed by the partnership to the 
                  partner, increased or decreased for the partner's 
                  distributive share of all reportable items as 
                  determined in section 702. If the partner acquires a 
                  partnership interest and the partnership makes an 
                  election under section 754, the partner's unreturned 
                  capital shall take into account appropriate adjustments 
                  under section 743.
                      ``(B) Reasonable rate of return.--A reasonable rate 
                  of return on unreturned capital shall equal 150 percent 
                  (or such higher rate as is established in regulations) 
                  of the highest applicable Federal rate, as determined 
                  under section 1274(d)(1), at the beginning of the 
                  partnership's taxable year.
              ``(3) Regulations.--The Secretary shall prescribe such 
          regulations as may be necessary to carry out the purposes of 
          this subsection.''.
      (c) Effective Date.--The amendments made by this section shall 
  apply with respect to services performed in taxable years beginning 
  after December 31, 2004.
target: Small Business Modernization Act of 2004 - Amends the Internal Revenue Code to: (1) terminate subchapter S corporation elections after 2004 and subchapter S status after 2014 and to allow privately-held domestic corporations, in lieu of electing subchapter S treatment, to elect to be treated as partnerships for tax purposes; (2) set forth rules for the tax treatment of former subchapter S corporations electing partnership status; and (3) exclude from net earnings from self-employment partnership income attributable to capital.
feat_title: To amend the Internal Revenue Code of 1986 to provide for unified income taxation with respect to pass-thru entities.