Thomas Offers S Corporations 'One-Time Election'

Until laws authorizing the limited liability company were developed, the S corporation was "for all practical purposes the sole means for a small or family business to obtain the benefits of limited liability" without the complexities of corporate tax, Thomas told the Senate. "For many years, a change to another form of business was relatively easy. But by the time an alternative to the S corporation became widely available, this avenue had been foreclosed by changes to the tax code," he said. Thomas noted his bill is aimed at older family businesses currently "locked into the corporate form simply because of the tax cost of changing to another form."

ELECTION FOR SPECIAL TAX TREATMENT OF CERTAIN S CORPORATION CONVERSIONS

Mr. THOMAS. Mr. President, today I join Senator ENZI in introducing legislation that will give small businesses more flexibility in how they choose to operate.

One of the most important decisions for the founder of a business is "choice of entity," whether to operate the business through a corporation, partnership, limited liability company or other form of business. This choice is plainly important for reaching business goals, and may be critical to the survival of the business. For the family business, the choice also is inseparable from the owner's preferences as to how the owner wants to relate to family co- owners. Choice of entity is therefore potentially one of the most important decisions for an owner.

The law concerning choice of entity has changed enormously in the last decade, particularly with the wide-spread adoption of laws authorizing the limited liability company (LLC). As a result, business owners have more flexibility in this area than ever before. Even so, older family businesses operated as S corporations may be "locked" into the corporate form, simply because of the tax cost of changing to another form. These businesses are thus unable to take advantages of the recent advancements in choice of entity.

In order to help these older businesses remain competitive with their younger rivals, the bill Senator ENZI and I introduce today will allow a one-time election for an S corporation to change to another form of business without incurring the normal tax cost of doing so.

Thousands of corporations have elected subchapter S status since President Eisenhower signed into law the Technical Amendments Act of 1958, which added subchapter S to the code. The legislative history makes clear that the purpose of subchapter S was to offer simplified tax rules for the small and family-owned business operating in the corporate form.

Until the rise of the LLC in the mid 1990's, the S corporation remained, for all practical purposes, the sole means for a small or family business to obtain the benefits of limited liability without the complex corporate tax. For many years, a change to another form of business was relatively easy. But by the time an alternative to the S corporation became widely available, this avenue had been foreclosed by changes to the tax code. Thus thousands of S corporations are saddled with the cumbersome and inflexible rules of the corporate form.

The Internal Revenue Code itself reflects a policy of respecting economic reality over form in the conduct of a trade or business. For example, Section 1031, which existed even in 1939, allows nonrecognition of gain or loss in the exchange of property used in a trade or business, or for investment, on the theory that the taxpayer has not cashed out his investment. Code Sections 351 and 721 allow nonrecognition on the contribution of property to a corporation or a partnership, on the rationale that the taxpayer is only changing the form of his investment.

The S election itself was a giant stride in removing tax considerations in choice of entity. More recently, the Internal Revenue Service has done much to remove tax considerations from the choice of business form through the check the box regulations. The Service should be commended for taking this step.

The next step in the process is allowing those S corporations that can more efficiently function as an LLC the one-time chance to make the conversion, without tax cost being the controlling factor. Until these conversions can be accomplished, the task of reducing the role of taxes in choosing a business form will remain unfinished.

I look forward to working with Senator ROTH and the other members of the Senate Finance Committee so we may take action on this measure as soon as possible.