S Corporation Modernization Act of 2026

This bill, titled the "S Corporation Modernization Act of 2026," introduces several key reforms to the Internal Revenue Code affecting S corporations. One major provision allows a new deduction for the S corporation built-in gain amount when a shareholder's stock basis is stepped up at death, amortized over 15 years with accelerated deductions for property dispositions. This aims to mitigate certain tax burdens associated with inherited S corporation stock.

The legislation significantly modifies the rules regarding passive investment income for S corporations. It raises the permissible passive investment income threshold from 25% to 60% and eliminates the termination of S corporation status for exceeding this limit. Furthermore, it broadens the definition of passive investment income to include exceptions for certain active business income, such as interest from inventory sales, income from lending or finance businesses, and dividends from active C corporation subsidiaries.

To expand eligibility, the bill permits nonresident alien individuals and Individual Retirement Accounts (IRAs), including Roth IRAs, to be S corporation shareholders. For nonresident aliens, it establishes rules to treat gain or loss from S corporation stock sales as effectively connected with a U.S. trade or business and imposes a corresponding withholding tax on effectively connected income. Additionally, it allows suspended losses of an S corporation shareholder to be transferred incident to the death of the transferor.

The bill also increases the maximum number of permitted S corporation shareholders from 100 to 250, and treats all employees of a firm and its wholly-owned entities as a single shareholder for this limit. This change aims to allow larger businesses to utilize the S corporation structure. Finally, it repeals Section 409A, which governs nonqualified deferred compensation plans, simplifying rules in this area.