The S Corporation Modernization Act of 2025 is a proposed law aimed at updating the rules for S corporations, which are a type of business structure that allows income to pass directly to shareholders to avoid double taxation. This bill seeks to simplify tax rules, expand investment opportunities, and reduce administrative burdens for these businesses.
What This Bill Does
The S Corporation Modernization Act of 2025 introduces several changes to the tax rules governing S corporations. One major change is how built-in gains are handled when a shareholder dies. Currently, when a shareholder passes away, the built-in gains of the corporation can lead to significant taxes for the heirs. The new bill proposes a deduction for these gains, making it easier for families to keep their businesses intact without having to sell off assets to pay taxes.
Another significant change is the adjustment of passive investment income rules. The bill proposes increasing the threshold for taxable passive income from 25% to 60%. This means that S corporations can earn more passive income, like rental income, without facing additional taxes. Additionally, the bill removes the rule that automatically terminates an S corporation if it exceeds the passive income limit, providing more stability for businesses.
The bill also expands who can invest in S corporations by allowing Individual Retirement Accounts (IRAs) to hold S corporation shares. This change could open up new investment opportunities for retirement savers and provide more capital for small businesses.
Furthermore, the bill simplifies rules around deferred compensation, which is a way for businesses to pay employees at a later date. By repealing certain reporting requirements, the bill aims to reduce compliance costs for businesses.
Why It Matters
This bill could have a significant impact on small businesses and their owners. S corporations are a popular choice for small business owners because they avoid the double taxation that C corporations face. By modernizing the rules, this bill could make it easier for these businesses to operate and grow.
For family-owned businesses, the changes to built-in gains rules could help preserve generational wealth. Families might not have to sell off parts of their business to pay taxes when a shareholder dies, allowing them to keep the business running smoothly.
The expansion of investment opportunities through IRAs could also benefit both investors and businesses. More people would have the chance to invest in S corporations, potentially increasing the flow of capital to these businesses and supporting their growth.
Key Facts
- Cost/Budget Impact: No official cost estimate yet, but similar past reforms have cost over $1 billion over ten years.
- Timeline for Implementation: Most provisions would take effect for taxable years beginning after December 31, 2025.
- Number of People Affected: Approximately 5.5 million S corporations and their shareholders.
- Key Dates: Bill introduced on June 10, 2025.
- Solo Sponsor: Introduced by Sen. Tim Sheehy (R-MT) with no cosponsors.
- Historical Context: Builds on past reforms from 1982 and 1996, with no direct precedent for some changes.
- Real-World Impact: Could stabilize businesses employing half of private-sector workers, indirectly supporting wages and jobs.
Arguments in Support
- Eases estate planning for family businesses: Helps families avoid selling assets to pay taxes after a shareholder's death.
- Expands investor access via IRAs: Allows more people to invest in S corporations, potentially increasing available capital.
- Reduces involuntary S corp terminations: Prevents businesses from losing their S corporation status due to passive income limits.
- Simplifies deferred compensation: Reduces compliance costs for businesses, making it easier to retain talent.
- Modernizes outdated rules: Updates tax rules that have been in place since the 1980s, making them more relevant to today's business environment.
Arguments in Opposition
- Revenue loss for Treasury: Changes could lead to a decrease in tax revenue, impacting government budgets.
- Abuse potential for IRAs: New rules might allow for transactions that avoid certain taxes, leading to potential abuses.
- Favors wealthy/passive owners: Benefits may primarily help investment-heavy businesses rather than active small businesses.
- Complexity in transitions: Changes to built-in gains rules could lead to more complicated tax filings and audits.
- Unequal treatment: Repealing deferred compensation rules might favor those with access to such plans over regular employees.