The S Corporation Modernization Act of 2026 updates tax regulations to increase shareholder limits, expand eligibility for foreign and retirement account investors, and simplify rules regarding passive income, inherited stock, and deferred compensation.
Mike Carey
Representative
OH-15
The S Corporation Modernization Act of 2026 introduces comprehensive reforms to the Internal Revenue Code to increase flexibility and growth opportunities for S corporations. Key provisions include raising the shareholder limit to 250, allowing IRAs and nonresident aliens as eligible shareholders, and easing restrictions on passive investment income. Additionally, the bill simplifies tax treatment for inherited stock, preserves suspended losses upon a shareholder's death, and repeals Section 409A regarding nonqualified deferred compensation.
S Corporation Modernization Act: 250-Shareholder Limit and New Tax Breaks for Heirs Set for 2026
The S Corporation Modernization Act of 2026 is a major overhaul of the rules for S corps—those popular small-to-mid-sized businesses that pass income directly to owners to avoid double taxation. Starting in 2026 and 2027, the bill significantly loosens the reins on who can own these companies and how much 'passive' money they can make. It raises the shareholder cap from 100 to 250 people (Section 9) and introduces a massive change for family businesses: heirs who inherit stock can now claim a tax deduction for the 'built-in gain' of the company's assets, amortized over 15 years (Section 2). This essentially lets the next generation chip away at their tax bill as they take over the family trade.
Expanding the Owner's Circle
For the first time, this bill opens the door for nonresident aliens and IRAs—including Roth IRAs—to own shares in an S corp (Sections 4 and 6). This is a big deal for a tech startup or a local manufacturer looking for global investors or wanting to let employees hold stock in their retirement accounts. To make this work, the bill creates a new 10% withholding tax that buyers must collect when purchasing stock from a foreign owner (Section 4). It also simplifies the 'headcount' for the 250-shareholder limit: all employees of the company now count as just one single shareholder (Section 5). This means a growing company can give stock options to hundreds of workers without worrying about hitting a legal ceiling that would mess up their tax status.
More Room for Passive Income
Under current rules, S corps can get in trouble if they make too much money from 'passive' sources like rent, dividends, or interest. This bill changes the game by raising the passive income threshold from 25% to 60% of gross receipts (Section 3). More importantly, it repeals the old 'death penalty' rule where an S corp would lose its tax status entirely if it exceeded the limit for three years. For a small business owner who owns a building and rents out the extra space, or a retired founder living off dividends, this provides a massive safety net against accidental tax hikes.
Cutting Red Tape and Preserving Losses
The bill also cleans up some of the messier parts of the tax code. It repeals Section 409A, which currently imposes strict, often confusing rules and penalties on deferred compensation plans (Section 8). While this makes life easier for HR departments, it does remove some of the guardrails around how executive pay is structured. On the flip side, for those dealing with a loss in the family, the bill now allows 'suspended losses'—business losses that couldn't be deducted before—to transfer directly to the heirs or the estate (Section 7). Previously, these tax benefits often vanished when the owner died, but now they stay with the business, helping the survivors keep the lights on during a transition.