47526 Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 

revisions to such drawings, they are 

controlled under Category VIII(h). 

* * * * * 

(h) Components, parts, accessories, 

attachments, and associated equipment 

(including ground support equipment) 

specifically designed or modified for the 

articles in paragraphs (a) through (d) of 

this category, excluding aircraft tires 

and propellers used with reciprocating 

engines. 

Note: The Export Administration 

Regulations (EAR) administered by the 

Department of Commerce control any 

component, part, accessory, attachment, and 

associated equipment (including propellers) 

designed exclusively for civil, non-military 

aircraft (see § 121.3 of this subchapter for the 

definition of military aircraft) and control 

any component, part, accessory, attachment, 

and associated equipment designed 

exclusively for civil, non-military aircraft 

engines. The International Traffic in Arms 

Regulations administered by the Department 

of State control any component, part, 

accessory, attachment, and associated 

equipment designed, developed, configured, 

adapted or modified for military aircraft, and 

control any component, part, accessory, 

attachment, and associated equipment 

designed, developed, configured, adapted or 

modified for military aircraft engines. For 

components and parts that do not meet the 

above criteria, including those that may be 

used on either civil or military aircraft, the 

following requirements apply. A non-SME 

component or part (as defined in §§ 121.8(b) 

and (d) of this subchapter) that is not 

controlled under another category of the 

USML, that: (a) Is standard equipment; (b) is 

covered by a civil aircraft type certificate 

(including amended type certificates and 

supplemental type certificates) issued by the 

Federal Aviation Administration for a civil, 

non-military aircraft (this expressly excludes 

military aircraft certified as restricted and 

any type certification of Military Commercial 

Derivative Aircraft); and (c) is an integral part 

of such civil aircraft, is subject to the 

jurisdiction of the EAR. In the case of any 

part or component designated as SME in this 

or any other USML category, a determination 

that such item may be excluded from USML 

coverage based on the three criteria above 

always requires a commodity jurisdiction 

determination by the Department of State 

under § 120.4 of this subchapter. The only 

exception to this requirement is where a part 

or component designated as SME in this 

category was integral to civil aircraft prior to 

August 14, 2008. For such part or 

component, U.S. exporters are not required to 

seek a commodity jurisdiction determination 

from State, unless doubt exists as to whether 

the item meets the three criteria above (See 

§ 120.3 and § 120.4 of this subchapter). Also, 

U.S. exporters are not required to seek a 

commodity jurisdiction determination from 

State regarding any non-SME component or 

part (as defined in §§ 121.8(b) and (d) of this 

subchapter) that is not controlled under 

another category of the USML, unless doubt 

exists as to whether the item meets the three 

criteria above (See § 120.3 and § 120.4 of this 

subchapter). These commodity jurisdiction 

determinations will ensure compliance with 

this section and the criteria of Section 17(c) 

of the Export Administration Act of 1979. In 

determining whether the three criteria above 

have been met, consider whether the same 

item is common to both civil and military 

applications without modification of the 

item’s form, fit, or function. Some examples 

of parts or components that are not common 

to both civil and military applications are tail 

hooks, rotodomes, and low observable rotor 

blades. ‘‘Standard equipment’’ is defined as 

a part or component manufactured in 

compliance with an established and 

published industry specification or an 

established and published government 

specification (e.g., AN, MS, NAS, or SAE). 

Parts and components that are manufactured 

and tested to established but unpublished 

civil aviation industry specifications and 

standards are also ‘‘standard equipment,’’

e.g., pumps, actuators, and generators. A part 

or component is not standard equipment if 

there are any performance, manufacturing or 

testing requirements beyond such 

specifications and standards. Simply testing 

a part or component to meet a military 

specification or standard for civil purposes 

does not in and of itself change the 

jurisdiction of such part or component. 

Integral is defined as a part or component 

that is installed in an aircraft. In determining 

whether a part or component may be 

considered as standard equipment and 

integral to a civil aircraft (e.g., latches, 

fasteners, grommets, and switches) it is 

important to carefully review all of the 

criteria noted above. For example, a part 

approved solely on a non-interference/ 

provisions basis under a type certificate 

issued by the Federal Aviation 

Administration would not qualify. Similarly, 

unique application parts or components not 

integral to the aircraft would also not qualify. 

* * * * * 

Dated: August 4, 2008. 

John C. Rood, 

Acting Under Secretary for Arms Control and 

International Security, Department of State. 

[FR Doc. E8–18844 Filed 8–13–08; 8:45 am] 

BILLING CODE 4710–25–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Parts 1 and 602 

[TD 9422] 

RIN 1545–BE95 

S Corporation Guidance Under AJCA 

of 2004 and GOZA of 2005 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations that provide guidance 

regarding certain changes made to the 

rules governing S corporations under 

the American Jobs Creation Act of 2004 

and the Gulf Opportunity Zone Act of 

2005. The final regulations replace 

obsolete references in the current 

regulations and allow taxpayers to make 

proper use of the provisions that made 

changes to prior law. The final 

regulations include guidance on the S 

corporation family shareholder rules, 

the definitions of ‘‘powers of 

appointment’’ and ‘‘potential current 

beneficiaries’’ (PCBs) with regard to 

electing small business trusts (ESBTs), 

the allowance of suspended losses to the 

spouse or former spouse of an S 

corporation shareholder, and relief for 

inadvertently terminated or invalid 

qualified subchapter S subsidiary 

(QSub) elections. The final regulations 

affect S corporations and their 

shareholders. 

DATES: Effective Date: These regulations 

are effective on August 14, 2008. 

Applicability Dates: For dates of 

applicability, see §§ 1.1361–4(a)(9)(ii), 

1.1361–6, 1.1362–4(g) and 1.1366–5. 

FOR FURTHER INFORMATION CONTACT: 

Charles J. Langley, Jr., (202) 622–3060 

(not a toll-free number). 

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collection of information 

contained in these final regulations has 

been reviewed and approved by the 

Office of Management and Budget for 

review in accordance with the 

Paperwork Reduction Act of 1995 (44 

U.S.C. 3507(d)) under control number 

1545–2114. 

The collection of information is 

required by § 1.1361–1(m)(2)(ii)(A) of 

these final regulations. This information 

is required to enable the IRS to verify 

whether the corporation is an eligible S 

corporation. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number. 

Books or records relating to a 

collection of information must be 

retained as long as their contents might 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

This document contains amendments 

to the Income Tax Regulations (26 CFR 

part 1) concerning S corporations under 

sections 1361, 1362, and 1366 of the 

Internal Revenue Code (Code). These 


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Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 47527 

sections were amended by sections 231, 

232, 233, 234, 235, 236, 237, 238, and 

239 of the American Jobs Creation Act 

of 2004 (Pub. L. 108–357, 118 Stat. 

1418) (the 2004 Act) and sections 403 

and 413 of the Gulf Opportunity Zone 

Act of 2005 (Pub. L. 109–135) (the 2005 

Act). This document does not address 

other amendments made by the 2004 

Act or the 2005 Act. In addition, this 

document contains additional 

amendments to the regulations under 

Code section 1362 necessary to conform 

the regulations to the changes made by 

section 1305(a) of the Small Business 

Job Protection Act of 1996 (Pub. L. 104–

188, 110 Stat. 1755) (the 1996 Act). 

On September 28, 2007, a notice of 

proposed rulemaking and a notice of 

public hearing (REG–143326–05) were 

published in the Federal Register (72 

FR 55132). 

No one requested to speak at the 

public hearing. Accordingly, the public 

hearing scheduled for January 16, 2008, 

was cancelled in a notice published in 

the Federal Register (73 FR 1131) on 

January 7, 2008. No one submitted 

written or electronic comments, which 

were due by December 27, 2007. Thus, 

the proposed regulations are adopted as 

revised by this Treasury decision, which 

make only administrative or ministerial 

changes to the proposed regulations. 

The proposed regulations conformed 

references in the regulations to the 

specific numbers of S corporation 

shareholders permissible under section 

1361. For purposes of determining the 

number of shareholders of an S 

corporation under Code section 

1361(b)(1)(A), the proposed regulations 

provided rules relating to stock owned 

by family members. 

Pursuant to section 1361(c)(2)(A)(vi), 

the proposed regulations provided rules 

regarding limited instances in which 

individual retirement accounts 

(including Roth IRAs), qualify as 

eligible shareholders of banks or 

depository institution holding 

companies. 

The proposed regulations provided 

that a disposition of the S corporation 

stock by a QSST shall be treated as a 

disposition by the income beneficiary 

for purposes of applying sections 465 

and 469 to the income beneficiary of a 

QSST. 

The proposed regulations described 

information that is required to be 

included in the ESBT election statement 

if the trust includes a power of 

appointment or other power to make 

distributions to certain organizations. 

The proposed regulations provided 

rules under which a person that may 

receive a distribution under a power of 

appointment will not be treated as a 

PCB. Also, the proposed regulations 

provided rules under which a class of 

organizations described in section 

1361(c)(6) will be treated as one PCB if 

the fiduciary has a power (other than a 

power of appointment) to make 

distributions to one or more members of 

the class. Also, the proposed regulations 

provided rules that any person who first 

met the definition of a PCB one year 

before the disposition by an ESBT of all 

of the stock of the S corporation will not 

be treated as a PCB or a shareholder of 

the S corporation. 

The proposed regulations provided 

that the Commissioner may provide 

relief for inadvertent invalid elections to 

be an S corporation or QSub or for 

inadvertent terminations of valid 

elections to be an S corporation or QSub 

and described the requirements to 

obtain that relief. 

Finally, with regard to a transfer of 

stock under Code section 1041(a), 

between spouses or incident to a 

divorce, the proposed regulations 

provided for the treatment of losses or 

deductions with respect to the 

transferred shares that are subject to the 

basis limitation under Code section 

1366(d)(1). 

Summary of Comments and 

Explanation of Revisions 

No comments were received. All 

revisions are administrative or 

ministerial and substantively conform to 

the proposed regulations. 

Effect on Other Documents 

The following publication is 

obsoleted as of August 14, 2008: 

Notice 2005–91 (2005–2 CB 1164). 

Effective Applicability Date 

These regulations are effective on 

August 14, 2008. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

has also been determined that section 

553(b) of the Administrative Procedure 

Act (5 U.S.C. chapter 5) does not apply 

to these regulations. Further, it has been 

determined that these regulations are 

not subject to the Regulatory Flexibility 

Act (5 U.S.C. chapter 6) because the 

collection of information required by 

these regulations is imposed on electing 

small business trusts and such entities 

are not ‘‘small entities’’ for purposes of 

the Regulatory Flexibility Act (5 U.S.C. 

chapter 6). Additionally, the 

information collection burden imposed 

on the electing small business trusts is 

minimal. Pursuant to section 7805(f) of 

the Internal Revenue Code, the notice of 

proposed rule making preceding this 

regulation was submitted to the Chief 

Counsel for Advocacy of the Small 

Business Administration for comment 

on its impact on small business. 

Drafting Information 

The principal author of these 

proposed regulations is Charles J. 

Langley, Jr. of the Office of Associate 

Chief Counsel (Passthroughs and 

Special Industries). 

List of Subjects 

26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

26 CFR Part 602 

Reporting and recordkeeping 

requirements. 

Adoption of Amendments to the 

Regulations 

■ Accordingly, 26 CFR parts 1 and 602 

are amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

■ Par. 2. Section 1.1361–0 is amended 

by adding a new entry in the table of 

contents for § 1.1361–1(e)(3) to read as 

follows: 

§ 1.1361–0 Table of contents. 

* * * * * 

§ 1.1361–1 S Corporation defined. 

* * * * * 

(e) * * * 

(3) Special rules relating to stock 

owned by members of a family. 

* * * * * 

■ Par. 3. Section 1.1361–1 is amended 

by: 

■ 1. Revising paragraphs (b)(1)(i) and 

(e)(1). 

■ 2. Adding paragraphs (e)(3), 

(h)(1)(vii), and (h)(3)(i)(G). 

■ 3. Adding a new sentence to the end 

of paragraphs (j)(8) and (k)(2)(i). 

■ 4. Revising paragraphs (m)(2)(ii)(A), 

(m)(4)(iii), and (m)(4)(vi). 

■ 5. Revising paragraphs (m)(8), 

Example 2 and Example 7. 

■ 6. Revising the seventh sentence of 

paragraph (m)(8), Example 5. 

■ 7. Adding paragraphs (m)(8), Example 

8 and Example 9. 

■ 8. Adding a sentence to the end of 

paragraph (m)(9). 

The revisions and additions read as 

follows: 


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47528 Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 

§ 1.1361–1 S Corporation defined. 

* * * * * 

(b) * * * 

(1) * * * 

(i) More than the number of 

shareholders provided in section 

1361(b)(1)(A); 

* * * * * 

(e) Number of shareholders—(1) 

General rule. A corporation does not 

qualify as a small business corporation 

if it has more than the number of 

shareholders provided in section 

1361(b)(1)(A). Ordinarily, the person 

who would have to include in gross 

income dividends distributed with 

respect to the stock of the corporation (if 

the corporation were a C corporation) is 

considered to be the shareholder of the 

corporation. For example, if stock 

(owned other than by a husband and 

wife or members of a family described 

in section 1361(c)(1)) is owned by 

tenants in common or joint tenants, 

each tenant in common or joint tenant 

is generally considered to be a 

shareholder of the corporation. (For 

special rules relating to stock owned by 

husband and wife or members of a 

family, see paragraphs (e)(2) and (3) of 

this section, respectively; for special 

rules relating to restricted stock, see 

paragraphs (b)(3) and (6) of this section.) 

The person for whom stock of a 

corporation is held by a nominee, 

guardian, custodian, or an agent is 

considered to be the shareholder of the 

corporation for purposes of this 

paragraph (e) and paragraphs (f) and (g) 

of this section. For example, a 

partnership may be a nominee of S 

corporation stock for a person who 

qualifies as a shareholder of an S 

corporation. However, if the partnership 

is the beneficial owner of the stock, then 

the partnership is the shareholder, and 

the corporation does not qualify as a 

small business corporation. In addition, 

in the case of stock held for a minor 

under a uniform transfers to minors act 

or similar statute, the minor and not the 

custodian is the shareholder. Except as 

otherwise provided in paragraphs (h) 

and (j) of this section, and for purposes 

of this paragraph (e) and paragraphs (f) 

and (g) of this section, if stock is held 

by a decedent’s estate or a trust 

described in section 1361(c)(2)(A)(ii) or 

(iii), the estate or trust (and not the 

beneficiaries of the estate or trust) is 

considered to be the shareholder; 

however, if stock is held by a subpart E 

trust (which includes a voting trust) or 

an electing QSST described in section 

1361(d)(1), the deemed owner of the 

trust is considered to be the 

shareholder. If stock is held by an ESBT 

described in section 1361(c)(2)(A)(v), 

each potential current beneficiary of the 

trust shall be treated as a shareholder, 

except that the trust shall be treated as 

the shareholder during any period in 

which there is no potential current 

beneficiary of the trust. If stock is held 

by a trust described in section 

1361(c)(2)(A)(vi), the individual for 

whose benefit the trust was created shall 

be treated as the shareholder. See 

paragraph (h) of this section for special 

rules relating to trusts. 

* * * * * 

(3) Special rules relating to stock 

owned by members of a family—(i) In 

general. For purposes of paragraph (e)(1) 

of this section, stock owned by members 

of a family is treated as owned by one 

shareholder. Members of a family 

include a common ancestor, any lineal 

descendant of the common ancestor 

(without any generational limit), and 

any spouse (or former spouse) of the 

common ancestor or of any lineal 

descendants of the common ancestor. 

An individual shall not be considered to 

be a common ancestor if, on the 

applicable date, the individual is more 

than six generations removed from the 

youngest generation of shareholders 

who would be members of the family 

determined by deeming that individual 

as the common ancestor. For purposes 

of this six-generation test, a spouse (or 

former spouse) is treated as being of the 

same generation as the individual to 

whom the spouse is or was married. 

This test is applied on the latest of the 

date the election under section 1362(a) 

is made for the corporation, the earliest 

date that a member of the family 

(determined by deeming that individual 

as the common ancestor) holds stock in 

the corporation, or October 22, 2004. 

For this purpose, the date the election 

under section 1362(a) is made for the 

corporation is the effective date of the 

election, not the date it is signed or 

received by any person. The test is only 

applied as of the applicable date, and 

lineal descendants (and spouses) more 

than six generations removed from the 

common ancestor will be treated as 

members of the family even if they 

acquire stock in the corporation after 

that date. The members of a family are 

treated as one shareholder under this 

paragraph (e)(3) solely for purposes of 

section 1361(b)(1)(A), and not for any 

other purpose, whether under section 

1361 or any other provision. 

Specifically, each member of the family 

who owns or is deemed to own stock 

must meet the requirements of sections 

1361(b)(1)(B) and (C) (regarding 

permissible shareholders) and section 

1362(a)(2) (regarding shareholder 

consents to an S corporation election). 

Although a person may be a member of 

more than one family under this 

paragraph (e)(3), each family (not all of 

whose members are also members of the 

other family) will be treated as one 

shareholder. For purposes of this 

paragraph (e)(3), any legally adopted 

child of an individual, any child who is 

lawfully placed with an individual for 

legal adoption by that individual, and 

any eligible foster child of an individual 

(within the meaning of section 

152(f)(1)(C)), shall be treated as a child 

of such individual by blood. 

(ii) Certain entities treated as 

members of a family. For purposes of 

this paragraph (e)(3), the estate or trust 

(described in section 1361(c)(2)(A)(ii) or 

(iii)) of a deceased member of the family 

will be considered to be a member of the 

family during the period in which the 

estate or such trust (if the trust is 

described in section 1361(c)(2)(A)(ii) or 

(iii)), holds stock in the S corporation. 

The members of the family also will 

include—

(A) In the case of an ESBT, each 

potential current beneficiary who is a 

member of the family; 

(B) In the case of a QSST, the income 

beneficiary who makes the QSST 

election, if that income beneficiary is a 

member of the family; 

(C) In the case of a trust created 

primarily to exercise the voting power 

of stock transferred to it, each 

beneficiary who is a member of the 

family; 

(D) The individual for whose benefit 

a trust described in section 

1361(c)(2)(A)(vi) was created, if that 

individual is a member of the family; 

(E) The deemed owner of a trust 

described in section 1361(c)(2)(A)(i) if 

that deemed owner is a member of the 

family; and 

(F) The owner of an entity disregarded 

as an entity separate from its owner 

under § 301.7701–3 of this chapter, if 

that owner is a member of the family. 

* * * * * 

(h) * * * 

(1) * * * 

(vii) Individual retirement accounts. 

In the case of a corporation which is a 

bank (as defined in section 581) or a 

depository institution holding company 

(as defined in section 3(w)(1) of the 

Federal Deposit Insurance Act (12 

U.S.C. 1813(w)(1)), a trust which 

constitutes an individual retirement 

account under section 408(a), including 

one designated as a Roth IRA under 

section 408A, but only to the extent of 

the stock held by such trust in such 

bank or company as of October 22, 2004. 

Individual retirement accounts 


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Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 47529 

(including Roth IRAs) are not otherwise 

eligible S corporation shareholders. 

* * * * * 

(3) * * * 

(i) * * * 

(G) If stock in an S corporation bank 

or depository institution holding 

company is held by an individual 

retirement account (including a Roth 

IRA) described in paragraph (h)(1)(vii) 

of this section, the individual for whose 

benefit the trust was created shall be 

treated as the shareholder. 

* * * * * 

(j) * * * 

(8) * * * However, solely for 

purposes of applying sections 465 and 

469 to the income beneficiary, a 

disposition of S corporation stock by a 

QSST shall be treated as a disposition 

by the income beneficiary. 

* * * * * 

(k) * * * 

(2) * * * 

(i) * * * Paragraphs (b)(1)(i), (e)(1), 

(e)(3), (h)(1)(vii), (h)(3)(i)(G), and the 

fifth sentence of paragraph (j)(8) are 

effective on August 14, 2008. 

* * * * * 

(m) * * * 

(2) * * * 

(ii) * * * 

(A) The name, address, and taxpayer 

identification number of the trust, the 

potential current beneficiaries, and the 

S corporations in which the trust 

currently holds stock. If the trust 

includes a power described in 

paragraph (m)(4)(vi)(B) of this section, 

then the election statement must 

include a statement that such a power 

is included in the instrument, but does 

not need to include the name, address, 

or taxpayer identification number of any 

particular charity or any other 

information regarding the power. 

* * * * * 

(4) * * * 

(iii) Special rule for dispositions of 

stock. Notwithstanding the provisions of 

paragraph (m)(4)(i) of this section, if a 

trust disposes of all of the stock which 

it holds in an S corporation, then, with 

respect to that corporation, any person 

who first met the definition of a 

potential current beneficiary during the 

1-year period ending on the date of such 

disposition is not a potential current 

beneficiary and thus is not a 

shareholder of that corporation. 

* * * * * 

(vi) Currently exercisable powers of 

appointment and other powers—(A) 

Powers of appointment. A person to 

whom a distribution may be made 

during any period pursuant to a power 

of appointment (as described for transfer 

tax purposes in section 2041 and 

§ 20.2041–1(b) of this chapter and 

section 2514 and § 25.2514–1(b) of this 

chapter) is not a potential current 

beneficiary unless the power is 

exercised in favor of that person during 

the period. It is immaterial for purposes 

of this paragraph (m)(4)(vi)(A) whether 

such power of appointment is a ‘‘general 

power of appointment’’ for transfer tax 

purposes as described in §§ 20.2041–

1(c) and 25.2514–1(c) of this chapter. 

The mere existence of one or more 

powers of appointment during the 

lifetime of a power holder that would 

permit current distributions from the 

trust to be made to more than the 

number of persons described in section 

1361(b)(1)(A) or to a person described in 

section 1361(b)(1)(B) or (C) will not 

cause the S corporation election to 

terminate unless one or more of such 

powers are exercised, collectively, in 

favor of an excessive number of persons 

or in favor of a person who is ineligible 

to be an S corporation shareholder. For 

purposes of this paragraph (m)(4)(vi)(A), 

a ‘‘power of appointment’’ includes a 

power, regardless of by whom held, to 

add a beneficiary or class of 

beneficiaries to the class of potential 

current beneficiaries, but generally does 

not include a power held by a fiduciary 

who is not also a beneficiary of the trust 

to spray or sprinkle trust distributions 

among beneficiaries. Nothing in this 

paragraph (m)(4)(vi)(A) alters the 

definition of ‘‘power of appointment’’

for purposes of any provision of the 

Internal Revenue Code or the 

regulations. 

(B) Powers to distribute to certain 

organizations not pursuant to powers of 

appointment. If a trustee or other 

fiduciary has a power (that does not 

constitute a power of appointment for 

transfer tax purposes as described in 

§§ 20.2041–1(b) and 25.2514–1(b) of this 

chapter) to make distributions from the 

trust to one or more members of a class 

of organizations described in section 

1361(c)(6), such organizations will be 

counted collectively as only one 

potential current beneficiary for 

purposes of this paragraph (m), except 

that each organization receiving a 

distribution also will be counted as a 

potential current beneficiary. This 

paragraph (m)(4)(vi)(B) shall not apply 

to a power to currently distribute to one 

or more particular charitable 

organizations described in section 

1361(c)(6). Each of such organizations is 

a potential current beneficiary of the 

trust. 

* * * * * 

(8) * * * 

Example 2. (i) Invalid potential current 

beneficiary. Effective January 1, 2005, Trust 

makes a valid ESBT election. On January 1, 

2006, A, a nonresident alien, becomes a 

potential current beneficiary of Trust. Trust 

does not dispose of all of its S corporation 

stock within one year after January 1, 2006. 

As of January 1, 2006, A is the potential 

current beneficiary of Trust and therefore is 

treated as a shareholder of the S corporation. 

Because A is not an eligible shareholder of 

an S corporation under section 1361(b)(1), 

the S corporation election of any corporation 

in which Trust holds stock terminates 

effective January 1, 2006. Relief may be 

available under section 1362(f). 

(ii) Invalid potential current beneficiary 

and disposition of S stock. Assume the same 

facts as in Example 2 (i) except that within 

one year after January 1, 2006, trustee of 

Trust disposes of all Trust’s S corporation 

stock. A is not considered a potential current 

beneficiary of Trust and therefore is not 

treated as a shareholder of any S corporation 

in which Trust previously held stock. 

* * * * * 

Example 5. * * * Trust-2 itself will not be 

counted toward the shareholder limit of 

section 1361(b)(1)(A). * * * 

* * * * * 

Example 7. Potential current beneficiaries 

and powers of appointment. M creates Trust 

from which A has a right to all net income 

and funds it with S corporation stock. A also 

has a currently exercisable power to appoint 

income or principal to anyone except A, A’s 

creditors, A’s estate, and the creditors of A’s 

estate. The potential current beneficiaries of 

Trust for any period will be A and each 

person who receives a distribution from 

Trust pursuant to A’s exercise of A’s power 

of appointment during that period. 

Example 8. Power to distribute to an 

unlimited class of charitable organizations 

not pursuant to a power of appointment. M 

creates Trust from which A has a right to all 

net income and funds it with S corporation 

stock. In addition, the trustee of Trust, who 

is not A or a descendant of M, has the power 

to make discretionary distributions of 

principal to the living descendants of M and 

to any organizations described in section 

1361(c)(6). The potential current 

beneficiaries of Trust for any period will be 

A, each then-living descendant of M, and 

each exempt organization described in 

section 1361(c)(6) that receives a distribution 

during that period. In addition, the class of 

exempt organizations will be counted as one 

potential current beneficiary. 

Example 9. Power to distribute to a class 

of named charitable organizations not 

pursuant to a power of appointment. M 

creates Trust from which A has a right to all 

net income and funds it with S corporation 

stock. In addition, the trustee of Trust, who 

is not A or a descendant of M, has the power 

to make discretionary distributions of 

principal to the living descendants of M and 

to X, Y, and Z, each of which is an 

organization described in section 1361(c)(6). 

The potential current beneficiaries of Trust 

for any period will be A, X, Y, Z, and each 

living descendant of M. 

(9) Effective/applicability date. * * * 

Paragraphs (m)(2)(ii)(A), (m)(4)(iii) and 


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47530 Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 

(vi), and (m)(8), Example 2, Example 5, 

Example 7, Example 8, and Example 9 

of this section are effective on August 

14, 2008. 

■ Par. 4. Section 1.1361–4 is amended 

by revising paragraph (a)(1) and adding 

new paragraph (a)(9) to read as follows: 

§ 1.1361–4 Effect of QSub election. 

(a) Separate existence ignored—(1) In 

general. Except as otherwise provided 

in paragraphs (a)(3), (a)(6), (a)(7), (a)(8), 

and (a)(9) of this section, for Federal tax 

purposes—

(i) A corporation that is a QSub shall 

not be treated as a separate corporation; 

and 

(ii) All assets, liabilities, and items of 

income, deduction, and credit of a QSub 

shall be treated as assets, liabilities, and 

items of income, deduction, and credit 

of the S corporation. 

* * * * * 

(9) Information returns—(i) In general. 

Except to the extent provided by the 

Secretary or Commissioner in guidance 

(including forms or instructions), 

paragraph (a)(1) of this section shall not 

apply to part III of subchapter A of 

chapter 61, relating to information 

returns. 

(ii) Effective/applicability date. This 

paragraph (a)(9) is effective on August 

14, 2008. 

* * * * * 

■ Par. 5. Section 1.1361–6 is amended 

by revising the first sentence to read as 

follows: 

§ 1.1361–6 Effective date. 

Except as provided in §§ 1.1361–

4(a)(3)(iii), 1.1361–4(a)(5)(i), 1.1361–

4(a)(6)(iii), 1.1361–4(a)(7)(ii), 1.1361–

4(a)(8)(ii), 1.1361–4(a)(9), and 1.1361–

5(c)(2), the provisions of §§ 1.1361–2 

through 1.1361–5 apply to taxable years 

beginning on or after January 20, 2000; 

however, taxpayers may elect to apply 

the regulations in whole, but not in part 

(aside from those sections with special 

dates of applicability), for taxable years 

beginning on or after January 1, 2000, 

provided all affected taxpayers apply 

the regulations in a consistent manner. 

* * * 

■ Par. 6. Section 1.1362–0 is amended 

by revising the heading of the table of 

contents for § 1.1362–4 and adding a 

new entry in the table of contents for 

§ 1.1362–4(g) to read as follows: 

§ 1.1362–0 Table of contents. 

* * * * * 

§ 1.1362–4 Inadvertent terminations and 

inadvertently invalid elections. 

* * * * * 

(g) Effective/applicability date. 

* * * * * 

■ Par. 7. Section 1.1362–4 is amended 

by: 

■ 1. Revising the section heading and 

paragraphs (a), (b), (c), (d), and (f). 

■ 2. Adding paragraph (g). 

The addition and revisions read as 

follows: 

§ 1.1362–4 Inadvertent terminations and 

inadvertently invalid elections. 

(a) In general. A corporation is treated 

as continuing to be an S corporation or 

a QSub (or, an invalid election to be 

either an S corporation or a QSub is 

treated as valid) during the period 

specified by the Commissioner if—

(1) The corporation made a valid 

election under section 1362(a) or section 

1361(b)(3) and the election terminated 

or the corporation made an election 

under section 1362(a) or section 

1361(b)(3) that was invalid; 

(2) The Commissioner determines that 

the termination or invalidity was 

inadvertent; 

(3) Within a reasonable period of time 

after discovery of the terminating event 

or invalid election, steps were taken so 

that the corporation for which the 

election was made or the termination 

occurred is a small business corporation 

or a QSub, as the case may be, or to 

acquire the required shareholder 

consents; and 

(4) The corporation and shareholders 

agree to adjustments that the 

Commissioner may require for the 

period. 

(b) Inadvertent termination or 

inadvertently invalid election. For 

purposes of paragraph (a) of this section, 

the determination of whether a 

termination or invalid election was 

inadvertent is made by the 

Commissioner. The corporation has the 

burden of establishing that under the 

relevant facts and circumstances the 

Commissioner should determine that 

the termination or invalid election was 

inadvertent. The fact that the 

terminating event or invalidity of the 

election was not reasonably within the 

control of the corporation and, in the 

case of a termination, was not part of a 

plan to terminate the election, or the 

fact that the terminating event or 

circumstance took place without the 

knowledge of the corporation, 

notwithstanding its due diligence to 

safeguard itself against such an event or 

circumstance, tends to establish that the 

termination or invalidity of the election 

was inadvertent. 

(c) Corporation’s request for 

determination of an inadvertent 

termination or invalid election. A 

corporation that believes that the 

termination or invalidity of its election 

was inadvertent may request a 

determination from the Commissioner 

that the termination or invalidity of its 

election was inadvertent. The request is 

made in the form of a ruling request and 

should set forth all relevant facts 

pertaining to the event or circumstance 

including, but not limited to, the facts 

described in paragraph (b) of this 

section, the date of the corporation’s 

election (or intended election) under 

section 1362(a) or 1361(b)(3), a detailed 

explanation of the event or 

circumstance causing the termination or 

invalidity, when and how the event or 

circumstance was discovered, and the 

steps taken under paragraph (a)(3) of 

this section. 

(d) Adjustments. The Commissioner 

may require any adjustments that are 

appropriate. In general, the adjustments 

required should be consistent with the 

treatment of the corporation as an S 

corporation or QSub during the period 

specified by the Commissioner. In the 

case of stock held by an ineligible 

shareholder that causes an inadvertent 

termination or invalid election for an S 

corporation under section 1362(f), the 

Commissioner may require the 

ineligible shareholder to be treated as a 

shareholder of the S corporation during 

the period the ineligible shareholder 

actually held stock in the corporation. 

Moreover, the Commissioner may 

require protective adjustments that 

prevent the loss of any revenue due to 

the holding of stock by an ineligible 

shareholder (for example, a nonresident 

alien). 

* * * * * 

(f) Status of corporation. The status of 

the corporation after the terminating 

event or invalid election and before the 

determination of inadvertence is 

determined by the Commissioner. 

Inadvertent termination or inadvertent 

invalid election relief may be granted 

retroactively for all years for which the 

terminating event or circumstance 

giving rise to invalidity is effective, in 

which case the corporation is treated as 

if its election was valid or had not 

terminated. Alternatively, relief may be 

granted only for the period in which the 

corporation became eligible for 

subchapter S or QSub treatment, in 

which case the corporation is treated as 

a C corporation or, in the case of a QSub 

with an inadvertently terminated or 

invalid election, as a separate C 

corporation, during the period for which 

the corporation was not eligible for its 

intended status. 

(g) Effective/applicability date. 

Paragraphs (a), (b), (c), (d), and (f) of this 

section are effective on August 14, 2008. 

■ Par. 8. Section 1.1366–0 is amended 

by adding new entries in the table of 


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Federal Register / Vol. 73, No. 158 / Thursday, August 14, 2008 / Rules and Regulations 47531 

contents for § 1.1366–2(a)(5)(i), (a)(5)(ii) 

and (a)(5)(iii) to read as follows: 

§ 1.1366–0 Table of contents. 

* * * * * 

§ 1.1366–2 Limitations on deduction of 

passthrough items of an S corporation to 

its shareholders. 

(a) * * * 

(5) * * * 

(i) In general. 

(ii) Exceptions for transfers of stock 

under section 1041(a). 

(iii) Examples. 

■ Par. 9. Section 1.1366–2(a)(5) is 

amended by: 

■ 1. Redesignating paragraph (a)(5) as 

(a)(5)(i). 

■ 2. Adding a heading and revising the 

first sentence of paragraph (a)(5)(i). 

■ 3. Adding paragraphs (a)(5)(ii) and 

(a)(5)(iii). 

The revisions and additions read as 

follows: 

§ 1.1366–2 Limitations on deduction of 

passthrough items of an S corporation to 

its shareholders. 

(a) In general. * * * 

(5) Nontransferability of losses and 

deductions—(i) In general. Except as 

provided in paragraph (a)(5)(ii) of this 

section, any loss or deduction 

disallowed under paragraph (a)(1) of 

this section is personal to the 

shareholder and cannot in any manner 

be transferred to another person. * * * 

(ii) Exceptions for transfers of stock 

under section 1041(a). If a shareholder 

transfers stock of an S corporation after 

December 31, 2004, in a transfer 

described in section 1041(a), any loss or 

deduction with respect to the 

transferred stock that is disallowed to 

the transferring shareholder under 

paragraph (a)(1) of this section shall be 

treated as incurred by the corporation in 

the following taxable year with respect 

to the transferee spouse or former 

spouse. The amount of any loss or 

deduction with respect to the stock 

transferred shall be determined by 

prorating any losses or deductions 

disallowed under paragraph (a)(1) of 

this section for the year of the transfer 

between the transferor and the spouse or 

former spouse based on the stock 

ownership at the beginning of the 

following taxable year. If a transferor 

claims a deduction for losses in the 

taxable year of transfer, then under 

paragraph (a)(4) of this section, if the 

transferor’s pro rata share of the losses 

and deductions in the year of transfer 

exceeds the transferor’s basis in stock 

and the indebtedness of the corporation 

to the transferor, then the limitation 

must be allocated among the transferor 

spouse’s pro rata share of each loss or 

deduction, including disallowed losses 

and deductions carried over from the 

prior year. 

(iii) Examples. The following 

examples illustrates the provisions of 

paragraph (a)(5)(ii) of this section: 

Example 1. A owns all 100 shares in X, a 

calendar year S corporation. For X’s taxable 

year ending December 31, 2006, A has zero 

basis in the shares and X does not have any 

indebtedness to A. For the 2006 taxable year, 

X had $100 in losses that A cannot use 

because of the basis limitation in section 

1366(d)(1) and that are treated as incurred by 

the corporation with respect to A in the 

following taxable year. Halfway through the 

2007 taxable year, A transfers 50 shares to B, 

A’s former spouse in a transfer to which 

section 1041(a) applies. In the 2007 taxable 

year, X has $80 in losses. On A’s 2007 

individual income tax return, A may use the 

entire $100 carryover loss from 2006, as well 

as A’s share of the $80 2007 loss determined 

under section 1377(a) ($60), assuming A 

acquires sufficient basis in the X stock. On 

B’s 2007 individual income tax return, B may 

use B’s share of the $80 2007 loss determined 

under section 1377(a) ($20), assuming B has 

sufficient basis in the X stock. If any 

disallowed 2006 loss is disallowed to A 

under section 1366(d)(1) in 2007, that loss is 

prorated between A and B based on their 

stock ownership at the beginning of 2008. On 

B’s 2008 individual income tax return, B may 

use that loss, assuming B acquires sufficient 

basis in the X stock. If neither A nor B 

acquires any basis during the 2007 taxable 

year, then as of the beginning of 2008, the 

corporation will be treated as incurring $50 

of loss with respect to A and $50 of loss with 

respect to B for the $100 of disallowed 2006 

loss, and the corporation will be treated as 

incurring $60 of loss with respect to A and 

$20 with respect to B for the $80 of 

disallowed 2007 loss. 

Example 2. Assume the same facts as 

Example 1, except that during the 2007 

taxable year, A acquires $10 of basis in A’s 

shares in X. For the 2007 taxable year, A may 

claim a $10 loss deduction, which represents 

$6.25 of the disallowed 2006 loss of $100 and 

$3.75 of A’s 2007 loss of $60. The disallowed 

2006 loss is reduced to $93.75. As of the 

beginning of 2008, the corporation will be 

treated as incurring half of the remaining 

$93.75 of loss with respect to A and half of 

that loss with respect to B for the remaining 

$93.75 of disallowed 2006 loss, and if B does 

not acquire any basis during 2007, the 

corporation will be treated as incurring 

$56.25 of loss with respect to A and $20 with 

respect to B for the remaining disallowed 

2007 loss. 

* * * * * 

■ Par. 10. Section 1.1366–5 is amended 

by adding a new sentence at the end to 

read as follows: 

§ 1.1366–5 Effective/applicability date. 

* * * Sections 1.1366–2(a)(5)(i), (ii) 

and (iii) are effective on August 14, 

2008. 

PART 602—OMB CONTROL NUMBERS 

UNDER THE PAPERWORK 

REDUCTION ACT 

■ Par. 11. The authority citation for part 

602 continues to read as follows: 

Authority: 26 U.S.C. 7805. 

■ Par. 12. Section 602.101, paragraph 

(b) is amended by adding the entry in 

numerical order to the table to read as 

follows: 

§ 602.101 OMB Control numbers. 

* * * * * 

(b) * * * 

CFR part or section where 

identified and described 

Current OMB 

control No. 

* * * * * 

1.1361–1 ............................... 1545–2114 

* * * * * 

Sherri L. Brown, 

Acting Deputy Commissioner for Services and 

Enforcement. 

Approved: August 5, 2008. 

Eric Solomon, 

Assistant Secretary of the Treasury (Tax 

Policy). 

[FR Doc. E8–18782 Filed 8–13–08; 8:45 am] 

BILLING CODE 4830–01–P 

DEPARTMENT OF HOMELAND 

SECURITY 

Coast Guard 

33 CFR Part 100 

[Docket No. USCG–2008–0789] 

RIN 1625–AA08 

Special Local Regulation; Cape Fear 

Dragon Boat Festival, Wilmington, NC 

AGENCY: Coast Guard, DHS. 

ACTION: Temporary final rule. 

SUMMARY: The Cape Fear Dragon Boat 

Festival will take place on the Cape Fear 

River in Wilmington, North Carolina on 

September 27, 2008. This event will 

consist of four 45 foot long Dragon boats 

racing a 250 meter course. 

DATES: This rule is effective from 8 a.m. 

to 6 p.m. on September 27, 2008. 

ADDRESSES: Documents indicated in this 

preamble as being available in the 

docket are part of docket USCG–2008–

0789 and are available online at 

www.regulations.gov. They are also 

available for inspection or copying at 

two locations: the Docket Management 

Facility (M–30), U.S. Department of 


rfrederick on PROD1PC67 with RULES