Source: https://www.federalregister.gov/articles/2014/07/23/2014-17336/basis-of-indebtedness-of-s-corporations-to-their-shareholders
Timestamp: 2015-11-30 13:24:55
Document Index: 422134512

Matched Legal Cases: ['art 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', 'art 1']

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Shorter URL: https://federalregister.gov/a/2014-17336 Related Topics
S Corporation Back-to-Back Loans 3 actions from June 12th, 2012 to December 2014
The final regulations contain amendments to the Income Tax Regulations (26 CFR part 1) under section 1366 of the Internal Revenue Code (Code). On June 12, 2012, the Treasury Department and the IRS published in the Federal Register (77 FR 34884) a notice of proposed rulemaking (REG-134042-07) (the proposed regulations) relating to when shareholders have basis in indebtedness that the S corporation owes to the shareholder (basis of indebtedness). The proposed regulations provide that basis of indebtedness of the S corporation to the shareholder means the shareholder's adjusted basis in any bona fide indebtedness of the S corporation that runs directly to the shareholder. No requests to speak at the scheduled public hearing were received and the hearing was canceled. Comments responding to the notice of proposed rulemaking were received. After consideration of all the comments, the proposed regulations are adopted without substantive change by this Treasury decision, except for changes to the effective/applicability date of the regulations and minor clarifying revisions. The comments, which are available at www.regulations.gov or upon request, are discussed in this preamble.
One commentator requested a change to the fact pattern presented in proposed regulations § 1.1366-2(a)(2)(iii), Example 4. In Example 4, a loan that originally was made by S1 to S2, two related S corporations wholly-owned by the same shareholder, is restructured to be a loan from the shareholder. The restructuring involved S1 distributing the debt to the shareholder and S2 being relieved of its liability to S1 so that S2 is only liable to the shareholder on the debt. The commentator recommended that Example 4 not require that S2 be relieved of its liability to S1. As stated in the proposed regulations and finalized in these regulations, whether indebtedness is bona fide indebtedness to a shareholder is determined under general Federal tax principles and depends upon all of the facts and circumstances. Whether S2 is relieved of the original liability is an appropriate fact to consider in determining whether the transaction is a restructuring of a debt that results in a bona fide debt that runs directly from S2 to the shareholder. See, for example, Rev. Rul. 75-144 (1975-1 CB 277) (holding that a shareholder increases the shareholder's basis of indebtedness when the shareholder, who had guaranteed a liability of his S corporation, executed his own promissory note in full satisfaction of the S corporation's note to the bank, the bank relieved the S corporation of its liability, and the S corporation became obligated to the shareholder under the doctrine of subrogation). See also Gilday v. Commissioner, T.C. Memo. 1982-242 (holding that shareholders increased their bases of indebtedness when the shareholders gave a bank their notes, the bank canceled the S corporation's note to the bank, and the facts indicated that the S corporation became indebted to the shareholders, regardless of whether subrogation occurred under state law). Accordingly, this comment is not adopted.
Another commentator requested that an example be added to the regulations concerning a fact pattern in which bona fide indebtedness is present, but the shareholder has zero basis in that indebtedness. The commentator concluded that the shareholder would have zero basis of indebtedness in the shareholder's S corporation because the shareholder's basis in the debt is zero. The Treasury Department and the IRS believe that the regulations are clear that shareholders only increase their basis of indebtedness to the extent of the shareholder's adjusted basis (as defined in § 1.1011-1 and as specifically provided in section 1367(b)(2)) in that bona fide indebtedness of the S corporation that runs directly to the shareholder. If the shareholder's basis in the indebtedness is zero, then the shareholder's basis of indebtedness is increased by zero. As such, an additional example illustrating a zero basis of indebtedness has not been added to the final regulations.
The preamble to the proposed regulations requested comments regarding the basis treatment when an S corporation shareholder or a partner contributes the shareholder's or partner's own note to an S corporation or a partnership. An S corporation shareholder does not increase his basis in the stock of his S corporation under section 1366(d)(1)(A) from a contribution of his own note. See Rev. Rul. 81-187 (1981-2 CB 167) (holding that a shareholder who (i) merely executed and transferred the shareholder's demand note to the shareholder's wholly owned S corporation, and (ii) made no payment on the note until the following year had a zero basis in the note until the following year when the shareholder made a payment on the note). The preamble to the proposed regulations described as one potential model § 1.704-1(b)(2)(iv)(d)(2), which provides that a partner's capital account is increased with respect to non-readily tradable partner notes only (i) when there is a taxable disposition of such note by the partnership, or (ii) when the partner makes principal payments on such note. One commentator recommended consideration of, and consistency with, § 1.166-9(c) (regarding contributions of debt to capital). Another commentator noted that courts have applied the “actual economic outlay” standard to determine when shareholders increase their bases in their S corporation stock. See, for example, Maguire v. Commissioner, T.C. Memo. 2012-160. This commentator requested that the final regulations provide that actual economic outlay does not apply to determinations of a shareholder's stock basis under section 1366(d)(1)(A). To expedite finalization of the proposed regulations, the scope of these final regulations is limited to basis of indebtedness. The Treasury Department and the IRS continue to study issues relating to stock basis and may address these issues in future guidance.
1.Removing the language “§ 1.1366-2(a)(5)” in paragraph (d)(2)(iii) and adding “§ 1.1366-2(a)(6)” in its place. 2.Adding two sentences to the end of paragraph (f)(2). The addition reads as follows:
Par. 3. Section 1.1366-0 is amended:
1.By redesignating the entries in the table of contents for § 1.1366-2(a)(2), (a)(3), (a)(4), (a)(5), and (a)(6) as § 1.1366-2 (a)(3), (a)(4), (a)(5), (a)(6), and (a)(7), respectively, and adding new entries for § 1.1366-2 (a)(2) and (a)(2)(i) through (iii). 2.By revising the heading in the table of contents for § 1.1366-5. The additions and revisions read as follows:
1.Removing the language “(a)(3)(i)” in paragraph (a)(1)(i), and adding the language “(a)(4)(i)” in its place. 2.Removing the language “paragraph (a)(3)(ii)” in paragraph (a)(1)(ii), andadding the language “paragraphs (a)(2) and (a)(4)(ii)” in its place. 3.Redesignating paragraphs (a)(2), (a)(3), (a)(4), (a)(5), and (a)(6) asparagraphs (a)(3), (a)(4), (a)(5), (a)(6), and (a)(7) respectively, and adding a new paragraph (a)(2). 4.Removing the language “(a)(3)(i) and (ii)” in newly designated paragraph(a)(3), and adding the language “(a)(4)(i) and (ii)” in its place. 5.Removing the language “paragraphs (a)(1)(i) and (2)” in newly designatedparagraph (a)(4)(i), and adding the language “paragraphs (a)(1)(i) and (3)” in its place. 6.Removing the language “paragraphs (a)(1)(ii) and (2)” in newly designatedparagraph (a)(4)(ii), and adding the language “paragraphs (a)(1)(ii) and (3)” in its place. 7.Removing the language “(a)(3)(i)” and “(a)(3)(ii)” in newly designatedparagraph (a)(5), and adding the language “(a)(4)(i)” and “(a)(4)(ii)”, respectively, in their place. 8.Removing the language “(a)(5)(ii)” in newly designated paragraphs (a)(6)(i)and (a)(6)(iii), and adding the language “(a)(6)(ii)” in its place. 9.Removing the language “(a)(4)” in newly designated paragraph (a)(6)(ii),and adding the language “(a)(5)” in its place. 10.Removing the language “paragraphs (a)(1)(i) and (2)” in newly designatedparagraph (a)(7), and adding the language “paragraphs (a)(1)(i) and (3)” in its place. The additions read as follows:
§ 1.1366-2 Limitations on deduction of passthrough items of an S corporation toits shareholders.
(2) Basis of indebtedness—(i) In general. The term basis of any indebtedness of the S corporation to the shareholder means the shareholder's adjusted basis (as defined in § 1.1011-1 and as specifically provided in section 1367(b)(2)) in any bona fide indebtedness of the S corporation that runs directly to the shareholder. Whether indebtedness is bona fide indebtedness to a shareholder is determined under general Federal tax principles and depends upon all of the facts and circumstances.
Par. 5. Section 1.1366-5 is revised to read as follows:
§ 1.1367-1 [Amended]
Par. 6. Section 1.1367-1(h) Example 5 (iii) is amended by removing the language “§ 1.1366-2(a)(2)” in the third and fourth sentences and adding the language “§ 1.1366-2(a)(3)” in its place.
Par. 7. Section 1.1367-3 is amended by adding two sentences to the end of the paragraph to read as follows:
* * * Section 1.1367-1(h), Example 5 (iii) applies on and after July 23, 2014. The rules that apply before July 23, 2014 are contained in § 1.1367-3 in effect prior to July 23, 2014 (see 26 CFR part 1 revised as of April 1, 2014).