Tax News

CCH (cch.taxgroup.com) reports:

The IRS has issued proposed regulations that provide guidance regarding changes made to the rules governing S corporations under the American Jobs Creation Act of 2004 (P.L. 108-357) and the Gulf Opportunity Zone Act of 2005 (P.L. 109-135). Proposed amendments to the regulations were also issued to conform the regulations to changes made by the Small Business Job Protection Act of 1996 (P.L. 104-188). The proposed regulations are necessary to replace obsolete references in the current regulations and to allow taxpayers to make proper use of the provisions that made changes to prior law. In particular, the proposed regulations provide guidance on: 1) the S corporation family shareholder rules; 2) the definitions of "powers of appointment" and "potential current beneficiaries" (PCBs) with regard to electing small business trusts; (ESBTs), 3) the allowance of suspended losses to the spouse or former spouse of an S corporation shareholder; and 4) relief for inadvertently terminated or invalid qualified subchapter S subsidiary (QSub) elections.
The proposed regulations also remove or amend several references in the regulations under Code Sec. 1361 that cite a specific number of permissible S corporation shareholders and add conforming language to Reg. §1.1361-1(j)(8) regarding passive activity losses and at-risk amounts of qualified subchapter S trusts.
Family Shareholders
Code Sec. 1361(c)(1) treats a husband and wife (and their estates), and all members of a family (and their estates) as one shareholder for purposes of the 100 shareholder limitation. Notice 2005-91, 2005-2 CB 1164, informed taxpayers that the Treasury Department and the IRS intended to issue guidance regarding the family shareholder election under Code Sec. 1361(c)(1) and provided that taxpayers could rely on the provisions of Notice 2005-91 until the issuance of that guidance. Although the portions of Notice 2005-91 addressing the manner of making the family shareholder election are no longer relevant, and Notice 2005-91 will be obsoleted when these proposed regulations are adopted as final, the proposed regulations retain the provisions of Notice 2005-91 describing certain entities other than individuals that will be treated as members of the family.
The regulations also clarify that the "six generation" test is applied only at the date specified in Code Sec. 1361(c)(1)((iii) for determining whether an individual meets the definition of "common ancestor," has no continuing significance in limiting the number of generations of a family that may hold stock and be treated as a single shareholder and there is no adverse consequence to a person being a member of two families.
Disregard of Unexercised Powers of Appointment in ESBTs
Code Sec. 1361(e)(2) provides that in determining an ESBT's PCBs for any period, powers of appointment will be disregarded to the extent not exercised by the end of that period. This section also increases the period from 60 days to one year during which an ESBT may safely dispose of S corporation stock after an ineligible shareholder becomes a PCB. The proposed regulations remove and replace the sections of the regulation inconsistent with current law.
The definition of "potential current beneficiary" is amended to provide that all members of a class of unnamed charities permitted to receive distributions under a discretionary distribution power held by a fiduciary that is not a power of appointment, will be considered, collectively, to be a single PCB for purposes of determining the number of permissible shareholders under Code Sec. 1361(b)(1)(A) unless the power is actually exercised, in which case each charity that actually receives distributions will also be a PCB. The ESBT election requirements under Reg. §1.1361-1(m)(2)(ii)(A) are amended to require a trust containing such a power to indicate the presence of the power in the election statement. This amended PCB definition applies only to powers to distribute to one or more members of a class of unnamed charities which is unlimited in number. The amended PCB definition does not apply to a power to make distributions to or among particular named charities.
The proposed regulations further provide that a power to add beneficiaries, whether or not charitable, to a class of current permissible beneficiaries is generally a power of appointment; thus, it will be disregarded to the extent it is not exercised. However, if the power is exercised and an unlimited class of charitable beneficiaries is added to the class of current permissible beneficiaries, that class will count as a single PCB under the amended definition of PCB and, to the extent distributions are actually made to one or more charities, those charities will each count as PCBs.
Transfer of Stock Between Spouses or Incident to Divorce
Code Sec. 1366(d)(2) provides that if the stock of an S corporation is transferred between spouses or incident to divorce under Code Sec. 1041(a), any loss or deduction with respect to the transferred stock which cannot be taken into account by the transferring shareholder in the year of the transfer because of the basis limitation in Code Sec. 1366(d)(1) shall be treated as incurred by the corporation in the succeeding tax year with regard to the transferee. The proposed regulations amend the provisions of Reg. §1.1366-2(a)(5) to include this exception to the general rule of nontransferability of losses and deductions.
QSub Relief and Inadvertent Invalid Elections or Terminations
Code Sec. 1362(f) provides that QSubs are eligible for relief for an inadvertent invalid QSub election or termination under the same standards applied to an inadvertent invalid S corporation election or termination. The proposed regulations make conforming changes to Reg. §1.1362-4 and make additional changes to Reg. §1.1362-4 addressing the change to Code Sec. 1362(f), which provided relief for corporations with inadvertently invalid S corporation elections.
Comments are requested with respect to these regulations. Written or electronic comments must be received by December 27, 2007. A public hearing is scheduled for January 16, 2008.
Proposed Regulations, NPRM REG-143326-05, 2007FED ¶49,767
Other References:
Code Sec. 1361
CCH Reference - 2007FED ¶32,022C
CCH Reference - 2007FED ¶32,024C
CCH Reference - 2007FED ¶32,025E
CCH Reference - 2007FED ¶32,025K
Code Sec. 1362
CCH Reference - 2007FED ¶32,041C
CCH Reference - 2007FED ¶32,045C
Code Sec. 1366
CCH Reference - 2007FED ¶32,080D
CCH Reference - 2007FED ¶32,082A
CCH Reference - 2007FED ¶32,082H
Tax Research Consultant
CCH Reference - TRC SCORP: 156
CCH Reference - TRC SCORP: 158
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CCH Reference - TRC SCORP: 550