Tax News

CCH (cch.taxgroup.com) reports:

  The IRS has finalized proposed regulations (NPRM REG-143326-05) 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). The amended regulations also conform to changes made by the Small Business Job Protection Act of 1996 (P.L. 104-188).

  The regulations are necessary to replace obsolete references in the old regulations and to allow taxpayers to make proper use of the provisions that made changes to the law. In particular, the 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 final regulations, which follow the proposed regulations with no substantive changes, 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 has been obsoleted with the publication of these final regulations, the 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," and 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.

Unexercised Powers of Appointment

 
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 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). However, if the power is actually exercised, 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. The amended PCB definition does not apply to a power to make distributions to or among particular named charities.

  The 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 Between Spouses

 
Code Sec. 1366(d)(2) provides that, if the stock of an S corporation is transferred between spouses or incident to divorce underCode Sec. 1041(a), any loss or deduction with respect to the transferred stock that 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) will be treated as incurred by the corporation in the succeeding tax year with regard to the transferee. The new 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

 
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 regulations make conforming changes to Reg. §1.1362-4 and make additional changes to that regulation that address the change to Code Sec. 1362(f), which provided relief for corporations with inadvertently invalid S corporation elections.

T.D. 9422, 2008FED ¶47,056

Other References:

 
Code Sec. 1361

  CCH Reference - 2008FED ¶32,022

  CCH Reference - 2008FED ¶32,024A

  CCH Reference - 2008FED ¶32,025D

  CCH Reference - 2008FED ¶32,025H

 
Code Sec. 1362

  CCH Reference - 2008FED ¶32,041

  CCH Reference - 2008FED ¶32,045

 
Code Sec. 1366

  CCH Reference - 2008FED ¶32,080B

  CCH Reference - 2008FED ¶32,082

  CCH Reference - 2008FED ¶32,082F

  Tax Research Consultant

  CCH Reference - TRC SCORP: 156
CCH Reference -
SCORP: 160
CCH Reference -
TRC SCORP: 166
CCH Reference -
TRC SCORP: 404