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Internal Revenue
bulletin
Bulletin No. 2000–2
January 10, 2000
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2000–1, page 250.
Federal rates; adjusted federal rates; adjusted federal
long-term rate, and the long-term exempt rate. For
purposes of sections 1274, 1288, 382, and other sections
of the Code, tables set forth the rates for January 2000.
T.D. 8849, page 245.
Final regulations under section 663(c) of the Code relate to
the separate share rules applicable to estates.
T.D. 8850, page 265.
Final regulations under section 6038 of the Code relate to
the reporting requirements of U.S. persons owning interests
in controlled foreign partnerships or corporations. Also, certain amendments to the final regulations under section
6038B govern reporting of transfers to foreign partnerships
and corporations.
T.D. 8851, page 275.
Final regulations under section 6046A of the Code relate to
the reporting requirements of U.S. persons that acquire or
dispose of an interest in a foreign partnership, or whose proportional interest in a foreign partnership changes.
T.D. 8852, page 253.
Final regulations under sections 1366, 1367, and 1368 of
the Code relate to the passthrough of items of an S corporation to its shareholders, the adjustments to the basis of
stock of the shareholders, and the treatment of distributions
by an S corporation.
REG–106012–98, page 290.
Proposed regulations under section 118 of the Code relate to the exclusion from gross income for a contribution in aid of construction (CIAC) from any person
(whether or not a shareholder) to a required public utility
that provides water or sewerage disposal services. The
regulations define what constitutes a CIAC and provides
rules for adjusting the basis of water or sewerage disposal facilities acquired as, or acquired or constructed
with any money received as, a CIAC. The regulations also
provide the time and manner for taxpayers to notify the
Secretary of amounts treated as a contribution to capital
under this provision. A public hearing is scheduled for
April 27, 2000.
Rev. Proc. 2000–10, page 287.
Qualified Zone Academy Bond limitations for 2000.
This procedure sets forth the maximum face amount of Qualified Zone Academy Bonds that may be issued for each
state in 2000. For this purpose, “state” includes the District
of Columbia and U.S. possessions.
Notice 2000–1, page 288.
Effective date of proposed regulations under section
1.368–2(d)(4). Proposed regulations relating to the solely
for voting stock requirement in reorganizations under section 368(a)(1)(C) of the Code, when finalized, will be modified
to generally apply to transactions occurring after December
31, 1999. But in certain cases, taxpayers will be able to request a private letter ruling permitting them to apply the proposed regulations to transactions occuring before the proposed effective date.
EMPLOYEE PLANS
Announcement 2000–1, page 294.
This document provides interim information about the reporting requirements applicable to certain plans of state and
local government employers for amounts provided under
section 457. Comments are also requested regarding types
of plans that should be treated as bona fide severance plans
for purposes of section 457.
(Continued on the page following the Introduction)
Finding Lists begin on page ii.
Department of the Treasury
Internal Revenue Service
The IRS Mission
Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents are consolidated semiannually into
Cumulative Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis,
and are published in the first Bulletin of the succeeding semiannual period, respectively.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.
ESTATE TAX
Announcement 2000–3, page 296.
This document contains corrections to T.D. 8846, 1999-51
I.R.B. 679, relating to the effect of certain administration expenses on the valuation of property for marital and charitable deduction purposes.
ADMINISTRATIVE
Rev. Proc. 2000–9, page 280.
travel expenses of an employee and for determining the
amount of deductible meals while traveling away from
home. Rev. Proc. 98–64 superseded.
Announcement 2000–2, page 295.
Information letters written by the national office of Chief
Counsel and by the Office of the Commissioner, Tax Exempt and Government Entities Division, to the public in response to inquiries postmarked or, if not mailed, received
after January 1, 2000, will be available for public inspection quarterly beginning March 31, 2000, and on a continuing quarterly basis.
Per diem allowances. This procedure provides optional
rules for substantiating the amount of certain reimbursed
insert photo
here
2000–2 I.R.B.
January 10, 2000
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 62.—Adjusted Gross
Income Defined
26 CFR 1.62–2: Reimbursements and other expense
allowance arrangements.
Rules are set forth under which a reimbursement
or other expense allowance arrangement for the cost
of lodging, meal, and incidental expenses or meal
and incidental expenses incurred by an employee
while traveling away from home will satisfy the requirements of § 62(c) of the Code as to substantiation of the amount of the expenses. See. Rev. Proc.
2000–9, page 280.
dental expenses or meal and incidental expenses incurred while traveling away from home do not
apply. See Rev. Proc. 2000–9, page 280.
term, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 274.—Disallowance of
Certain Entertainment, Etc.,
Expenses
Section 467.—Certain Payments
for the Use of Property or
Services
26 CFR 1.274–5T: Substantiation requirements
(temporary).
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Rules are set forth for an optional method for
substantiating the amount of ordinary and necessary
business expenses of an employee for lodging, meal,
and incidental expenses or meal and incidental expenses incurred while traveling away from home
when a payor provides a per diem allowance under a
reimbursement or other expense allowance arrangement to pay for such expenses. Rules are also set
forth for an optional method for employees and selfemployed individuals to use in computing the deductible costs of business meal and incidental expenses paid or incurred while traveling away from
home. See Rev. Proc. 2000–9, page 280.
Section 468.—Special Rules for
Mining and Solid Waste
Reclamation and Closing Costs
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
26 CFR 1.62–2T: Reimbursements and other
expense allowance arrangements (temporary).
Rules are set forth under which a reimbursement
or other expense allowance arrangement for the cost
of lodging, meal, and incidental expenses or meal
and incidental expenses incurred by an employee
while traveling away from home will satisfy the requirements of § 62(c) of the Code as to substantiation of the amount of expenses. See Rev. Proc.
2000–9, page 280.
Section 162.—Trade or Business
Expense
26 CFR 1.274(d)–1T: Substantiation requirements
(temporary).
Rules are set forth for an optional method for
substantiating the amount of ordinary and necessary business expenses of an employee for lodging, meal, and incidental expenses or meal, and incidental expenses incurred while traveling away
from home when a payor provides a per diem allowance under a reimbursement or other expense
allowance arrangement to pay for such expenses.
See Rev. Proc. 2000–9, page 280.
26 CFR 1.162–17: Reporting and substantiation of
certain business expenses of employees.
Section 280G.—Golden
Parachute Payments
Rules are set forth for substantiating the amount
of a deduction or an expense for lodging, meal, and
incidental expenses or meal and incidental expenses
incurred while traveling away from home that most
nearly represents current costs. See Rev. Proc.
2000–9, page 280.
Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2000. See
Rev. Rul. 2000–1, page 250.
Section 267.—Losses,
Expenses, and Interest With
Respect to Transactions
Between Related Taxpayers
Section 382.—Limitation on Net
Operating Loss Carryforwards
and Certain Built-In Losses
Following Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of January 2000. See Rev.
Rul. 2000–1, page 250.
26 CFR 1.267(a)–1: Deductions disallowed.
When a payor provides a per diem allowance to
an employee who is a related party, the rules set
forth for the deemed substantiation to the payor of
the amount of the employee’s ordinary and necessary business expenses for lodging, meal, and inci-
January 10, 2000
Section 412.—Minimum Funding
Standards
The adjusted applicable federal short-term, mid-
244
Section 482.—Allocation of
Income and Deductions Among
Taxpayers
Federal short-term, mid-term, and long-term
rates are set forth for the month of Janyary 2000. See
Rev. Rul. 2000–1, page 250.
Section 483.—Interest on Certain
Deferred Payments
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 642.—Special Rules for
Credits and Deductions
Federal short-term, mid-term, and long-term
rates are set forth for the month of January 2000. See
Rev. Rul. 2000–1, page 250.
Section 663.—Special Rules
Applicable to Sections 661
and 662
26 CFR 1.663(a)–1: Special rules applicable to
sections 661 and 662; exclusion; gifts, bequests, etc.
2000–2 I.R.B.
T.D. 8849
General Separate Share Rules
DEPARTMENT OF TREASURY
Internal Revenue Service
The proposed regulations define a separate share as a separate economic interest
in one beneficiary or class of beneficiaries
of the decedent’s estate such that the economic interests of the beneficiary or class
of beneficiaries (for example, rights to income or gains from specified items of
property) are not affected by economic interests accruing to another beneficiary or
class of beneficiaries. The proposed regulations conclude that there are separate
shares in an estate when a beneficiary or
class of beneficiaries has an interest in a
decedent’s estate (whether corpus or income, or both) that no other beneficiary
or class of beneficiaries has.
Two commentators suggested a narrower definition of a separate share. One
commentator suggested that separate
shares exist only when the estate is administered as two or more well-defined
shares that could be separate estates. Another commentator suggested that separate share treatment should apply only
where the existence of separate shares is
clear and the funding thereof does not require burdensome adjustments due to disproportionate distributions.
Generally, the final regulations clarify
the definition and narrow the application
of the separate share rules that are in the
proposed regulations. The final regulations generally define a separate share as
a separate economic interest in one beneficiary or class of beneficiaries of the
decedent’s estate such that the economic
interests of the beneficiary or class of
beneficiaries neither affect nor are affected by economic interests accruing to
another beneficiary or class of beneficiaries. The final regulations add “nor are
affected by” to clarify the definition of a
separate share. Under this revised definition, a separate share generally exists only
if it includes both corpus and the income
attributable thereto and is independent
from any other share. Thus, income
earned on assets in one share (first share)
and appreciation and depreciation in the
value of those assets have no effect on
any other share. Similarly, the income
and changes in value of any other share
have no effect on the first share.
Effect on Section 663(a)(1)
The proposed regulations provide that
the separate share rules do not change the
26 CFR Part 1
Section 663(c); Separate Share
Rules Applicable to Estates
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations concerning
separate share rules applicable to estates
under section 663(c) of the Internal Revenue Code. These regulations provide
that substantively separate and independent shares of different beneficiaries are
to be treated as separate estates for purposes of computing distributable net income and applying the distribution provisions of sections 661 and 662. These
regulations also provide that a surviving
spouse’s statutory elective share of a
decedent’s estate and a pecuniary formula
bequest are separate shares. Further, a revocable trust that elects to be treated as
part of a decedent’s estate is a separate
share.
DATES: Effective Date: December 28,
1999.
Applicability Dates: For dates of applicability of these regulations, see
§1.663(c)-6.
FOR FURTHER INFORMATION CONTACT: Laura Howell, (202) 622-3060
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 6, 1999, a notice of proposed rulemaking was published in the
Federal Register (64 FR 790
(REG–114841–98, 1999–11 I.R.B., 41))
relating to the application of the separate
share rules to estates under section
663(c). Written comments were received
on the proposed regulations, and a public
hearing was held on April 22, 1999. After
consideration of all the comments, the
proposed regulations under section 663(c)
are adopted as revised by this Treasury
decision.
Explanation of Provisions
2000–2 I.R.B.
245
rules involving bequests of specific sums
of money or specific property described
in section 663(a)(1).
Commentators asked for clarification
concerning whether the separate share
rules apply to bequests described in section 663(a)(1). One commentator recommended that separate share treatment
should apply to these bequests. Another
commentator suggested that while revising §1.663(c) to apply to estates, the IRS
and the Treasury Department should reconsider and amend §1.663(a)-1(b)(1) to
permit principal distributions that are
made to fund both pecuniary formula bequests and surviving spouses’ elective
shares to be recognized as coming within
the definition of excluded gifts or bequests described in section 663(a)(1).
The final regulations provide that bequests described in section 663(a)(1) are
not separate shares. The separate share
rules are applicable only to determine the
distributable net income of each share
when applying the distribution provisions
of sections 661 and 662 to the trust or estate and its beneficiaries. Bequests described in section 663(a)(1) are not subject to the distribution provisions and
therefore are not separate shares.
Surviving Spouse’s Elective Share
The proposed regulations provide that a
surviving spouse’s statutory elective share
constitutes a separate share of an estate.
As a result, the surviving spouse may be
taxed on the estate’s gross income only to
the extent of the surviving spouse’s share
of that income under state law.
One commentator recommended that
separate share treatment for a surviving
spouse’s elective share should be reconsidered. Elective shares should be a matter of further study because they are
forced by state law, differ from state to
state, and usually are part of an acrimonious conflict. Another commentator requested clarification of whether a surviving spouse’s statutory elective share is
included in the subchapter J estate. Further, this commentator recommended that
an elective share that is not entitled to income or appreciation should be excluded
from the subchapter J estate, but an elective share that is entitled to income and
appreciation should be included in the
subchapter J estate.
Conversely, other commentators agreed
that separate share treatment should apply
January 10, 2000
to a surviving spouse’s statutory elective
share regardless of whether the surviving
spouse is entitled to income and shares in
appreciation or depreciation. One commentator suggested that the separate share
examples in the proposed regulations be
revised to track more closely the Uniform
Probate Code model because it will likely
be adopted by most states.
These final regulations do not change
the result of the proposed regulations.
However, under these final regulations, a
surviving spouse’s elective share that
under local law is entitled to income and
to share in appreciation or depreciation
constitutes a separate share under the general definition. Further, under a special
rule in the final regulations, a surviving
spouse’s elective share that is not entitled
to income or does not share in appreciation or depreciation is also a separate
share.
Revocable Trust as a Part Of Estate
The proposed regulations provide that a
qualified revocable trust that elects under
section 645 to be treated as part of the
decedent’s estate for income tax purposes
constitutes a separate share. In response
to comments, these final regulations include a reference that the electing revocable trust itself may have two or more separate shares. These final regulations
further provide that qualified revocable
trusts within the definition of section
645(b)(1) are subject to the separate share
rules applicable to estates rather than
trusts whether or not an election is made
to be part of the estate.
Pecuniary Formula Bequests
The preamble to the proposed regulations requests comments concerning the
treatment of pecuniary formula bequests
as separate shares. Several commentators, noting that pecuniary formula bequests are similar to a surviving spouse’s
statutory elective share, suggested that
such bequests be treated as separate
shares. Commentators disagreed, however, on whether pecuniary formula bequests not entitled to income should be
separate shares.
Under these final regulations, any pecuniary formula bequest that is entitled to
income and to share in appreciation or depreciation under the governing instrument
or local law constitutes a separate share
under the general definition. Further,
under a special rule, a pecuniary formula
January 10, 2000
bequest that is not entitled to income or to
share in appreciation or depreciation is
also a separate share if the governing instrument does not provide that it is to be
paid or credited in more than three installments. This provision regarding three or
fewer installments parallels the specific
bequest requirements in section
663(a)(1).
Administrative Rules
Commentators requested guidance concerning several administrative matters.
Commentators asked for guidance concerning when separate shares come into
existence. The final regulations provide
that separate shares come into existence at
the earliest moment that a fiduciary may
reasonably determine, based upon the
known facts, that a separate share exists.
Two commentators expressed concern
about the need to readjust the separate
shares as a result of an IRS examination.
One commentator suggested that separate
share treatment should apply to pecuniary
formula bequests only if no amended returns and no adjustments to any tax periods would be required when the tax returns were filed in good faith. Another
commentator recommended that separate
share treatment should not apply to residuary bequests unless or until the regulations provide simple and practical methods of compliance for possible
adjustments made during IRS examinations.
These final regulations do not adopt either suggestion. The regulations provide
that the fiduciary must use a reasonable
and equitable method to determine the
value of each separate share and the allocation of taxable income to each share.
This approach gives the fiduciary flexibility, within limits, in applying the separate
share rules. However, redeterminations in
value of those separate shares must be
taken into account.
Commentators asked for a clarification
of whether gross income of an estate must
be allocated to a separate share based
upon the amount of income each share is
entitled to under the terms of the governing instrument or applicable local law.
These final regulations clarify that, in
computing the distributable net income
for each separate share, the portion of
gross income that is income within the
meaning of section 643(b) must be allocated to each share based upon the
246
amount of income each share is entitled to
under the terms of the governing instrument or applicable local law. A similar allocation rule is provided for the amount of
gross income that is not attributable to
cash received by a trust or estate, such as
a distributive share of a partnership’s tax
items, or the pro rata share of an S corporation’s tax items.
Commentators asked whether the general rule for allocating gross income is applicable for income in respect of a decedent under section 691(a). These final
regulations clarify that such gross income
is allocated among the separate shares
that could potentially be funded with
these amounts irrespective of whether a
share is entitled to receive any income
under the terms of the governing instrument or applicable local law. The amount
allocated to each share is based upon the
relative value of each of those shares that
could potentially be funded with such
amounts.
One commentator requested clarification concerning the allocation of expenses
to a separate share. These final regulations do not change the long standing rule
under §1.663(c)-2 of the Income Tax Regulations that any expense which is applicable solely to one separate share of a trust
is not available as a deduction to any
other share of the same trust. The IRS
and the Treasury Department are not
aware of any issues that have arisen in applying this rule.
Interest on Pecuniary Bequests or Delayed Estate Distributions
Commentators questioned why the proposed regulations take the position that
interest, imposed by state law, on a pecuniary bequest or a delayed estate distribution is a payment of interest by the estate
and not a distribution for purposes of sections 661 and 662. These same commentators indicated that alternatively such interest payments should be deductible
administrative expenses if the interest was
required to be paid by state law as part of
the distribution and settlement of the estate. The final regulations retain the position taken in the proposed regulations because the IRS and the Treasury
Department view this result as compelled
by section 163(h) which disallows a deduction for personal interest as described
in section 163(h)(2).
Requests Concerning Applicable Dates
2000–2 I.R.B.
One commentator suggested that either
the applicable date of these final regulations should be retroactive to the date that
section 1307 of the Tax Reform Act of
1997 became applicable, or the regulations should provide that during the interim period before final regulations are
published, the IRS will accept any reasonable interpretation of the separate share
rules, including those rules provided in
the proposed regulations.
Another commentator requested that
the final regulations, to the extent applicable to trusts, apply prospectively and
apply either only to trusts that become irrevocable after the date the regulations
are finalized or only to taxable years of
trusts beginning after the date the regulations are finalized.
The final regulations have taken these
comments into account as noted below.
Effective Dates
These final regulations are applicable
for estates and qualified revocable trusts
within the meaning of section 645(b)(1)
with respect to decedents who die after
December 28, 1999. However, for estates
and qualified revocable trusts with respect
to decedents who died after the date that
section 1307 of the Tax Reform Act of
1997 became effective but before December 28, 1999, the IRS will accept any reasonable interpretation of the separate
share provisions, including those provisions provided in 1999-11 I.R.B. 41 (see
§601.601(d)(2)(ii)(b)). For trusts other
than qualified revocable trusts, §1.663(c)2 is applicable for taxable years of such
trusts beginning after December 28, 1999.
Effect on Other Documents
The following publications are obsolete
as of December 28, 1999:
Rev. Rul. 64-101 (1964-1 C.B. 77).
Rev. Rul. 71-167 (1971-1 C.B. 163).
Special Analyses
It has been determined that these final
regulations are not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations and, because these final regulations
2000–2 I.R.B.
do not impose a collection of information
requirement on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations 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 regulations is Laura Howell of the Office of Assistant Chief Counsel (Passthroughs and
Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sections 1.663(c)-1, 1.663(c)-2, 1.663(c)3, 1.663(c)-4, 1.663(c)-5, and 1.663(c)-6
also issued under 26 U.S.C. 663(c).
***
Par. 2. In §1.663(a)-1, paragraph (b)(3)
is amended by revising Example 1, Example 2, and Example 3 to read as follows:
§1.663(a)-1 Special rules applicable to
sections 661 and 662; exclusion; gifts, bequests, etc.
*****
(b) * * *
(3) * * *
Example 1. Under the terms of a will, a legacy
of $5,000 was left to A, 1,000 shares of X company stock was left to W, and the balance of the estate was to be divided equally between W and B.
No provision was made in the will for the disposition of income of the estate during the period of
administration. The estate had income of $25,000
during the taxable year 1954, which was accumulated and added to corpus for estate accounting
purposes. During the taxable year, the executor
paid the legacy of $5,000 in a lump sum to A,
transferred the X company stock to W, and made
no other distributions to beneficiaries. The distributions to A and W qualify for the exclusion under
247
section 663(a)(1).
Example 2. Under the terms of a will, the testator’s estate was to be distributed to A. No provision was made in the will for the distribution of
the estate’s income during the period of administration. The estate had income of $50,000 for the
taxable year. The estate distributed to A stock with
a basis of $40,000 and with a fair market value of
$40,000 on the date of distribution. No other distributions were made during the year. The distribution does not qualify for the exclusion under section 663(a)(1), because it is not a specific gift to A
required by the terms of the will. Accordingly, the
fair market value of the property ($40,000) represents a distribution within the meaning of sections
661(a) and 662(a) (see §1.661(a)-2(c)).
Example 3. Under the terms of a trust instrument, trust income is to be accumulated for a period of 10 years. During the eleventh year, the
trustee is to distribute $10,000 to B, payable from
income or corpus, and $10,000 to C, payable out
of accumulated income. The trustee is to distribute the balance of the accumulated income to A.
Thereafter, A is to receive all the current income
until the trust terminates. Only the distribution to
B would qualify for the exclusion under section
663(a)(1).
*****
Par. 3. Section 1.663(c)-1 is amended
as follows:
1. The section heading is revised.
2. Paragraph (a) is amended by revising the words “trust” and “trusts” to read
“trust (or estate)” and “trusts (or estates)”,
respectively, in the first through fourth
sentences.
3. Paragraph (b)(2) is removed and
paragraphs (b)(3) and (b)(4) are redesignated as paragraphs (b)(2) and (b)(3), respectively.
4. Paragraphs (b) through (d) are
amended by revising the words “trust”
and “trusts” to read “trust (or estate)” and
“trusts (or estates)”, respectively.
The revision reads as follows:
§1.663(c)-1 Separate shares treated as
separate trusts or as separate estates; in
general.
*****
Par. 4. Section 1.663(c)-2, is revised to
read as follows:
§1.663(c)-2 Rules of administration.
(a) When separate shares come into
existence. A separate share comes into
existence upon the earliest moment that a
fiduciary may reasonably determine,
based upon the known facts, that a separate economic interest exists.
January 10, 2000
(b) Computation of distributable net
income for each separate share—(1)
General rule. The amount of distributable
net income for any share under section
663(c) is computed as if each share constituted a separate trust or estate. Accordingly, each separate share shall calculate its
distributable net income based upon its portion of gross income that is includible in
distributable net income and its portion of
any applicable deductions or losses.
(2) Section 643(b) income. This paragraph (b)(2) governs the allocation of the
portion of gross income includible in distributable net income that is income
within the meaning of section 643(b).
Such gross income is allocated among the
separate shares in accordance with the
amount of income that each share is entitled to under the terms of the governing
instrument or applicable local law.
(3) Income in respect of a decedent.
This paragraph (b)(3) governs the allocation of the portion of gross income includible in distributable net income that
is income in respect of a decedent within
the meaning of section 691(a) and is not
income within the meaning of section
643(b). Such gross income is allocated
among the separate shares that could potentially be funded with these amounts
irrespective of whether the share is entitled to receive any income under the
terms of the governing instrument or applicable local law. The amount of such
gross income allocated to each share is
based on the relative value of each share
that could potentially be funded with
such amounts.
(4) Gross income not attributable to
cash. This paragraph (b)(4) governs the
allocation of the portion of gross income
includible in distributable net income
that is not attributable to cash received
by the estate or trust (for example, original issue discount, a distributive share of
partnership tax items, and the pro rata
share of an S corporation’s tax items).
Such gross income is allocated among
the separate shares in the same proportion as section 643(b) income from the
same source would be allocated under
the terms of the governing instrument or
applicable local law.
(5) Deductions and losses. Any deduction or any loss which is applicable
solely to one separate share of the trust or
estate is not available to any other share
January 10, 2000
of the same trust or estate.
(c) Computations and valuations. For
purposes of calculating distributable net
income for each separate share, the fiduciary must use a reasonable and equitable
method to make the allocations, calculations, and valuations required by paragraph (b) of this section.
Par. 5. Section 1.663(c)-3 is amended
by revising the section heading and the
first sentence of paragraph (a), and removing paragraph (f) to read as follows:
§1.663(c)-3 Applicability of separate
share rule to certain trusts.
(a) The applicability of the separate
share rule provided by section 663(c) to
trusts other than qualified revocable trusts
within the meaning of section 645(b)(1)
will generally depend upon whether distributions of the trust are to be made in
substantially the same manner as if separate trusts had been created.
*****
§1.663(c)-4 [Redesignated as §1.663(c)-5]
Par. 6. Section 1.663(c)-4 is redesignated as §1.663(c)-5.
Par. 7. A new §1.663(c)-4 is added to
read as follows:
§1.663(c)-4 Applicability of separate
share rule to estates and qualified revocable trusts.
(a) General rule. The applicability of
the separate share rule provided by section 663(c) to estates and qualified revocable trusts within the meaning of section 645(b)(1) will generally depend
upon whether the governing instrument
and applicable local law create separate
economic interests in one beneficiary or
class of beneficiaries of such estate or
trust. Ordinarily, a separate share exists
if the economic interests of the beneficiary or class of beneficiaries neither affect nor are affected by the economic interests accruing to another beneficiary
or class of beneficiaries. Separate
shares include, for example, the income
on bequeathed property if the recipient
of the specific bequest is entitled to such
income and a surviving spouse’s elective share that under local law is entitled
to income and appreciation or depreciation. Furthermore, a qualified revocable
trust for which an election is made under
section 645 is always a separate share of
the estate and may itself contain two or
more separate shares. Conversely, a gift
248
or bequest of a specific sum of money or
of property as defined in section
663(a)(1) is not a separate share.
(b) Special rule for certain types of beneficial interests. Notwithstanding the provisions of paragraph (a) of this section, a surviving spouse’s elective share that under
local law is determined as of the date of the
decedent’s death and is not entitled to income or any appreciation or depreciation is
a separate share. Similarly, notwithstanding the provisions of paragraph (a) of this
section, a pecuniary formula bequest that,
under the terms of the governing instrument or applicable local law, is not entitled
to income or to share in appreciation or depreciation constitutes a separate share if the
governing instrument does not provide that
it is to be paid or credited in more than
three installments.
(c) Shares with multiple beneficiaries
and beneficiaries of multiple shares. A
share may be considered as separate
even though more than one beneficiary
has an interest in it. For example, two
beneficiaries may have equal, disproportionate, or indeterminate interests in one
share which is economically separate
and independent from another share in
which one or more beneficiaries have an
interest. Moreover, the same person
may be a beneficiary of more than one
separate share.
Par. 8. Newly designated §1.663(c)-5
is amended by:
1. Revising the section heading and
introductory text.
2. Redesignating the Example as Example 1 and, in newly designated Example 1, redesignating paragraphs (a)
through (e) as paragraphs (i) through
(v), respectively.
3. Adding Example 2, Example 3, Example 4, Example 5, Example 6, Example
7, Example 8, Example 9, Example 10,
and Example 11.
The revisions and additions read as follows:
§1.663(c)-5 Examples.
Section 663(c) may be illustrated by
the following examples:
Example 1. * * *
Example 2 (i) Facts. Testator, who dies in
2000, is survived by a spouse and two children.
Testator’s will contains a fractional formula bequest dividing the residuary estate between the
surviving spouse and a trust for the benefit of the
children. Under the fractional formula, the marital
2000–2 I.R.B.
bequest constitutes 60% of the estate and the chil-
amount needed to reduce the estate taxes to zero
trust and the separate share for the surviving
dren’s trust constitutes 40% of the estate. During
and a bequest of the residuary to the surviving
spouse may potentially be funded with the pro-
the year, the executor makes a partial proportion-
spouse. The will provides that the bequest to the
ceeds from the individual retirement account.
ate distribution of $1,000,0000, ($600,000 to the
child’s trust is not entitled to any of the estate’s in-
Therefore, a portion of the $900,000 gross income
surviving spouse and $400,000 to the children’s
come and does not participate in appreciation or
must be allocated to the trust’s separate share. The
trust) and makes no other distributions. The estate
depreciation in estate assets. During the 2000 tax-
amount allocated to the trust’s share must be based
receives dividend income of $20,000, and pays ex-
able year, the estate receives dividend income of
upon the relative values of the two separate shares
penses of $8,000 that are deductible on the estate’s
$200,000 and pays expenses of $15,000 that are
using a reasonable and equitable method. The es-
federal income tax return.
deductible on the estate’s federal income tax re-
tate is entitled to a deduction under section 661 for
(ii) Conclusion. The fractional formula be-
turn. The executor partially funds the child’s trust
the portion of the $900,000 properly allocated to
quests to the surviving spouse and to the children’s
by distributing to it securities that have an adjusted
the trust’s separate share, and the trust must in-
trust are separate shares. Because Testator’s will
basis to the estate of $350,000 and a fair market
clude this amount in income under section 662.
provides for fractional formula residuary bequests,
value of $380,000 on the date of distribution. As a
Example 7 (i) Facts. Testator, who dies in
the income and any appreciation in the value of the
result of this distribution, the estate realizes long-
2000, is survived by a spouse and three adult chil-
estate assets are proportionately allocated between
term capital gain of $30,000.
dren. Testator’s will divides the residue of the es-
the marital share and the trust’s share. Therefore,
(ii) Conclusion. The estate has two separate
tate equally among the three children. The surviv-
in determining the distributable net income of each
shares consisting of a formula pecuniary bequest
ing spouse files an election under the applicable
share, the income and expenses must be allocated
to the child’s trust and a residuary bequest to the
state’s elective share statute. Under this statute, a
60% to the marital share and 40% to the trust’s
surviving spouse. Because, under the terms of the
surviving spouse is entitled to one-third of the
share. The distributable net income is $7,200
will, no estate income is allocated to the bequest to
decedent’s estate after the payment of debts and
(60% of income less 60% of expenses) for the
the child’s trust, the distributable net income for
expenses. The statute also provides that the sur-
marital share and $4,800 (40% of income less 40%
that trust’s share is zero. Therefore, with respect
viving spouse is not entitled to any of the estate’s
of expenses) for the trust’s share. Because the
to the $380,000 distribution to the child’s trust, the
income and does not participate in appreciation or
amount distributed in partial satisfaction of each
estate is allowed no deduction under section 661,
depreciation of the estate’s assets. However,
bequest exceeds the distributable net income of
and no amount is included in the trust’s gross in-
under the statute, the surviving spouse is entitled
each share, the estate’s distribution deduction
come under section 662. Because no distributions
to interest on the elective share from the date of
under section 661 is limited to the sum of the dis-
were made to the spouse, there is no need to com-
the court order directing the payment until the ex-
tributable net income for both shares. The estate is
pute the distributable net income allocable to the
ecutor actually makes payment. During the es-
allowed a distribution deduction of $12,000
marital share. The taxable income of the estate for
tate’s 2001 taxable year, the estate distributes to
($7,200 for the marital share and $4,800 for the
the 2000 taxable year is $214,400 ($200,000 (divi-
the surviving spouse $5,000,000 in partial satisfac-
trust’s share). As a result, the estate has zero tax-
dend income) plus $30,000 (capital gain) minus
tion of the elective share and pays $200,000 of in-
able income ($20,000 income less $8,000 ex-
$15,000 (expenses) and minus $600 (personal ex-
terest on the delayed payment of the elective
penses and $12,000 distribution deduction).
emption)).
share. During that year, the estate receives divi-
Under section 662, the surviving spouse and the
Example 5. The facts are the same as in Exam-
dend income of $3,000,000 and pays expenses of
trust must include in gross income $7,200 and
ple 4, except that during 2000 the estate reports on
$60,000 that are deductible on the estate’s federal
$4,800, respectively.
its federal income tax return a pro rata share of an
income tax return.
Example 3. The facts are the same as in Exam-
S corporation’s tax items and a distributive share
(ii) Conclusion. The estate has four separate
ple 2, except that in 2000 the executor makes the
of a partnership’s tax items allocated on Form K-
shares consisting of the surviving spouse’s elective
payment to partially fund the children’s trust but
1s to the estate by the S corporation and by the
share and each of the three children’s residuary be-
makes no payment to the surviving spouse. The
partnership, respectively. Because, under the
quests. Because the surviving spouse is not entitled
fiduciary must use a reasonable and equitable
terms of the will, no estate income from the S cor-
to any estate income under state law, none of the es-
method to allocate income and expenses to the
poration or the partnership would be allocated to
tate’s gross income is allocated to the spouse’s sepa-
trust’s share. Therefore, depending on when the
the pecuniary bequest to child’s trust, none of the
rate share for purposes of determining that share’s
distribution is made to the trust, it may no longer
tax items attributable to the S corporation stock or
distributable net income. Therefore, with respect to
be reasonable or equitable to determine the distrib-
the partnership interest is allocated to the trust’s
the $5,000,000 distribution, the estate is allowed no
utable net income for the trust’s share by allocat-
separate share. Therefore, with respect to the
deduction under section 661, and no amount is in-
ing to it 40% of the estate’s income and expenses
$380,000 distribution to the trust, the estate is al-
cluded in the spouse’s gross income under section
for the year. The computation of the distributable
lowed no deduction under section 661, and no
662. The $200,000 of interest paid to the spouse
net income for the trust’s share should take into
amount is included in the trust’s gross income
must be included in the spouse’s gross income under
consideration that after the partial distribution the
under section 662.
section 61. Because no distributions were made to
relative size of the trust’s separate share is reduced
Example 6. The facts are the same as in Exam-
any other beneficiaries during the year, there is no
and the relative size of the spouse’s separate share
ple 4, except that during 2000 the estate receives a
need to compute the distributable net income of the
is increased.
distribution of $900,000 from the decedent’s indi-
other three separate shares. Thus, the taxable in-
Example 4 (i) Facts. Testator, who dies in
vidual retirement account that is included in the
come of the estate for the 2000 taxable year is
2000, is survived by a spouse and one child. Tes-
estate’s gross income as income in respect of a
$2,939,400 ($3,000,000 (dividend income) minus
tator’s will provides for a pecuniary formula be-
decedent under section 691(a). The entire
$60,000 (expenses) and $600 (personal exemption)).
quest to be paid in not more than three install-
$900,000 is allocated to corpus under applicable
The estate’s $200,000 interest payment is a nonde-
ments to a trust for the benefit of the child in the
local law. Both the separate share for the child’s
ductible personal interest expense described in sec-
2000–2 I.R.B.
249
January 10, 2000
tion 163(h).
Example 8. The will of Testator, who dies in
2000, directs the executor to distribute the X stock
and all dividends therefrom to child A and the
residue of the estate to child B. The estate has two
separate shares consisting of the income on the X
stock bequeathed to A and the residue of the estate
bequeathed to B. The bequest of the X stock meets
the definition of section 663(a)(1) and therefore is
not a separate share. If any distributions, other than
shares of the X stock, are made during the year to either A or B, then for purposes of determining the distributable net income for the separate shares, gross
income attributable to dividends on the X stock must
be allocated to A’s separate share and any other income must be allocated to B’s separate share.
Example 9. The will of Testator, who dies in
2000, directs the executor to divide the residue of
the estate equally between Testator’s two children, A
and B. The will directs the executor to fund A’s
share first with the proceeds of Testator’s individual
retirement account. The date of death value of the
estate after the payment of debts, expenses, and estate taxes is $9,000,000. During 2000, the $900,000
balance in Testator’s individual retirement account
is distributed to the estate. The entire $900,000 is
allocated to corpus under applicable local law. This
amount is income in respect of a decedent within the
meaning of section 691(a). The estate has two separate shares, one for the benefit of A and one for the
benefit of B. If any distributions are made to either
A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of income in respect of a
decedent must be allocated to A’s share.
Example 10. The facts are the same as in Example 9, except that the will directs the executor to
fund A’s share first with X stock valued at
$3,000,000, rather than with the proceeds of the individual retirement account. The estate has two separate shares, one for the benefit of A and one for the
benefit of B. If any distributions are made to either
A or B during the year, then, for purposes of determining the distributable net income for each separate share, the $900,000 of gross income attributable
to the proceeds from the individual retirement account must be allocated between the two shares to
the extent that they could potentially be funded with
those proceeds. The maximum amount of A’s share
that could potentially be funded with the income in
respect of decedent is $1,500,000 ($4,500,000 value
of share less $3,000,000 to be funded with stock)
and the maximum amount of B’s share that could
potentially be funded with income in respect of
decedent is $4,500,000. Based upon the relative values of these amounts, the gross income attributable
to the proceeds of the individual retirement account
is allocated $225,000 (or one-fourth) to A’s share
January 10, 2000
and $675,000 (or three-fourths) to B’s share.
Example 11. The will of Testator, who dies in
2000, provides that after the payment of specific bequests of money, the residue of the estate is to be divided equally among the Testator’s three children,
A, B, and C. The will also provides that during the
period of administration one-half of the income
from the residue is to be paid to a designated charitable organization. After the specific bequests of
money are paid, the estate initially has three equal
separate shares. One share is for the benefit of the
charitable organization and A, another share is for
the benefit of the charitable organization and B, and
the last share is for the benefit of the charitable organization and C. During the period of administration,
payments of income to the charitable organization
are deductible by the estate to the extent provided in
section 642(c) and are not subject to the distribution
provisions of sections 661 and 662.
Par. 9. Section 1.663(c)-6 is added to
read as follows:
§1.663(c)-6 Effective dates.
Sections 1.663(c)-1 through 1.663(c)-5
are applicable for estates and qualified revocable trusts within the meaning of section 645(b)(1) with respect to decedents
who die after December 28, 1999. However, for estates and qualified revocable
trusts with respect to decedents who died
after the date that section 1307 of the Tax
Reform Act of 1997 became effective but
before December 28, 1999, the IRS will
accept any reasonable interpretation of
the separate share provisions, including
those provisions provided in 1999-11
I.R.B. 41 (see §601.601(d)(2)(ii)(b) of
this chapter). For trusts other than qualified revocable trusts, §1.663(c)-2 is applicable for taxable years of such trusts
beginning after December 28, 1999.
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved December 13, 1999.
Jonathan Talisman,
Acting Assistant Secretary
for the Treasury.
(Filed by the Office of the Federal Register on
December 27, 1999, 8:45 a.m., and published in
the issue of the Federal Register for December 28,
1999, 64 F.R. 72540)
Section 807.—Rules for Certain
Reserves
250
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul 2000–1, page 250.
Section 846.—Discounted
Unpaid Losses Defined
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
Section 1274.—Determination
of Issue Price in the Case of
Certain Debt Instruments Issued
for Property
(Also Sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal rates;
adjusted federal long-term rate, and
the long-term exempt rate. For purposes
of sections 1274, 1288, 382, and other
section of the Code, tables set forth the
rates for January 2000.
Rev. Rul. 2000-1
This revenue ruling provides various
prescribed rates for federal income tax
purposes for January 2000 (the current
month.) Table 1 contains the short-term,
mid-term, and long-term applicable federal rates (AFR) for the current month for
purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the
short-term, mid-term, and long-term adjusted applicable federal rates (adjusted
AFR) for the current month for purposes
of section 1288(b). Table 3 sets forth the
adjusted federal long-term rate and the
long-term tax-exempt rate described in
section 382(f). Table 4 contains the appropriate percentages for determining the
low-income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Table 5
contains the federal rate for determining
the present value of an annuity, an interest
for life or for a term of years, or a remainder or a reversionary interest for purposes
of section 7520. Finally, Table 6 contains
the deemed rate of return for transfers
made during calendar year 2000 to pooled
income funds described in § 642(c)(5)
that have been in existence for less than 3
taxable years immediately preceding the
taxable year in which the transfer is made.
2000–2 I.R.B.
REV. RUL. 2000-1 TABLE 1
Applicable Federal Rates (AFR) for January 2000
Period for Compounding
Annual
Semiannual
Quarterly
Monthly
5.88%
6.48%
7.08%
7.68%
5.80%
6.38%
6.96%
7.54%
5.76%
6.33%
6.90%
7.47%
5.73%
6.30%
6.86%
7.42%
6.21%
6.84%
7.47%
8.12%
9.39%
11.00%
6.12%
6.73%
7.34%
7.96%
9.18%
10.71%
6.07%
6.67%
7.27%
7.88%
9.08%
10.57%
6.04%
6.64%
7.23%
7.83%
9.01%
10.48%
6.45%
7.11%
7.77%
8.43%
6.35%
6.99%
7.62%
8.26%
6.30%
6.93%
7.55%
8.18%
6.27%
6.89%
7.50%
8.12%
Short-Term
AFR
110% AFR
120% AFR
130% AFR
Mid-Term
AFR
110% AFR
120% AFR
130% AFR
150% AFR
175% AFR
Long-Term
AFR
110% AFR
120% AFR
130% AFR
REV. RUL. 2000-1 TABLE 2
Adjusted AFR for January 2000
Period for Compounding
Annual
Semiannual
Quarterly
Monthly
Short-term
adjusted AFR
4.01%
3.97%
3.95%
3.94%
Mid-term
adjusted AFR
4.66%
4.61%
4.58%
4.57%
Long-term
adjusted AFR
5.59%
5.51%
5.47%
5.45%
2000–2 I.R.B.
251
January 10, 2000
REV. RUL. 2000-1 TABLE 3
Rates Under Section 382 for January 2000
Adjusted federal long-term rate for the current month
5.59%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the
adjusted federal long-term rates for the current month and the prior two months.)
5.72%
REV. RUL. 2000-1 TABLE 4
Appropriate Percentages Under Section 42(b)(2)
for January 2000
Appropriate percentage for the 70% present
value low-income housing credit
8.48%
Appropriate percentage for the 30% present
value low-income housing credit
3.64%
REV. RUL. 2000-1 TABLE 5
Rate Under Section 7520 for January 2000
Applicable federal rate for determining the present
value of an annuity, an interest for life or a term
of years, or a remainder or reversionary interest
7.4%
Rev. Rul. 2000-1 TABLE 6
Deemed Rate of Transfers to New Pooled Income Funds During 2000
Deemed rate of return for transfers during 2000 to pooled
income funds that have been in existence for less than 3
taxable years
January 10, 2000
252
6.80%
2000–2 I.R.B.
Section 1288.—Treatment of
Original Issue Discounts on TaxExempt Obligations
SUPPLEMENTARY INFORMATION:
Explanation of Revisions and
Summary of Comments
Paperwork Reduction Act
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of January 2000. See Rev. Rul. 2000–1, page 250.
The collection of information contained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507) under control
number 1545-1613. Responses to this
collection of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
control number.
The burden for this requirement is reflected in the burden of Form 1040, “U.S.
Individual Income Tax Return”, and Form
1120S, “U.S. Income Tax Return for an S
corporation”.
Suggestions for reducing this burden
should be sent to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224,
and to the Office of Management and
Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.
Books or records relating to this collection of information must be retained as
long as their contents may 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.
1. Aggregation of deductions from an S
corporation with deductions from other
sources.
The proposed regulations provide that a
shareholder of an S corporation must aggregate its separate deductions and exclusions with the shareholder’s pro rata share
of the S corporation’s separately stated
deductions or exclusions in determining
the allowable amount of any deduction or
exclusion that is subject to a limitation in
the Code.
The proposed regulations provide an
example of this rule for property expensed under section 179. A commentator suggested that the example implies
that a shareholder must expense its pro
rata share of section 179 expense from the
S corporation before it can expense any
separately acquired property.
The example is intended to illustrate
that a shareholder may expense only up to
the amount allowable under section 179
in any given year regardless of whether
the property is owned individually or
through an S corporation. The example is
not intended to imply that a shareholder
must elect to expense property held in an
S corporation before it can expense any
separately acquired property. However,
once an S corporation elects to expense
property under section 179, a shareholder
will generally elect to expense personal
property only to the extent the shareholder’s pro rata share of the corporation’s section 179 expense does not exceed the shareholder ’s individual
limitation under section 179(b). Accordingly, no modifications have been made
to the example in the final regulations.
The commentator also requested that
the final regulations provide additional
examples that illustrate the aggregation of
the shareholder’s pro rata share of deductions and exclusions from an S corporation with deductions and exclusions from
other sources and the operation of any
limitations on those aggregated deductions and exclusions. Specifically, the
commentator requested that the final regulations include an example in which the
shareholder’s aggregate section 179 expenses from several passthrough sources
exceeds the maximum section 179 expense allowable. The allocation of the
section 179 expense among the various
Section 1366.—Pass-Thru of
Items to Shareholders
26 CFR 1.1366–1: Shareholder’s share of items of
an S corporation.
T.D. 8852
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Passthrough of Items of an S
Corporation to its Shareholders
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final
regulations relating to the passthrough of
items of an S corporation to its shareholders,
the adjustments to the basis of stock of the
shareholders, and the treatment of distributions by an S corporation. Changes to the
applicable law were made by the Subchapter
S Revision Act of 1982, the Tax Reform Act
of 1984, the Tax Reform Act of 1986, the
Technical and Miscellaneous Revenue Act
of 1988, and the Small Business Job Protection Act of 1996. These regulations provide
the public with guidance needed to comply
with the applicable law and will affect S corporations and their shareholders.
DATES: Effective Date: These regulations are effective August 18, 1998.
Applicability Dates: For dates of applicability, see §1.1366-5, §1.1367-3,
and §1.1368-4, plus Transition Rule and
Effective Date under
SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations
under section 1366, Martin Schäffer,
Deane M. Burke, or David Shulman
(202) 622-3070; concerning the regulations under sections 1367 and 1368,
Brenda Stewart, (202) 622-3120.
2000–2 I.R.B.
Background
This document amends 26 CFR part 1 to
provide additional rules under sections 1366,
1367, and 1368 relating to the passthrough
of items of an S corporation to its shareholders, the adjustments to the basis of stock of
the shareholders, and the treatment of distributions by an S corporation.
On August 18, 1998, the IRS published
in the Federal Register (63 FR 44181), a
notice of proposed rulemaking (REG209446-82) regarding sections 1366,
1367, and 1368. Comments responding
to the proposed regulations were received. The public hearing was canceled
because there were no requests to speak.
After considering the comments received,
the proposed regulations are adopted as
amended by this Treasury decision.
253
January 10, 2000
sources is more appropriately addressed
in the regulations under section 179 and is
beyond the scope of these regulations.
Accordingly, the final regulations do not
adopt this comment.
2. Recharacterization of gains and losses
at the shareholder level.
Generally, the items of an S corporation that are passed through, and reported
by, a shareholder are characterized at the
corporate level in the same manner that
partnership items are characterized at the
partnership level.
However, the proposed regulations also
contain exceptions to this general rule for
contributions of either noncapital gain
property or capital loss property if an S
corporation is formed or availed of by any
shareholder or shareholders for a principal purpose of selling or exchanging the
property that in the hands of the shareholder or shareholders would have produced a different character of gain or loss.
The character of the gain or loss will be
the same as it would have been if the
property were in the hands of the shareholder or shareholders at the time of the
sale or exchange.
Commentators suggested that, in the
absence of a statutory provision like section 724 in the partnership context, the
IRS lacked the authority to recharacterize
gain or loss at the shareholder level.
Thus, the commentators asserted that the
final regulations should not adopt the
recharacterization rules.
Alternatively, the commentators suggested limiting the recharacterization rule
to sales or exchanges occurring within a
specified time period.
Unlike the partnership rules, the
recharacterization rules in the proposed
regulations are limited to transactions in
which an S corporation is used for a principal purpose of changing the character of
the gain or loss of contributed property.
These rules are reasonable approaches to
remedying any improper attempts to utilize section 1366(b) to avoid tax. The
length of time between the contribution of
the property to the S corporation and the S
corporation’s sale or exchange of the
property will be a factor considered in
evaluating whether the S corporation was
availed of for a principal purpose of
changing the character of the gain or loss.
However, the final regulations do not
adopt any particular time period. Thus,
January 10, 2000
the final regulations retain the recharacterization rules as proposed.
3. Gross income reporting requirement.
Section 1366(c), like section 702(c) in
the partnership context, provides for the
passthrough of gross income to a shareholder for federal income tax purposes.
Thus, where it is necessary to determine
the amount or character of the gross income of a shareholder, the proposed regulations provide that a shareholder’s gross
income includes the shareholder’s pro
rata share of the gross income of the S
corporation. This amount is the amount
of gross income of the corporation used to
derive the shareholder’s pro rata share of
S corporation taxable income or loss.
A commentator suggested that the rule
in the proposed regulations attempts to
narrow the disclosure exception under
section 6501(e) by applying a pro rata
concept with respect to a shareholder’s
gross income. The commentator recommended that the final regulations not
adopt the gross income reporting rules or,
alternatively, provide a de minimis exception to the rule for certain shareholders
who own minority interests in an S corporation.
The rule in the proposed regulations
parallels the rules for determining the
amount of gross income reported by a
partner in a partnership. See section
702(c); §1.702-1(c)(2). Accordingly,
the final regulations do not adopt this
suggestion.
4. Carryover of disallowed losses under
section 1366(d).
Section 1366(d) provides that a shareholder’s disallowed losses and deductions
for any taxable year shall be treated as incurred by the corporation in the succeeding taxable year with respect to that shareholder. The proposed regulations provide
that a shareholder’s losses and deductions
disallowed under section 1366(d) are personal to the shareholder and cannot in any
manner be transferred to another person.
A commentator requested that the final
regulations provide an exception to this
rule for transferees that have an identity
of investment interest or common basis
with the transferor, such as when stock is
transferred incident to divorce under section 1041.
Under section 1366(d), the carryover of
disallowed losses and deductions is with
respect to the shareholder whose invest-
254
ment limited the items of loss or deduction. Thus, the carryover is not available
to a transferee who acquires the stock
whether by sale, death, gift, or otherwise.
Accordingly, the final regulations retain
the rule that disallowed losses and deductions are nontransferable.
The proposed regulations also provide
that if a shareholder transfers all of the
shareholder’s stock in the corporation,
any disallowed loss or deduction is permanently disallowed. A commentator
suggested that the final regulations permit
a former shareholder of an S corporation
who subsequently reacquires stock in the
S corporation to utilize the losses and deductions previously disallowed to the
shareholder.
Losses and deductions that are disallowed in any taxable year carry over
under section 1366(d) to the succeeding
taxable year of the corporation with respect to a particular shareholder. If a
shareholder completely terminates its interest in the corporation, the shareholder
will not be a shareholder in the succeeding taxable year of the corporation and the
disallowed losses would not carry over.
There is no statutory authority for the carryover of disallowed items if a shareholder is not a shareholder in the year succeeding the disallowance. The disallowed
items of loss and deduction are amounts
that exceed the shareholder’s economic
investment in the corporation. Once the
shareholder terminates its interest in the
corporation, it is not necessary to preserve
the shareholder’s position in the corporation. Thus, the final regulations do not
adopt this commentator’s suggestion.
5. Basis in S corporation stock received
as a gift.
Section 1366(d)(1) limits the amount of
corporate losses and deductions that can
pass through to, and be deducted by, a
shareholder to the shareholder’s adjusted
basis in the corporation’s stock and debt
of the corporation to the shareholder.
The proposed regulations provide that,
for purposes of section 1366(d)(1), a
shareholder’s basis in stock acquired by
gift is the basis of the stock used for purposes of determining loss under section
1015. Thus, if the fair market value of the
stock exceeds the donor’s adjusted basis
on the date of the gift, for purposes of section 1366(d)(1), the adjusted basis of the
stock in the hands of the donee is its ad-
2000–2 I.R.B.
justed basis in the hands of the donor.
However, if the donor’s adjusted basis in
the stock exceeds the stock’s fair market
value on the date of the gift, for purposes
of section 1366(d)(1), the adjusted basis
of the stock in the hands of the donee is
the stock’s fair market value on the date
of the gift.
One commentator argued that the
basis for determining loss under section
1015 is applicable only on the disposition of the gifted asset. The basis for determining loss in section 1015 generally
does not affect the basis for depreciation
or the deductibility of net expenses arising out of the use or operation of the
gifted asset.
The proposed regulations, however,
apply the loss basis rule in section 1015
not for purposes of determining the depreciable basis of a gifted asset, but
rather for purposes of determining the
amount of passthrough losses and deductions (including depreciation deductions and operating losses) that are allowable to a shareholder under section
1366. The donee of loss stock cannot
dispose of the stock and recognize the
loss inherent in the stock on the date of
gift. If the donee could use the donor’s
basis to take depreciation deductions
and operating losses of the S corporation, the donee in effect would realize
the benefit of the loss inherent in the
stock.
Another commentator agreed that the
basis for determining loss in section
1015 ought to be the basis of gifted
stock for purposes of section 1366.
Thus, the final regulations continue to
provide that for purposes of section
1366, the basis of stock acquired by gift
is the basis for determining loss under
section 1015.
6. Allocation of disallowed losses in certain corporate separations.
The proposed regulations provide
rules for the carryover of disallowed
losses and deductions in the case of certain corporate reorganizations. In the
case of an S corporation that transfers a
part of its assets constituting an active
trade or business to another corporation
in a transaction to which section
368(a)(1)(D) applies, and immediately
thereafter the stock and securities of the
controlled corporation are distributed in
a distribution or exchange to which sec-
2000–2 I.R.B.
tion 355 (or so much of section 356 as
relates to section 355) applies, any disallowed loss or deduction with respect to a
shareholder of the distributing corporation immediately before the transaction
is allocated between the distributing corporation and the controlled corporation
with respect to the shareholder. The
proposed regulations provide that the
amount of disallowed loss or deduction
allocated to the distributing (or controlled) corporation with respect to the
shareholder is an amount that bears the
same ratio to each item of disallowed
loss or deduction as the value of the
shareholder’s stock in the distributing
(or controlled) corporation bears to the
total value of the shareholder’s stock in
the distributing and controlled corporations, in each case as determined immediately after the distribution.
A commentator suggested that the
term value as used in the proposed regulations is ambiguous and that the final
regulations should specifically state
“fair market value.” The commentator
also recommended that because the
computation of fair market value introduces a host of valuation issues into the
transaction, the final regulations should
permit an allocation of disallowed losses
and deductions based on the relative adjusted bases of the assets of the distributing and controlled corporations. Finally, the commentator requested that
the final regulations allow S corporations to allocate disallowed losses and
deductions to the controlled or distributing corporation based upon the source of
those losses and deductions. The final
regulations permit shareholders to allocate disallowed losses and deductions
according to any reasonable method, including a method based on the relative
fair market value of the shareholder’s
stock in the distributing and controlled
corporations immediately after the distribution, a method based on the relative
adjusted bases of the assets in the distributing and controlled corporations
immediately after the distribution, or, in
the case of losses and deductions clearly
attributable to either the distributing or
controlled corporation, a method that allocates such losses and deductions accordingly.
7. Allocation of tax on passive investment income under section 1366(f)(3).
255
Section 1366(f)(3) provides that if
any tax is imposed under section 1375
for a taxable year, each item of passive
investment income is reduced by an
amount which bears the same ratio to
the amount of the tax as the amount of
the item bears to the total passive investment income for the taxable year.
A commentator requested guidance in
the final regulations on whether the allocation of any tax imposed under section
1375 is made based on the total gross or
total net passive investment income.
Under section 1375, the amount of excess passive investment income is allocated to the items of passive investment
income based on the net passive investment income of the corporation. The allocation of the tax imposed on the excess passive investment income should
be similarly allocated. Accordingly, the
final regulations clarify that the allocation of any tax under section 1375 is
based on the total net passive investment
income for the taxable year.
8. Accrual of charitable contribution deductions under section 170(a)(2).
The proposed regulations under section 1366 provide that each shareholder
must take into account the shareholder’s
pro rata share of any charitable contributions paid by the corporation during the
corporation’s taxable year. A commentator requested that the final regulations
clarify that separately stated items include charitable contributions paid or
deemed to be paid. The commentator
suggested that an accrual basis S corporation may elect under section 170(a)(2)
to treat charitable contributions as paid
in the year prior to the year in which the
charitable contribution is actually paid.
Under section 1363(b), S corporations
generally compute their taxable income
in the same manner as in the case of an
individual. However, S corporations are
not permitted to take charitable contribution deductions by virtue of the cross
reference in section 1363(b)(2) to section 703(a)(2). Instead, the deductions
for charitable contributions pass through
to the shareholders of the S corporation.
Individuals cannot make the election
under section 170(a)(2). Treasury and
the Service believe that an S corporation
also cannot make the election under section 170(a)(2). Accordingly, the final
regulations do not adopt this suggestion.
January 10, 2000
9. Treatment of section 108 income
The regulations enumerate items of
income (including tax-exempt income),
loss, deduction, or credit of an S corporation that must be taken into account
separately by each shareholder pursuant
to section 1366(a)(1)(A). “Tax-exempt
income” does not include income from
discharge of indebtedness excluded
from income under section 108 because
such income is not permanently excludible from income in all circumstances in
which section 108 applies. One commentator objected to this treatment of
section 108 income, arguing that such
income is tax-exempt and that application of section 108 at the S corporation
level pursuant to section 108(d)(7)(A)
does not preclude the pass-through of
section 108 income. Another commentator, however, agreed with the approach
taken by the regulations.
Treasury and the Service continue to
believe that the absence of a stock basis
increase for income of an S corporation
excluded under section 108(a) is consistent with the legislative history of section 108 and the specific rules that apply
to the discharge of indebtedness income
of S corporations. Accordingly, the
treatment of section 108 income is unchanged in the final regulations.
10. Adjustment to Basis of Stock
Section 1367(a) and §1.1367-1 of the
proposed regulations prescribe the order
of adjustments required by subchapter S
to the basis of a shareholder’s stock in
an S corporation and the manner in
which those adjustments are made.
A commentator suggested that the
final regulations should provide that life
insurance premiums on policies owned
by the S corporation do not affect either
a shareholder’s basis in stock/debt or the
corporation’s accumulated adjustments
account (AAA). The commentator further suggested that §1.1367-1(c)(2) (relating to noncapital, nondeductible expenses) be amended to make special
provision for accounts receivable when
debt is restored.
Because these comments relate to
provisions in §1.1367-1 that were not
affected by the amendments contained
in the proposed regulations, the comments are not reflected in the final regulations.
11. Adjustments Required Before Deter-
January 10, 2000
mining Tax Effect of Distribution.
Section 1.1368-2 of the proposed regulations provides rules for determining
the source of a distribution made by an S
corporation with respect to its stock and
the tax effect of the distribution to the
shareholders for taxable years of the
corporation beginning on or after August 18, 1998.
One commentator interpreted
§1.1368-2(a)(5) of the proposed regulations, which prescribes the order in
which adjustments are made to the AAA
for purposes of determining the source
of a distribution, as providing that the
AAA is adjusted in the same order as the
adjustments to the basis of a share of
stock under §1.1367-1 of the proposed
regulations. The commentator stated
that although the Small Business Job
Protection Act of 1996 (1996 Act)
changed the order of the adjustments to
the basis of a share of stock, the 1996
Act did not change the order of the adjustments to the AAA except in situations involving a net negative adjustment (where the reductions in the
account for the taxable year exceed the
increases for the taxable year). When a
net negative adjustment occurs, the
AAA is adjusted to take into account
distributions before the AAA is adjusted
to take into account any net negative adjustment.
Consistent with the comment received, the final regulations make clear
that except in situations involving a net
negative adjustment, the order of adjustments to the AAA is not changed. Examples are added to the final regulations to
illustrate the effect of the 1996 Act on
the AAA ordering rules.
12. Transition Rule and Effective Date
sections 1367 and 1368.
Sections 1.1367-3 and 1.1368-4 of the
proposed regulations provide that the
amendments to the final regulations
under section 1367 and 1368 apply only
to taxable years of the corporation beginning on or after August 18, 1998.
Commentators suggested that because
the amendments to sections 1367 and
1368 under the 1996 Act are effective
for taxable years beginning after December 31, 1996, the final regulations
should be effective, at least on an elective basis, for the period beginning from
the effective date of the 1996 Act and
256
ending on the effective date of the final
regulations.
Sections 1.1367-3 and 1.1368-4 of the
final regulations reflect this comment
and provide that for taxable years beginning on or after January 1, 1997, and before August 18, 1998, the adjustments to
the basis of a shareholder’s stock and
the treatment of distributions by an S
corporation, respectively, must be determined in a reasonable manner, taking
into account the statute and the legislative history. Return positions consistent
with the final regulations will be considered reasonable.
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. It is hereby certified that the collection of information in these regulations
will not have a significant economic impact on a substantial number of small entities. This certification is based upon the
fact that these regulations do not impose a
collection of information that is not already required by the underlying statute
or the current regulations and reflected in
the appropriate forms. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter
6) is not required. Pursuant to section
7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding
these regulations 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 authors of these final
regulations are Terri A. Belanger, Deane
M. Burke, and Brenda Stewart of the
Office of Chief Counsel (Passthroughs
and Special Industries), Internal Revenue Service. However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
2000–2 I.R.B.
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. Sections 1.1366-0 and 1.1366-1
are added, §1.1366-2 is revised, and
§§1.1366-3 through 1.1366-5 are added to
read as follows:
§1.1366-0 Table of contents.
The following table of contents is provided to facilitate the use of §§1.1366-1
through 1.1366-5:
§1.1366-1 Shareholder’s share of items
of an S corporation.
(a) Determination of shareholder’s tax liability.
(1) In general.
(2) Separately stated items of income,
loss, deduction, or credit.
(3) Nonseparately computed income or
loss.
(4) Separate activities requirement.
(5) Aggregation of deductions or exclusions for purposes of limitations.
(b) Character of items constituting pro
rata share.
(1) In general.
(2) Exception for contribution of noncapital gain property.
(3) Exception for contribution of capital
loss property.
(c) Gross income of a shareholder.
(1) In general.
(2) Gross income for substantial omission of items.
(d) Shareholders holding stock subject to
community property laws.
(e) Net operating loss deduction of shareholder of S corporation.
(f) Cross-reference.
§1.1366-2 Limitations on deduction of
passthrough items of an S corporation to
its shareholders.
(a) In general.
(1) Limitation on losses and deductions.
(2) Carryover of disallowance.
(3) Basis limitation amount.
(i) Stock portion.
(ii) Indebtedness portion.
(4) Limitation on losses and deductions
2000–2 I.R.B.
allocated to each item.
(5) Nontransferability of losses and deductions.
(6) Basis of stock acquired by gift.
(b) Special rules for carryover of disallowed losses and deductions to post-termination transition period described in
section 1377(b).
(1) In general.
(2) Limitation on losses and deductions.
(3) Limitation on losses and deductions
allocated to each item.
(4) Adjustment to the basis of stock.
(c) Carryover of disallowed losses and
deductions in the case of liquidations, reorganizations, and divisions.
(1) Liquidations and reorganizations.
(2) Corporate separations to which section 368(a)(1)(D) applies.
§1.1366-3 Treatment of family groups.
(a) In general.
(b) Examples.
§1.1366-4 Special rules limiting the
passthrough of certain items of an S corporation to its shareholders.
(a) Passthrough inapplicable to section
34 credit.
(b) Reduction in passthrough for tax imposed on built-in gains.
(c) Reduction in passthrough for tax imposed on excess net passive income.
§1.1366-5 Effective date. §1.1366-1
Shareholder’s share of items of an S corporation.
(a) Determination of shareholder’s tax
liability—(1) In general. An S corporation must report, and a shareholder is required to take into account in the shareholder’s return, the shareholder’s pro rata
share, whether or not distributed, of the S
corporation’s items of income, loss, deduction, or credit described in paragraphs
(a)(2), (3), and (4) of this section. A
shareholder’s pro rata share is determined
in accordance with the provisions of section 1377(a) and the regulations thereunder. The shareholder takes these items
into account in determining the shareholder’s taxable income and tax liability
for the shareholder’s taxable year with or
within which the taxable year of the corporation ends. If the shareholder dies (or
if the shareholder is an estate or trust and
the estate or trust terminates) before the
257
end of the taxable year of the corporation,
the shareholder’s pro rata share of these
items is taken into account on the shareholder’s final return. For the limitation
on allowance of a shareholder’s pro rata
share of S corporation losses or deductions, see section 1366(d) and §1.1366-2.
(2) Separately stated items of income,
loss, deduction, or credit. Each shareholder must take into account separately
the shareholder’s pro rata share of any
item of income (including tax-exempt income), loss, deduction, or credit of the S
corporation that if separately taken into
account by any shareholder could affect
the shareholder’s tax liability for that taxable year differently than if the shareholder did not take the item into account
separately. The separately stated items of
the S corporation include, but are not limited to, the following items—
(i) The corporation’s combined net
amount of gains and losses from sales or
exchanges of capital assets grouped by
applicable holding periods, by applicable
rate of tax under section 1(h), and by any
other classification that may be relevant
in determining the shareholder’s tax liability;
(ii) The corporation’s combined net
amount of gains and losses from sales or
exchanges of property described in section 1231 (relating to property used in the
trade or business and involuntary conversions), grouped by applicable holding periods, by applicable rate of tax under section 1(h), and by any other classification
that may be relevant in determining the
shareholder’s tax liability;
(iii) Charitable contributions, grouped
by the percentage limitations of section
170(b), paid by the corporation within the
taxable year of the corporation;
(iv) The taxes described in section 901
that have been paid (or accrued) by the
corporation to foreign countries or to possessions of the United States;
(v) Each of the corporation’s separate
items involved in the determination of
credits against tax allowable under part
IV of subchapter A (section 21 and following) of the Internal Revenue Code,
except for any credit allowed under section 34 (relating to certain uses of gasoline and special fuels);
(vi) Each of the corporation’s separate
items of gains and losses from wagering
transactions (section 165(d)); soil and
January 10, 2000
water conservation expenditures (section 175); deduction under an election to
expense certain depreciable business expenses (section 179); medical, dental,
etc., expenses (section 213); the additional itemized deductions for individuals provided in part VII of subchapter B
(section 212 and following) of the Internal Revenue Code; and any other itemized deductions for which the limitations on itemized deductions under
sections 67 or 68 applies;
(vii) Any of the corporation’s items of
portfolio income or loss, and expenses related thereto, as defined in the regulations
under section 469;
(viii) The corporation’s tax-exempt income. For purposes of subchapter S, taxexempt income is income that is permanently excludible from gross income in all
circumstances in which the applicable
provision of the Internal Revenue Code
applies. For example, income that is excludible from gross income under section
101 (certain death benefits) or section 103
(interest on state and local bonds) is taxexempt income, while income that is excludible from gross income under section
108 (income from discharge of indebtedness) or section 109 (improvements by
lessee on lessor’s property) is not tax-exempt income;
(ix) The corporation’s adjustments described in sections 56 and 58, and items
of tax preference described in section 57;
and
(x) Any item identified in guidance (including forms and instructions) issued by
the Commissioner as an item required to
be separately stated under this paragraph
(a)(2).
(3) Nonseparately computed income or
loss. Each shareholder must take into account separately the shareholder’s pro
rata share of the nonseparately computed
income or loss of the S corporation. For
this purpose, nonseparately computed income or loss means the corporation’s
gross income less the deductions allowed
to the corporation under chapter 1 of the
Internal Revenue Code, determined by
excluding any item requiring separate
computation under paragraph (a)(2) of
this section.
(4) Separate activities requirement. An
S corporation must report, and each
shareholder must take into account in the
shareholder’s return, the shareholder’s
January 10, 2000
pro rata share of an S corporation’s items
of income, loss, deduction, or credit described in paragraphs (a)(2) and (3) of this
section for each of the corporation’s activities as defined in section 469 and the regulations thereunder.
(5) Aggregation of deductions or exclusions for purposes of limitations—(i) In
general. A shareholder aggregates the
shareholder’s separate deductions or exclusions with the shareholder’s pro rata
share of the S corporation’s separately
stated deductions or exclusions in determining the amount of any deduction or
exclusion allowable to the shareholder
under subtitle A of the Internal Revenue
Code as to which a limitation is imposed.
(ii) Example. The provisions of paragraph (a)(5)(i) of this section are illustrated by the following example:
Example. In 1999, Corporation M, a calendar
year S corporation, purchases and places in service
section 179 property costing $10,000. Corporation
M elects to expense the entire cost of the property.
Shareholder A owns 50 percent of the stock of Corporation M. Shareholder A’s pro rata share of this
item after Corporation M applies the section 179(b)
limitations is $5,000. Because the aggregate amount
of Shareholder A’s pro rata share and separately acquired section 179 expense may not exceed $19,000
(the aggregate maximum cost that may be taken into
account under section 179(a) for the applicable taxable year), Shareholder A may elect to expense up to
$14,000 of separately acquired section 179 property
that is purchased and placed in service in 1999, subject to the limitations of section 179(b).
(b) Character of items constituting pro
rata share—(1) In general. Except as
provided in paragraph (b)(2) or (3) of this
section, the character of any item of income, loss, deduction, or credit described
in section 1366(a)(1)(A) or (B) and paragraph (a) of this section is determined for
the S corporation and retains that character in the hands of the shareholder. For
example, if an S corporation has capital
gain on the sale or exchange of a capital
asset, a shareholder’s pro rata share of
that gain will also be characterized as a
capital gain regardless of whether the
shareholder is otherwise a dealer in that
type of property. Similarly, if an S corporation engages in an activity that is not for
profit (as defined in section 183), a shareholder’s pro rata share of the S corporation’s deductions will be characterized as
not for profit. Also, if an S corporation
makes a charitable contribution to an or-
258
ganization qualifying under section
170(b)(1)(A), a shareholder’s pro rata
share of the S corporation’s charitable
contribution will be characterized as
made to an organization qualifying under
section 170(b)(1)(A).
(2) Exception for contribution of noncapital gain property. If an S corporation
is formed or availed of by any shareholder
or group of shareholders for a principal
purpose of selling or exchanging contributed property that in the hands of the
shareholder or shareholders would not
have produced capital gain if sold or exchanged by the shareholder or shareholders, then the gain on the sale or exchange
of the property recognized by the corporation is not treated as a capital gain.
(3) Exception for contribution of capital loss property. If an S corporation is
formed or availed of by any shareholder
or group of shareholders for a principal
purpose of selling or exchanging contributed property that in the hands of the
shareholder or shareholders would have
produced capital loss if sold or exchanged by the shareholder or shareholders, then the loss on the sale or exchange of the property recognized by
the corporation is treated as a capital
loss to the extent that, immediately before the contribution, the adjusted basis
of the property in the hands of the shareholder or shareholders exceeded the fair
market value of the property.
(c) Gross income of a shareholder—(1)
In general. Where it is necessary to determine the amount or character of the
gross income of a shareholder, the shareholder’s gross income includes the shareholder’s pro rata share of the gross income of the S corporation. The
shareholder’s pro rata share of the gross
income of the S corporation is the amount
of gross income of the corporation used in
deriving the shareholder’s pro rata share
of S corporation taxable income or loss
(including items described in section
1366(a)(1)(A) or (B) and paragraph (a) of
this section). For example, a shareholder
is required to include the shareholder’s
pro rata share of S corporation gross income in computing the shareholder’s
gross income for the purposes of determining the necessity of filing a return
(section 6012(a)) and the shareholder’s
gross income derived from farming (sections 175 and 6654(i)).
2000–2 I.R.B.
(2) Gross income for substantial omission of items—(i) In general. For purposes of determining the applicability of
the 6- year period of limitation on assessment and collection provided in section
6501(e) (relating to omission of more
than 25 percent of gross income), a shareholder’s gross income includes the shareholder’s pro rata share of S corporation
gross income (as described in section
6501(e)(1)(A)(i)). In this respect, the
amount of S corporation gross income
used in deriving the shareholder’s pro rata
share of any item of S corporation income, loss, deduction, or credit (as included or disclosed in the shareholder’s
return) is considered as an amount of
gross income stated in the shareholder’s
return for purposes of section 6501(e).
(ii) Example. The following example
illustrates the provisions of paragraph
(c)(2)(i) of this section:
Example. Shareholder A, an individual, owns 25
percent of the stock of Corporation N, an S corporation that has $10,000 gross income and $2,000 taxable
income. A reports only $300 as A’s pro rata share of
N’s taxable income. A should have reported $500 as
A’s pro rata share of taxable income, derived from A’s
pro rata share, $2,500, of N’s gross income. Because
A’s return included only $300 without a disclosure
meeting the requirements of section 6501(e)(1)(A)(ii)
describing the difference of $200, A is regarded as
having reported on the return only $1,500 ($300/$500
of $2,500) as gross income from N.
(d) Shareholders holding stock subject
to community property laws. If a shareholder holds S corporation stock that is
community property, then the shareholder’s pro rata share of any item or
items listed in paragraphs (a)(2), (3), and
(4) of this section with respect to that
stock is reported by the husband and wife
in accordance with community property
rules.
(e) Net operating loss deduction of
shareholder of S corporation. For purposes of determining a net operating loss
deduction under section 172, a shareholder of an S corporation must take into
account the shareholder’s pro rata share
of items of income, loss, deduction, or
credit of the corporation. See section
1366(b) and paragraph (b) of this section
for rules on determining the character of
the items. In determining under section
172(d)(4) the nonbusiness deductions allowable to a shareholder of an S corporation (arising from both corporation
2000–2 I.R.B.
sources and any other sources), the shareholder separately takes into account the
shareholder’s pro rata share of the deductions of the corporation that are not attributable to a trade or business and combines
this amount with the shareholder’s nonbusiness deductions from any other
sources. The shareholder also separately
takes into account the shareholder’s pro
rata share of the gross income of the corporation not derived from a trade or business and combines this amount with the
shareholder’s nonbusiness income from
all other sources. See section 172 and the
regulations thereunder.
(f) Cross-reference. For rules relating
to the consistent tax treatment of subchapter S items, see section 6037(c).
§1.1366-2 Limitations on deduction of
passthrough items of an S corporation to
its shareholders.
(a) In general—(1) Limitation on
losses and deductions. The aggregate
amount of losses and deductions taken
into account by a shareholder under
§1.1366-1(a)(2), (3), and (4) for any taxable year of an S corporation cannot exceed the sum of—
(i) The adjusted basis of the shareholder’s stock in the corporation (as determined under paragraph (a)(3)(i) of this
section); and
(ii) The adjusted basis of any indebtedness of the corporation to the shareholder
(as determined under paragraph (a)(3)(ii)
of this section).
(2) Carryover of disallowance. A
shareholder’s aggregate amount of losses
and deductions for a taxable year in excess of the sum of the adjusted basis of
the shareholder’s stock in an S corporation and of any indebtedness of the S corporation to the shareholder is not allowed
for the taxable year. However, any disallowed loss or deduction retains its character and is treated as incurred by the corporation in the corporation’s first succeeding
taxable year, and subsequent taxable
years, with respect to the shareholder. For
rules on determining the adjusted bases of
stock of an S corporation and indebtedness of the corporation to the shareholder,
see paragraphs (a)(3)(i) and (ii) of this
section.
(3) Basis limitation amount—(i)
Stock portion. A shareholder generally
determines the adjusted basis of stock for
purposes of paragraphs (a)(1)(i) and (2) of
259
this section (limiting losses and deductions) by taking into account only increases in basis under section 1367(a)(1)
for the taxable year and decreases in basis
under section 1367(a)(2)(A), (D) and (E)
(relating to distributions, noncapital,
nondeductible expenses, and certain oil
and gas depletion deductions) for the taxable year. In so determining this loss limitation amount, the shareholder disregards
decreases in basis under section
1367(a)(2)(B) and (C) (for losses and deductions, including losses and deductions
previously disallowed) for the taxable
year. However, if the shareholder has in
effect for the taxable year an election
under §1.1367-1(g) to decrease basis by
items of loss and deduction prior to decreasing basis by noncapital, nondeductible expenses and certain oil and gas
depletion deductions, the shareholder also
disregards decreases in basis under section 1367(a)(2)(D) and (E). This basis
limitation amount for stock is determined
at the time prescribed under §1.13671(d)(1) for adjustments to the basis of
stock.
(ii) Indebtedness portion. A shareholder determines the shareholder’s adjusted basis in indebtedness of the corporation for purposes of paragraphs
(a)(1)(ii) and (2) of this section (limiting
losses and deductions) without regard to
any adjustment under section
1367(b)(2)(A) for the taxable year. This
basis limitation amount for indebtedness
is determined at the time prescribed under
§1.1367-2(d)(1) for adjustments to the
basis of indebtedness.
(4) Limitation on losses and deductions
allocated to each item. If a shareholder’s
pro rata share of the aggregate amount of
losses and deductions specified in
§1.1366-1(a)(2), (3), and (4) exceeds the
sum of the adjusted basis of the shareholder’s stock in the corporation (determined in accordance with paragraph
(a)(3)(i) of this section) and the adjusted
basis of any indebtedness of the corporation to the shareholder (determined in accordance with paragraph (a)(3)(ii) of this
section), then the limitation on losses and
deductions under section 1366(d)(1) must
be allocated among the shareholder’s pro
rata share of each loss or deduction. The
amount of the limitation allocated to any
loss or deduction is an amount that bears
the same ratio to the amount of the limita-
January 10, 2000
tion as the loss or deduction bears to the
total of the losses and deductions. For
this purpose, the total of losses and deductions for the taxable year is the sum of
the shareholder’s pro rata share of losses
and deductions for the taxable year, and
the losses and deductions disallowed and
carried forward from prior years pursuant
to section 1366(d)(2).
(5) Nontransferability of losses and deductions. 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. If a shareholder transfers
some but not all of the shareholder’s stock
in the corporation, the amount of any disallowed loss or deduction under this section is not reduced and the transferee does
not acquire any portion of the disallowed
loss or deduction. If a shareholder transfers all of the shareholder’s stock in the
corporation, any disallowed loss or deduction is permanently disallowed.
(6) Basis of stock acquired by gift. For
purposes of section 1366(d)(1)(A) and
paragraphs (a)(1)(i) and (2) of this section, the basis of stock in a corporation
acquired by gift is the basis of the stock
that is used for purposes of determining
loss under section 1015(a).
(b) Special rules for carryover of disallowed losses and deductions to post-termination transition period described in
section 1377(b)—(1) In general. If, for
the last taxable year of a corporation for
which it was an S corporation, a loss or
deduction was disallowed to a shareholder by reason of the limitation in paragraph (a) of this section, the loss or deduction is treated under section
1366(d)(3) as incurred by that shareholder
on the last day of any post-termination
transition period (within the meaning of
section 1377(b)).
(2) Limitation on losses and deductions. The aggregate amount of losses
and deductions taken into account by a
shareholder under paragraph (b)(1) of this
section cannot exceed the adjusted basis
of the shareholder’s stock in the corporation determined at the close of the last day
of the post-termination transition period.
For this purpose, the adjusted basis of a
shareholder’s stock in the corporation is
determined at the close of the last day of
the post-termination transition period
without regard to any reduction required
January 10, 2000
under paragraph (b)(4) of this section. If
a shareholder disposes of a share of stock
prior to the close of the last day of the
post-termination transition period, the adjusted basis of that share is its basis as of
the close of the day of disposition. Any
losses and deductions in excess of a
shareholder’s adjusted stock basis are permanently disallowed. For purposes of
section 1366(d)(3)(B) and this paragraph
(b)(2), the basis of stock in a corporation
acquired by gift is the basis of the stock
that is used for purposes of determining
loss under section 1015(a).
(3) Limitation on losses and deductions
allocated to each item. If the aggregate
amount of losses and deductions treated
as incurred by the shareholder under paragraph (b)(1) of this section exceeds the
adjusted basis of the shareholder’s stock
determined under paragraph (b)(2) of this
section, the limitation on losses and deductions under section 1366(d)(3)(B)
must be allocated among each loss or deduction. The amount of the limitation allocated to each loss or deduction is an
amount that bears the same ratio to the
amount of the limitation as the amount of
each loss or deduction bears to the total of
all the losses and deductions.
(4) Adjustment to the basis of stock.
The shareholder’s basis in the stock of the
corporation is reduced by the amount allowed as a deduction by reason of this
paragraph (b). For rules regarding adjustments to the basis of a shareholder’s stock
in an S corporation, see §1.1367-1.
(c) Carryover of disallowed losses and
deductions in the case of liquidations, reorganizations, and divisions—(1) Liquidations and reorganizations. If a corporation acquires the assets of an S
corporation in a transaction to which section 381(a) applies, any loss or deduction
disallowed under paragraph (a) of this
section with respect to a shareholder of
the distributor or transferor S corporation
is available to that shareholder as a shareholder of the acquiring corporation.
Thus, where the acquiring corporation is
an S corporation, a loss or deduction of a
shareholder of the distributor or transferor
S corporation disallowed prior to or during the taxable year of the transaction is
treated as incurred by the acquiring S corporation with respect to that shareholder
if the shareholder is a shareholder of the
acquiring S corporation after the transac-
260
tion. Where the acquiring corporation is a
C corporation, a post-termination transition period arises the day after the last day
that an S corporation was in existence and
the rules provided in paragraph (b) of this
section apply with respect to any shareholder of the acquired S corporation that
is also a shareholder of the acquiring C
corporation after the transaction. See the
special rules under section 1377 for the
availability of the post-termination transition period if the acquiring corporation is
a C corporation.
(2) Corporate separations to which
section 368(a)(1)(D) applies. If an S corporation transfers a portion of its assets
constituting an active trade or business to
another corporation in a transaction to
which section 368(a)(1)(D) applies, and
immediately thereafter the stock and securities of the controlled corporation are
distributed in a distribution or exchange
to which section 355 (or so much of section 356 as relates to section 355) applies,
any loss or deduction disallowed under
paragraph (a) of this section with respect
to a shareholder of the distributing S corporation immediately before the transaction is allocated between the distributing
corporation and the controlled corporation with respect to the shareholder. Such
allocation shall be made according to any
reasonable method, including a method
based on the relative fair market value of
the shareholder’s stock in the distributing
and controlled corporations immediately
after the distribution, a method based on
the relative adjusted basis of the assets in
the distributing and controlled corporations immediately after the distribution,
or, in the case of losses and deductions
clearly attributable to either the distributing or controlled corporation, any method
that allocates such losses and deductions
accordingly.
§1.1366-3 Treatment of family groups.
(a) In general. Under section 1366(e),
if an individual, who is a member of the
family of one or more shareholders of an
S corporation, renders services for, or furnishes capital to, the corporation without
receiving reasonable compensation, the
Commissioner shall prescribe adjustments to those items taken into account
by the individual and the shareholders as
may be necessary to reflect the value of
the services rendered or capital furnished.
For these purposes, in determining the
2000–2 I.R.B.
reasonable value for services rendered, or
capital furnished, to the corporation, consideration will be given to all the facts and
circumstances, including the amount that
ordinarily would be paid in order to obtain comparable services or capital from a
person (other than a member of the family) who is not a shareholder in the corporation. In addition, for purposes of section 1366(e), if a member of the family of
one or more shareholders of the S corporation holds an interest in a passthrough
entity (e.g., a partnership, S corporation,
trust, or estate), that performs services for,
or furnishes capital to, the S corporation
without receiving reasonable compensation, the Commissioner shall prescribe
adjustments to the passthrough entity and
the corporation as may be necessary to reflect the value of the services rendered or
capital furnished. For purposes of section
1366(e), the term family of any shareholder includes only the shareholder’s
spouse, ancestors, lineal descendants, and
any trust for the primary benefit of any of
these persons.
(b) Examples. The provisions of this
section may be illustrated by the following examples:
Example 1. The stock of an S corporation is
owned 50 percent by F and 50 percent by T, the
minor son of F. For the taxable year, the corporation
has items of taxable income equal to $70,000. Compensation of $10,000 is paid by the corporation to F
for services rendered during the taxable year, and no
compensation is paid to T, who rendered no services.
Based on all the relevant facts and circumstances,
reasonable compensation for the services rendered
by F would be $30,000. In the discretion of the Internal Revenue Service, up to an additional $20,000
of the $70,000 of the corporation’s taxable income,
for tax purposes, may be allocated to F as compensation for services rendered. If the Internal Revenue
Service allocates $20,000 of the corporation’s taxable income to F as compensation for services, taxable income of the corporation would be reduced by
$20,000 to $50,000, of which F and T each would be
allocated $25,000. F would have $30,000 of total
compensation paid by the corporation for services
rendered.
Example 2. The stock of an S corporation is
owned by A and B. For the taxable year, the corporation has paid compensation to a partnership that
rendered services to the corporation during the taxable year. The spouse of A is a partner in that partnership. Consequently, if based on all the relevant
facts and circumstances the partnership did not receive reasonable compensation for the services ren-
2000–2 I.R.B.
dered to the corporation, the Internal Revenue Service, in its discretion, may make adjustments to
those items taken into account by the partnership
and the corporation as may be necessary to reflect
the value of the services rendered.
§1.1366-4 Special rules limiting the
passthrough of certain items of an S corporation to its shareholders.
(a) Passthrough inapplicable to section
34 credit. Section 1.1366-1(a) does not
apply to any credit allowable under section 34 (relating to certain uses of gasoline and special fuels).
(b) Reduction in passthrough for tax
imposed on built-in gains. For purposes
of §1.1366-1(a), if for any taxable year of
the S corporation a tax is imposed on the
corporation under section 1374, the
amount of the tax imposed is treated as a
loss sustained by the S corporation during
the taxable year. The character of the
deemed loss is determined by allocating
the loss proportionately among the net
recognized built-in gains giving rise to the
tax and attributing the character of each
net recognized built-in gain to the allocable portion of the loss.
(c) Reduction in passthrough for tax
imposed on excess net passive income.
For purposes of §1.1366-1(a), if for any
taxable year of the S corporation a tax is
imposed on the corporation under section
1375, each item of passive investment income shall be reduced by an amount that
bears the same ratio to the amount of the
tax as the amount of the item bears to the
total net passive investment income for
that taxable year.
§1.1366-5 Effective date.
Sections 1.1366-1 through 1.1366-4
apply to taxable years of an S corporation
beginning on or after August 18, 1998.
Par. 3. Section 1.1367-0 is amended in
the table as follows:
1. The entries for §1.1367-1(e) through
(g) are revised.
2. The entries for §1.1367-1(h)
through (j) are added.
The additions and revisions read as follows:
§1.1367-0 Table of contents.
*****
§1.1367-1 Adjustments to basis of shareholder’s stock in an S corporation.
*****
(e) Ordering rules for taxable years beginning before January 1, 1997.
(f) Ordering rules for taxable years begin-
261
ning on or after
August 18, 1998.
(g) Elective ordering rule.
(h) Examples.
(i) [Reserved]
(j) Adjustments for items of income in respect of a decedent.
*****
Par. 4. Section 1.1367-1 is amended as
follows:
1. The paragraph heading and introductory text of paragraph (e) are revised.
2. Paragraphs (f) and (g) are redesignated as paragraphs (g) and (h), respectively.
3. New paragraph (f) is added.
4. The first and second sentences of
newly designated paragraph (g) are revised.
5. Newly designated paragraph (h) is
amended as follows:
a. The heading for Example 1 is revised.
b. Example 2 and Example 3 are redesignated as Example 3 and Example 4, respectively.
c. New Example 2 is added.
d. The heading of newly designated
Example 4 is revised.
e. Example 5 is added.
6. Paragraph (i) is added and reserved
and paragraph (j) is added.
The additions and revisions read as follows:
§1.1367-1 Adjustments to basis of shareholder’s stock in an S corporation.
*****
(e) Ordering rules for taxable years beginning before January 1, 1997. For any
taxable year of a corporation beginning
before January 1, 1997, except as provided in paragraph (g) of this section, the
adjustments required by section 1367(a)
are made in the following order—
*****
(f) Ordering rules for taxable years beginning on or after August 18, 1998. For
any taxable year of a corporation beginning on or after August 18, 1998, except
as provided in paragraph (g) of this section, the adjustments required by section
1367(a) are made in the following
order—
(1) Any increase in basis attributable to
the income items described in section
1367(a)(1)(A) and (B), and the excess of
the deductions for depletion described in
section 1367(a)(1)(C);
January 10, 2000
(2) Any decrease in basis attributable to
a distribution by the corporation described in section 1367(a)(2)(A);
(3) Any decrease in basis attributable
to noncapital, nondeductible expenses described in section 1367(a)(2)(D), and the
oil and gas depletion deduction described
in section 1367(a)(2)(E); and
(4) Any decrease in basis attributable to
items of loss or deduction described in
section 1367(a)(2)(B) and (C).
(g) Elective ordering rule. A shareholder may elect to decrease basis under
paragraph (e)(3) or (f)(4) of this section,
whichever applies, prior to decreasing
basis under paragraph (e)(2) or (f)(3) of
this section, whichever applies. If a
shareholder makes this election, any
amount described in paragraph (e)(2) or
(f)(3) of this section, whichever applies,
that is in excess of the shareholder’s basis
in stock and indebtedness is treated,
solely for purposes of this section, as an
amount described in paragraph (e)(2) or
(f)(3) of this section, whichever applies,
in the succeeding taxable year. * * *
(h) * * *
Example 1. Adjustments to basis of stock for taxable years beginning before January 1, 1997. * * *
Example 2. Adjustments to basis of stock for taxable years beginning on or after August 18, 1998. (i)
On December 31, 2001, A owns a block of 50 shares
of stock with an adjusted basis per share of $6 in
Corporation S. On December 31, 2001, A purchases
for $400 an additional block of 50 shares of stock
with an adjusted basis of $8 per share. Thus, A
holds 100 shares of stock for each day of the 2002
taxable year. For S’s 2002 taxable year, A’s pro rata
share of the amount of items described in section
1367(a)(1)(A) (relating to increases in basis of
stock) is $300, A’s pro rata share of the amount of
the items described in section 1367(a)(2)(B) (relating to decreases in basis of stock attributable to
items of loss and deduction) is $300, and A’s pro rata
share of the amount of the items described in section
1367(a)(2)(D) (relating to decreases in basis of stock
attributable to noncapital, nondeductible expenses)
is $200. S makes a distribution to A in the amount
of $100 during 2002.
(ii) Pursuant to the ordering rules of paragraph (f)
of this section, A first increases the basis of each
share of stock by $3 ($300/100 shares) and then decreases the basis of each share by $1 ($100/100
shares) for the distribution. A next decreases the
basis of each share by $2 ($200/100 shares) for the
noncapital, nondeductible expenses and then decreases the basis of each share by $3 ($300/100
shares) for the items of loss. Thus, on January 1,
January 10, 2000
2003, A has a basis of $3 per share in the original
block of 50 shares ($6 + $3 - $1 - $2 - $3) and a
basis of $5 per share in the second block of 100
shares ($8 + $3 - $1 - $2 - $3).
*****
Example 4. Effects of section 1377(a)(2) election
and distribution on basis of stock for taxable years
beginning before January 1, 1997. * * *
Example 5. Effects of section 1377(a)(2) election
and distribution on basis of stock for taxable years
beginning on or after August 18, 1998. (i) The facts
are the same as in Example 4, except that all of the
events occur in 2001 rather than in 1994 and except
as follows: On June 30, 2001, B sells 25 shares of
her stock for $5,000 to D and 25 shares back to Corporation S for $5,000. Under section 1377(a)(2)(B)
and §1.1377-1(b)(2), B and C are affected shareholders because B has transferred shares to Corporation S. Pursuant to section 1377(a)(2)(A) and
§1.1377-1(b)(1), B and C, the affected shareholders,
and Corporation S agree to treat the taxable year
2001 as if it consisted of two separate taxable years
for all affected shareholders for the purposes set
forth in §1.1377-1(b)(3)(i).
(ii) On June 30, 2001, B and C, pursuant to the
ordering rules of paragraph (f)(1) of this section, increase the basis of each share by $60 ($6,000/100
shares) for the nonseparately computed income.
Then B and C reduce the basis of each share by $120
($12,000/100 shares) for the distribution. Finally, B
and C decrease the basis of each share by $40
($4,000/100 shares) for the separately stated deduction item.
(iii) The basis of the stock of B is reduced from
$120 to $20 per share ($120 + $60 - $120 - $40).
Prior to accounting for the separately stated deduction item, the basis of the stock of C is reduced from
$80 to $20 ($80 + $60 - $120). Finally, because the
period from January 1 through June 30, 2001 is
treated under §1.1377-1(b)(3)(i) as a separate taxable year for purposes of making adjustments to the
basis of stock, under section 1366(d) and §1.13662(a)(2), C may deduct only $20 per share of the remaining $40 of the separately stated deduction item,
and the basis of the stock of C is reduced from $20
per share to $0 per share. Under section 1366 and
§1.1366-2(a)(2), C’s remaining separately stated deduction item of $20 per share is treated as having
been incurred in the first succeeding taxable year of
Corporation S, which, for this purpose, begins on
July 1, 2001.
(i) [Reserved]
(j) Adjustments for items of income in
respect of a decedent. The basis determined under section 1014 of any stock in
an S corporation is reduced by the portion
of the value of the stock that is attributable to items constituting income in re-
262
spect of a decedent. For the determination of items realized by an S corporation
constituting income in respect of a decedent, see sections 1367(b)(4)(A) and 691
and applicable regulations thereunder.
For the determination of the allowance of
a deduction for the amount of estate tax
attributable to income in respect of a
decedent, see section 691(c) and applicable regulations thereunder.
Par. 5. §1.1367-3 is revised to read as
follows:
§1.1367-3 Effective date and transition
rule.
Except for §1.1367-1(f), (h) Example 2
and Example 5, and (j), §§1.1367-1 and
1.1367-2 apply to taxable years of the
corporation beginning on or after January
1, 1994. Section 1.1367-1(f), (h) Example 2 and Example 5, and (j) apply only to
taxable years of the corporation beginning
on or after August 18, 1998. For taxable
years beginning before January 1, 1994,
and taxable years beginning on or after
January 1, 1997, and before August 18,
1998, the basis of a shareholder’s stock
must be determined in a reasonable manner, taking into account the statute and
legislative history. Except for §1.13671(f), (h) Example 2 and Example 5, and
(j), return positions consistent with
§§1.1367-1 and 1.1367-2 are reasonable
for taxable years beginning before January 1, 1994. Return positions consistent
with §1.1367-1(f), (h) Example 2 and Example 5, and (j) are reasonable for taxable
years beginning on or after January 1,
1997, and before August 18, 1998.
Par. 6. Section 1.1368-0 is amended in
the table as follows:
1. The entry for §1.1368-1(e) is revised and entries for §1.1368-1(e)(1) and
(2) are added.
2. The entry for §1.1368-2(a)(4) is revised.
3. An entry for §1.1368-2(a)(5) is
added.
4. The entry for §1.1368-2(d) is revised.
The additions and revisions read as follows:
§1.1368-0 Table of contents.
*****
§1.1368-1 Distributions by S corporations.
*****
(e) Certain adjustments taken into account.
2000–2 I.R.B.
(1) Taxable years beginning before January 1, 1997.
(2) Taxable years beginning on or after
August 18, 1998.
*****
§1.1368-2 Accumulated adjustments account (AAA).
(a) * * *
(4) Ordering rules for the AAA for taxable
years beginning before January 1, 1997.
(5) Ordering rules for the AAA for taxable
years beginning on or after August 18,
1998.
*****
(d) Adjustment in the case of redemptions, liquidations, reorganizations, and
divisions.
*****
Par. 7. Section 1.1368-1 is amended by
revising paragraphs (d)(1) and (e) to read
as follows:
§1.1368-1 Distributions by S corporations.
*****
(d) S corporation with earnings and
profits—(1) General treatment of distribution. Except as provided in paragraph
(d)(2) of this section, a distribution made
with respect to its stock by an S corporation that has accumulated earnings and
profits as of the end of the taxable year of
the S corporation in which the distribution
is made is treated in the manner provided
in section 1368(c). See section 316 and
§1.316-2 for provisions relating to the allocation of earnings and profits among
distributions.
*****
(e) Certain adjustments taken into account—(1) Taxable years beginning before January 1, 1997. For any taxable
year of the corporation beginning before
January 1, 1997, paragraphs (c) and (d) of
this section are applied only after taking
into account—
(i) The adjustments to the basis of the
shares of a shareholder’s stock described
in section 1367 (without regard to section
1367(a)(2)(A) (relating to decreases attributable to distributions not includible in
income)) for the S corporation’s taxable
year; and
(ii) The adjustments to the AAA required by section 1368(e)(1)(A) (but
without regard to the adjustments for distributions under §1.1368-2(a)(3)(iii)) for
the S corporation’s taxable year.
(2) Taxable years beginning on or after
2000–2 I.R.B.
August 18, 1998. For any taxable year of
the corporation beginning on or after August 18, 1998, paragraphs (c) and (d) of
this section are applied only after taking
into account—
(i) The adjustments to the basis of the
shares of a shareholder’s stock described
in section 1367(a)(1) (relating to increases in basis of stock) for the S corporation’s taxable year; and
(ii) The adjustments to the AAA required by section 1368(e)(1)(A) (but
without regard to the adjustments for distributions under §1.1368-2(a)(3)(iii)) for
the S corporation’s taxable year. Any net
negative adjustment (as defined in section
1368(e)(1)(C)(ii)) for the taxable year
shall not be taken into account.
*****
Par. 8. Section 1.1368-2 is amended as
follows:
1. Paragraphs (a)(1) and (a)(3)(ii), and
the paragraph heading and introductory
text of paragraph (a)(4) are revised.
2. Paragraph (a)(5) is added.
3. The paragraph heading for paragraph (d) is revised.
The additions and revisions read as follows:
§1.1368-2 Accumulated adjustments account (AAA).
(a)
Accumulated
adjustments
account—(1) In general. The accumulated adjustments account is an account of
the S corporation and is not apportioned
among shareholders. The AAA is relevant for all taxable years beginning on or
after January 1, 1983, for which the corporation is an S corporation. On the first
day of the first year for which the corporation is an S corporation, the balance of
the AAA is zero. The AAA is increased in
the manner provided in paragraph (a)(2)
of this section and is decreased in the
manner provided in paragraph (a)(3) of
this section. For the adjustments to the
AAA in the case of redemptions, liquidations, reorganizations, and corporate separations, see paragraph (d) of this section.
*****
(3) * * *
(ii) Extent of allowable reduction. The
AAA may be decreased under paragraph
(a)(3)(i) of this section below zero. The
AAA is decreased by noncapital, nondeductible expenses under paragraph
(a)(3)(i)(C) of this section even though a
portion of the noncapital, nondeductible
263
expenses is not taken into account by a
shareholder under §1.1367-1(g) (relating
to the elective ordering rule). The AAA is
also decreased by the entire amount of
any loss or deduction even though a portion of the loss or deduction is not taken
into account by a shareholder under section 1366(d)(1) or is otherwise not currently deductible under the Internal Revenue Code. However, in any subsequent
taxable year in which the loss, deduction,
or noncapital, nondeductible expense is
treated as incurred by the corporation
with respect to the shareholder under section 1366(d)(2) or §1.1367-1(g) (or in
which the loss or deduction is otherwise
allowed to the shareholder), no further adjustment is made to the AAA.
*****
(4) Ordering rules for the AAA for taxable years beginning before January 1,
1997. For any taxable year beginning before January 1, 1997, the adjustments to
the AAA are made in the following
order—
*****
(5) Ordering rules for the AAA for taxable years beginning on or after August
18, 1998. For any taxable year of the S
corporation beginning on or after August
18, 1998, the adjustments to the AAA are
made in the following order—
(i) The AAA is increased under paragraph (a)(2) of this section before it is decreased under paragraph (a)(3)(i) of this
section for the taxable year;
(ii) The AAA is decreased under paragraph (a)(3)(i) of this section (without
taking into account any net negative adjustment (as defined in section
1368(e)(1)(C)(ii)) before it is decreased
under paragraph (a)(3)(iii) of this section;
(iii) The AAA is decreased (but not
below zero) by any portion of an ordinary
distribution to which section 1368(b) or
(c)(1) applies;
(iv) The AAA is decreased by any net
negative adjustment (as defined in section
1368(e)(1)(C)(ii)); and
(v) The AAA is adjusted (whether negative or positive) for redemption distributions under paragraph (d)(1) of this section.
*****
(d) Adjustment in the case of redemptions, liquidations, reorganizations, and
divisions * * *
*****
January 10, 2000
Par. 9. Section 1368-3 is amended as
follows:
1. The heading for Example 1 is revised.
2. Example 3 through Example 6 are redesignated as Example 6 through Example 9, respectively.
3. Example 2 is redesignated as Example 3.
4. The heading for newly redesignated
Example 3 is revised.
5. New Example 2, Example 4, and Example 5 are added.
The revisions and additions read as follows:
§1.1368-3 Examples.
*****
Example 1. Distributions by S corporations
without C corporation earnings and profits for taxable years beginning before January 1, 1997. * * *
Example 2. Distributions by S corporations
without earnings and profits for taxable years beginning on or after August 18, 1998. (i) Corporation S,
an S corporation, has no earnings and profits as of
January 1, 2001, the first day of its 2001 taxable
year. S’s sole shareholder, A, holds 10 shares of S
stock with a basis of $1 per share as of that date. On
March 1, 2001, S makes a distribution of $38 to A.
The balance in Corporation S’s AAA is $100. For
S’s 2001 taxable year, A’s pro rata share of the
amount of the items described in section 1367(a)(1)
(relating to increases in basis of stock) is $50. A’s
pro rata share of the amount of the items described
in sections 1367(a)(2)(B) through (D) (relating to
decreases in basis of stock for items other than distributions) is $26, $20 of which is attributable to
items described in section 1367(a)(2)(B) and (C)
and $6 of which is attributable to items described in
section 1367(a)(2)(D) (relating to decreases in basis
attributable to noncapital, nondeductible expenses).
(ii) Under section 1368(d)(1) and §1.13681(e)(1) and (2), the adjustments to the basis of A’s
stock in S described in sections 1367(a)(1) are made
before the distribution rules of section 1368 are applied. Thus, A’s basis per share in the stock is $6.00
($1 + [$50/10]) before taking into account the distribution. Under section 1367(a)(2)(A), the basis of
A’s stock is decreased by distributions to A that are
not includible in A’s income. Under §1.13671(c)(3), the amount of the distribution that is attributable to each share of A’s stock is $3.80 ($38 distribution/10 shares). Thus, A’s basis per share in the
stock is $2.20 ($6.00 - $3.80), after taking into account the distribution. Under section 1367(a)(2)(D),
the basis of each share of A’s stock in S after taking
into account the distribution, $2.20, is decreased by
$.60 ($6 noncapital, nondeductible expenses/10).
Thus, A’s basis per share after taking into account
January 10, 2000
the nondeductible, noncapital expenses is $1.60.
Under section 1367(a)(2)(B) and (C), A’s basis per
share is further decreased by $2 ($20 items described in section 1367(a)(2)(B) and (C)/10 shares).
However, basis may not be reduced below zero.
Therefore, the basis of each share of A’s stock is reduced to zero. As of January 1, 2002, A has a basis
of $0 in his shares of S stock. Pursuant to section
1366(d)(2), the $.40 of loss in excess of A’s basis in
each of his shares of S stock is treated as incurred by
the corporation in the succeeding taxable year with
respect to A.
Example 3. Distributions by S corporations with
C corporation earnings and profits for taxable years
beginning before January 1, 1997. * * *
Example 4. Distributions by S corporations with
earnings and profits and no net negative adjustment
for taxable years beginning on or after August 18,
1998. (i) Corporation S, an S corporation, has accumulated earnings and profits of $1,000 and a balance
in the AAA of $2,000 on January 1, 2001. S’s sole
shareholder B holds 100 shares of stock with a basis
of $20 per share as of January 1, 2001. On April 1,
2001, S makes a distribution of $1,500 to B. B’s pro
rata share of the income earned by S during 2001 is
$2,000 and B’s pro rata share of S’s losses is $1,500.
For the taxable year ending December 31, 2001, S
does not have a net negative adjustment as defined
in section 1368(e)(1)(C). S does not make the election under section 1368(e)(3) and §1.1368-1(f)(2) to
distribute its earnings and profits before its AAA.
(ii) The AAA is increased from $2,000 to $4,000
for the $2,000 of income earned during the 2001 taxable year. The AAA is decreased from $4,000 to
$2,500 for the $1,500 of losses. The AAA is decreased from $2,500 to $1,000 for the portion of the
distribution ($1,500) to B that does not exceed the
AAA.
(iii) As of December 31, 2001, B’s basis in his
stock is $10 ($20 + $20 ($2,000 income/100 shares)
- $15 ($1,500 distribution/100 shares) - $15 ($1,500
loss/100 shares).
Example 5. Distributions by S corporations with
earnings and profits and net negative adjustment for
taxable years beginning on or after August 18, 1998.
(i) Corporation S, an S corporation, has accumulated
earnings and profits of $1,000 and a balance in the
AAA of $2,000 on January 1, 2001. S’s sole shareholder B holds 100 shares of stock with a basis of
$20 per share as of January 1, 2001. On April 1,
2001, S makes a distribution of $2,000 to B. B’s pro
rata share of the income earned by S during 2001 is
$2,000 and B’s pro rata share of S’s losses is $3,500.
For the taxable year ending December 31, 2001, S
has a net negative adjustment as defined in section
1368(e)(1)(C). S does not make the election under
section 1368(e)(3) and §1.1368-1(f)(2) to distribute
its earnings and profits before its AAA.
264
(ii) The AAA is increased from $2,000 to $4,000
for the $2,000 of income earned during the 2001 taxable
year.
Because
under
section
1368(e)(1)(C)(ii)and §1.1368-2(a)(ii), the net negative adjustment is not taken into account, the AAA is
decreased from $4,000 to $2,000 for the portion of
the losses ($2,000) that does not exceed the income
earned during the 2001 taxable year. The AAA is reduced from $2,000 to zero for the portion of the distribution to B ($2,000) that does not exceed the
AAA. The AAA is decreased from zero to a negative
$1,500 for the portion of the $3,500 of loss that exceeds the $2,000 of income earned during the 2001
taxable year.
(iii) Under §1.1367-1(c)(1), the basis of a shareholder’s share in an S corporation stock may not be
reduced below zero. Accordingly, as of December
31, 2001, B’s basis per share in his stock is zero ($20
+ $20 income - $20 distribution - $35 loss). Pursuant to section 1366(d)(2), the $15 of loss in excess
of B’s basis in each of his shares of S stock is treated
as incurred by the corporation in the succeeding taxable year with respect to B.
*****
Par. 10. §1.1368-4 is revised to read as
follows:
§1.1368-4 Effective date and transition
rule.
Except for §§1.1368-1(e)(2), 1.13682(a)(5), and 1.1368-3 Example 2, Example 4, and Example 5, §§1.1368-1,
1.1368-2, and 1.1368-3 apply to taxable
years of the corporation beginning on or
after January 1, 1994. Section 1.13681(e)(2), §1.1368-2(a)(5), and §1.1368-3
Example 2, Example 4, and Example 5
apply only to taxable years of the corporation beginning on or after August 18,
1998. For taxable years beginning before
January 1, 1994, and taxable years beginning on or after January 1, 1997, and before August 18, 1998, the treatment of
distributions by an S corporation to its
shareholders must be determined in a reasonable manner, taking into account the
statute and legislative history. Except
with regard to the deemed dividend rule
under §1.1368-1(f)(3), §1.1368-1(e)(2),
§1.1368-2(a)(5), and §1.1368-3 Example
2, Example 4, and Example 5, return positions consistent with §§1.1368-1, 1.13682, and 1.1368-3 are reasonable for taxable
years beginning before January 1, 1994.
Return positions consistent with
§§1.1368-1(e)(2), 1.1368-2(a)(5), and
1.1368-3 Example 2, Example 4, and Example 5 are reasonable for taxable years
beginning on or after January 1, 1997, and
2000–2 I.R.B.
before August 18, 1998.
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. In §602.101, paragraph (b) is
amended by adding the entry for 1.1366-1
to the table as follows:
§602.101 OMB Control numbers.
*****
(b) * * *
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the office of the Federal Register on December 21, 1999, 8:45 a.m., and published in the
issue of the Federal Register for December 22, 1999,
64 F.R. 71641)
Approved December 13, 1999.
CFR part or section where
identified and described
Current OMB
control No.
*****
1.1366-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1613
*****
Section 1397E.—Credit to
Holders of Qualified Zone
Academy Bonds
What is the 2000 qualified zone academy bond
national limitation for each State, the District of Columbia, and the possessions of the United States?
See Rev. Proc. 2000–10, page 287.
Section 6038.—Information
Reporting With Respect to
Certain Foreign Corporations and
Partnerships
26 CFR 1.6038–2: Information returns required of
United States persons with respect to annual
accounting periods of certain foreign corporations
beginning after December 31, 1962.
T.D. 8850
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Information Reporting With
Respect to Certain Foreign
Partnerships and Certain
Foreign Corporations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
2000–2 I.R.B.
SUMMARY: This document contains
final regulations under section 6038 of
the Internal Revenue Code relating to
information reporting requirements for
United States persons owning interests
in controlled foreign partnerships
(CFPs). This document also contains
amendments to the final regulations
under section 6038 relating to the reporting requirements of U.S. shareholders of certain foreign corporations and
amendments to the final regulations
under section 6038B relating to the reporting requirements with respect to
transfers of property to foreign partnerships and to foreign corporations.
DATES: Effective Dates: These regulations are effective December 29, 1999,
except that §1.6038B-2(a)(5) is effective
January 1, 2000.
Applicability Dates: For dates of applicability, see §§1.6038-2(l), 1.6038-3(l),
and 1.6038B-2(c)(4) and (j)(3).
FOR FURTHER INFORMATION CONTACT: Eliana Dolgoff, (202) 622-3860
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations have been
reviewed and approved by the Office of
Management and Budget in accordance
265
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
numbers 1545-1615, 1545-1617, and
1545-1317. Responses to these collections of information are mandatory.
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
assigned by the Office of Management
and Budget.
The burden of complying with the collection of information required to be reported on Form 8865 is reflected in the
burden for Form 8865.
The burden of complying with the collection of information required to be reported on Form 5471 is reflected in the
burden for Form 5471.
The burden of complying with the collection of information required to be reported on Form 926 is reflected in the
burden for Form 926.
The estimated annual burden per respondent of complying with the collection of information in §1.6038-3(c)(1)(ii)(B) and
(2)(ii)(B) varies from .5 hours to 1.5 hours,
depending on individual circumstances,
with an estimated average of 1 hour.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224, and to the Office of
January 10, 2000
Management and Budget, Attn: Desk
Officer of the Department of the Treasury,
Office of Information and Regulatory Affairs, Washington, DC 20503.
Books or records relating to this collection of information must be retained as
long as their contents may 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
On September 9, 1998, the IRS published in the Federal Register (63 FR
48144 (REG–118966–97, 1998–39 I.R.B.
29)) proposed regulations relating to the reporting requirements under section 6038 of
United States persons that are direct or indirect partners of CFPs. A public hearing on
the proposed regulations was held on November 10, 1998, even though no requests
to speak at the hearing were received.
Though no comments were made at the
hearing, written comments were received.
After consideration of all of the written
comments, the proposed regulations under
section 6038 are adopted as revised by this
Treasury decision. The revisions are discussed in the Summary of Public Comments and Explanation of Revisions section
of this preamble. This document also contains amendments to certain other final regulations. These amendments are also discussed below.
Summary of Public Comments and
Explanation of Revisions
A. General Comments Regarding the
Proposed Section 6038 CFP Regulations
Some commentators suggested that the
final regulations should exempt state and
local government employee retirement
plans from the section 6038 reporting requirements. The final regulations provide
that trusts relating to state and local government employee retirement plans are not required to report under section 6038, unless
required to do so in the instructions to Form
8865, “Return of U.S. Persons with Respect to Certain Foreign Partnerships.”
One commentator asserted that the reasonable cause exception to the section
6038 penalties appears to apply only to
failures to file Form 8865 and therefore
would not protect a taxpayer who files an
incomplete Form 8865 because the taxpayer was unable to obtain all the re-
January 10, 2000
quired information from the foreign partnership. The reasonable cause exception
has been modified to make clear that it
applies to both a failure to file Form 8865
and to a failure to submit all information
required to be submitted.
Commentators requested that the final
regulations provide that the section 6038
penalties do not apply when there is
minor noncompliance with the reporting
requirements under section 6038. The
commentators expressed concern that taxpayers will be subject to penalties for
small discrepancies in the information reported and suggested that the penalties
apply only if there is a substantial failure
to report the required information, or if
materially false or inaccurate information
is submitted. Because the IRS and Treasury believe adding such a standard might
encourage taxpayers to submit incomplete
Forms 8865, the standard was not added
to the final regulations. A taxpayer may,
nonetheless, avoid application of the section 6038 penalties because of minor noncompliance with the section 6038 reporting requirements by demonstrating
reasonable cause. See §1.6038-3(k)(4).
Commentators also requested that the
IRS add additional, specific reasonable
cause exceptions to the section 6038 penalties. For example, one commentator requested a specific exception be provided
for controlling ten-percent partners (see definition in §1.6038-3(a)(2)) that are unable
to obtain all information required to be reported by controlling ten-percent partners.
The final regulations do not contain additional, specific reasonable cause exceptions. Whether there is reasonable cause
depends on all the facts and circumstances
of the particular case. Any person who is
unable to obtain information may apply for
a reasonable cause determination specific
to that person’s situation.
Finally, a commentator asked that in
the case of an affiliated group of corporations filing a consolidated income tax return, the final regulations not require the
members to file separate Forms 8865 if
one member of the group files Form
8865. The final regulations adopt this
recommendation. The common parent
corporation of an affiliated group of corporations filing a consolidated income tax
return may file one Form 8865 on behalf
of all other members of the group required to file Form 8865 pursuant to sec-
266
tion 6038 with respect to a particular foreign partnership.
B. Section 6038/Section 6031 Overlap.
Some commentators requested that the
final regulations address the potential overlap between section 6031 and section 6038.
In general, section 6031(e) provides that a
foreign partnership must file Form 1065,
“U.S. Partnership Return of Income,” if it
has gross income derived from sources
within the United States or gross income
that is effectively connected with the conduct of a trade or business within the United
States. Section 6038 provides generally that
a U.S. partner of a foreign partnership must
file Form 8865 with respect to that partnership if the partner individually, or collectively with other ten- percent or greater U.S.
partners, owns more than a fifty-percent interest in the partnership. Therefore, in some
cases, both Forms 1065 and 8865 would be
required to be filed with regard to the same
partnership for the same tax year of the partnership. Although the two forms are not
identical, and one is filed by the partnership
while the other is filed by the relevant partners, the information required by the two
forms is substantially the same.
Additionally, some confusion may result from the fact that the two forms contain similarly titled schedules. In particular, each form has a Schedule K-1 on
which information about a partner’s distributive share of partnership income, deductions, etc., is to be reported. The IRS
is working to eliminate discrepancies between the two schedules. However, even
if the discrepancies are eliminated, it is
still possible the two schedules will not
contain identical information because one
schedule will be prepared by a partner and
one will be prepared by the partnership.
In response to the comments that the
overlap between section 6031 and section
6038 reporting will be burdensome to taxpayers when both sets of requirements
apply, and to help avoid any confusion on
the part of taxpayers with respect to
which Schedule K-1 they should use to
compute their tax liabilities, the final section 6038 regulations reduce the burden
imposed by section 6038 in the case of an
overlap. They provide that if a foreign
partnership completes and files Form
1065, a U.S. person required to report
under section 6038 must use a copy of the
filed Form 1065, including the Schedules
K-1, in conjunction with fulfilling the
2000–2 I.R.B.
person’s section 6038 reporting obligation. Specifically, the instructions to
Form 8865 will state which schedules on
Form 1065 are considered equivalent to
schedules on Form 8865. A U.S. partner
must attach to the partner’s Form 8865 a
copy of the Form 1065 schedules that are
considered equivalent to the schedules the
partner is required to complete on Form
8865 as a controlling fifty-percent partner
(see definition in §1.6038-3(a)(1)) or as a
controlling ten-percent partner. A partner
should not complete a schedule on Form
8865 when the partner attaches a copy of
the equivalent Form 1065 schedule to its
Form 8865. Should a schedule on Form
8865 ask for information that is not required to be reported on the equivalent
Form 1065 schedule, the partner is not required to report that information on its
Form 8865 if a copy of the completed
equivalent Form 1065 schedule is attached to its Form 8865. A partner attaching copies of schedules from Form 1065
to its Form 8865 must still complete the
parts of Form 8865 that the person is required to complete as a controlling fiftypercent partner, or as a controlling tenpercent partner, and for which there is no
equivalent Form 1065 schedule (for example, a partner must still complete the
first page of Form 8865 and certain
schedules on page two of the form).
An example of how a person will use a
completed Form 1065 to fulfill its section
6038 filing obligation is as follows. Section
1.6038-3(g)(2)(iii) requires a controlling
fifty-percent partner to report aggregate information about the partners’ distributive
shares of income, gain, losses, deductions
and credits. Such information is reported on
Schedule K of Form 8865. The same information is also required to be submitted on
Schedule K of Form 1065. The instructions
to Form 8865 will provide that Schedules K
on Forms 1065 and 8865 are equivalent.
Accordingly, if the partnership completes
and files a Form 1065, a controlling fiftypercent partner filing Form 8865 must attach
a copy of the Schedule K from the Form
1065 to the partner’s Form 8865 and should
not complete Schedule K on Form 8865.
The partner must also attach all other Form
1065 schedules that are considered equivalent to Form 8865 schedules that the partner
must complete as a controlling fifty-percent
partner. Additionally, the partner must still
complete page one of Form 8865 and Sched-
2000–2 I.R.B.
ules A ”Constructive Ownership of Partnership Interest,” A-1 “Certain Partners of Foreign Partnership,” A-2 “Affiliation Schedule,” and N “Transactions Between
Controlled Foreign Partnership and Partners
or Other Related Entities” of Form 8865.
Similarly, a controlling ten-percent
partner must submit on Schedule K-1 of
Form 8865 a statement of the income,
gain, losses, deductions and credits allocated to the partner’s direct interest in the
partnership. See §1.6038-3(g)(1)(i). The
same information is also required to be reported on Schedule K-1 of Form 1065.
Therefore, if the partnership completes
and files Form 1065, the partner must attach to its Form 8865 a copy of its Schedule K-1 from the Form 1065 completed
by the partnership and should not complete Schedule K-1 on Form 8865. The
partner is still required to complete the
portions of pages one and two of Form
8865 applicable to controlling ten-percent
partners, as well as Schedule N.
Another comment asserted that the proposed regulations imposed an excessive
reporting burden on taxpayers and that
they had the effect of nullifying the section 6031(e) limitation on reporting required of foreign partnerships. The comment suggested that the IRS require only
those items specifically enumerated in
section 6038(a)(1) to be reported under
section 6038.
Section 6038 grants the IRS authority
to require taxpayers to submit more than
the items enumerated in section
6038(a)(1). Section 6038 provides that
the Secretary may require the furnishing
of any other information that is similar or
related in nature to that specified in the
first sentence of section 6038(a)(1), or
which the Secretary determines to be appropriate to carry out the provision of
Title 26. The IRS has determined that all
of the information that the final section
6038 regulations require taxpayers to submit is necessary for the IRS to carry out
the provisions of Title 26.
Additionally, as explained above, section
6031(e) and section 6038 differ with respect to whom they require to report and
when the reporting obligation applies. Section 6031(e) applies only to the requirement that a Form 1065 be filed, to the application of the TEFRA partnership-level
audit procedures, and to the requirement
that a partnership report information about
267
its operations, even when there is limited
U.S. ownership in the partnership. In contrast, section 6038 requires certain U.S.
partners to report information when the foreign partnership in which they own an interest has substantial U.S. ownership. Section 6031(e) was added to the Internal
Revenue Code at the same time that section
6038 was amended to apply to CFPs. See
Taxpayer Relief Act of 1997, Public Law
105-34, sections 1141-1142 (111 Stat.
983)(1997). Therefore, rather than intending section 6031(e) to limit the amount of
information required to be reported pursuant to section 6038, Congress intended
the two provisions to work together to ensure that the IRS receives sufficient information about foreign partnerships.
C. Tiered Partnerships
Commentators requested that section
6038 reporting apply only to first-tier
CFPs, i.e., section 6038 reporting should
only be required of U.S. persons with respect to foreign partnerships in which they
own a direct interest. However, section
6038(e)(3)(B) provides that rules similar to
the rules of section 267(c) shall apply when
determining whether a person owns a fiftypercent interest in a foreign partnership.
Additionally, the statute does not require
that a U.S. person own its interest in the
CFP directly. Therefore, the final regulations require section 6038 reporting of
United States persons whose ownership interests are entirely the result of constructive
ownership from other persons.
Nevertheless, certain exceptions and
modifications to this rule may apply. Persons that do not own direct interests may
qualify for a reduced reporting obligation
pursuant to the exception for constructive
owners in §1.6038-3(c)(2). Additionally,
certain information required by the final
section 6038 regulations must be submitted only if the partner owns a direct interest in the foreign partnership. For example, §1.6038-3(g)(1)(i) provides that the
person reporting under section 6038 must
provide a statement of the income, gain,
losses, deductions and credits allocated to
that person’s direct interest in the partnership. Accordingly, if a person is reporting
under section 6038 but owns no direct interest in the partnership, that person will
not have to submit information under
§1.6038-3(g)(1)(i). Finally, the final regulations require attribution from nonresident alien family members only if the per-
January 10, 2000
son to whom the interest is being attributed already owns a direct or indirect
(under the rules of section 267(c)(1) or
(5)) interest in the partnership. See
§1.6038-3(b)(4).
D. Failure to Recognize That an Arrangement is a Partnership or That a Partnership is a Foreign Partnership
Commentators expressed concern that
taxpayers might fail to report under section 6038 because they failed to recognize
that their arrangement constituted a partnership. Additionally, if no entity is
formed under foreign law, but a partnership is determined to exist, it may be difficult to determine whether the partnership is foreign or domestic. Some
commentators recommended that the IRS
exclude partnerships not formed under a
foreign law statute from the reporting requirements, subject to an anti-abuse rule.
The final regulations do not adopt this
recommendation and additional guidance
on these issues is beyond the scope of this
document. They do, however, provide
that the section 6038 reporting requirements do not apply to any United States
person with respect to a foreign partnership that has validly elected (or is deemed
to have elected) to be excluded from the
application of subchapter K. See
§1.6038-3(e). Additionally, a taxpayer
that does not comply with section 6038
because it mistakenly concluded that its
arrangement was not a partnership, or that
it was not a foreign partnership, may
apply for a reasonable cause determination. See §1.6038-3(k)(4).
E. Section 6038 (CFPs) Effective Date.
Section 1.6038-3 is applicable to CFP
tax years ending on or after December 31,
2000. United States persons are not required to report under section 6038 for
CFP tax years ending before December
31, 2000.
F. Availability of Form 8865.
A United States person required to report information pursuant to section 6038
must do so by completing and filing Form
8865. A final version of Form 8865 will
be released prior to January 1, 2000. Taxpayers will be able to download a copy of
the form and its instructions from the IRS
Internet website located at www.irs.ustreas.gov.
G. Clarification of Section 6501(c)(8).
Section 6501(c)(8) provides that in the
case of information required to be re-
January 10, 2000
ported under section 6038, 6038A,
6038B, 6046, 6046A, or 6048, the time
for assessment of any tax imposed by
Title 26 with respect to any event or period to which such information relates
shall not expire before the date that is
three years after the date on which the
Secretary is furnished the information required to be reported under such section.
Taxpayers have expressed uncertainty
about the application of this rule in the
context of a failure to properly report information required under sections 6038,
6038B, or 6046A, with respect to an interest in a foreign corporation or a foreign
partnership, as applicable. The IRS and
Treasury wish to clarify that if a U.S. person fails to comply with sections 6038,
6038B, or 6046A, the extended statute of
limitations provided by section
6501(c)(8) shall apply only to the tax consequences related to the information required to be reported under the relevant
reporting section and not to all transactions within the U.S. person’s tax year at
issue. For example, if a U.S. person with
a calendar tax year fails to comply with
section 6038 for a controlled foreign partnership’s 2001 calendar tax year, section
6501(c)(8) will only extend the statute of
limitations applicable to the U.S. person’s
2001 tax year with respect to any tax consequences associated with the U.S. person’s interest in the foreign partnership
during the partnership’s 2001 tax year.
H. Amendment to Final Section 6038
Foreign Corporation Regulations
In order to reduce the burden that section 6038 imposes on taxpayers, this document also amends the final regulations
under section 6038 applicable to shareholders of certain foreign corporations.
The regulations provide that if a United
States person does not own a direct or indirect interest in the foreign corporation,
but is attributed an interest from a nonresident alien, the person is not required to
report under section 6038. This amendment is effective for tax years of foreign
corporations ending on or after December
29, 1999.
I. Amendments to Final Section 6038B
Regulations Applicable to Transfers of
Property to Foreign Partnerships
On February 5, 1999, the IRS published in the Federal Register final regulations under section 6038B relating to
the information reporting requirements
268
for certain contributions of property by
United States persons to foreign partnerships. See T.D. 8817, 1999–8 I.R.B. 51
(64 FR 5713). This document makes several amendments to those final regulations. Each amendment either reduces the
burden that section 6038B imposes on
taxpayers, or does not affect the burden
imposed by section 6038B.
First, the amount of information required to be submitted by a person reporting a transfer of property to a foreign partnership is reduced. Rather than submit
the names and addresses of all the foreign
partnership’s partners, the person reporting the transfer (the transferor) must provide only the names and
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