Daily Tax Update - April 11, 2007


TREASURY AND IRS FINALIZE PORTFOLIO INTEREST REGULATIONS: Today, the Treasury Department and IRS finalized regulations (T.D. 9323) proposed last June regarding the treatment of U.S. source interest paid to a partnership with a nonresident alien or foreign corporation as a partner.

  • Interest payments to 10-percent shareholders do not qualify for the exemption from withholding tax generally applicable to "portfolio interest."  The new rules allow partnerships to be treated as aggregates rather than entities for purposes of determining whether the foreign recipients are 10-percent shareholders.  As such, foreign persons that own less than 10 percent of the U.S. payor indirectly through partnerships can qualify for the exemption even if the partnership owns more than 10 percent of the payor.
  • Significantly, the rules are electively retroactive for all open years (back to the July 18, 1984 effective date of the portfolio interest rules), even though they are nominally effective April 12, 2007.
  • For additional information, contact Phil West or Stanley Smilack.

TREASURY AND IRS Issue Proposed Amendments to Regulations Relating to Treatment of Open Account Debt Between S Corporations and Their Shareholders: Today, Treasury and the IRS released proposed regulations (REG-144859-04) providing rules regarding the definition of open account debt and the adjustments in basis of any indebtedness of an S corporation to a shareholder under section 1367(b)(2) of the Internal Revenue Code for shareholder advances and repayments of open account debt.

  • Current rules under section 1367, as interpreted by the Tax Court in Brooks v. Commissioner, compute the basis of open account indebtedness by netting at the close of the year advances and repayments of open account debt during the year.  The IRS and Treasury are concerned that the rules are being used to indefinitely defer recognition of income on repayment of open account debt.
  • Thus, the proposed regulations would amend Treas. Reg. § 1.1367-2 to narrow the definition of open account debt to include shareholder advances not evidenced by separate written instruments for which the principal amount of the aggregate advances does not exceed $10,000 at the close of any day during the S corporation’s taxable year.  For this purpose, the shareholder would be required to maintain a “running balance” of advances and repayments and of the outstanding principal amount of the open account debt.
  • In addition, the proposed regulations would modify the manner in which repayments on open account debt are accounted for by requiring any net repayment by the shareholder to be taken into account as a general basis adjustment under the current rules and requiring any net advance to be carried forward with the outstanding principal amount of the open account debt.
  • For additional information, contact Aaron Nocjar.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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