Daily Tax Update - June 11, 2012: Proposed Regs Issued Relating To Basis Of Indebtedness Of S Corps To Their Shareholders

PROPOSED REGULATIONS ISSUED RELATING TO BASIS OF INDEBTEDNESS OF S CORPORATIONS TO THEIR SHAREHOLDERS:  Today, Treasury and the Service issued proposed regulations that provide that an S corporation shareholder may increase its basis in debt of the S corporation to the extent the indebtedness is bona fide under general Federal tax principles.  Section 1366(d)(1) provides that the aggregate amount of losses and deductions that a shareholder may take into account for any taxable year cannot exceed the sum of the shareholder’s adjusted basis in stock and adjusted basis of any indebtedness of the S corporation to that shareholder. 

  • The proposed regulations, which will amend Treas. Reg. § 1.1366-2(a), provide that, in order to increase the shareholder’s basis of indebtedness, the loan must represent bona fide indebtedness of the shareholder that runs directly to the shareholder.  The determination of whether indebtedness is bona fide will be made under general Federal tax principles and all of the facts and circumstances.  The preamble indicates that, if a loan transaction represents bona fide indebtedness, it need not otherwise satisfy the “actual economic outlay” doctrine.
  • The proposed regulations also affirm that a shareholder acting as a guarantor of S corporation debt does not create or increase basis of indebtedness for the shareholder simply by becoming a guarantor.
  • The proposed regulations leave unchanged the conclusion in published guidance that a shareholder of an S corporation does not increase its basis in stock for purposes of section 1366(d)(1)(A) upon the contribution of the shareholder’s own unsecured demand promissory note to the corporation.  Treasury and the Service request comments on whether this position (and a similar position in the partnership context), or an alternative based on the capital account maintenance rules in the partnership context, should be promulgated as a regulation.
  • The proposed regulations will be effective upon the publication of final regulations.
  • For additional information, contact - Aaron P. Nocjar - anocjar@steptoe.com

BAUCUS ANNOUNCES GOALS FOR NEW TAX CODE FOR NEW ERA:  In remarks to the Bipartisan Policy Center today, Senate Finance Chairman Max Baucus explained his goals for comprehensive tax reform.  Baucus said tax reform is an opportunity to “cement America's lead in the 21st century global economy, and focusing reform on jobs, competitiveness, innovation and opportunity is the way to accomplish that.”  Baucus also stated that he is “making progress on a detailed tax reform proposal that will attract bipartisan support.”

  • Baucus said, “We need to get our fiscal house in order. . . Any tax reform plan must be developed with a sound budget in mind that reduces deficits and debt.  But the deficit is not our only hurdle – not by a long shot.  Since the last major tax reform in 1986, the world has changed drastically.  Our tax code hasn’t kept up, and now it’s acting as a brake on our economy when we need to move at full speed.  It’s time we had a tax code for the 21st century.”
  • On the issue of global competiveness, Baucus said, “[T]he US has one of the highest statutory corporate tax rates in the world.  We give countless tax breaks to business, but many don’t attract or retain investment.  That’s a waste.  We have stuck with a worldwide system.  But in some ways, we have weakened protections against shifting income to tax havens.  As a result, the US loses billions in revenue every year to tax havens.”
  • On the issue of creating jobs, Baucus said that we need to trim “the fat from the code.”  Baucus added, “Most economists agree that lowering rates and paying for it by getting rid of tax expenditures generates growth.  Tax breaks have doubled since 1986.  They now cost as much in revenue as the entire income tax brings in.  Some are worthwhile, but many fail to create jobs or growth.”  Baucus said that Congress needs to examine the expiring tax extenders to determine which ones need to be permanent and which ones to eliminate.
  • Baucus also said that the United States must support innovation and we should “use tax measures to put research and new technologies on a more level playing field with existing technologies, particularly in the energy sector.”

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
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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