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October 20,  2008

Federal Headlines


Final Regulations Address Treatment of Open Account Debt Between S Corporations and Their Shareholders (T.D. 9428)

 

Final regulations have been released regarding the treatment of open account debt between S corporations and their shareholders. The regulations provide rules regarding the definition of open account debt and adjustments in basis of any indebtedness of an S corporation to a shareholder under Code Sec. 1367(b)(2) for shareholder advances and repayments on advances of open account debt.

 

CCH Comment. The regulations were originally proposed in response to F.G. Brooks, Dec. 56,127(M), TC Memo. 2005-204, 90 TCM 172, in which advances of open account debt by taxpayers to their closely held S corporation provided the taxpayers with basis to offset repayments of open account debt made by the company prior to each advance. Because the multiple advances by the taxpayers and repayments by the corporation constituted open account indebtedness, they were treated as a single indebtedness rather than separate indebtedness. The basis of the indebtedness was, therefore, computed by netting, at the close of the year, the advances and repayments of open account debt during the year. As a result, by restoring the basis in their debts, the advances that the taxpayers made to the S corporation shielded them from the realization of gain on debt repayments made during the years at issue. In the preamble to the final regulations, the IRS rejected as inadequate practitioner suggestions that it could adequately address its concerns regarding Brooks through established judicial doctrines such as substance over form, business purpose, sham transaction, and economic substance or through a narrowly drawn anti-abuse rule targeting open account debt.

 

Under the proposed regulations, open account debt was defined as shareholder advances not evidenced by separate written instruments for which the principal amount of the aggregate advances (net of repayments on the advances) does not exceed $10,000 at the close of any day during the S corporation's tax year. Separate advances under a line-of-credit agreement not evidenced by a separate written instrument would be included in the definition.

 

Commentators expressed concerns that the proposed $10,000 aggregate principal threshold was too low for most businesses. The American Institute of Certified Public Accountants (AICPA) recommended that the threshold be "at least $250,000 but preferably $1 million" (TAXDAY, 2007/11/06, I.6). In response, the final regulations adopted a $25,000 aggregate principal threshold amount per shareholder for open account debt. For example, the IRS pointed out, an S corporation with 10 shareholders could receive up to $250,000 of open account debt as long as no single shareholder advanced more than $25,000. Nevertheless, despite the $25,000 threshold amount, the provisions under Code Sec. 7872 and related regulations for corporate-shareholder loans in excess of $10,000 separately apply to open account debt in excess of $10,000 for each advance if the corporation is not required to pay a market rate of interest on the advances.

 

Commentators also expressed concerns that day-to-day monitoring of open account debt would impose an unreasonable burden on shareholders. In response, the final regulations provide that a determination of whether the threshold balance of $25,000 is exceeded will be made at the end of the S corporation's tax year. However, if open account debt is disposed of in whole or in part prior to the end of the S corporation's tax year, the determination of whether the advances and repayments have exceeded the designated aggregate principal amount must be made immediately before the disposition of the debt during that tax year. Further, if a shareholder with open account debt is no longer a shareholder at the end of the S corporation's tax year, the determination must be made immediately before the shareholder's interest in the S corporation is terminated.

 

The final regulations apply to any and all shareholder advances to the S corporation made on or after October 20, 2008, and repayments on those advances by the S corporation. The regulations, however, clarify that, if a shareholder has open account debt (net of prior repayments in the tax year) outstanding prior to the effective date, the rules under prior final regulations (T.D. 8508), published on January 3, 1994, and amended on December 22, 1999 (T.D. 8852), apply to any repayments on such pre-effective date open account debt. Accordingly, that pre-effective date open account debt will not be subject to any aggregate principal threshold dollar amount. The shareholder may not make additional advances with respect to the pre-effective date open account debt since all shareholder advances made on or after the effective date constitute new open account debt subject to the final regulations.

T.D. 9428, 2008FED ¶47,060

Other References:

 

Code Sec. 1367

 

CCH Reference - 2008FED ¶32,100C

 

CCH Reference - 2008FED ¶32,100D

 

Tax Research Consultant

 

CCH Reference - TRC SCORP: 408

CCH Reference - TRC SCORP: 410.10

 

Applicable Federal Rates for November 2008 Released (Rev. Rul. 2008-50)

 

Various prescribed rates for federal income tax purposes for November 2008 have been provided by the IRS. The annual short-term, mid-term, and long-term applicable federal interest rates (AFRs) are 1.63 percent, 2.97 percent and 4.24 percent, respectively. The semiannual short-term, mid-term, and long-term AFRs are 1.62 percent, 2.95 percent and 4.20 percent, respectively. Quarterly short-term, mid-term and long-term AFRs are 1.62 percent, 2.94 percent and 4.18 percent, respectively. Finally, the monthly short-term, mid-term and long-term rates are 1.61 percent, 2.93 percent and 4.16 percent, respectively.

 

The short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for November 2008 for purposes of Code Sec. 1288(b) are 2.20 percent, 3.35 percent, and 4.94 percent, respectively, when annual compounding is used.

 

Additionally, the Code Sec. 382 adjusted federal long-term rate is 4.94 percent, and the long-term tax-exempt rate is 4.94 percent. The Code Sec. 42(b)(2) appropriate percentage for the 70-percent present-value, low-income housing credit is 7.83 percent, and the appropriate percentage for the 30-percent present-value, low-income housing credit is 3.36 percent. Finally, the Code Sec. 7520 AFR for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest is 3.60 percent.

Rev. Rul. 2008-50, 2008FED ¶46,632

Rev. Rul. 2008-50, FINH ¶30,603

Other References:

 

Code Sec. 42

 

CCH Reference - 2008FED ¶173.02

 

CCH Reference - 2008FED ¶176.01

 

CCH Reference - 2008FED ¶4385.03

 

Code Sec. 382

 

CCH Reference - 2008FED ¶17,115.28

 

Code Sec. 642

 

CCH Reference - 2008FED ¶24,308.1885

 

Code Sec. 1274

 

CCH Reference - 2008FED ¶31,310.05

 

Code Sec. 7520

 

CCH Reference - 2008FED ¶42,785.40

 

CCH Reference - FINH ¶22,630.05

 

Code Sec. 7872

 

CCH Reference - FINH ¶18,950.05

 

Tax Research Consultant

 

CCH Reference - TRC ACCTNG: 36,162.05


State Headlines


New Jersey --Multiple Taxes: Governor Proposes Economic Stimulus Package

 

New Jersey Gov. Jon S. Corzine has proposed an economic stimulus package to a joint session of the Legislature that contains the following tax proposals:

 

-- support for pending legislation to allow businesses to carry forward net operating tax losses for up to 20 years (currently, New Jersey allows net operating loss carryforwards for seven years);

 

-- support for the elimination of the "throw out" rule and the regular place of business designation;

 

-- a move toward a single sales factor tax computation;

 

-- a two-year job creation incentive program targeted at businesses with 500 or fewer employees. The proposal would provide small to mid-size businesses in the state with a $3,000 incentive for each new full-time job they create and retain for one year;

 

-- a sales tax credit for qualifying capital investments; and

 

-- a change in the senior property tax freeze program by increasing the income eligibility cap to $80,000 over the next three years, up from the present ceiling of $53,000.

 

Subscribers to CCH Tax Research NetWork can view the entire release.

Press Release,, New Jersey Gov. Jon S. Corzine, October 16, 2008.

 


Washington --Miscellaneous Tax: Seattle Tax for Fire Hydrant Costs Upheld

 

A Seattle tax imposed on Seattle Public Utility (SPU) to pay for fire hydrants and SPU's corresponding rate increases have been upheld by the Washington Supreme Court. SPU formerly paid for hydrants by charging its water ratepayers a flat hydrant fee added to their water charges. The city directed SPU to stop charging ratepayers for hydrants in light of a Washington Supreme Court decision striking down a similar charge for streetlights (Okeson v. City of Seattle, 78 P.3d 1279 (2003)). Seattle then began to pay for the hydrants out of its general fund and raised taxes on SPU to make up the difference.

 

The Supreme Court found that Seattle had complied with the requirements for a valid tax. The city had explicitly stated that it was taxing SPU, the tax was properly adopted, and the tax expressly stated that it was subject to referendum. Also, the 6% limit referenced in Okeson did not apply to taxes on businesses providing water, and Seattle had statutory authority to impose a tax on SPU.

 

SPU illegally charged ratepayers for hydrant costs before 2005 and therefore had to refund the charges for three years as allowed by the applicable statute of limitations. The trial court allowed ratepayers interest of 1%, but the Supreme Court determined they were entitled to interest at the 12% statutory rate applicable to judgments.

Lane v. City of Seattle, Washington Supreme Court, No. 80204-1, October 16, 2008, ¶202-772

 

Other References:

 

Explanations at ¶80-400


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