New Section 385 Regulations for S Corps: Protecting S Elections and Avoiding Debt Reclassification

Analyzing Related-Party Debt Instruments to Withstand IRS Challenge to S Corp Status

Recording of a 110-minute CPE webinar with Q&A


Conducted on Wednesday, August 3, 2016

Recorded event now available

or call 1-800-926-7926
Program Materials

This webinar will provide tax advisers with a critical first look into the impact of IRS proposed Section 385 regulations reclassifying certain related-party debt as equity will have specifically on S corporations and domestic entities. The panel will discuss the scope of the proposed regulations, examine what types of structures and transactions are subject to reclassification as equity, and offer practical guidance for tax advisers to identify debt instruments that could potentially trigger reclassification to equity, leading to a currently taxable event and potentially jeopardizing S corporation status.

Description

The newly-proposed Section 385 regulations, while aimed primarily at multinational transactions, will have far-reaching effects on many U.S. domestic entities. Many commonly employed inter-company loan transactions among related parties, which currently generate interest deductions for the affiliate lending the cash, will be treated as creating equity interests under the proposed regulations. This will reduce the tax benefits of a frequently used vehicle. Additionally, the proposed regulations could put many S elections at risk of being voided, and tax advisers must be able to identify problematic debt structures to avoid severe tax and operational consequences.

The key provision of the proposed regulations allows the IRS to re-characterize certain related-party debt transactions as equity for income tax purposes. This not only can create tax liability for corporations on inter-company loans by disallowing interest deductions, but will jeopardize the S election status of S corporations engaged in covered transactions. The regulations call for the IRS to reclassify these debt obligations into preferred shares, which violates the prohibition against more than one class of S corp stock.

Tax advisers are uniquely positioned to identify those related-party debt obligations that could create a negative tax result or put an S election at risk. Advisers must know the rules and planning options available to avoid a taxable event and protect clients’ S corp status.

Listen as our experienced panel of advisers provides a critical first look at the Section 385 regulations and their potential impact on S corporations and other domestic entities.

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Outline

  1. Related party debt rules
  2. Debt bifurcation rules
  3. Debt reporting requirements
  4. Potential problem transactions in S corporation transactions
  5. Restructuring options to avoid reclassification to preferred shares

Benefits

The panel will discuss these and other critical questions:

  • What is the purpose of the proposed regulations?
  • What common transactions and instruments are subject to possible re-characterization?
  • What impact will the proposed regulations have on documentation requirements?
  • How can tax advisers identify potentially problematic debt transactions in an S corporation’s financials?
  • What planning options are available for S corp advisers to ensure a related-party debt instrument will be respected as debt to avoid reclassification to preferred stock?

Faculty

Matthew A. Stevens
Matthew A. Stevens
Principal
Ernst & Young

Mr. Stevens focuses on planning and controversy matters regarding the U.S. federal income tax consequences of...  |  Read More

Andrew L. Howlett
Andrew L. Howlett

Miller & Chevalier

Mr. Howlett practices in the area of federal income tax with an emphasis on tax planning, tax-related...  |  Read More

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