[Federal Register Volume 60, Number 133 (Wednesday, July 12, 1995)]
[Proposed Rules]
[Pages 35881-35887]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-16653]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 18
[PS-268-82]
RIN 1545-AE94
Definitions Under Subchapter S of the Internal Revenue Code
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations for S corporations
and their shareholders relating to the definitions and the special rule
provided in section 1377 of the Internal Revenue Code of 1986. The
proposed regulations reflect changes to the law made by the Subchapter
S Revision Act of 1982. The proposed regulations are necessary to
provide guidance needed by taxpayers to comply with the law.
DATES: Written comments and requests for a public hearing must be
received by October 10, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (PS-268-82), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (PS-268-82),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Brian J.
O'Connor, (202) 622-3060; concerning submissions and the hearing,
Michael Slaughter, (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act (44 U.S.C.
3504(h)). Comments on the collections of information should be sent 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, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC
20224.
A collection of information is required under Sec. 1.1377-1(b).
This information is required by the IRS to verify the event giving rise
to the making of an election under section 1377(a)(2) by an S
corporation. The likely respondents and/or recordkeepers will be S
corporations and shareholders of S corporations.
Estimated total annual reporting burden: 1,000 hours.
The estimated annual burden per respondent varies from .2 hour to
.5 hour, depending on individual circumstances, with an estimated
average of .25 hour.
Estimated number of respondents: 4,000.
Estimated annual frequency of responses: 1.
Background
This document proposes amendments to the Income Tax Regulations (26
CFR part 1) under section 1377 of the Internal Revenue Code (Code).
Section 18.1377-1 was issued by TD 7872 (48 FR 3590). The proposed
regulations would conform the regulations to the addition of section
1377 to the Code by section 2 of the Subchapter S Revision Act of 1982,
Pub. L. 97-354 (1982-2 C.B. 702, 710).
Explanation of Provisions
Shareholder's Pro Rata Share of Items of Income, Loss, Deduction, and
Credit
Section 1366(a)(1) requires a shareholder of an S corporation to
take into account the shareholder's pro rata share of the corporation's
items of income, loss, deduction, and credit. The proposed regulations
provide that, except in the case of an election under section
1377(a)(2), each shareholder's pro rata share of an item for a taxable
year is the sum of the amounts determined with respect to the
shareholder by assigning an equal portion of the item to each day of
the S corporation's taxable year, and then dividing that portion pro
rata among the shares outstanding on that day.
The proposed regulations contain several special rules for
determining a shareholder's pro rata share. First, solely for purposes
of determining a shareholder's pro rata share of an item, an S
corporation's taxable year does not include any day on which the
corporation has no shareholders. This rule ensures that the full amount
of all items of the S corporation will be allocated to the
corporation's shareholders. Second, a shareholder who disposes of stock
of an S corporation is treated as the shareholder for the day of the
disposition. Finally, a shareholder who dies is treated as the
shareholder for the day of the shareholder's death.
Election To Treat Taxable Year as Separate Taxable Years
Under section 1377(a)(2), if a shareholder's interest in an S
corporation is terminated during the taxable year and all persons who
are shareholders during the taxable year agree, the corporation may
elect (terminating election) to apply section 1377(a)(1) as if the
taxable year of the S corporation consisted of two taxable years, the
first of which ends on the date of the termination. The proposed
regulations provide rules concerning the time and manner of making a
terminating election and, therefore, it is proposed that Sec. 18.1377-1
(which provides temporary rules concerning the time and manner of
making a terminating election) be removed. The proposed regulations
also provide that the terminating election is irrevocable and is
effective only for the terminating event for which it is made.
The proposed regulations clarify that a terminating election may be
made only if a shareholder's entire interest as a shareholder in the S
corporation is terminated. A shareholder's entire interest as a
shareholder is terminated under the proposed regulations on the
occurrence of any event through which a shareholder's entire stock
ownership in the S corporation ceases, including a sale, exchange, or
other disposition of all of the stock held by the shareholder; a gift
under section 102(a) of all the shareholder's stock; a spousal transfer
under section 1041(a) of all the shareholder's stock; a redemption, as
defined in section 317(b), of all of the shareholder's stock,
regardless of the tax treatment of the redemption under section 302;
and the death of the shareholder. A shareholder's entire interest in an
S corporation is not terminated under the proposed regulations if the
shareholder retains ownership of any stock that would result in the
shareholder continuing to be considered a shareholder of the
corporation for purposes of section 1362(a)(2). Thus, in determining
whether a shareholder's entire interest in an S corporation has been
terminated, any options held by the shareholder (other than options
that are treated as stock under Sec. 1.1361-1(l)(4)(iii)) and any
interest in the S corporation held by the shareholder as a creditor,
employee, director, or in any other non-shareholder capacity are
disregarded.
The proposed regulations also describe the effects of a terminating
election. Under the proposed regulations, an S corporation that makes a
terminating election must treat its taxable year as two separate
taxable
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years for purposes of computing and allocating to each shareholder
items of income (including tax-exempt income), loss, deduction, and
credit; making adjustments to the accumulated adjustments account
(AAA), earnings and profits, and basis; and determining the tax effect
of a distribution to the shareholders. This treatment is required to
give full effect to treating the taxable year as two separate taxable
years. The proposed regulations also require the S corporation to
assign items of income, loss, deduction, and credit to each deemed
separate taxable year using the corporation's normal method of
accounting as determined under section 446(a). The proposed regulations
provide that a terminating election does not affect the due date of the
S corporation's tax return for the taxable year or the time when the
shareholders must include their pro rata allocations of items from the
S corporation. The proposed regulations also provide that a terminating
election by an S corporation that is a partner in a partnership is
treated as a sale or exchange of the corporation's entire interest in
the partnership for purposes of section 706(c) (closing of the
partnership's taxable year) if the taxable year of the partnership ends
after the shareholder's interest is terminated and within the full
taxable year of the S corporation for which the terminating election is
made. This rule conforms terminating elections with the rule for S
termination years. See Sec. 1.1362-3(c)(1).
The proposed regulations coordinate the application of the
terminating election under section 1377(a)(2) with the election under
section 1362(e)(3) (election to have items assigned to each short
taxable year of an S termination year under normal accounting rules
rather than pro rata) and the election under Sec. 1.1368-1(g)(2)
(election to terminate the taxable year when there is a qualifying
disposition). Under the proposed regulations, if a transfer results in
a termination of the shareholder's entire interest as a shareholder and
the transfer also constitutes a qualifying disposition under
Sec. 1.1368-1(g)(2)(i), the terminating election rules under these
proposed regulations take precedence and a qualifying disposition
election cannot be made. If a termination of a shareholder's entire
interest results in a termination under section 1362(d)(2) of the
corporation's election to be an S corporation, however, the proposed
regulations provide that the corporation may not make a terminating
election. When a corporation's election to be an S corporation
terminates, the portion of the corporation's taxable year ending at the
close of the day preceding the day for which the terminating event is
effective is treated as an S short year, and the remainder is treated
as a C short year. Thus, because the day upon which a terminating event
occurs is the first day of a C short year, as of that date there is no
S corporation taxable year that may be divided into two separate years
under section 1377(a)(2). Under section 1362(e)(2), the income or loss
for the entire S termination year is allocated on a pro rata basis
between the S and C short years. However, if the corporation makes an
election under section 1362(e)(3), the corporation allocates income and
loss to each short taxable year under the corporation's normal tax
accounting rules. Thus, when a corporation makes an election under
section 1362(e)(3), a shareholder of an S corporation may achieve a
result similar to the result of an election under section 1377(a)(2)
and these proposed regulations (which also require an allocation of
income and loss to each short taxable year under normal accounting
rules).
Post-Termination Transition Period
Section 1377(b) provides that the term post-termination transition
period (PTTP) for purposes of subchapter S of chapter 1 of the Code
means: (1) The period beginning on the day after the last day of the
corporation's last taxable year as an S corporation and ending on the
later of the day which is 1 year after such last day, or the due date
for filing the return for the last taxable year as an S corporation
(including extensions); and (2) the 120-day period beginning on the
date of a determination that the corporation's election under section
1362(a) had terminated for a previous taxable year. The PTTP is
relevant for purposes of section 1366(d)(3) (carryover of disallowed
losses after the last taxable year for which a corporation is an S
corporation) and section 1371(e) (distributions of money by a
corporation with respect to its stock after termination of S
corporation status).
The proposed regulations clarify that a PTTP arises following the
termination under section 1362(d) of a corporation's S election. For
example, a PTTP arises in the case of a C corporation that acquires the
assets of an S corporation in a transaction to which section 381(a)(2)
applies. However, if an S corporation acquires the assets of another S
corporation in a transaction to which section 381(a)(2) applies, a PTTP
does not arise. Instead, under Sec. 1.1368-2(d)(2), the acquiring S
corporation succeeds to and merges its AAA with the AAA of the
distributor or transferor S corporation.
The proposed regulations clarify that the last day of a
corporation's last taxable year as an S corporation is the last day of
the short S taxable year under section 1362(e)(1)(A) or the date of
transfer in the event that a C corporation acquires the assets of an S
corporation in a transaction to which section 381(a)(2) applies. The
proposed regulations also provide that the special treatment under
section 1371(e)(1) is available only to those shareholders who were
shareholders in the S corporation at the time of the termination.
The proposed regulations provide additional guidance on the
definition of a determination for purposes of ascertaining when a PTTP
begins under section 1377(b)(1)(B). Under the proposed regulations, a
determination includes a written agreement between an S corporation and
the Commissioner that the corporation failed to qualify as an S
corporation. The agreement must be signed by the appropriate district
director and an authorized officer of the corporation. In addition, if
there is no written agreement, a determination results from the
expiration of the period specified in section 6226 for filing a
petition for readjustment of a final S corporation administrative
adjustment finding that the corporation failed to qualify as an S
corporation, provided that no petition is filed prior to the expiration
of the period. For corporations not subject to the audit and assessment
provisions of subchapter C of chapter 63 of subtitle A (dealing with
the tax treatment of partnership items) a determination results from
the expiration of the period for filing a petition under section 6213
for the shareholder's taxable year for which the Commissioner has made
a finding that the corporation failed to qualify as an S corporation,
provided that no petition was timely filed before the expiration of the
period.
Effective Date
The regulations under section 1377 are proposed to apply to taxable
years of an S corporation beginning after the date of publication as
final regulations in the Federal Register.
Special Analysis
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 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) and the Regulatory
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Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations,
and, therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, this notice
of proposed rulemaking will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact
on small business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying. A public
hearing may be scheduled if requested in writing by a person that
timely submits written comments. If a public hearing is scheduled,
notice of the date, time, and place for the hearing will be published
in the Federal Register.
Drafting Information
The principal author of these regulations is Brian J. O'Connor,
Office of Assistant Chief Counsel (Passthroughs and Special
Industries). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Parts 1 and 18
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 18 are proposed to be 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 as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1377-1 also issued under 26 U.S.C. 1377 (a)(2) and
(c).
Par. 2. Sections 1.1377-0, 1.1377-1, 1.1377-2, and 1.1377-3 are
added under the heading ``Small Business Corporations and Their
Shareholders'' to read as follows:
Sec. 1.1377-0 Table of contents.
The following table of contents is provided to facilitate the use
of Secs. 1.1377-1 through 1.1377-3:
Sec. 1.1377-1 Pro rata share.
(a) Computation of pro rata shares.
(1) In general.
(2) Special rules.
(i) Days without shareholders.
(ii) Determining shareholder for day of stock disposition.
(b) Election to terminate year.
(1) In general.
(2) Effect of the terminating election.
(i) In general.
(ii) Due date of S corporation return.
(iii) Taxable year of inclusion by shareholder.
(iv) S Corporation that is a partner in a partnership.
(3) Determination of whether an S shareholder's entire interest
has terminated.
(4) Time and manner of making terminating election.
(i) In general.
(ii) Shareholders required to consent.
(iii) More than one terminating election.
(c) Examples.
Sec. 1.1377-2 Post-termination transition period.
(a) In general.
(b) When a post-termination transition period arises.
(c) Last day of last taxable year.
(d) Determination defined.
(e) Time of determination.
(1) Court decision.
(2) Closing agreement.
(3) Written agreement.
(4) Implied agreement.
Sec. 1.1377-3 Effective date.
Sec. 1.1377-1 Pro rata share.
(a) Computation of pro rata shares--(1) In general. For purposes of
subchapter S of chapter 1 of the Code and this section, each
shareholder's pro rata share of any S corporation item described in
section 1366(a) for any taxable year is the sum of the amounts
determined with respect to the shareholder by assigning an equal
portion of the item to each day of the S corporation's taxable year,
and then dividing that portion pro rata among the shares outstanding on
that day. See paragraph (b) of this section for rules pertaining to the
computation of each shareholder's pro rata share when an election is
made under section 1377(a)(2) to treat the taxable year of an S
corporation as if it consisted of two taxable years in the case of a
termination of a shareholder's entire interest in the corporation.
(2) Special rules--(i) Days without shareholders. Solely for
purposes of determining a shareholder's pro rata share of an item for a
taxable year under section 1377(a) and this section, an S corporation's
taxable year does not include any day on which the corporation has no
shareholders.
(ii) Determining shareholder for day of stock disposition. A
shareholder who disposes of stock in an S corporation is treated as the
shareholder for the day of the disposition. A shareholder who dies is
treated as the shareholder for the day of the shareholder's death.
(b) Election to terminate year--(1) In general. If a shareholder's
entire interest in an S corporation is terminated during the S
corporation's taxable year and all persons who are shareholders during
the taxable year agree (as prescribed in paragraph (b)(4) of this
section), the S corporation may elect under section 1377(a)(2) and this
paragraph (b) (terminating election) to treat its taxable year as if it
consisted of two separate taxable years, the first of which ends at the
close of the day on which the shareholder's entire interest in the S
corporation is terminated. If the event resulting in the termination of
the shareholder's entire interest also constitutes a qualifying
disposition as described in Sec. 1.1368-1(g)(2), the election under
Sec. 1.1368-1(g)(2) cannot be made. An S corporation may not make a
terminating election if the cessation of a shareholder's interest
occurs in a transaction which results in a termination under section
1362(d)(2) of the corporation's election to be an S corporation. (See
section 1362(e)(3) for an election to have items assigned to each short
taxable year under normal tax accounting rules in the case of a
termination of a corporation's election to be an S corporation.) A
terminating election is irrevocable and is effective only for the
terminating event for which it is made.
(2) Effect of the terminating election--(i) In general. An S
corporation that makes a terminating election for a taxable year must
treat the taxable year as separate taxable years for purposes of
allocating items of income (including tax-exempt income), loss,
deduction, and credit; making adjustments to the accumulated
adjustments account, earnings and profits, and basis; and determining
the tax effect of a distribution to the shareholders. An S corporation
that makes a terminating election must assign items of income
(including tax-exempt income), loss, deduction, and credit to each
deemed separate taxable year using its normal method of accounting as
determined under section 446(a).
(ii) Due date of S corporation return. A terminating election does
not affect the due date of the S corporation's return required to be
filed under section 6037(a) for a taxable year (determined without
regard to a terminating election).
(iii) Taxable year of inclusion by shareholder. A terminating
election does not affect the taxable year in which a shareholder
(including any shareholder whose entire interest in the corporation has
terminated during the
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corporation's taxable year) must take into account the shareholder's
pro rata share of the S corporation's items of income, loss, deduction,
and credit.
(iv) S corporation that is a partner in a partnership. A
terminating election by an S corporation that is a partner in a
partnership is treated as a sale or exchange of the corporation's
entire interest in the partnership for purposes of section 706(c)
(relating to closing the partnership taxable year), if the taxable year
of the partnership ends after the shareholder's interest is terminated
and within the taxable year of the S corporation (determined without
regard to any terminating election) for which the terminating election
is made.
(3) Determination of whether an S shareholder's entire interest has
terminated. For purposes of section 1377(a)(2) and paragraph (b) of
this section, a shareholder's entire interest in an S corporation is
terminated on the occurrence of any event through which a shareholder's
entire stock ownership in the S corporation ceases, including a sale,
exchange, or other disposition of all of the stock held by the
shareholder; a gift under section 102(a) of all the shareholder's
stock; a spousal transfer under section 1041(a) of all the
shareholder's stock; a redemption, as defined in section 317(b), of all
the shareholder's stock, regardless of the tax treatment of the
redemption under section 302; and the death of the shareholder. A
shareholder's entire interest in an S corporation is not terminated if
the shareholder retains ownership of any stock that would result in the
shareholder continuing to be considered a shareholder of the
corporation for purposes of section 1362(a)(2). Thus, in determining
whether a shareholder's entire interest in an S corporation has been
terminated, any options held by the shareholder (other than options
that are treated as stock under Sec. 1.1361-1(l)(4)(iii)) and any
interest held by the shareholder as a creditor, employee, director, or
in any other non-shareholder capacity are disregarded. (See
Sec. 1.1361-1(l)(4)(iii) for circumstances under which an option is
treated as stock of the corporation and, therefore, the holder of the
option is treated as owning a stock interest in the corporation.)
(4) Time and manner of making terminating election--(i) In general.
An S corporation makes a terminating election by attaching a statement
to its timely filed original or amended return required to be filed
under section 6037(a) (that is, a Form 1120S) for the taxable year
during which a shareholder's entire interest is terminated. A single
election statement may be filed by the S corporation for all
terminating elections for the taxable year. The election statement must
include--
(A) A declaration by the S corporation that it is electing under
section 1377(a)(2) and Sec. 1.1377-1(b) to treat the taxable year as if
it consisted of two separate taxable years;
(B) Information setting forth when and how the shareholder's entire
interest was terminated (for example, a sale or gift);
(C) The signature on behalf of the S corporation of an authorized
officer of the corporation under penalties of perjury; and
(D) A notice of consent, signed by each person who is a shareholder
in the S corporation during the taxable year (determined without regard
to the terminating election), including any shareholder whose entire
interest terminates during the taxable year, in which each shareholder
consents to the S corporation making the terminating election.
(ii) Shareholders required to consent. For purposes of paragraph
(b)(4)(i)(D) of this section, a shareholder of the S corporation for
the taxable year is a shareholder as described in section 1362(a)(2).
For example, the person who under Sec. 1.1362-6(b)(2) must consent to a
corporation's S election in certain special cases is the person who
must consent to the terminating election. In addition, an executor or
administrator of an estate of a deceased shareholder may consent to the
terminating election on behalf of the deceased shareholder.
(iii) More than one terminating election. A shareholder whose
entire interest in an S corporation is terminated in an event for which
a terminating election was made is not required to consent to a
terminating election made with respect to a subsequent termination
within the same taxable year of the entire interest of another
shareholder.
(c) Examples. The following examples illustrate the provisions of
this section.
Example 1. General rule. (i) On January 2, 1997, X, a calendar
year corporation, is incorporated. On January 4, 1997, X acquires
assets. On January 6, 1997, X issues 100 shares of common stock to
each of A and B and files an election to be an S corporation
effective for its 1997 taxable year. During its 1997 taxable year, X
has nonseparately computed income (as defined in section 1366(a)(2))
of $720,000.
(ii) Each shareholder's pro rata share of X's nonseparately
computed income for 1997 is determined by assigning an equal portion
of the income to each day of X's taxable year on which X had
shareholders. In the present case, there are only 360 days on which
X had shareholders because X had no shareholders until January 6,
1997. Thus, $2,000 of nonseparately computed income is assigned to
each day that X had shareholders ($720,000/360 days=$2,000 per day).
The amount assigned to each day is multiplied by the percentage of
shares held by the shareholder on that day. Because A and B each
owned 50 percent of the shares of stock outstanding on each day that
X had shareholders, each shareholder's daily pro rata share of X's
nonseparately computed income is $1,000 ($2,000 per day x 50%).
Finally, the amounts of each shareholder's daily pro rata shares are
aggregated to produce the shareholder's pro rata share of X's
nonseparately computed income for 1997. During 1997, A and B each
held X stock for 360 days. Thus, each shareholder's pro rata share
of X's nonseparately computed income for 1997 is $360,000 ($1,000
per day x 360 days).
Example 2. Shareholder's pro rata share in the case of a partial
disposition of stock. (i) X, a newly incorporated calendar year
corporation, issues 100 shares of common stock on January 6, 1997,
to each of A and B and files an election to be an S corporation for
its 1997 taxable year. On July 24, 1997, B sells 50 shares of X
stock to C. Thus, in 1997, A owned 50 percent of the outstanding
shares of X on each day of X's 1997 taxable year on which X had
shareholders, B owned 50 percent on each day from January 6, 1997,
to July 24, 1997 (200 days), and 25 percent from July 25, 1997, to
December 31, 1997 (160 days), and C owned 25 percent from July 25,
1997, to December 31, 1997 (160 days).
(ii) Because B's entire interest in X is not terminated when B
sells 50 shares to C on July 24, 1997, X cannot make a terminating
election under section 1377(a)(2) and paragraph (b) of this section
for B's sale of 50 shares to C. Although B's sale of 50 shares to C
is a qualifying disposition under Sec. 1.1368-1(g)(2)(i), X does not
make an election to terminate its taxable year under Sec. 1.1368-
1(g)(2). During its 1997 taxable year, X has nonseparately computed
income of $720,000.
(iii) For each day in X's 1997 taxable year, A's daily pro rata
share of X's nonseparately computed income is $1,000 ($720,000/360
days x 50%). Thus, A's pro rata share of X's nonseparately computed
income for 1997 is $360,000 ($1,000 x 360 days). B's daily pro rata
share of X's nonseparately computed income is $1,000 ($720,000/
360 x 50%) for the first 200 days of X's taxable year on which X has
shareholders, and $500 ($720,000/360 x 25%) for the following 160
days in 1997. Thus, B's pro rata share of X's nonseparately computed
income for 1997 is $280,000 (($1,000 x 200 days) + ($500 x 160
days)). C's daily pro rata share of X's nonseparately computed
income is $500 ($720,000/360 x 25%) for 160 days in 1997. Thus, C's
pro rata share of X's nonseparately computed income for 1997 is
$80,000 ($500 x 160 days).
Example 3. Shareholder's pro rata share when an S corporation
makes a terminating election under section 1377(a)(2). (i) On
January 6, 1997, X, a newly incorporated calendar year corporation,
issues 100 shares of common stock to each of A and B and files an
election to be treated as an S corporation for its 1997 taxable
year. On July 24, 1997,
[[Page 35886]]
B sells B's entire 100 shares of X corporation stock to C. During its
1997 taxable year, X has nonseparately computed income of $720,000.
X makes an election under section 1377(a)(2) and paragraph (b) of
this section for the termination of B's entire interest arising from
B's sale of 100 shares to C. As a result of the election, each
shareholder's pro rata share is determined as if X's taxable year
consisted of two separate taxable years, the first of which ends on
July 24, 1997, the date B's entire interest in X terminates.
(ii) Under X's normal method of accounting, $200,000 of the
$720,000 of nonseparately computed income is allocable to the period
of January 6, 1997, through July 24, 1997 (the first deemed taxable
year), and the remaining $520,000 is allocable to the period of July
25, 1997, through December 31, 1997 (the second deemed taxable
year).
(iii) The pro rata share of the $200,000 of nonseparately
computed income for each of A and B for the first deemed taxable
year is determined by assigning the $200,000 of nonseparately
computed income to each day of the first deemed taxable year
($200,000/200 days=$1,000 per day). Thus, for each day of the first
deemed taxable year, $1,000 is allocated between A and B based on
their proportionate stock ownership. Because A and B each held 50%
of X's authorized and issued shares on each day of the first deemed
taxable year, the daily pro rata share for each of A and B for each
day of the first deemed taxable year is $500 ($1,000 per day x 50%).
Thus, each shareholder's pro rata share of the $200,000 of
nonseparately computed income for the first deemed taxable year is
$100,000 ($500 per day x 200 days). A and B must report these
amounts for their respective taxable years with or within which X's
full taxable year ends (December 31, 1997).
(iv) The pro rata share of the $520,000 of nonseparately
computed income for each of A and C for the second deemed taxable
year is determined by assigning the $520,000 of nonseparately
computed income to each day of the second deemed taxable year
($520,000/160 days=$3,250 per day). Thus, for each day of the second
deemed taxable year, $3,250 is allocated between A and C based on
their proportionate ownership. Because A and C each held 50% of X's
authorized and issued shares on each day of the second deemed
taxable year, the daily pro rata shares for each of A and C for each
day of the second deemed taxable year is $1,625 ($3,250 per
day x 50%). Therefore, each shareholder's pro rata share of the
$520,000 nonseparately computed income is $260,000 ($1,625 per
day x 160 days). A and C must report these amounts for their
respective taxable years with or within which X's full taxable year
ends (December 31, 1997).
Example 4. Interaction between the terminating election under
section 1377(a)(2) and section 1362(e). (i) On January 1, 1997, X, a
calendar year S corporation, has two shareholders, A and B, owning
60 shares and 40 shares, respectively. On June 29, 1997, B sells B's
40 shares to C. On July 20, 1997, C sells C's 40 shares to P, a
partnership, causing a termination under section 1362(d)(2) of X's
election to be an S corporation. X makes an election under section
1377(a)(2) and paragraph (b) of this section with regard to the
termination of B's entire interest on June 29, 1997. Because the
termination on July 20, 1997, of C's entire interest results in a
termination of X's election to be an S corporation, X cannot make a
terminating election under section 1377(a)(2) and paragraph (b) of
this section with regard to C's sale of 40 shares to P. However, X
makes an election under section 1362(e)(3) to assign items to each
short taxable year of the S termination year under X's normal method
of accounting. X has nonseparately computed income of $530,000 for
its 1997 taxable year.
(ii) As a result of the election under section 1362(e)(3), the
portion of X's taxable year ending at the close of the day prior to
the termination of X's S corporation election (January 1, 1997,
through July 19, 1997) is treated as a short taxable year for which
X is an S corporation, and the portion of the year beginning on the
day the termination is effective (July 20, 1997, through December
31, 1997) is treated as a short taxable year for which X is a C
corporation. Under X's normal method of accounting, $200,000 of the
$530,000 of X's taxable income is allocable to the S short year and
the remaining $330,000 is allocable to the C short year. Of the
$200,000 allocable to the S short year, $90,000 is allocable to the
first deemed taxable year (January 1, 1997, through June 29, 1997)
(180 days), and $110,000 is allocable to the second deemed taxable
year (June 30, 1997, through July 19, 1997) (20 days) under X's
normal method of accounting.
(iii) Each shareholder's pro rata share of X's income for the
first deemed taxable year within the S short year is determined as
follows. Because A owns 60% of the stock outstanding during the
first deemed taxable year, A's pro rata share for that period is
$54,000 ($90,000/180 days in the period x 60% x 180 days). B's pro
rata share for that period, reflecting B's 40% ownership, is $36,000
($90,000/180 days in the period x 40% x 180 days). A and B must
report these amounts for their respective taxable years with or
within which the S termination year ends (December 31, 1997).
(iv) Each shareholder's pro rata share of X's income for the
second deemed taxable year within the S short year is determined as
follows. Because A owns 60% of the stock outstanding during the
second deemed taxable year, A's pro rata share for that period is
$66,000 ($110,000/20 days in the period x 60% x 20 days). C's pro
rata share for that period, reflecting C's 40% ownership, is $44,000
($110,000/20 days in the period x 40% x 20 days). A and C must
report these amounts for their respective taxable years with or
within which the S termination year ends (December 31, 1997).
Sec. 1.1377-2 Post-termination transition period.
(a) In general. For purposes of subchapter S of chapter 1 of the
Code and this section, the term post-termination transition period
means--
(1) The period beginning on the day after the last day of the
corporation's last taxable year as an S corporation and ending on the
later of--
(i) The day which is 1 year after such last day; or
(ii) The due date for filing the return for the last taxable year
as an S corporation (including extensions); and
(2) The 120-day period beginning on the date of a determination
that the corporation's election under section 1362(a) had terminated
for a previous taxable year.
(b) When a post-termination transition period arises. A post-
termination transition period arises following the termination under
section 1362(d) of a corporation's S election. For example, a post-
termination transition period arises if a C corporation acquires the
assets of an S corporation in a transaction to which section 381(a)(2)
applies. However, if an S corporation acquires the assets of another S
corporation in a transaction to which section 381(a)(2) applies, a
post-termination transition period does not arise. (See Sec. 1.1368-
2(d)(2) for the treatment of the acquisition of the assets of an S
corporation by another S corporation in a transaction to which section
381(a)(2) applies.) The special treatment under section 1371(e)(1) of
distributions of money by a corporation with respect to its stock
during the post-termination transition period is available only to
those shareholders who were shareholders in the S corporation at the
time of the termination.
(c) Last day of last taxable year. For purposes of section
1377(b)(1)(A) and paragraph (a)(1) of this section, the last day of a
corporation's last taxable year as an S corporation is--
(1) The last day of the short S taxable year under section
1362(e)(1)(A); or
(2) The date of transfer (within the meaning of section 381(a)(2))
in the event that a C corporation acquires the assets of an S
corporation in a transaction to which section 381(a)(2) applies.
(d) Determination defined. For purposes of section 1377(b)(1)(B)
and paragraph (a)(2) of this section, the term determination means--
(1) A court decision rendered by a court of competent jurisdiction;
(2) A closing agreement entered into between the Secretary and the
taxpayer pursuant to section 7121;
(3) A written agreement between the corporation and the
Commissioner (including a statement acknowledging that the
corporation's election to be an S corporation terminated under section
1362(d)) that the corporation failed to qualify as an S corporation;
(4) For a corporation subject to the audit and assessment
provisions of subchapter C of chapter 63 of subtitle A,
[[Page 35887]]
the expiration of the period specified in section 6226 for filing a
petition for readjustment of a final S corporation administrative
adjustment finding that the corporation failed to qualify as an S
corporation, provided that no petition was timely filed before the
expiration of the period; and
(5) For a corporation not subject to the audit and assessment
provisions of subchapter C of chapter 63 of subtitle A, the expiration
of the period for filing a petition under section 6213 for the
shareholder's taxable year for which the Commissioner has made a
finding that the corporation failed to qualify as an S corporation,
provided that no petition was timely filed before the expiration of the
period.
(e) Time of determination--(1) Court decision. A court decision
becomes a determination on the date the decision becomes final under
rules applicable to the court rendering the decision.
(2) Closing agreement. A closing agreement becomes a determination
on the date of its approval by the Commissioner.
(3) Written agreement. A written agreement described in paragraph
(d)(3) of this section becomes a determination when it is signed by the
district director having jurisdiction over the corporation (or by
another Service official to whom authority to sign the agreement is
delegated) and by an officer of the corporation authorized to sign on
its behalf. Neither the request for a written agreement nor the terms
of the written agreement suspend the running of any statute of
limitations.
(4) Implied agreement. A determination under paragraph (d)(4) or
(d)(5) of this section becomes effective on the day after the date of
expiration of the period specified under section 6226 or 6213,
respectively.
Sec. 1.1377-3 Effective date.
Sections 1.1377-1 and 1.1377-2 apply to taxable years of an S
corporation beginning after [the date of publication as final
regulations in the Federal Register].
PART 18--TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S
REVISION ACT OF 1982
Par. 3. The authority citation for part 18 continues to read as
follows:
Authority: 26 U.S.C. 7805 sec. (6)(c)(3)(B)(iii) of the
Subchapter S Revision Act of 1982.
Sec. 18.1377-1 [Removed]
Par. 4. Section 18.1377-1 is removed.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-16653 Filed 7-11-95; 8:45 am]
BILLING CODE 4830-01-U
