Comment on FR Doc # E7-06764

July 7, 2007 Sent via certified mail CC:PA:LPD:PR (REG-144859-04) Room 5203 Internal Revenue Service P.O. Box 7604 Ben Franklin Station Washington, DC 20044 Dear Sir or Madam: I am very concerned about the proposed changes advanced in Proposed Regulation 1.1367-2 Adjustments to Basis of Indebtedness to Shareholder (Prop Reg). This Prop Reg would impose a substantial annual burden on many thousands of taxpayers. This burden far exceeds the benefit of these proposed rules, as drafted. Except for those exceedingly rare occurrences involving many millions of dollars, this proposed rule is clearly unnecessary?the underlying S Corporation rules have served well in its absence for more than 20 years. To create this sweeping accounting and administrative burden to address an exceedingly unusual egregious circumstance is not good tax or administrative policy. I respectfully submit that this Prop Reg is not needed and should be scrapped. If it finalized, the di minimus threshold must be raised to well in excess of $100,000 and it must be annually adjusted upwards for inflation. I. Impact on Taxpayers This is an overreaction to the F.G. Brooks, TC Memo 2005-204 decision. The Treasury?s estimated impact of this Prop Reg is dramatically understated. Most small S Corporations have shareholder loans. Many thousands of S Corporation taxpayers and their tax advisors would have to address and apply this rule each year. Competent taxpayers and advisors would have to periodically review the shareholder loans during the course of each year. The burden of this proposal, as drafted, far exceeds the benefit of policing the rare egregious circumstances. II. Di Minimus Rule Basing the $10,000 di minimus rule on IRC 7872?s limit is incongruent and completely inappropriate. While IRC 7872 is not inflation adjusted, as it should be, any finalized threshold under the Prop Reg should be annually adjusted upwards for inflation. IRC 7872 was intended to properly capture related party interest income and expense?it has no remote connection to an S Corporation shareholder?s basis. Indeed, there is no connection between IRC 7872 and IRC 1367 and there should not be. Invoking IRC 7872 is a mere justification for this proposal?IRC 7872 is not a reasonable basis for a di minimus rule. F.G. Brooks involved loans in the millions of dollars and might well present egregious facts. However, bad facts cannot be permitted to promote bad regulation. The small proposed di minimus rule is the reason this Prop Reg would have a huge, inappropriate impact. If this rule is finalized, it should be with a di minimus well in excess of $100,000 that is annually adjusted for inflation. III. Authority What authority does the Treasury have to set an open account debt limitation? IRC 7872 does not provide any such authority. IV. S Corporations and Partnerships For decades, the S Corporation rules have moved closer to the partnership rules. Because of their vestigial double taxation regimen, S Corporations raise more revenue than do partnerships therefore, the Internal Revenue Service has been generous in promoting S Corporations. Because a partner?s basis includes debt and partnership distributions are generally suspended and netted at the close of the year, the Prop Reg would make S Corporations an even less favorable operating entity. This Prop Reg would provide yet another reason to operate as a partnership/limited liability company, rather than as an S Corporation. V. Unequal Application This Prop Reg would only affect S Corporations with more than one shareholder and any S Corporation with significant Accumulated Subchapter C Earnings & Profits (AE&P). This provision is easily avoided by single-shareholder S Corporations without AE&P. Such taxpayers would merely run the basis-affecting withdrawals and contributions through equity. VI. Unfair Application This Pro Reg would only make a difference if the shareholder open account debt were needed to allow the deduction of loss allocations and the company has not yet generated the income to restore the basis in the open account debt. Yet, regardless of its income or loss, the S Corporation would have to separately track the open account debt to comply with the $10,000 per-debt limitation. If the company is successful, this Prop Reg will generally not change the shareholder?s tax. However, if the company ultimately fails and this Prop Reg had required the shareholder to recognize income, thereby increasing his basis in the debt, then the shareholder?s loss could be unfairly converted from an ordinary loss to a capital loss on the ultimately worthless debt. This is a classic illustration of a bad rule impelled by an overreaction to a correct judicial decision involving egregious facts. This Prop Reg would apply unequally, based on solely the factors of whether an S Corporation has more than one owner and AE&P. It would encourage more businesses to operate as partnerships. This ill advised Prop Reg must not be permitted to affect many thousands of taxpayers who will have to annually comb their books to determine whether there was a nanosecond during which a shareholder open account debt peaked over $10,000. For thousands of truly small businesses that operate as S Corporations, that accounting question might annually require substantial time and cost to answer. I respectfully submit that this Prop Reg be scrapped. In the alternative, the di minimus must be raised to over $100,000 and adjusted for inflation. I appreciate the opportunity to respond to this Proposed Regulation and appreciate your favorable consideration. If you would like to discuss any of these issues, please call me. Sincerely, PULAKOS & ALONGI, LTD. Carl D. Harper CDH/cdh Enclosures-Eight Copies