IRS proposes to remove regulations under Section 385

Tax Hot Topics newsletter The IRS issued proposed regulations (REG-130244-17) to remove final regulations under Treas. Reg. Sec. 1.385-2 that would become effective on Jan. 1, 2019.

The IRS issued final and temporary regulations under Section 385 on Oct. 21, 2016, which specified the minimum documentation required to be established and maintained for certain instruments to qualify as debt for U.S. federal income tax purposes. The documentation rules applied to instruments issued by a corporation to related parties that were members of its “expanded group” as defined in the regulations under Section 385. Specifically, the documentation rules mandated documentation to support: (i) an unconditional obligation to repay a sum certain; (ii) creditor’s rights; (iii) a reasonable expectation of ability to repay; and (iv) actions evidencing a debt-creditor relationship.

Under Treas. Reg. Sec. 1.385-2(b), if the requirements are met, the determination of an interest as debt or stock is determined based on general tax principles. If the requirements are not met, the instrument is treated as stock for all federal tax purposes subject to certain exceptions.

In Notice 2017-38, the IRS identified the documentation rules to either: (i) impose an undue financial burden on U.S. taxpayers; or (ii) add undue complexity to the federal tax laws. Additionally, in October 2017, Treasury identified the documentation rules to be considered for partial revocation in the Second Report to the President on Identifying and Reducing Tax Regulatory Burdens.

The preamble of the proposed regulations states that the Treasury and the IRS will continue to study the issues addressed by the documentation rules, and that they may propose a modified version when the study is complete.

Josh Brady
Principal, Washington National Tax Office
T +1 202 521 1563

Jeff Borghino
Director, Washington National Tax Office
T +1 202 521 1532

Bryan Keith
Managing Director, Washington National Tax Office
T +1 202 861 4116

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