The Internal Revenue Service (IRS) issued proposed regulations April 4 that were promoted by the Obama administration as an attempt to stop inversions of U.S. companies. Inversions occur when domestic companies move their headquarters overseas to take advantage of lower corporate tax rates. However, further analysis of these regulations, if finalized, indicates U.S. businesses structured as S corporations could be negatively affected.
The new rules
Under the proposed regulations, the IRS would be authorized to reclassify certain related-party debt as equity (stock), in whole or in part, for federal income tax purposes. Business owners with a number of entities, including S corporations, who use technical cash pooling arrangements or short-term intercompany loans are at greatest risk. By reclassifying debt as stock, these S corporations could lose their S statuses and, therefore, would become taxed as C corporations. If a business were to lose its S status, it could be faced with thousands of dollars in taxes and fees.
The proposed regulations were not included in the Department of Treasury's second quarter Priority Guidance Plan, which outlines the regulations on which the department is working. Therefore, businesses had no idea this rule was being formulated and no time to plan future business activities accordingly. The proposed regulations retroactively set the effective date to April 4, 2016.