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.
Also included in the proposed regulations is the 72-month "per se" rule. This wide timeframe, with vague exemptions, could lead normal business transactions among related companies to alter a business's corporate status. If a company issues a debt during the period beginning 36 months before the date of the distribution or acquisition of another company and ending 36 months after the date of the distribution or acquisition, it is treated as being issued with a principal purpose of funding the distribution or acquisition, thereby casting that initial debt as equity.
The regulations also include hefty reporting requirements, further adding to the paperwork burden business owners already have to address. For example, businesses would only have 30 days following the issuance of debt to finalize the required documentation substantiating an instrument should qualify as debt for U.S. tax purposes.
The Obama administration has been aggressively targeting corporate inversions, but these proposed regulations punish domestic companies and threaten everyday business activities of S corporations. These businesses have done nothing wrong and are not seeking to move their headquarters overseas for a lower tax rate. They are paying millions of dollars in U.S. taxes and employing millions of people. These regulations would stunt economic growth, shifting resources away from job creation and toward paperwork compliance.
NRCA opposes the proposed regulations and has submitted comments urging they be withdrawn or amended to include wide exemptions for S corporations. The best way the IRS can address the proposed regulations is to completely carve out S corporations. Anything less would be a compliance nightmare for businesses.
NRCA also issued an Action Alert urging its members to contact their elected officials to put pressure on the IRS. There is bipartisan support from the House Ways and Means and Senate Finance committees to make changes to the proposed regulations. Both committees have sent letters to the IRS and met with key Treasury officials to raise the concerns NRCA has voiced.
The public comment period closed July 7 followed by a public hearing the next week. The IRS now is required to review the comments and address the concerns raised. More than 200 comments were submitted, and given the enormous effects these proposed regulations have on businesses it is unclear how long it will take the IRS to revise the rules or choose to withdraw them. However, IRS officials have said they plan to "move swiftly to finalize" these rules, so NRCA does not believe they will be withdrawn.
It is unclear what, if any, changes will be made to the final rule or when it will be released. Although NRCA hopes S corporations will be fully excluded, the Obama administration believes many large S corporations should be converted to C corporations for tax purposes, and these regulations would accomplish that. It also is unlikely the regulations' effective date will be changed. NRCA will continue to work with its bipartisan allies to make significant changes or stop the proposed regulations.
Andrew Felz is NRCA's manager of federal affairs.