Reference: Proposed Regs Sec 1.385-1 through 4.
For the first time, the IRS has issued regulations (proposed) for IRC Section 385. The powers are extensive allowing, for example, the IRS to re-characterize a related party debt into partial debt and partial equity.
IMPORTANT FOR SMALL CORPORATIONS: It is imperative that small corporations, Subchapter S or C, do the following with respect to debt:
- Have a written note with reasonable interest.
- Follow the terms of the note as to payment.
- Timely report on interest paid to the related party on Form 1099-INT.
Reclassification of a debt instrument can have harmful tax effects on the corporation. These proposed regulations illustrate that the IRS is looking to expand their authority in this arena.
Please contact us if you have questions as to your own corporate situation.
