IRS Proposes to Withdraw Debt-Equity Documentation Regulations
Over the years, the determination of whether an item constitutes debt or equity has generated significant litigation. Courts have developed multifactor tests and engaged in intensive fact finding to make this determination. Arguably, part of the reason for the numerous disputes was the lack of regulations under Internal Revenue Code (Code) Section 385, which explicitly authorizes the US Department of Treasury (Treasury) to issue regulations to determine whether an interest in a corporation is to be treated for purposes of the Code as stock or indebtedness.
Proposed regulations under Code Section 385 were issued on April 14, 2016, but did not receive a warm welcome from the tax bar. This was particularly so with respect to strict contemporaneous written documentation requirements in the proposed regulations. After receiving substantial comments, Treasury released final regulations effective as of October 21, 2016, which retained the strict documentation requirements. However, President Trump subsequently issued Executive Order 13771 and Executive Order 13789 calling for a reduction in regulatory burdens and costs. In late 2017, Treasury indicated that it might revoke the documentation requirements under the Code Section 385 regulations. That day has now come.
Treasury and the Internal Revenue Service (IRS) have now issued proposed regulations removing the strict documentation requirements. Written or electronic comments and requests for a public hearing must be received by the IRS by late December.
Prior coverage of the Code Section 385 regulations can be found in our previously posted articles.
Practice Point: Although the strict requirements for documenting may be just a memory at this point, the need to document your lending transactions, especially intercompany transactions, is still present. At the very least, the old rules may have instilled more discipline into lending transactions, which may help support positions (e.g., Code Section 165 deductions) on your return.