Controlled Groups and the Sec. 179 Election for S Corporations

By Robert W. Jamison, CPA, Ph.D., MBA, and Christopher W. Hesse, CPA


  • Regs. Sec. 1.1563-1(b)(2)(ii)(C) excludes an S corporation from being treated as a component member of a controlled group “for purposes of any tax benefit item described in section 1561(a) to which it is not subject.”
  • Sec. 179(d)(6) states that component members of a controlled group are treated as a single taxpayer for purposes of that section’s limitations on qualifying property that may be expensed in a tax year. However, in light of the regulatory language under Sec. 1563, it was not clear that an S corporation in a controlled group should not be treated as a component member of the controlled group for this purpose.
  • In response to the AICPA’s request for clarification, the IRS Office of Chief Counsel recently released a memorandum, which states that for purposes of the controlled-group rules of Sec. 179, an S corporation is treated as an excluded member of a controlled group and may therefore apply the full limita tion amounts of Secs. 179(b)(1) and (2) independently of other members.

Since the inception of subchapter S in 1958, the relationship of this part of the Code to other tax rules governing corporations has been unclear. In 1982, Congress stated that the rules of subchapter C apply to S corporations unless those rules are inconsistent with the purposes of subchapter S. 1 However, one of the basic rules regarding the taxation of S corporations is that the corporation computes its income in the same manner as an individual. 2 Since the adoption of these two provisions more than 30 years ago, no regulations have amplified them, and cases and rulings have been few and narrow in scope.

The gray areas become even grayer when a particular rule is not within subchapter C and is clearly inapplicable to individuals. Examples include the income exclusion under Sec. 118 for contributions to capital. This provision applies specifically to corporations but is not within subchapter C. Cases and rulings have implicitly allowed S corporations to exclude contributions to capital from income. 3

Controlled Groups of Corporations

Another area of importance is the controlled group problem. Secs. 1561 and 1563, which define and limit tax benefits of certain controlled corporations, are not within subchapter C and are not relevant to the individual taxpayer. Thus there is no direct link from any provision in subchapter S to these Code sections.

Sec. 1561 enumerates certain attributes, such as the graduated corporate rate structure, as items that members of a controlled group must share. However, the sharing is limited to the “component” members and does not apply to “excluded” members. Sec. 1563, which defines the relationships necessary for two or more corporations to be included in a controlled group, does not specifically include or exclude S corporations.


Historically, the regulations have not been terribly helpful in providing guidance. Before December 2006, only one terse statement dealt with the status of S corporations and the controlled group rules. Regs. Sec. 1.1563-1(b)(2)(ii)(c) 4 excluded an electing small business corporation (S corporation) if it was “not subject to the tax imposed by section 1378.” 5 That tax, on “certain capital gains,” was the predecessor of the current built-in gains (BIG) tax and required an S corporation to use the graduated Sec. 11 rate schedule in certain instances when it was subject to the tax.

By the end of 2006, almost 24 years had passed since the effective date of the Subchapter S Revision Act of 1982. Moreover, 20 years had elapsed since Congress had replaced the S corporation capital gain tax with the BIG tax. Treasury finally in December 2006 issued temporary and proposed regulations that correspond with the changed nomenclature and cross references, as well as recognize that the passive investment income tax and the BIG tax did not use the graduated rate structure of Sec. 11.

The preamble to the 2006 temporary and proposed regulations stated:

Since an S corporation is not currently subject to any tax to which either the tax bracket amounts of section 11(b) apply, or any other tax benefit item to which section 1561(a) applies, it is appropriate to treat that corporation as an excluded member of a controlled group. 6

These proposed regulations were adopted as final without substantive change in May 2009, and the temporary regulations were removed. 7

If one were to read the preamble to the temporary and proposed regulations before seeing the regulations, one would expect to see that the regulations would treat S corporations as excluded members without further qualification. However, the operative language of the regulation defining excluded members contains a clause that the preamble does not explain: An excluded member includes “[a]n S corporation (as defined in section 1361) for purposes of any tax benefit item described in section 1561(a) to which it is not subject 8 (emphasis added).

Thus, the regulation implies that an S corporation might be a component member of a controlled group of corporations when another Code provision apportions any attribute among such members. However, the description of component members in the same regulation makes no mention of S corporations. Thus, a reasonable interpretation of the regulation would be that an S corporation is a component member for purposes of Code provisions other than Sec. 1561. However, the language of the preamble appears to universally exclude S corporations from component membership status.

Four months after the 2009 final regulations were issued, the IRS proposed another amendment that seems to ignore the conditional language, although it would not amend that particular portion of the current regulation. 9 The proposed amendment to Regs. Sec. 1.1563-1 somewhat cryptically stated that inclusion in a controlled group is not determined by a corporation’s status as an included or excluded component member of a controlled group as defined in Sec. 1563(b). 10 An accompanying proposed amendment contained an example of three S corporations with one owner. It stated that the three are members of a brother-sister controlled group of corporations, even though each is treated as an excluded member. 11 These proposed amendments were adopted as final in 2011, with a slight clarification. 12 Thus, in the strange parlance of the tax law, excluded members are included in a controlled group of corporations. However, they are not component members.

Current Interpretations

Thus, for some purposes, such as credits, nondiscrimination plans, and accounting method rules, the entire group, both excluded and component members, must aggregate their activities. 13 The related-party rules under Sec. 267 also apply to members (component and excluded) of a controlled group of corporations, 14 although there are certain modifications of the disallowance rules, and of the parent-subsidiary group definition. 15 Therefore, it seems clear that an S corporation must observe the controlled-group rules with respect to these issues.

Sec. 179

In the context of the Sec. 1561 attributes, it would make little sense to subject an S corporation to a portion of the graduated rate schedule or the other attributes that are irrelevant to determining the taxable income of an S corporation or of its shareholders, none of whom may be taxable corporations. However, numerous other rules refer to controlled groups of corporations and do not explicitly include or exclude S corporations. A prime example is Sec. 179, which has several references to component members of controlled groups of corporations. One of these references is part of the definition of “purchase,” which is a prerequisite for qualifying for the expensing election. Among other limits, a purchase from one member of a controlled group by another member disqualifies the purchaser from expensing the property. 16

Sec. 179 requires apportionment of three limitations among component members of a controlled group of corporations: 17

  • The dollar limitation ($500,000 for 2013) of the aggregate cost of qualified property that may be taken into account during a tax year. 18
  • The reduction in limitation threshold for taxpayers placing Sec. 179 property in service during the year ($2 million for 2013). 19
  • The limitation based on taxable income from trades or businesses before claiming the Sec. 179 deduction. 20

Examples Comparing C Corp. and S Corp. Treatments

In all examples, Ess Inc. and Subs Inc. are S corporations. See Inc. and Sea Inc. are C corporations. Moreover, all of the corporations in each example have identical ownership, and five individuals own all the stock in identical proportions. No corporation is a direct owner of the stock of any of the others. Thus, if all were C corporations, they would clearly be component members of the same brother-sister controlled group. No other corporations’ ownership would include them in the same group.

Example 1 : Ess, Subs, See, and Sea each placed in service $600,000 of qualified Sec. 179 property in 2013. Since the Sec. 179 deduction is not an attribute listed in Sec. 1561, the corporations need to determine which, if any, of them must combine limitations with the others.

All four corporations are members of a single controlled group of corporations. If they are all treated as component members, they would need to apportion a single expensing limit. Moreover, since their combined Sec. 179 property placed in service for the year is $2.4 million, reducing the $500,000 limitation by $400,000, the expensing limit for the four corporations combined would be $100,000.

Guidance From the IRS

The AICPA S Corporation Technical Resource Panel requested guidance from the IRS on whether S corporations should be considered component members for purposes of this rule, since it is not one of the Sec. 1561 attributes. The IRS responded with a position that is consistent with the preamble to the 2006 proposed and temporary regulations cited above, that an S corporation “is treated as an excluded member of a controlled group.” 21 The Office of Chief Counsel thus does not regard the phrase “for purposes of any tax benefit item described in section 1561(a) to which it is not subject” 22 as limiting the treatment of an S corporation as an excluded member to situations involving tax benefits of Sec. 1561.

Example 2: Applying the same facts as Example 1, See and Sea would be allowed a combined $500,000 of expensing for 2013, since they are both component members of a brother-sister controlled group. However, Ess and Subs are excluded members. Thus, neither of these corporations needs to combine its limits with the C corporations or with each other. Sea and See together have placed in service $1.2 million of qualifying Sec. 179 property in 2013, well short of the $2 million limitation reduction threshold. Sea and See would allocate the $500,000 limit between them.

Ess and Subs would not consider property placed in service by either of the other two corporations, and each would have $600,000 of qualifying Sec. 179 property placed in service. However, Ess and Subs would need to watch this election carefully, especially if any of the common shareholders assumed more than 50% of both corporations such that a total of more than $500,000 were allocated to one taxpayer. The $500,000 limit applies to each shareholder. 23

There could also be a trap if two shareholder s are married and file a joint return and in combination own more than 50% of the total shares of both corporations, since the $500,000 limit applies both at the corporation and at the shareholder levels.

Example 3: K and L are husband and wife. K owns 60% of Ess, and L owns 60% of Subs. Even though Ess and Subs might each be able to claim a $500,000 Sec. 179 deduction in 2013, this would be an ill-advised move. With the maximum elections, K and L would each be allocated $300,000 of Sec. 179 deductions in 2013.

However, on a joint return, they can claim only a $500,000 Sec. 179 deduction because they are treated as a single taxpayer. 24 Filing separately would not help, because the limit would become $250,000 for each. 25 Thus, either filing status costs the couple $100,000 of tax benefit. To add insult to injury, no provision allows for a carryover of excess Sec. 179 expensing unless the excess results from the taxable income limitation. That was not the problem with these taxpayers. There are still other negative results. K and L would each need to reduce stock (and/or debt) basis by the full $300,000 allocated to him or her. Each S corporation would reduce its accumulated adjustments account by the entire $500,000 elected, even though some of this election provides no tax benefit in any year to some of the shareholders.

The treatment of the S corporations as excluded members would also have an effect on intercompany transfers of potentially qualifying Sec. 179 property. A “purchase” for this purpose may not include an acquisition of property by one component member from another component member of a controlled group of corporations. 26 It appears that this restriction does not apply if the buyer or the seller (or both) is an excluded member and neither is a component member. However, this allowance has little application, in that a purchase does not include an acquisition from a person or entity with respect to whom a loss transaction would be disallowed by Sec. 267. 27 Among the relationships specified in Sec. 267 are members of the same controlled group of corporations. 28 This rule makes no distinction between component members and excluded members, so mere “membership” is sufficient to disallow losses and thus to disallow the benefits of Sec. 179 for property purchased by one member from another.

Example 4: Subs purchased $300,000 of the property from Ess and $300,000 from See. Although Subs is not a component member with Ess or See, all three are related within the meaning of Sec. 267. Thus, none of the property purchased from either of these corporations is eligible for the expensing election.

The exclusion of S corporations from component membership may be a mixed blessing. Perhaps the one area in which “more is always better” in the Sec. 179 rules is the taxable income limit. In any given year, a taxpayer cannot claim a Sec. 179 deduction in excess of taxable income from trades or businesses. For a C corporation the taxable income limitation is not reduced for any net operating loss deduction. 29 However, this limit, as well as those on the maximum expensing amount and the maximum property placed in service, requires combining the taxable incomes of all component members of a controlled group of corporations.

Example 5: Assume that Sea had purchased $100,000 of qualifying Sec. 179 property. Sea had $750,000 of taxable income before any Sec. 179 deduction. See’s purchases of qualifying property were all from unrelated parties. However, See’s taxable income before the Sec. 179 deduction was $1,000. Therefore, if See needs to base its Sec. 179 limit on its own taxable income, the limit would only be $1,000. However, See and Sea combined have taxable income of $751,000 and are able to claim the entire $500,000 expense limit for the year. Sea could therefore claim the full $100,000 purchased, leaving See a potential deduction of up to $400,000. Or, the two corporations could apportion the $500,000 differently between them, up to the cost of qualifying property each member purchased and placed in service during the tax year.

For an S corporation, the taxable income limitation applies to each S corporation separately, considering all income and deductions for all trades or businesses conducted by the corporation. 30 However, the limit also applies to each shareholder. Each shareholder’s taxable income from a trade or business includes income or loss passed through from the S corporation. 31 Shareholder taxable income from a trade or business also includes wages received as an employee in a trade or business. 32

Deducting Wisely

The treatment of S corporations as excluded members within controlled groups of corporations provides some interesting planning opportunities as well as an occasional pitfall. Since S corporations are excluded members, each S corporation within a controlled group of corporations may claim the entire Sec. 179 expensing limit, currently $500,000. Moreover, the amount of Sec. 179 property placed in service by other members does not affect the $2 million limitation reduction threshold of any S corporation. In contrast, component members of a controlled group must allocate a single limit and reduction threshold.

The principal hazard is that claiming the maximum deduction by each S corporation within a controlled group of corporations may overload one or more shareholders, who will lose basis but never receive the full tax benefit.

Thus, although the Sec. 179 expensing election may be a valuable option for business taxpayers, it has its hazards. The exclusion of S corporations from component membership in controlled groups of corporations multiplies the planning opportunities for businesses under common control but calls for vigilance by tax professionals to use this deduction wisely.

Treasury seems to have thrown some superfluous wording into Regs. Sec. 1.1563-1(b)(2)(ii)(C) that appears to only partially exclude S corporations from being component members of controlled groups of corporations. The IRS has provided guidance by releasing its letter to the AICPA (with reference to the AICPA redacted) that the exclusion applies for purposes of the rules of Sec. 179. However, it may be necessary to request specific guidance on other situations affecting the taxation of controlled group members regarding tax benefit items that are not specifically contained in Sec. 1561.


1 Sec. 1371, added by the Subchapter S Revision Act of 1982, P.L. 97-354, §2.

2 Sec. 1363(b).

3 See IRS Letter Ruling 8303018 (10/14/82). See also Nathel, 131 T.C. 262 (2008), aff’d, 615 F.3d 83 (2d Cir. 2010).

4 Prior to amendment by T.D. 9304.

5 Redesignated Sec. 1374 by the Subchapter S Revision Act of 1982 and repealed in 1986, when it was replaced by the current Sec. 1374, the built-in gains statute.

6 T.D. 9304, Explanation of Provisions, part 3.C.

7 T.D. 9451.

8 Regs. Sec. 1.1563-1(b)(2)(ii)(C).

9 REG-135005-07.

10 Prop. Regs. Sec. 1.1563-1(a)(1)(ii).

11 Regs. Sec. 1.1563-1(b)(4), Example (4).

12 T.D. 9522. The final regulation clarifies that, in addition to Sec. 1563(b), paragraph (b) of the same regulation is not taken into account for determining whether a corporation is included in a controlled group.

13 See, e.g., Sec. 52(a) (work opportunity credit) and Sec. 448(c)(2) (gross receipts limitation on use of cash method of accounting), and the related automatic consent procedures in Rev. Proc. 2001-10, §5.03, 2001-1 C.B. 272, and Rev. Proc. 2002-28, §5.06, 2002-1 C.B. 815.

14 Sec. 267(b)(3).

15 Sec. 267(f).

16 Sec. 179(d)(2)(B).

17 Sec. 179(d)(6)(A).

18 Sec. 179(b)(1).

19 Sec. 179(b)(2).

20 Sec. 179(b)(3).

21 IRS Office of Chief Counsel, Information Letter 2013-0016 (6/28/13).

22 Regs. Sec. 1.1563-1(b)(2)(ii)(C).

23 Sec. 179(d)(8).

24 Regs. Sec. 1.179-2(b)(5).

25 Regs. Sec. 1.179-2(b)(6). Under this provision, the couple can elect to split the amount other than 50/50.

26 Sec. 179(d)(2)(B).

27 Sec. 179(d)(2)(A).

28 Secs. 267(b)(3) and (f).

29 Regs. Sec. 1.179-2(c)(4).

30 Regs. Sec. 1.179-2(c)(3)(ii).

31 Regs. Sec. 1.179-2(c)(3)(i).

32 Regs. Sec. 1.179-2(c)(6)(iv).



Robert Jamison is a professor of accounting in the Kelley School of Business of Indiana University–Purdue University Indianapolis. Christopher Hesse is chair of the AICPA S Corporation Technical Resource Panel and a partner in the Federal Tax Resource Group of CliftonLarsonAllen LLP in Minneapolis. For more information about this article, contact Prof. Jamison at


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