Sec. 179 Deduction Limitation Applied to S Corps. in a Controlled Group

Editor: Alan Wong, CPA

S Corporations

The IRS recently released Information Letter 2013-0016 (6/28/13) to clarify the treatment of the Sec. 179 limitations applied to members of a controlled group, in which certain members had made an election to be treated as an S corporation under Sec. 1362(a)(1). This pro-taxpayer letter makes clear the proper (beneficial) treatment of S corporations under Sec. 179.

In practice, many taxpayers may have erroneously applied controlled group limitations to the Sec. 179 deduction for S corporations in a controlled group. This may necessitate a “call to action” by practitioners. Even a major tax research publication concluded that S corporations should be subject to controlled group limitations on the Sec. 179 deduction. This conclusion was based on the interpretation that S corporation exclusion as a component member of a controlled group under Regs. Sec. 1.1563-1(b)(2)(ii)(C) applied only to items that would have been apportioned among C corporations under Sec. 1561(a). The IRS’s information letter clarifies its interpretation of the law on the definition of “component member.”

Sec. 179 permits taxpayers to recover 100% of a newly purchased asset’s cost in the year of acquisition, up to a specified maximum dollar amount ($500,000 for 2013). If property acquired during the year exceeds the specified investment amount ($2 million for 2013), the Sec. 179 deduction is limited under Sec. 179(b)(2). Each dollar of acquired Sec. 179 property in excess of the specified investment amount reduces the permitted Sec. 179 deduction dollar for dollar until it is eliminated.

Deductions permissible under Sec. 179(b) are restricted under Sec. 179(d)(6) by rules governing controlled groups. Since component members of a controlled group under Sec. 179(d)(6) are treated as a single taxpayer, the deduction and associated limitation must be apportioned among the members. A controlled group is defined under Sec. 179(d)(7) by reference to the same term as it is used under Sec. 1563(a), “except that, for such purposes, the phrase ‘more than 50 percent’ shall be substituted for the phrase ‘at least 80 percent’ each place it appears in section 1563(a)(1).”

There are four types of controlled groups defined under Sec. 1563(a) (i.e., the parent-subsidiary, brother-sister, combined group, and certain insurance companies). The two types of controlled groups that are most likely to have an S corporation as a member are parent-subsidiary and brother-sister groups. An S corporation could be a member in a parent-subsidiary (as a parent), but it is more likely to be a member within a brother-sister group. The parent-subsidiary controlled group under Sec. 1563(a)(1) exists when, applying the ownership rule from Sec. 179(d)(7), a corporation owns 50% or greater of the total combined voting power of all stock classes, or at least 50% of the total value of all classes of stock in the corporation.

A brother-sister controlled group under Sec. 1563(a)(2) has two or more corporations with five or fewer shareholders that are individuals, estates, or trusts owning (under Sec. 1563(d)(2)) more than 50% of the total combined voting power of all classes of stock entitled to vote or the value of all classes of stock in the corporation, taking into account each person’s stock ownership only to the extent that stock ownership is identical for each corporation. Sec. 1563(d)(2) defines ownership as stock “owned directly by such person, and stock owned with the application of subsection (e)” (i.e., specified constructive ownership rules).

While the S corporation could be considered part of a controlled group for purposes of Sec. 179(d)(7), only component members of the controlled group are subject to limitations on the deduction (Sec. 179(d)(6)). Sec. 1563(b)(2) lists members of a controlled group that should be excluded from being a component member. Although Sec. 1563(b)(2) does not explicitly state that S corporations are excluded from being component members, the regulation (Regs. Sec. 1.1563-1(b)(2)(ii)(C)) does exclude S corporations from being component members of a controlled group. Information Letter 2013-0016 states:

An S corporation is treated as an excluded member of a controlled group. See §1.1563-1(b)(2)(ii)(C). As noted above, pursuant to §1.1563-1(a)(1)(ii), it is a member of a controlled group for purposes of section 1563(a). As also noted above, section 179(d)(6)(A) applies the controlled group rules of section 1563(a) by only taking into account the component members of a controlled group. Since an S corporation is not a component member of a controlled group, section 179(d)(6)(A) does not apply.

Accordingly, since S corporations cannot be component members of a controlled group, Sec. 179(d)(6) exempts them from the controlled group limitations for Sec. 179 (which require the benefits of Sec. 179 to be spread over the entire controlled group). In short, the Sec. 179 deduction is determined for an S corporation as if it is an independent entity and not attributed to the other members of the controlled group. The Sec. 179 deduction claimed by the S corporation is subject to the maximum dollar amount limitation at the S corporation level and then again at the shareholder level.

Since Rev. Proc. 2008-54 permits taxpayers to take Sec. 179 deductions on amended returns, every practitioner should evaluate whether the Sec. 179 tax benefits were fully used by S corporation members of controlled groups in prior years. If previously filed returns improperly limited the Sec. 179 deduction, practitioners should amend the prior-year returns, as failure to do so may be malpractice.

EditorNotes

Alan Wong is a senior manager–tax with Baker Tilly Virchow Krause LLP, in New York City.

For additional information about these items, contact Mr. Wong at 212-792-4986, ext. 986, or awong@bakertilly.com.

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.