Final regs. clarify when interest in corporation is stock vs. debt

By Dave Strausfeld, J.D.

The IRS on Wednesday issued final regulations (T.D. 9897) regarding the classification of certain related-party interests in corporations as stock vs. indebtedness.

The distinction between debt and equity can have important tax consequences because, for instance, a corporation can deduct interest payments but not distributions. Under Sec. 385, Treasury is authorized to prescribe rules to determine whether an interest in a corporation is treated as stock or indebtedness (or as in part stock and in part indebtedness).

T.D. 9897 finalizes 2016 proposed regulations (REG-130314-16) without any substantive change. Under the final regulations, certain interests in a corporation that are held by a member of the corporation’s expanded group and that otherwise would be treated as indebtedness for federal tax purposes are treated as stock. The final regulations generally affect corporations, including those that are partners of certain partnerships, when those corporations or partnerships issue purported indebtedness to related corporations or partnerships.

Treasury and the IRS refer to these regulations as “distribution regulations,” distinguishing them from “documentation regulations” in Regs. Sec. 1.385-2 that were issued in 2016 (T.D. 9790) and later revoked in 2019 (T.D. 9880) as a result of Executive Order 13789.

The IRS stated it received comments that suggested removing the distribution regulations. Cognizant that a complete withdrawal of the distribution regulations could restore incentives for multinational corporations to generate additional interest deductions without new investment, the IRS determined that they continue to be necessary. However, according to T.D. 9897’s preamble, Treasury and the IRS “continue to study all appropriate modifications to the distribution regulations,” and intend to issue proposed regulations to make these regulations “more streamlined and targeted, including by withdrawing the per se rule.”

The new regulations are effective upon publication in the Federal Register and are applicable as specified in Regs. Secs. 1.385-3(j)(1) and (k) and 1.385-4(g).

Dave Strausfeld, J.D., (David.Strausfeld@aicpa-cima.com) is a Tax Adviser senior editor.

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