This article explores the second limitation on the IRC (Internal Revenue Code) §318 re-attribution rule – family re-attribution limitation.
Family Re-Attribution Limitation: General §318 Re-Attribution Rule
The general §318 re-attribution rule states that a constructively-owned corporate stock should be treated as actually owned for the purpose of further re-attribution of stock to other persons. §318(a)(5)(A). This re-attribution should occur with respect to other persons considered related persons under §318.
As I stated in another article, unless checked, the general §318 re-attribution rule may ultimately cause persons completely unrelated to the actual owners of corporate stock to be considered as constructive owners of this stock. For this reason, the IRS imposed a number of limitations on this re-attribution rule. One of the limitations concerns specifically §318 family attribution rules.
Family Re-Attribution Limitation: No Family Re-Attribution
Under §318(a)(5)(B), corporate stock constructively owned by a person pursuant to the §318 family attribution rules is not considered as owned by this person for the purpose of re-attributing stock ownership to another family member.
This rule is clear: stock attributed to one family member cannot be re-attributed for the second time to another family member. The idea of this rule is also very clear – to prevent re-attribution of stock to remote family members.
Family Re-Attribution Limitation: Examples
Let’s look at a couple of hypothetical examples to gain deeper understanding of the family re-attribution limitation.
First hypothetical: grandfather GF owns 100 shares of X corporation. Under the family attribution rules, this ownership is attributed to GF’s son, A. However, due to §318(a)(5)(B), this constructively-owned stock cannot be attributed for the second time to A’s wife and A’s son.
Second hypothetical: X, a C-corporation has 200 shares outstanding; A owns 100 shares, S (A’s son) owns 40 shares and D (A’s daughter) owns 60 shares. Under §318(a)(1)(A)(ii): A actually owns 100 shares and constructively owns his children’s 100 shares; S actually owns 40 shares and constructively owns his mother’s 100 shares; D actually owns 60 shares and constructively owns her mother’s 100 shares.
However, due to the re-attribution limitations under §318(a)(5)(B), the shares A constructively owns are not re-attributed from one child to another. Hence, 40 shares of S are not re-attributed to D through their father’s constructive ownership of shares actually owned by S. Similarly, D’s 60 shares are not re-attributed to S through A’s constructive ownership of D’s shares.
Family Re-Attribution Limitation: Interaction with the §318 Option Attribution Rule
It is important to understand that §318(a)(5)(B) does not per se prohibit the re-attribution of stock to another family member. Rather, this re-attribution limitation only applies to stock constructively owned under the §318 family attribution rules. However, the stock may still be re-attributed to another family member through the operation of another rule such as the §318 option attribution rule.
The most prominent example of such a situation is situations where ownership of stock is imputed under both §318 family attribution rule and §318 option attribution rule at the same time. Under §318(a)(5)(D), if a stock is attributed under both, §318 family attribution rules and §318 option attribution rules, then the option rules take priority. This means that, if both rules apply, the option rule governs and the person is deemed to own stock under the option rule rather than under the family rule.
In situations where corporate stock is deemed to be owned under both, family and option attribution rules, the option rule will allow the re-attribution of stock to another family member. In such cases, §318(a)(5)(B) is powerless to stop the application of re-attribution due to the precedence of the option rules.
Family Re-Attribution Limitation: Example of the Option Rule Family Re-Attribution
Let’s look at an example to illustrate the §318 option attribution rule and the §318 family attribution rules interaction with respect to family re-attribution limitation. Let’s suppose that S, son of F, directly owns 100 shares of X, a C-corporation; F has an option to buy all 100 shares from S; D, F’s daughter and S’ sister, does not actually own any shares of X or a contract to buy any shares of X. The issue is whether D is deemed to own any shares of X.
F constructively owns all of his son’s shares of X under the family attribution rules and the option attribution rules. Normally, no shares would be attributed to D due to the family re-attribution limitations, but, in this case, F actually owns an option to buy all 100 shares. The option attribution rule holds preeminence over the family re-attribution limitation. Hence, F is deemed to own S’ shares under the option rule first and foremost; as a consequence, these shares are then re-attributed to D. Thus, D is treated as an owner of all of S’ 100 shares of X.
Family Re-Attribution Limitation: Advanced Summary of Family Attribution Rules
Now that we have a more advanced understanding of the family attribution rules and the limits placed on the family re-attribution limitations, we can modify our earlier definition of the §318 family attribution rules in the following manner: where A and B are family members within the meaning of §318(a)(1), A is deemed to own: (1) all corporate stocks actually owned by B; (2) all corporate stocks constructively owned by B under the §318 option attribution rules; and (3) all stocks constructively owned by B pursuant to §318(a)(2) – i.e. due to the fact that he is a beneficiary of a trust, a partner in a partnership or a shareholder of a corporation.
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