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§318 Downstream Corporate Attribution | Corporate Tax Lawyer & Attorney

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This article continues a series of articles on the constructive ownership rules of the IRC (Internal Revenue Code) §318. Today, we will discuss corporate attribution rules, even more specifically the §318 downstream corporate attribution rules.

§318 Downstream Corporate Attribution: Two Types of Attribution

There are two types of §318 corporate attribution rules: downstream and upstream. Under the downstream corporate attribution rules, stocks owned by a corporation are attributed to this corporation’s shareholders. The upstream corporate attribution rules are exactly the opposite: stocks (in another corporation) owned by shareholders are attributed to the corporation. As stated above, this article will focus on the downstream attribution rules; the upstream attribution rules will be covered in a future article.

§318 Downstream Corporate Attribution: Main Rule

Under §318(a)(2)(C), if a person owns, directly and indirectly, 50% or more in value of the stock “such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.”

There are two critical parts of this downstream attribution rule: 50% threshold and proportionality. Let’s discuss each part in more detail.

§318 Downstream Corporate Attribution: 50% Threshold

A person must own directly or indirectly 50% or more of the stock value of a corporation in order for the §318 corporate attribution rules to apply. Under Treas. Reg. §1.318-1(b)(3), in determining whether the 50% threshold is satisfied, one must aggregate all stocks that the person actually and constructively owns.

The valuation of stocks should be determined in reference to the relative rights of the outstanding stock of a corporation. All restrictions, such as limitations on transferability, should be considered. On the other hand, the presence or absence of control of the corporation is irrelevant. This means that the value of stocks may differ from the voting power associated with these stocks.

Let’s use the following fact scenario to demonstrate the potential complexity of stock valuation: C, a C-corporation, has two classes of stocks – 100 shares of common stock with a value of $1 each and 50 shares of preferred stock with a value of $1 each (i.e. the total value of common stock is $100 and the total value of preferred stock is $50) – with only common stocks having voting rights; A owns 60 shares of common stock and 10 shares of preferred stock (i.e. his common stock is worth $60 and his preferred stock $10); C owns all of the outstanding shares of another corporation, X. The issue is how many shares of X should be attributed to A?

The answer is none. A does not constructively own any of X’s shares because his total value of C’s stocks is below 50% (the value of his stocks is $60 + $10 = $70, but the total value of C’s stocks is $100 + $50 = $150). The fact that A controls C through his 60% voting power is irrelevant.

§318 Downstream Corporate Attribution: Proportionality

As it was stated above, if the 50% corporate ownership threshold is met, then the shareholder will be considered a constructive owner of shares owned by the corporation in another corporation in proportion to the value of his stock.

While this looks like a straightforward rule, there is one problem. Whether the 50% threshold is satisfied should be determined by the combination of actual and constructive stock ownership. Does it mean that the attribution of corporate stocks under §318 should be in proportion to the value of both actual and constructive ownership combined? Or, does the proportionality of attribution based solely on the actual stock ownership in the holding corporation?

As of the time of this writing, the IRS still has not issued any guidance on this problem. Hence, taking either position is fine by an attorney as long as it is reasonable under the facts.

§318 Downstream Corporate Attribution: S-Corporations

It should be emphasized that the §318 downstream corporate attribution rules do not apply S-corporations with respect to attribution of corporate stock between an S-corporation and its shareholders. Rather, in such cases, the S-corporation is treated as a partnership and its shareholders as partners. See §318(a)(5)(E). Hence, generally, corporate stocks owned by an S-corporation are attributed on a proportionate basis even to shareholders who own less than 50% of the value of the S-corporation stock.

Keep in mind, however, that the usual constructive ownership rules for corporations and shareholders apply for the purpose of determination of whether any person owns stock in an S-corporation.

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US Information Returns: Introduction | International Tax Lawyer Minnesota

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In this article, I would like to introduce the readers to the concept of US information returns; I will also explore the differences between US information returns and US tax returns.

US Information Returns: Two Types of Returns

The US tax system is a self-assessment system where taxpayers must file certain forms or returns developed by the IRS in order to report information required by the Internal Revenue Code and the Treasury Regulations. The Internal Revenue Code specifies the due date for these returns.

There are two primary types of returns: tax returns and information returns. A tax return is a form that a taxpayer uses to compute the tax that he owes to the IRS. A tax return requires the taxpayer to set forth the relevant information and amounts for this computation.

On the other hand, the IRS requires US taxpayers to file information returns in order to obtain information on transactions and payments to taxpayers that may affect the information reflected on tax returns. In other words, the IRS uses information returns not to compute the tax liability, but to obtain information (or verification of information) to make sure that the tax returns were properly filed.

US Information Returns: Hybrid Returns

This ideal distinction between the two types of returns is often not preserved. Instead, there are many hybrid returns which possess the features of both, tax returns and information returns. For example, Part III of Form 1040 Schedule B is an information return which forms part of the overall tax return (i.e. Form 1040). Similarly, Form 8621 is a US international information return that is a hybrid return for the reporting of ownership of PFICs and calculation of PFIC tax at the same time.

US Information Returns: Domestic vs. International

The information returns are subdivided into two categories: domestic and international. The domestic information returns are usually filed by third parties with respect to US-source income or income under the supervision of a domestic financial institution. For example, US brokers provide Forms 1099-INT to report US-source interest income and foreign interest income that the taxpayer earned by investing through a domestic financial institution.

It should be mentioned that, due to the implementation of FATCA (Foreign Account Tax Compliance Act), some foreign subsidiaries of US banks also began to issue Forms 1099 to US taxpayers with respect to foreign income from their foreign accounts. The most prominent example is Citibank. However, this is a tiny minority of foreign financial institutions at this point.

On the other hand, international information returns primarily report information concerning foreign assets, foreign income and foreign transactions; there are even information returns concerning foreign owners of US businesses. Usually, these returns are filed not by third parties, but by taxpayers directly – individuals, businesses, trusts and estates. For example, Form 5471 is an international tax return which US taxpayers must file to report their ownership of a foreign corporation, its financial statements and its certain transactions.

US Information Returns: High Civil Penalties

One of the most distinguishing characteristics of information returns are high noncompliance civil penalties. This is very different from tax returns.

The tax return civil penalties are calculate based on a taxpayer’s unpaid income tax liability. The worst case scenario is a civil fraud penalty of 75% of unpaid tax liability. This is followed by negligence, failure-to-file and accuracy penalties.

The noncompliance penalties for information returns, however, do not depend on whether there was ever any tax liability connected with the failure to file an accurate information return; in fact, many information return penalties are imposed in a situation where there is no income tax noncompliance at all. This is logical, because pure information returns would never have any income tax noncompliance directly related to them.

Hence, in order to enforce compliance with information returns, the IRS imposes objective noncompliance penalties per each unfiled or incorrect information return. This divorce between income tax noncompliance and information return penalties, however, may produce extremely unjust results. For example, failure to file a Form 5471 for a foreign corporation which never produced any revenue may result in the imposition of a $10,000 penalty.

It should be emphasized that the domestic information return penalties are much smaller in size than those imposed for noncompliance with international information returns. Again the logic is clear: since the temptation to avoid compliance with US international tax laws is much greater overseas, Congress wanted to raise the stakes for such noncompliant taxpayers in order to make the risk of noncompliance intolerable for most taxpayers.

US Information Returns: Special Case of FBAR

The IRS may impose the most severe penalties out of all information returns for a failure to file a correct FinCEN Form 114, commonly known as “FBAR”. The paradox of these penalties is that FBAR is not a tax form, but a Bank Secrecy Act information return. FBAR was created to fight financial crimes, not for tax enforcement. Its penalties were originally meant to deter and punish criminals, not induce self-compliance with US tax laws – this is precisely why FBAR penalties may easily exceed the penalties imposed with respect to any other US international information return.

So, why is the IRS able to use FBAR as a tax information return and impose FBAR penalties? The reason is that the US Congress turned over FBAR enforcement to the IRS after September 11, 2001. Since then, even though FBAR is not part of the Internal Revenue Code, the IRS has used this form as an information return for tax purposes.

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§318 Estate Beneficiary Definition | US International Tax Law Firm

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The Internal Revenue Code (“IRC”) §318 contains corporate stock attribution rules between an estate and its beneficiaries. In order to apply these rules correctly, one must understand how §318 defines “beneficiary” for the purposes of upstream and downstream estate attribution rules. This articles will introduce the readers to this §318 estate beneficiary definition.

§318 Estate Beneficiary Definition: General Rule

Treas. Regs. §1.318-3(a) defines “beneficiary” for the purposes of §318 attribution rules (on a separate note, pursuant to Rev. Rul. 71-353, the attribution rules for the personal holding company provisions, collapsible corporation provisions (now repealed), and affiliated group provisions also use this definition of a beneficiary).

Treas. Regs. §1.318-3(a) states that “the term beneficiary includes any person entitled to receive property of a decedent pursuant to a will or pursuant to laws of descent and distribution.” Hence, in order to be considered a beneficiary under §318 , a person must have a direct present interest in the property of the estate or in income generated by that property.

Moreover, a person entitled to property not subject to administration by the executor is not a beneficiary for purposes of the §318 estate attribution rules unless the property is subject to the executor’s claim for a share of the federal estate tax.

§318 Estate Beneficiary Definition: Certain Specific Cases

This definition of beneficiary produces interesting results in some specific cases which are actually quite common.

Let’s first see the result of the application of the §318 estate beneficiary definition to life estates. A person with a life estate in estate property is a beneficiary. On the other hand, if a person owns only a remainder interest (i.e. an interest that vests only after the death of the life tenant), then he is not a beneficiary.

A beneficiary of life insurance proceeds is not considered a beneficiary for the §318 estate attribution rule purposes. This is because this is not a property subject to administration by the executor.

Similarly, an executor or administrator is usually not a beneficiary simply by virtue of occupying either of these positions. The main exception to this rule is a situation where an executor or administrator is otherwise considered a beneficiary.

Finally, a residuary testamentary trust presents a very interesting and complex issue. Under Rev. Rul. 67-24, it may be treated as a beneficiary of an estate before the residue of the estate is actually transferred to it. Moreover, it appears that such a trust (in that case, it was an unfunded testamentary trust) needs to worry about the §318(a)(3)(B) trust attribution rules.

§318 Estate Beneficiary Definition: Cessation of Beneficiary Status

It is important to note that §318 estate attribution rules cease to operate with respect to a person who stops being a beneficiary. See Tres. Reg. §1.318-3(a). There is an exception to this rule though: pursuant to Rev. Rul. 60-18, a residuary legatee does not stop being a beneficiary until the estate is closed. “Residual legatee” is a person named in a will to receive any residue left in an estate after the bequests of specific items are made.

When does a person stop being a beneficiary for the purposes of §318? Treas. Reg. Reg. §1.318-3(a) sets forth the following criteria that must be met for a person to no longer be considered a beneficiary: (a) the person has received all property to which he is entitled; (b) ”when he no longer has a claim against the estate arising out of having been a beneficiary”; and (c) “when there is only a remote possibility that it will be necessary for the estate to seek the return of property or to seek payment from him by contribution or otherwise to satisfy claims against the estate or expenses of administration”.

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§318 Downstream Estate Attribution | International Tax Lawyer & Attorney

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This article continues a series of articles on the Internal Revenue Code (“IRC”) §318 constructive ownership rules. Today, the topic is §318 estate attribution rules – i.e. attribution of ownership of corporate stock from estate to its beneficiaries and vice versa. Since this is a long topic, I will divide it into three articles. This article focuses on the §318 downstream estate attribution rules.

§318 Estate Attribution Rules: Two Types

There are two types of the IRC §318 estate attribution rules: downstream and upstream. The downstream attribution rules attribute the ownership of corporate stocks owned by an estate to its beneficiaries. On the other hand, the upstream attribution rules attribute the ownership of corporate stocks owned by beneficiaries to the estate. As I stated above, this article focuses on the first type – i.e. §318 downstream estate attribution rules.

§318 Downstream Estate Attribution: Attribution from Estate to Beneficiary

Under the IRS §318(a)(2)(A), corporate stock owned directly or indirectly by or on behalf of an estate is deemed to be owned proportionately by its beneficiaries. It is very important to understand that the actual disposition of estate property by the testator does not matter to the proportionate attribution of estate property between the beneficiaries. Thus, even if the will demands that all corporate stocks be inherited by only one beneficiary, the ownership of these stocks will be attributed to all beneficiaries in proportion to their respective interests in the estate.

Three questions arise with respect to the application of this §318 downstream estate attribution rule: (1) What stocks are considered to be owned by the estate? (2) Who is deemed to be a beneficiary of an estate? and (3) How does the proportionality rule work?

§318 Downstream Estate Attribution: Stocks Owned by Estate

Treas. Regs. §1.318-3(a) defines when an estate is deemed to be an owner of corporate stock for the §318 attribution purposes. It states that corporate stocks (as well as any other property) shall be considered as owned by an estate if “such property is subject to administration by the executor or administrator for the purpose of paying claims against the estate and expenses of administration.” This is the case even if the legal title to the stock vests immediately upon death in the decedent’s heirs, legatees, or devisees under local law. Id.

§318 Downstream Estate Attribution: Definition of a Beneficiary

I address the definition of a beneficiary for the §318 attribution purposes in more detail in another article. Here, I will only state the general rule.

Treas. Regs. §1.318-3(a) states that “the term beneficiary includes any person entitled to receive property of a decedent pursuant to a will or pursuant to laws of descent and distribution.” Hence, in order to be considered a beneficiary under §318, a person must have a direct present interest in the property of the estate or in income generated by that property.

§318 Downstream Estate Attribution: Proportionality

As in many other cases concerning attribution proportionality, there is very little guidance from the IRS and Treasury regulations concerning determination of a beneficiary’s proportionate interest in an estate. Hence, an attorney has a considerable freedom in determining the reasonable methodology with respect to the application of the proportionality requirement. It appears that one method may be particularly acceptable to the IRS: measuring the relative values of each beneficiary’s interest.

§318 Downstream Estate Attribution: No Re-Attribution

Similarly to many other IRC provisions concerning constructive ownership, §318 estate attribution rules contain a prohibition on re-attribution of stocks. Under §318(a)(5)(C), a beneficiary’s stock constructively owned by an estate through the operation of the §318 estate attribution rules cannot be attributed to another beneficiary.

§318 Downstream Estate Attribution: Example

Let’s conclude this article with an illustration of how the §318 downstream estate attribution rules actually work. The proposed hypothetical scenario is as follows: an estate owns 100 of the total 200 outstanding shares of X, a South Dakota C-corporation; A is entitled to 50% of the property of the estate and actually owns 24 shares of X; B owns 36 shares of X and has a life estate in the other 50% of the estate; and C owns 40 shares of X and only has a remainder interest in the estate after the death of B. Here is how the §318 estate attribution constructive rules would work in this case:

A actually owns 24 shares of X and constructively owns another 50 shares of X through his 50% beneficiary interest in the estate. In other words, A’s total ownership of X equals 74 shares.

B actually owns 36 shares of X and constructively owns another 50 shares of X through his life estate; his total number of shares of X equals 86.

Finally, C owns 40 shares of X only. He does not have any constructive ownership of any shares of X, because his remainder interest in the estate is not a present interest in the estate; hence, he is not a beneficiary of the estate.

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The constructive ownership rules of §318 are crucial to proper identification of US tax reporting requirements with respect domestic and especially foreign business entities. Hence, if you a beneficiary of an estate or an executor/administrator of an estate that owns stocks in a domestic or foreign corporation, contact Sherayzen Law Office for professional help with §318 estate attribution rules.

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IRC §318 Importance | International Tax Lawyer & Attorney

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It is difficult to overstate the significant role the Internal Revenue Code (“IRC”) §318 plays in US corporate tax law and US international tax law. In this article, I will explain the §318 importance and list out major IRC provisions which reference §318.

IRC §318 Importance: Fundamental Purpose

§318 sets forth the circumstances when the ownership of stock is attributed from one person or entity to another. This is one of the most important sections of the Internal Revenue Code, because it contains a set of constructive stock ownership rules which affect a bewildering variety of IRC tax provisions.

It is important to point out that §318 constructive ownership rules do not apply throughout the IRC. Rather, §318 applies only when it is expressly adopted by a specific tax section.

IRC §318 Importance: Non-Exclusive List of IRC Sections

The IRC §318 importance is extensive in both domestic and international tax provisions of the Internal Revenue Code. The CFC (controlled foreign corporation) rules, FIRPTA, FTC (foreign tax credit rules), BEAT, FATCA and so on – all of these US international tax laws adopted §318 for at least one purpose. The §318 importance can even be seen in the 2017 tax reform (for example, the FDII rules).

The following is a non-exclusive list of major IRC sections which adopted the §318 constructive stock ownership rules:

• §59A(g)(3) (related party under BEAT rules)
• §105(h)(5)(B)
• §168(h)(6)(F)(iii)(III)
• §250(b)(5)(D) (sales or services to related party under FDII rules by reference to §954(d)(3) and §958)
• §263A(e)(2)(B)(ii)
• §267A(b)(2) (related party amounts in hybrid transaction by reference to §954(d)(3) and §958)
• §269A(b)(2)
• §269B(e)(2)(B)
• §301(e)(2)
• §302(c) (stock redemptions)
• §304 (redemptions by related corporations)
• §306(b)(1)(A) (disposition or redemption of §306 stock)
• §338(h)(3)
• §355(d)(8)(A)
• §356(a)(2)
• §367(c)(2)
• §382(l)(3)(A) (net operating loss carryovers)
• §409(n)(1)
• §409(p)(3)(B)
• §414(m)(6)(B)
• §416(i)(1)(B) (key employee for top heavy plans)
• §441(i)(2)(B)
• §453(f)(1)(A)
• §465(c)(7)(D)(iii), §465(c)(7)(E)(i) (at-risk loss limitations)
• §469(j)(2)(B) (passive activity loss limitations)
• §512(b)(13)(D)(ii) (unrelated business taxable income from controlled entity)
• §856(d)(5) (REIT rental income)
• §871(h)(3)(C) (portfolio interest withholding tax exemption)
• §881(b)(3)(B) (portfolio interest withholding tax exemption)
• §897(c)(6)(C) (FIRPTA rules)
• §898(b)(2)(B) (adopting §958‘s modified §318 rules for determination of foreign corporation’s tax year)
• §904(h)(6) (foreign tax credit re-sourcing rules)
• §951(b) (U.S. shareholder of controlled foreign corporation (CFC) by reference to §958(b))
• §954(d)(3) (CFC related party rules by reference to §958)
• §958(b) (CFC rules)
• §1042(b)(2)
• §1060(e)(2)(B)
• §1061(d)(2)(A) (transfer of partnership interest received for performance of services)
• §1239(b)(2)
• §1372(b)
• §1471(e) (imposing FATCA reporting requirements on foreign financial institution members of an expanded affiliated group determined under §954(d)(3)’s control test, which adopts §958‘s modified §318 rules)
• §2036(b)(2)
• §6038(e)(2) (information reporting for controlled foreign corporations)
• §6038A(c)(5)
• §7704(d)(3)(B)

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Trying to comply with the extremely complex provisions of US international tax law on your own is even worse than playing Russian roulette. In all likelihood, you will soon find yourself in the ever-deepening pit of legal problems and IRS penalties from which it will be very difficult to extricate yourself.

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