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§318 Sidewise Attribution Limitation | US International Tax Attorney

This article explores the third main limitation on the general IRC (Internal Revenue Code) §318 corporate stock re-attribution rules – §318 Sidewise Attribution Limitation.

§318 Sidewise Attribution Limitation: What is “Sidewise Attribution”?

A sidewise attribution occurs when corporate stock owned by an owner of a business entity (or a beneficiary of a trust or estate) is first attributed to this business entity (or estate or trust) and then re-attributed again to another owner of the same business entity (or another beneficiary of the same trust or estate). In other words, stock deemed to be owned by an entity due to the ownership of that stock by an owner or beneficiary of the entity is re-attributed “sidewise” to another owner or beneficiary of the same entity.

Sidewise attribution may have far-reaching income tax and tax reporting consequences, because it may result in a person with no real ownership of a corporation being treated as an owner of this corporation’s stock simply because a member of another entity (in which the first person also has an ownership interest) happens to own corporate stock of this corporation.

§318 Sidewise Attribution Limitation: §318(a)(5)(C) Prohibition

§318(a)(5)(C) describes the §318 Sidewise Attribution Limitation. Under §318(a)(5)(C), stock constructively owned by a partnership, estate, trust or corporation pursuant to §318(a)(3) is not treated as owned by this partnership, estate, trust or corporation for the purpose of treating a partner, beneficiary, or shareholder as owner of the stock. In other words, the sidewise attribution limitation prevents re-attribution of corporate stock to an owner of an entity where such stock is constructively-owned by an entity solely by virtue of ownership of this stock by another owner of the entity.

Let’s look at the following example to illustrate the §318 Sidewise Attribution Limitation: A and B are unrelated persons, they equally own a partnership P and A owns 100 shares of corporation X’s stock. In this situation, partnership P is a constructive owner of A’s 100 shares of X under §318(a)(3)(A). Without any sideways limitation, B would have been also treated as an owner of these 100 shares of X due to §318(a)(2)(A). Under §318(a)(5)(C), however, none of these stocks are attributed to B.

§318 Sidewise Attribution Limitation: Attribution from Actual Ownership Not Affected

It is important to emphasize that §318(a)(5)(C) applies only to the re-attribution of stock constructively owned as a result of the application of §318(a)(3). This prohibition does not affect the §318(a)(2) attribution of stock actually owned by an entity to its beneficiary, partner, or shareholder.

§318 Sidewise Attribution Limitation: Re-Attribution Under Other Rules

Additionally, stock constructively owned under §318(a)(3) may still be re-attributed under an attribution rule other than §318(a)(2). In other words, stock constructively owned under §318(a)(3) may still be re-attributed under the upstream corporate attribution rules or the option attribution rules of §318(a)(4) (see Treas. Reg. §1.318-4(c)(2)).

Moreover, re-attribution under the §318 family attribution rules still possible. A potential situation for such re-attribution would arise in a situation where corporate stock is attributed from an entity to its member and from this member to a qualified family member of the same entity. Berenbaum v. Commissioner, 369 F.2d 337 (10th Cir. 1966), rev’g T.C. Memo 1965-147.

Let’s look at a couple of examples to understand better the interaction between the §318 Sidewise Attribution Limitation and the re-attribution rules other than §318(a)(2).

Here is the first hypothetical fact pattern: A is a beneficiary of a trust T, B is another beneficiary of T, T is a beneficiary of an estate, and A owns 100 shares of a c-corporation X. Under §318(a)(3)(B), T is a constructive owner of 100 shares of X. Since T is a constructive owner of A’s shares of X, these shares are re-attributed to the estate under §318(a)(3)(A); §318(a)(5)(C) does not apply to this type of a re-attribution since it is not a sidewise attribution. On the other hand, the §318 Sidewise Attribution Limitation would prevent the re-attribution of A’s shares of X to B that otherwise would have occurred under §318(a)(2)(B).

Note, however, that, if B is A’s son (or other qualified relative under the §318 family attribution rules), then the re-attribution of A’s stocks of X to B is possible under §318(a)(1)(A).

Let’s now look at another fact pattern to understand the power of the option rule attribution vis-a-vis §318(a)(5)(C): A and B are beneficiaries of a trust T; T has an option to buy corporate stock from A. The most important point to understand here is the fact that T is considered here as an owner of A’s stock not under the upstream trust attribution rules of §318(a)(3)(B), but under the option attribution rules of §318(a)(4). Hence, the sidewise attribution limitation under §318(a)(5)(C) does not apply and B becomes a constructive owner of a his proportional part of A’s stock under the downstream trust attribution rules of §318(a)(2)(B).

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US international tax law is incredibly complex and the penalties for noncompliance are exceptionally severe. This means that an attempt to navigate through the maze of US international tax laws without assistance of an experienced professional will most likely produce unfavorable and even catastrophic results.

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§318 Upstream Estate Attribution | International Tax Lawyer & Attorney

This article continues a series of articles concerning the constructive ownership rules of the Internal Revenue Code (“IRC”) §318. Today’s focus is on the §318 upstream estate attribution rules.

§318 Estate Attribution Rules: Downstream Attribution vs. Upstream Attribution

There are two types of the IRC §318 estate attribution rules: downstream and upstream. In a previous article, I discussed the downstream attribution rules concerning attribution of ownership of corporate stocks held by an estate to its beneficiaries. This brief article focuses on the upstream attribution rules, which means rules governing the attribution to the estate of corporate stocks held by its beneficiaries.

§318 Upstream Estate Attribution: Main Rule

The IRC §318(a)(3)(A) states the general rule for the upstream estate attribution of beneficiaries’ corporate stock: irrespective of the proportion of his beneficiary interest in the estate, all corporate stocks owned directly or indirectly by a beneficiary are deemed to be owned by the estate.

Notice the difference here between the downstream and the upstream estate attribution rules. §318 downstream estate attribution rules attribute the ownership of corporate stock proportionately from an estate to its beneficiaries. The upstream attribution rules under §318, however, completely disregard the proportionality rule; instead, all of the stocks of a beneficiary are attributed to the estate even if he has only 1% interest in the estate.

For example, let’s suppose that W owns 100 shares in corporation X; then, H dies and leaves one-tenth of his property to W. Due to the fact that W is a beneficiary of H’s estate, the estate constructively owns all of W’s 100 shares in X.

§318 Upstream Estate Attribution: No Re-Attribution

I already stated this rule in another article on estate attribution, but it is also important to re-state it here. §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.

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If you have questions concerning US business tax in general and US international business tax law specifically, contact Sherayzen Law Office for professional help. We are a highly-experienced tax law firm that specializes in US international tax law, including offshore voluntary disclosures, US international tax compliance for businesses and individuals and US international tax planning.

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§318 Downstream Estate Attribution | International Tax Lawyer & Attorney

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 Family Attribution | International Tax Law Firm Minnesota

In a previous article, I outlined six main relationship categories of the Internal Revenue Code (“IRC”) §318. In this article, I will focus on the first of these categories: the IRC §318 family attribution rules.

§318 Family Attribution: General Rule

§318(a)(1)(A) describes the §318 family attribution rule . It states that an individual is a constructive owner of shares owned (directly and indirectly) by his spouse, children, grandchildren and parents. While it appears to be simple, this general rule has a number of exceptions and complications.

§318 Family Attribution: Certain Exceptions for Spouses

Under §318(a)(1)(A)(i), ownership of stock held by a spouse who is legally separated under a decree of divorce or separate maintenance is not attributed to her spouse. However, based on the §318 legislative history and Commissioner v. Ostler, 237 F.2d 501 (9th Cir. 1956), it appears that an interlocutory decree of divorce would not prevent the attribution of stock ownership between spouses, because such decree is not final.

§318 Family Attribution: Special Cases Involving Children and Grandchildren

§318(a)(1)(B) expands the attribution of shares from children to shares held by legally adopted children. Without legal adoption, however, shares owned by a step-child cannot be attributed to step-parents and step-grandparents. Similarly, absent legal adoption of a step-child, there is no attribution from a step-parent to the step-child.

Treas. Reg. §1.318-2(b) also makes it clear that there is no attribution of shares owned by grandparents to their grandchildren. Only shares owned by grandchildren can be attributed to their grandparents. For example, if a grandfather and a grandson each own 100 shares of X, a C-corporation, the grandfather will be deemed to own 200 shares while the grandson’s stock ownership will be based only on his actual ownership of 100 shares.

Also, note that great-grandchildren are not listed under §318(a)(1). Hence, the shares owned by great-grandchildren are not attributed to great-grandparents; this is different from §267.

§318 Family Attribution: Other Relatives

The §318 definition of family excludes aunts, uncles, nieces, nephews and cousins; this treatment is identical to that of §267. Moreover, unlike §267(c)(4), there is no attribution of stock between siblings under §318(a)(1).

§318 Family Attribution: Prohibition of Double Attribution

Treas. Reg. §1.318-4(b) explains that §318 family attribution rules do not allow double attribution of stock among family members. Under §318(a)(5)(B), stock deemed owned through a family member under §318(a)(1)(A) may not be re-attributed to another family member under the family attribution rules of §318.

For example, let’s say that mother M, daughter D and son S each own one-third of the outstanding shares of X corporation; each of them owns 100 shares. Under §318(a)(1)(A), M owns 100 shares and is deemed to own her children’s 200 shares. On the other hand, D actually owns 100 shares and is deemed to own her mother’s 100 shares – i.e. 200 shares total; under §318(a)(5)(B), while M is deemed to own 100 of S, there is no re-attribution of S’ 100 shares to D. In other words, §318(a)(5)(B) prevents the attribution of brother’s stock to his sister through the deemed ownership of brother’s stock by their mother. Also, as explained above, there is no family attribution of stocks between siblings.

§318 Family Attribution: Special Rule Concerning §302(c)(2)

IRC §302(c)(2) relates to redemptions of corporate stock and contains a special rule concerning the waiver of §318 family attribution of stocks. This section permits the termination of attribution of stock from family members when a shareholder severs ties with the corporation. The purpose of this rule is to allow such a shareholder to report capital gains instead of dividends upon the redemption of corporate stock.

§318 Family Attribution: Multiple Control of Corporation Possible

The upshot of the §318 rules is the expansion of stock ownership to an extent where multiple related parties may be deemed to be in control of a corporation (and even be deemed as owners of all shares of the corporation) at the same time.

For example, let’s suppose that there are five family members: husband (H), wife (W), son (S), H’s mother (i.e. grandmother – M) and son of S (i.e. grandson – G). Each of them actually owns 100 shares of corporation Y; there are 500 shares outstanding in total. Let’s analyze each of these person’s actual and constructive ownership of shares under the §318 family attribution rules.

H owns all 500 shares under the §318 family attribution rules. He actually owns 100 shares; the rest of the shares are attributed to him from his mother, his wife, son and grandson.

W owns 400 shares under the §318 family attribution rules. She actually owns 100 shares and constructively owns 300 shares that belong to her husband, son and grandson. However, she does not own 100 shares owned by her mother-in-law and the re-attribution of ownership of these shares through her husband is prevented by §318(a)(5)(B).

M owns 300 shares under the §318 family attribution rules. She actually owns 100 shares and is deemed to own 100 shares owned by her son and 100 shares owned by her grandson. M, however, is not deemed to own stocks held by her daughter-in-law W and her great-grandson G.

S owns 400 shares under the §318 family attribution rules. He actually owns 100 shares and constructively owns 200 shares owned by his parents and 100 shares owned by his son. S, however, does not constructively own shares held by his grandmother.

Finally, G owns 200 shares under the §318 family attribution rules. He actually owns 100 shares and constructively owns 100 shares held by his father S. G, however, does not constructively own shares held by his grandparents H and M as well as his great-grandmother M.

Thus, even though each family member actually owns only 100 shares, four of them (out of the total five) are deemed to be in control of the corporation and H is deemed to own the entire corporation. If we transfer this scenario to US international tax law, we can immediately see that the application of §318 constructive ownership rules through family attribution may greatly increase the tax compliance burden for this family.

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IRC §318 is but a tiny part of the incredible voluminous US domestic and international tax law. US international tax law is not only very complex, but it is also very severe with respect to noncompliant taxpayers. In other words, it is very easy to get yourself into trouble with respect to US international tax compliance and, once this happens, you may be subject to high IRS penalties.

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§318 Relationship Categories | International Business Tax Lawyer & Attorney

In a previous article I discussed the importance of the Internal Revenue Code (“IRC”) §318 constructive stock ownership rules. Today, I would like to introduce the readers to the various §318 relationship categories – i.e. what types of taxpayers are affected by this section’s constructive ownership rules.

§318 Relationship Categories: Related Persons

The Congress created IRC §318 constructive ownership rules to prevent or minimize the possibility of using business transactions between related persons for tax avoidance purposes. In other words, in order for §318 to be relevant, there must be some type of a close relationship between persons engaged in a business transaction.

It is important to point out that one should not confuse §267 definition of related persons with the one described in §318. These are two completely separate sets of rules that apply to different situations.

§318 Relationship Categories: Six Main Categories

§318 deals specifically with six main categories of related individuals and entities. I will list them here with only a general description; in future articles, I will address each of these §318 relationship categories specifically.

  1. Family members: certain family members are treated as related persons for §318. Again, the §318 definition of “family” should not be confused with the §267 definition.
  2. Partnerships and partners: unlike §267, the constructive ownership rules of §318 are both “upstream” and “downstream”. In other words, the attribution of stock ownership works both ways: from partners to partnership and from partnership to partners. Additionally, one must remember that an S-corporation and its shareholders are treated respectively as a partnership and partners for the purposes of §318.
  3. Estates and beneficiaries: the IRS §318 constructive ownership rules with respect to estates and beneficiaries are quite unique and invasive. They also work downstream and upstream – i.e. the stocks owned by estate are attributed to its beneficiaries and vice-versa.
  4. Trusts and beneficiaries: again, the stock ownership attribution rules of §318 between a trust and its beneficiaries can be downstream and upstream. Stock owned, directly or indirectly, by or for a trust is considered owned by its beneficiaries in proportion to their actuarial interests in the trust. The upstream relationship is more complex: while generally all stocks owned directly or indirectly by a beneficiary of a trust is considered owned by the trust, there are important exceptions.
  5. Corporations and shareholders: surprisingly, §318 attribution rules between a corporation and its shareholders also contain both downstream and upstream provisions. The application of these rules, however, is limited to persons who own directly and indirectly 50% or more of the value of stocks in the corporation. Again, the corporate attribution rules under §318 apply only to C-corporations; S-corporations are treated as partnerships for the purposes of this section.
  6. Holders of stock options: unlike §267, the constructive stock ownership rules of §318 are expanded to options. §318(a)(4) classifies a holder of an option to acquire stock as the owner of that stock. There are detailed rules for defining what an “option” is for the §318 purposes. Interestingly, the stock option attribution rule supersedes the family member attribution rules (which often results in a more extensive constructive ownership).

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US business tax law is incredibly complex. In fact, an ordinary taxpayer who attempts to decipher it on his own is likely to get himself into deep trouble; this is especially the case, if one deals with the international aspects of US business tax law.

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