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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).

Contact Sherayzen Law Office for Professional Help With US International Tax Law Compliance

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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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.

Contact Sherayzen Law Office for Professional Help With US International Tax Law

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.

In order to avoid such an undesirable result, you need the help of Sherayzen Law Office. We are a highly-experienced US international tax law firm that has helped clients from over 70 countries with their US international tax compliance. We can help you!

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2019 Tax Filing Season for Individual Filers Opens on January 27 2020

On January 6, 2020, the IRS announced that the 2019 tax filing season will commence on Monday, January 27, 2020. In other words, on that date, the IRS will begin accepting and processing the 2019 tax returns.

This year the deadline for the filing of the 2019 tax returns as well as any payment of taxes owed is April 15, 2020. The IRS expects that individual taxpayers will file more than 150 million tax returns for the tax year 2019; the vast majority of them should come in prior to the April deadline.

This is not the case, however, for US taxpayers with exposure to international tax requirements. Usually, most of these taxpayers file extensions in order to properly prepare all of the required international information returns by the extended deadline in October. Often, such tax filing extensions are necessary in order to obtain the necessary information from foreign countries which may operate on a fiscal year rather than a calendar year. However, even in such cases, taxpayers are expected to pay at least 90% of the tax owed by April 15, 2020.

Moreover, it should be mentioned that taxpayers who reside overseas receive an automatic tax filing extension. For such taxpayers, the 2019 tax filing season will commence also on January 27, 2020, but their tax return filing deadline is June 15, 2020.

The IRS is certain that it will be ready for the 2019 tax filing season by January 27, 2020. In other words, the agency believes that it will not only be able to process the returns smoothly, but all of its security systems will be operational by that date. The IRS also believes that, by January 27, 2020, it will address the potential impact of recent tax legislation on 2019 tax returns

The IRS encourages everyone to e-file their 2019 tax returns. This, however, is not always possible for US taxpayers who have to file international information returns due to software limitations.

Contact Sherayzen Law Office for Professional Help With Your 2019 Tax Filing Season If You Have To Comply With US International Tax Filing Requirements

Sherayzen Law Office helps US and foreign persons with their US international tax compliance requirements, including the filing of all required international information returns such as FBAR, FATCA Form 8938, Form 3520, Form 3520-A, Form 5471, Form 8865, Form 8858, Form 926 and other relevant forms.

With respect to taxpayers who have not been in full compliance with these requirements in the past, Sherayzen Law Office helps you to choose, prepare and file the relevant offshore voluntary disclosure option, including Streamlined Domestic Offshore Procedures, Streamlined Foreign Offshore Procedures, Delinquent International Information Return Submission Procedures, Delinquent FBAR Submission Procedures, Reasonable Cause Noisy Disclosures and Modified IRS Traditional Voluntary Disclosures.

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§267 Entity-to-Member Attribution | International Tax Lawyer & Attorney

In a previous article, I introduced the Internal Revenue Code (“IRC”) §267 constructive ownership rules. Today, I would like to focus specifically on the §267 entity-to-member attribution rule.

§267 Entity-to-Member Attribution: General Rule

§267(c)(1) describes the §267 entity-to-member attribution rule. It states that stocks owned by a corporation, partnership, estate or trust will be treated as owned proportionately by its shareholders, partners, or beneficiaries.

Let’s use an example to explain §267(c)(1). Let’s imagine that Peter and Mary (both US citizens who are not family members within the meaning of §267(c)(4)) own 70% and 30% respectively of shares of X, a C-corporation organized in South Dakota. X owns 100% of shares of N, a Nevada C-corporation.

In this situation, under §267(c)(1), Peter and Mary constructively own 70% and 30% of shares of N. Hence, pursuant to §267(b)(2), Peter is considered to be a related person with respect to X and N corporations due to actual constructive ownership of 70% of shares of both corporations (since this is higher than the 50%-of-value threshold demanded by §267(b)(2)).

Also, note that X and N are related persons, because, pursuant to §267(b)(3), they are members of the same controlled group. §267(b)(3) relies on §267(f) for the definition of the “controlled group”; §267(f), in turn, mostly adopts §1563 definition of controlled group (the main difference is that §267(f) reduces the required level of ownership to more than 50% of voting power and value of the stock as opposed to more than 80% demanded by §1563).

§267 Entity-to-Member Attribution: How Stock is Attributed

The §267(c)(1) is a downstream attribution rule. This means that the attribution of stock flows only in one direction – from entity to the shareholder, partner or beneficiary. There is no “upstream attribution” from shareholder, partner, or beneficiary to the corporation, partnership, estate or trust. Note that this differs from the attribution rules for many corporate transactions governed by §318.

Section 267(c)(1) fails to specify the manner in which attributed stock ownership should be apportioned. The most convincing authority for the apportionment of attributed stocks can be found in case law, particularly Hickman v. Commissioner, 30 T.C. Memo 1972-208. In that case, the Tax Court determined that stock would be attributed from a trust to its beneficiaries proportionately based on the fair market value without any discount for indirect ownership. Actuarial value apportionment was also rejected.

§267 Entity-to-Member Attribution: Chain Ownership

It is important to understand that stock constructively owned by a shareholder, partner, or beneficiary pursuant to §267(c)(1) is treated as actually owned for the purposes of further attribution. In other words, the constructive ownership of a shareholder, partner or beneficiary may be further attributed to others. Moreover, such attribution does not have to be under §267(c)(1); rather, any other attribution category can be used (for example, family member stock attribution).

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US tax law is extremely complex. An ordinary person will simply get lost in this labyrinth of tax rules, exceptions and requirements. Once you get into trouble with US tax law, it is much more difficult and expensive to extricate yourself from it due to high IRS penalties.

This is why it is important to contact Sherayzen Law Office for professional help with US tax law as soon as possible. We have helped hundreds of US taxpayers around the world to successfully resolve their US tax compliance and US tax planning issues. We can help you!

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Related Person Definition – IRC §267 | International Tax Lawyer & Attorney

Internal Revenue Code (“IRC”) §267 imposes significant restrictions on the ability of related persons to recognize loss from a transaction that involves a sale or exchange of property. Hence, it is important for a tax attorney who advises on such a transaction to understand the concept of a “related person” in order to properly advise his client. In this article, I will discuss the general related person definition; in a future article, I will discuss the related person definition in a more specific context.

Related Person Definition: IRC §267(b) and IRC §267(a)(2)

The related person definition is set forth in two part of IRC §267. The first and most comprehensive description of related persons can be found in IRC §267(b) – this description is used throughout IRC §267. The second part is found §267(a)(2) and it applies for the purposes of §267(a)(2) only. Let’s discuss both parts of the related party definition in more detail.

Related Person Definition: Thirteen Categories of IRC §267(b)

IRC §267(b) describes the following thirteen categories of related persons:

1). Family Members;

2). A corporation and an individual shareholder who owns more than 50% of the value of the stock;

3). Two corporations which are members of the same controlled group. Pursuant to §267(b)(3), the term “controlled group” is similar to the definition used for the purposes of the affiliated corporation rules, but with merely a 50% instead of 80% common ownership requirement;

4). A grantor and a fiduciary of any trust;

5). Fiduciaries of different trusts if the same person is the grantor of both trusts;

6). A fiduciary of a trust and a beneficiary of that trust;

7). A fiduciary of a trust and a beneficiary of another trust as long as the same person is the grantor of both trusts;

8). A corporation and a fiduciary of a trust that owns more than 50% of the value of the stock (also, if the trust’s grantor owns more than 50% of the value of the stock);

9). A tax-exempt organization and a person or individual or the individual’s family member who controls the organization;

10). A corporation and a partnership if the same person owns more than 50% of the value of the corporate stock and more than 50% of the capital or profits interest in the partnership;

11). Two or more S-corporations owned more than 50% by the same person;

12). An S-corporation and a C-corporation if the same person owns more than 50% of the value of each; and

13). An executor and a beneficiary of an estate (there is an exception where a sale of property is made to satisfy a pecuniary bequest).

Related Person Definition: IRC §267(a)(2) Category

As it was mentioned above, the fourteenth category of related persons is described in §267(a)(2). This section contains the income-deduction matching provision (i.e. deduction can be taken in a related party transaction by a related party only when an income is recognized by the second party). For the purposes of §267(a)(2), a personal service corporation (within the meaning of IRC §441(i)(2)) and any employee-owner (within the meaning of §269A(b)(2), as modified by §441(i)(2)) are related as persons under IRC §267.

Related Person Definition: Special Rules for Pass-Through Entities

While I will not cover them over here, it is important to note that special rules exist with respect to pass-through entities such as partnerships and S-corporation. These rules can be found in two separate code provisions. IRC §707(b)(1) governs disallowance of losses on transactions between a partnership and its members. IRC §267(a)(1) governs losses on sales or exchanges between a partnership and any person other than a member of the partnership (a third party).

Related Person Definition: Constructive Ownership Rules

Moreover, I would like to emphasize that the determination of whether a person or entity satisfies any of the IRC §267 categories of the related person definition is not limited to the actual ownership percentage of such person or entity. Rather, §267(c) contains elaborate constructive ownership rules that force one to include in the analysis the ownership by closely connected individuals or entities.

Contact Sherayzen Law Office for Professional Help With IRC §267 Related Person Definition and Other Business Tax Issues

US tax law is incredibly complex; the related person definition of IRC §267 is just one example of this complexity. In order to safely navigate through the labyrinth of US tax laws, you need an experienced tax attorney.

This is why you should contact Sherayzen Law Office for professional help. Our legal team, headed by an international tax attorney Eugene Sherayzen, is highly experienced in helping US taxpayers with proper individual and business tax planning and tax compliance. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!