[Federal Register Volume 61, Number 247 (Monday, December 23, 1996)]
[Rules and Regulations]
[Pages 67454-67458]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-31966]



[[Page 67454]]

=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 18, and 602

[TD 8696]
RIN 1545-AE94


Definitions Under Subchapter S of the Internal Revenue Code

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations for S corporations 
and their shareholders relating to the definitions and the special rule 
provided in section 1377 of the Internal Revenue Code. The final 
regulations reflect changes to the law made by the Subchapter S 
Revision Act of 1982 and the Small Business Job Protection Act of 1996. 
These final regulations are necessary to provide guidance for taxpayers 
to comply with the law.

EFFECTIVE DATE: These regulations are effective January 1, 1997.

FOR FURTHER INFORMATION CONTACT: Laura Howell, (202) 622-3060 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1462. Responses to this collection of information 
are required to verify the event giving rise to the making of an 
election under section 1377(a)(2) by an S corporation.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    The estimated annual burden per respondent varies from .2 hour to 
.5 hour, depending on individual circumstances, with an estimated 
average of .25 hour.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, 
DC 20224, and to the Office of Management and Budget, Attn: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On July 12, 1995, the IRS published in the Federal Register a 
notice of proposed rulemaking containing proposed amendments to the 
Income Tax Regulations (26 CFR part 1) under section 1377 of the 
Internal Revenue Code (Code). These amendments were proposed to conform 
the regulations to the addition of section 1377 to the Code by section 
2 of the Subchapter S Revision Act of 1982, Public Law 97-354 (1982-2 
C.B. 702, 710). Written comments responding to this notice were 
received. No public hearing was held because no hearing was requested. 
On August 20, 1996, the Small Business Job Protection Act of 1996, 
Public Law 104-188, 110 Stat. 1755, was enacted. Sections 1306 and 1307 
of the Small Business Job Protection Act of 1996 amended section 1377 
of the Code. After consideration of all comments received, and the 
changes to section 1377 by the Small Business Job Protection Act of 
1996, the proposed amendments are adopted as revised by this Treasury 
decision.

Explanation of Provisions

Days on Which Stock Has Not Been Issued

    Section 1366(a)(1) requires a shareholder of an S corporation to 
take into account the shareholder's pro rata share of the corporation's 
items of income, loss, deduction, and credit. Section 1377(a) provides 
that, except in the case of an election under section 1377(a)(2), each 
shareholders's pro rata share of any item for any taxable year shall be 
the sum of the amounts determined with respect to the shareholder by 
assigning an equal portion of such item to each day of the taxable 
year, and then by dividing that portion pro rata among the shares 
outstanding on such day. The proposed regulations provide that solely 
for purposes of determining a shareholder's pro rata share of an item, 
an S corporation's taxable year does not include any day on which the 
corporation has no shareholders.
    One commentator suggested that a person who beneficially owns the 
corporation should be treated as a shareholder of an S corporation for 
any day on which the corporation has assets and conducts business, but 
has not issued any stock. The final regulations revise the rule 
concerning no shareholder days and provide that, solely for purposes of 
determining a shareholder's pro rata share of an item for a taxable 
year under section 1377(a), the beneficial owners of the corporation 
are treated as the shareholders of the corporation for any day on which 
the corporation has not issued any stock.

When a Post-Termination Transition Period Arises

    The proposed regulations provide that a post-termination transition 
period (PTTP) arises following the termination under section 1362(d) of 
a corporation's S election. By example, the proposed regulations state 
that a PTTP arises when a C corporation acquires the assets of an S 
corporation in a transaction to which section 381(a)(2) applies. 
Several commentators requested clarification concerning whether the 
example results in a termination under section 1362(d) of the 
corporation's election to be an S corporation or merely the cessation 
of the S corporation's taxable year. The final regulations clarify 
that, pursuant to the rule in section 1377(b)(1), a PTTP arises the day 
after the last day that an S corporation was in existence if a C 
corporation acquires the assets of an S corporation in a transaction to 
which section 381(a)(2) applies.

Changes to Section 1377 Made by the Small Business Job Protection 
Act of 1996

Agreement to Terminate Year

    Section 1306 of the Small Business Job Protection Act of 1996 
amended section 1377(a)(2) to provide that only the affected 
shareholders and the corporation must consent to an election to treat 
the corporation's taxable year as two taxable years in the event of a 
complete termination of a shareholder's interest in the corporation. In 
addition, the terminating election under section 1377(a)(2) applies 
only to the affected shareholders. H.R. Conf. Rep. No. 104-737, 104th 
Cong., 2d Sess. 222 (1986). The term affected shareholders is defined 
as the shareholder whose interest is terminated and all shareholders to 
whom the shareholder has transferred shares during the taxable year. If 
the shareholder has transferred shares to the corporation, affected 
shareholders include all persons who are shareholders during the 
taxable year. The final regulations reflect these changes made to 
section 1377(a)(2) by the Small Business Job Protection Act of 1996.

[[Page 67455]]

Expansion of Post-Termination Transition Period

    Section 1307(a) of the Small Business Job Protection Act of 1996 
expands the definition of PTTP under section 1377(b)(1) to include the 
120-day period beginning on the date of any determination pursuant to 
an audit of the taxpayer that follows the termination of the S 
corporation's election and that adjusts a subchapter S item of income, 
loss, or deduction of the S corporation during the S period. In 
addition, the definition of determination is expanded to include any 
determination under section 1313(a). The effect of this change is to 
expand the definition of determination to include a final disposition 
by the Secretary of a claim for refund and certain agreements between 
the Secretary and any person relating to the tax liability of the 
person. The final regulations reflect these changes made to section 
1377(b) by section 1307 of the Small Business Job Protection Act of 
1996.

Coordination With Other Provisions and Other Clarifying Changes

    In response to comments, the final regulations add cross-references 
and make certain clarifying revisions. The proposed regulations 
coordinate the application of the terminating election under section 
1377(a)(2) with the election that may be made under Sec. 1.1368-1(g)(2) 
when there is a qualifying disposition by: (i) Removing the section 
1377 reference in Sec. 1.1368-1(g)(1) because all of the rules for a 
section 1377(a)(2) terminating election are now entirely stated in 
these final regulations; and (ii) amending Sec. 1.1368-1(g)(2) to 
provide that a qualifying disposition election cannot be made if a 
transfer results in a termination of the shareholder's entire interest 
as a shareholder.
    The proposed regulations provide that a section 1377(a)(2) 
terminating election must contain the written consent of each 
shareholder. The final regulations revise the shareholder consent rules 
by removing the written consent requirement for each shareholder. The 
final regulations merely require an S corporation to include a 
statement by the corporation that each affected shareholder and the 
corporation consent to the election.
    In response to comments, the final regulations clarify that a 
shareholder's entire interest in an S corporation is not terminated if 
the shareholder retains ownership of any stock, including an interest 
treated as stock under Sec. 1.1361-1(l), that would result in the 
shareholder continuing to be considered a shareholder of the 
corporation for purposes of section 1362(a)(2). In addition, the final 
regulations clarify that a shareholder whose entire interest in an S 
corporation is terminated in an event for which a terminating election 
was made is not required to consent to an election under section 
1377(a)(2) for a subsequent termination of another shareholder within 
the taxable year unless the shareholder is an affected shareholder with 
respect to the subsequent termination.

Effective Date

    These regulations apply to taxable years of an S corporation 
beginning after December 31, 1996.

Special Analysis

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required. It has also been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because the notice of proposed 
rulemaking preceding the regulations was issued prior to March 29, 
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Laura Howell, Office 
of Assistant Chief Counsel (Passthroughs and Special Industries). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects

26 CFR Parts 1 and 18

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 18, and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805. * * *
    Section 1.1377-1 also issued under 26 U.S.C. 1377 (a)(2) and 
(c). * * *

    Par. 2. Section 1.1368-0 is amended by:
    1. Revising the entry for paragraphs (g) and (g)(1) of Sec. 1.1368-
1.
    2. Adding an entry for paragraph (g)(2)(iv) of Sec. 1.1368-1.
    The revisions and addition read as follows:


Sec. 1.1368-0   Table of contents.

* * * * *


Sec. 1.1368-1   Distributions by S corporations.

* * * * *
    (g) Special rule.
    (1) Election to terminate year under Sec. 1.1368-1(g)(2).
    (2) * * *
    (iv) Coordination with election under section 1377(a)(2).
* * * * *
    Par. 3. Section 1.1368-1 is amended by:
    1. Revising the heading for paragraph (g).
    2. Revising paragraph (g)(1).
    3. Adding paragraph (g)(2)(iv).
    The revisions and addition read as follows:


Sec. 1.1368-1   Distributions by S corporations.

* * * * *
    (g) Special rule--(1) Election to terminate year under Sec. 1.1368-
1(g)(2). If an election is made under paragraph (g)(2) of this section 
to terminate the year when there is a qualifying disposition, this 
section applies as if the taxable year consisted of separate taxable 
years, the first of which ends at the close of the day on which there 
is a qualifying disposition of stock.
    (2) * * *
    (iv) Coordination with election under section 1377(a)(2). If the 
event resulting in a qualifying disposition also results in a 
termination of a shareholder's entire interest as described in 
Sec. 1.1377-1(b)(4), the election under this paragraph (g)(2) cannot be 
made. Rather, the election under section 1377(a)(2) and Sec. 1.1377-
1(b) may be made. See Sec. 1.1377-1(b) (concerning the election under 
section 1377(a)(2)).
    Par. 4. Sections 1.1377-0, 1.1377-1, 1.1377-2, and 1.1377-3 are 
added under the undesignated center heading ``Small Business 
Corporations and Their Shareholders'' to read as follows:


Sec. 1.1377-0   Table of contents.

    The following table of contents is provided to facilitate the use 
of Secs. 1.1377-1 through 1.1377-3:

[[Page 67456]]

Sec. 1.1377-1  Pro rata share

    (a) Computation of pro rata shares.
    (1) In general.
    (2) Special rules.
    (i) Days on which stock has not been issued.
    (ii) Determining shareholder for day of stock disposition.
    (b) Election to terminate year.
    (1) In general.
    (2) Affected shareholders.
    (3) Effect of the terminating election.
    (i) In general.
    (ii) Due date of S corporation return.
    (iii) Taxable year of inclusion by shareholder.
    (iv) S Corporation that is a partner in a partnership.
    (4) Determination of whether an S shareholder's entire interest 
has terminated.
    (5) Time and manner of making a terminating election.
    (i) In general.
    (ii) Affected shareholders required to consent.
    (iii) More than one terminating election.
    (c) Examples.

Sec. 1.1377-2  Post-termination transition period

    (a) In general.
    (b) Special rules for post-termination transition period.
    (c) Determination defined.
    (d) Date a determination becomes effective.
    (1) Determination under section 1313(a).
    (2) Written agreement.
    (3) Implied agreement.

Sec. 1.1377-3  Effective date


Sec. 1.1377-1   Pro rata share.

    (a) Computation of pro rata shares--(1) In general. For purposes of 
subchapter S of chapter 1 of the Internal Revenue Code and this 
section, each shareholder's pro rata share of any S corporation item 
described in section 1366(a) for any taxable year is the sum of the 
amounts determined with respect to the shareholder by assigning an 
equal portion of the item to each day of the S corporation's taxable 
year, and then dividing that portion pro rata among the shares 
outstanding on that day. See paragraph (b) of this section for rules 
pertaining to the computation of each shareholder's pro rata share when 
an election is made under section 1377(a)(2) to treat the taxable year 
of an S corporation as if it consisted of two taxable years in the case 
of a termination of a shareholder's entire interest in the corporation.
    (2) Special rules--(i) Days on which stock has not been issued. 
Solely for purposes of determining a shareholder's pro rata share of an 
item for a taxable year under section 1377(a) and this section, the 
beneficial owners of the corporation are treated as the shareholders of 
the corporation for any day on which the corporation has not issued any 
stock.
    (ii) Determining shareholder for day of stock disposition. A 
shareholder who disposes of stock in an S corporation is treated as the 
shareholder for the day of the disposition. A shareholder who dies is 
treated as the shareholder for the day of the shareholder's death.
    (b) Election to terminate year--(1) In general. If a shareholder's 
entire interest in an S corporation is terminated during the S 
corporation's taxable year and the corporation and all affected 
shareholders agree, the S corporation may elect under section 
1377(a)(2) and this paragraph (b) (terminating election) to apply 
paragraph (a) of this section to the affected shareholders as if the 
corporation's taxable year consisted of two separate taxable years, the 
first of which ends at the close of the day on which the shareholder's 
entire interest in the S corporation is terminated. If the event 
resulting in the termination of the shareholder's entire interest also 
constitutes a qualifying disposition as described in Sec. 1.1368-
1(g)(2)(i), the election under Sec. 1.1368-1(g)(2) cannot be made. An S 
corporation may not make a terminating election if the cessation of a 
shareholder's interest occurs in a transaction that results in a 
termination under section 1362(d)(2) of the corporation's election to 
be an S corporation. (See section 1362(e)(3) for an election to have 
items assigned to each short taxable year under normal tax accounting 
rules in the case of a termination of a corporation's election to be an 
S corporation.) A terminating election is irrevocable and is effective 
only for the terminating event for which it is made.
    (2) Affected shareholders. For purposes of the terminating election 
under section 1377(a)(2) and paragraph (b) of this section, the term 
affected shareholders means the shareholder whose interest is 
terminated and all shareholders to whom such shareholder has 
transferred shares during the taxable year. If such shareholder has 
transferred shares to the corporation, the term affected shareholders 
includes all persons who are shareholders during the taxable year.
    (3) Effect of the terminating election--(i) In general. An S 
corporation that makes a terminating election for a taxable year must 
treat the taxable year as separate taxable years for all affected 
shareholders for purposes of allocating items of income (including tax-
exempt income), loss, deduction, and credit; making adjustments to the 
accumulated adjustments account, earnings and profits, and basis; and 
determining the tax effect of a distribution. An S corporation that 
makes a terminating election must assign items of income (including 
tax-exempt income), loss, deduction, and credit to each deemed separate 
taxable year using its normal method of accounting as determined under 
section 446(a).
    (ii) Due date of S corporation return. A terminating election does 
not affect the due date of the S corporation's return required to be 
filed under section 6037(a) for a taxable year (determined without 
regard to a terminating election).
    (iii) Taxable year of inclusion by shareholder. A terminating 
election does not affect the taxable year in which an affected 
shareholder must take into account the affected shareholder's pro rata 
share of the S corporation's items of income, loss, deduction, and 
credit.
    (iv) S corporation that is a partner in a partnership. A 
terminating election by an S corporation that is a partner in a 
partnership is treated as a sale or exchange of the corporation's 
entire interest in the partnership for purposes of section 706(c) 
(relating to closing the partnership taxable year), if the taxable year 
of the partnership ends after the shareholder's interest is terminated 
and within the taxable year of the S corporation (determined without 
regard to any terminating election) for which the terminating election 
is made.
    (4) Determination of whether an S shareholder's entire interest has 
terminated. For purposes of the terminating election under section 
1377(a)(2) and paragraph (b) of this section, a shareholder's entire 
interest in an S corporation is terminated on the occurrence of any 
event through which a shareholder's entire stock ownership in the S 
corporation ceases, including a sale, exchange, or other disposition of 
all of the stock held by the shareholder; a gift under section 102(a) 
of all the shareholder's stock; a spousal transfer under section 
1041(a) of all the shareholder's stock; a redemption, as defined in 
section 317(b), of all the shareholder's stock, regardless of the tax 
treatment of the redemption under section 302; and the death of the 
shareholder. A shareholder's entire interest in an S corporation is not 
terminated if the shareholder retains ownership of any stock (including 
an interest treated as stock under Sec. 1.1361-1(l)) that would result 
in the shareholder continuing to be considered a shareholder of the 
corporation for purposes of section 1362(a)(2). Thus, in determining 
whether a shareholder's entire interest in an S corporation has been 
terminated, any interest held by the shareholder as a creditor, 
employee,

[[Page 67457]]

director, or in any other non-shareholder capacity is disregarded.
    (5) Time and manner of making a terminating election--(i) In 
general. An S corporation makes a terminating election by attaching a 
statement to its timely filed original or amended return required to be 
filed under section 6037(a) (that is, a Form 1120S) for the taxable 
year during which a shareholder's entire interest is terminated. A 
single election statement may be filed by the S corporation for all 
terminating elections for the taxable year. The election statement must 
include--
    (A) A declaration by the S corporation that it is electing under 
section 1377(a)(2) and this paragraph (b) to treat the taxable year as 
if it consisted of two separate taxable years;
    (B) Information setting forth when and how the shareholder's entire 
interest was terminated (for example, a sale or gift);
    (C) The signature on behalf of the S corporation of an authorized 
officer of the corporation under penalties of perjury; and
    (D) A statement by the corporation that the corporation and each 
affected shareholder consent to the S corporation making the 
terminating election.
    (ii) Affected shareholders required to consent. For purposes of 
paragraph (b)(5)(i)(D) of this section, a shareholder of the S 
corporation for the taxable year is a shareholder as described in 
section 1362(a)(2). For example, the person who under Sec. 1.1362-
6(b)(2) must consent to a corporation's S election in certain special 
cases is the person who must consent to the terminating election. In 
addition, an executor or administrator of the estate of a deceased 
affected shareholder may consent to the terminating election on behalf 
of the deceased affected shareholder.
    (iii) More than one terminating election. A shareholder whose 
entire interest in an S corporation is terminated in an event for which 
a terminating election was made is not required to consent to a 
terminating election made with respect to a subsequent termination 
within the same taxable year unless the shareholder is an affected 
shareholder with respect to the subsequent termination.
    (c) Examples. The following examples illustrate the provisions of 
this section:

    Example 1. Shareholder's pro rata share in the case of a partial 
disposition of stock. (i) On January 6, 1997, X incorporates as a 
calendar year corporation, issues 100 shares of common stock to each 
of A and B, and files an election to be an S corporation for its 
1997 taxable year. On July 24, 1997, B sells 50 shares of X stock to 
C. Thus, in 1997, A owned 50 percent of the outstanding shares of X 
on each day of X's 1997 taxable year, B owned 50 percent on each day 
from January 6, 1997, to July 24, 1997 (200 days), and 25 percent 
from July 25, 1997, to December 31, 1997 (160 days), and C owned 25 
percent from July 25, 1997, to December 31, 1997 (160 days).
    (ii) Because B's entire interest in X is not terminated when B 
sells 50 shares to C on July 24, 1997, X cannot make a terminating 
election under section 1377(a)(2) and paragraph (b) of this section 
for B's sale of 50 shares to C. Although B's sale of 50 shares to C 
is a qualifying disposition under Sec. 1.1368-1(g)(2)(i), X does not 
make an election to terminate its taxable year under Sec. 1.1368-
1(g)(2). During its 1997 taxable year, X has nonseparately computed 
income of $720,000.
    (iii) For each day in X's 1997 taxable year, A's daily pro rata 
share of X's nonseparately computed income is $1,000 ($720,000/360 
days x 50%). Thus, A's pro rata share of X's nonseparately computed 
income for 1997 is $360,000 ($1,000 x 360 days). B's daily pro rata 
share of X's nonseparately computed income is $1,000 ($720,000/
360 x 50%) for the first 200 days of X's 1997 taxable year, and $500 
($720,000/360 x 25%) for the following 160 days in 1997. Thus, B's 
pro rata share of X's nonseparately computed income for 1997 is 
$280,000 (($1,000 x 200 days) + ($500 x 160 days)). C's daily pro 
rata share of X's nonseparately computed income is $500 ($720,000/
360 x 25%) for 160 days in 1997. Thus, C's pro rata share of X's 
nonseparately computed income for 1997 is $80,000 ($500 x 160 days).
    Example 2. Shareholder's pro rata share when an S corporation 
makes a terminating election under section 1377(a)(2). (i) On 
January 6, 1997, X incorporates as a calendar year corporation, 
issues 100 shares of common stock to each of A and B, and files an 
election to be an S corporation for its 1997 taxable year. On July 
24, 1997, B sells B's entire 100 shares of X stock to C. With the 
consent of B and C, X makes an election under section 1377(a)(2) and 
paragraph (b) of this section for the termination of B's entire 
interest arising from B's sale of 100 shares to C. As a result of 
the election, the pro rata shares of B and C are determined as if 
X's taxable year consisted of two separate taxable years, the first 
of which ends on July 24, 1997, the date B's entire interest in X 
terminates. Because A is not an affected shareholder as defined by 
section 1377(a)(2)(B) and paragraph (b)(2) of this section, the 
treatment as separate taxable years does not apply to A.
    (ii) During its 1997 taxable year, X has nonseparately computed 
income of $720,000. Under X's normal method of accounting, $200,000 
of the $720,000 of nonseparately computed income is allocable to the 
period of January 6, 1997, through July 24, 1997 (the first deemed 
taxable year), and the remaining $520,000 is allocable to the period 
of July 25, 1997, through December 31, 1997 (the second deemed 
taxable year).
    (iii) B's pro rata share of the $200,000 of nonseparately 
computed income for the first deemed taxable year is determined by 
assigning the $200,000 of nonseparately computed income to each day 
of the first deemed taxable year ($200,000/200 days = $1,000 per 
day). Because B held 50% of X's authorized and issued shares on each 
day of the first deemed taxable year, B's daily pro rata share for 
each day of the first deemed taxable year is $500 ($1,000 per day 
x  50%). Thus, B's pro rata share of the $200,000 of nonseparately 
computed income for the first deemed taxable year is $100,000 ($500 
per day  x  200 days). B must report this amount for B's taxable 
year with or within which X's full taxable year ends (December 31, 
1997).
    (iv) C's pro rata share of the $520,000 of nonseparately 
computed income for the second deemed taxable year is determined by 
assigning the $520,000 of nonseparately computed income to each day 
of the second deemed taxable year ($520,000/160 days = $3,250 per 
day). Because C held 50% of X's authorized and issued shares on each 
day of the second deemed taxable year, C's daily pro rata shares for 
each day of the second deemed taxable year is $1,625 ($3,250 per day 
 x  50%). Therefore, C's pro rata share of the $520,000 of 
nonseparately computed income is $260,000 ($1,625 per day  x  160 
days). C must report this amount for C's taxable year with or within 
which X's full taxable year ends (December 31, 1997).


Sec. 1.1377-2  Post-termination transition period.

    (a) In general. For purposes of subchapter S of chapter 1 of the 
Internal Revenue Code (Code) and this section, the term post-
termination transition period means--
    (1) The period beginning on the day after the last day of the 
corporation's last taxable year as an S corporation and ending on the 
later of--
    (i) The day which is 1 year after such last day; or
    (ii) The due date for filing the return for the last taxable year 
as an S corporation (including extensions);
    (2) The 120-day period beginning on the date of any determination 
pursuant to an audit of the taxpayer which follows the termination of 
the corporation's election and which adjusts a subchapter S item of 
income, loss, or deduction of the corporation arising during the S 
period (as defined in section 1368(e)(2)); and
    (3) The 120-day period beginning on the date of a determination 
that the corporation's election under section 1362(a) had terminated 
for a previous taxable year.
    (b) Special rules for post-termination transition period. Pursuant 
to section 1377(b)(1) and paragraph (a)(1) of this section, a post-
termination transition period arises the day after the last day that an 
S corporation was in existence if a C corporation acquires the assets 
of the S corporation in a transaction to which section 381(a)(2) 
applies. However, if an S corporation acquires the assets of another S 
corporation in a

[[Page 67458]]

transaction to which section 381(a)(2) applies, a post-termination 
transition period does not arise. (See Sec. 1.1368-2(d)(2) for the 
treatment of the acquisition of the assets of an S corporation by 
another S corporation in a transaction to which section 381(a)(2) 
applies.) The special treatment under section 1371(e)(1) of 
distributions of money by a corporation with respect to its stock 
during the post-termination transition period is available only to 
those shareholders who were shareholders in the S corporation at the 
time of the termination.
    (c) Determination defined. For purposes of section 1377(b)(1) and 
paragraph (a) of this section, the term determination means--
    (1) A determination as defined in section 1313(a);
    (2) A written agreement between the corporation and the 
Commissioner (including a statement acknowledging that the 
corporation's election to be an S corporation terminated under section 
1362(d)) that the corporation failed to qualify as an S corporation;
    (3) For a corporation subject to the audit and assessment 
provisions of subchapter C of chapter 63 of subtitle A of the Code, the 
expiration of the period specified in section 6226 for filing a 
petition for readjustment of a final S corporation administrative 
adjustment finding that the corporation failed to qualify as an S 
corporation, provided that no petition was timely filed before the 
expiration of the period; and
    (4) For a corporation not subject to the audit and assessment 
provisions of subchapter C of chapter 63 of subtitle A of the Code, the 
expiration of the period for filing a petition under section 6213 for 
the shareholder's taxable year for which the Commissioner has made a 
finding that the corporation failed to qualify as an S corporation, 
provided that no petition was timely filed before the expiration of the 
period.
    (d) Date a determination becomes effective--(1) Determination under 
section 1313(a). A determination under paragraph (c)(1) of this section 
becomes effective on the date prescribed in section 1313 and the 
regulations thereunder.
    (2) Written agreement. A determination under paragraph (c)(2) of 
this section becomes effective when it is signed by the district 
director having jurisdiction over the corporation (or by another 
Service official to whom authority to sign the agreement is delegated) 
and by an officer of the corporation authorized to sign on its behalf. 
Neither the request for a written agreement nor the terms of the 
written agreement suspend the running of any statute of limitations.
    (3) Implied agreement. A determination under paragraph (c) (3) or 
(4) of this section becomes effective on the day after the date of 
expiration of the period specified under section 6226 or 6213, 
respectively.


Sec. 1.1377-3  Effective date.

    Sections 1.1377-1 and 1.1377-2 apply to taxable years of an S 
corporation beginning after December 31, 1996.

PART 18--TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S 
REVISION ACT OF 1982

    Par. 5. The authority citation for part 18 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


Sec. 18.1377-1  [Removed]

    Par. 6. Section 18.1377-1 is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 7. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 8. In Sec. 602.101, paragraph (c) is amended as follows:
    1. Removing the following entry from the table:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
 CFR part or section where identified and                               
                described                     Current OMB control No.   
------------------------------------------------------------------------
                                                                        
                  *        *        *        *        *                 
18.1377-1................................  1545-0130                    
                                                                        
                  *        *        *        *        *                 
------------------------------------------------------------------------

    2. Adding an entry in numerical order to the table to read as 
follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

------------------------------------------------------------------------
 CFR part of section where identified and                               
                described                     Current OMB control No.   
------------------------------------------------------------------------
                                                                        
                  *        *        *        *        *                 
1.1377-1.................................  1545-1462                    
                                                                        
                  *        *        *        *        *                 
------------------------------------------------------------------------

Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: November 1, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 96-31966 Filed 12-20-96; 8:45 am]
BILLING CODE 4830-01-U