[Federal Register Volume 73, Number 203 (Monday, October 20, 2008)]
[Rules and Regulations]
[Pages 62199-62203]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-24926]



[[Page 62199]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9428]
RIN 1545-BD72


Section 1367 Regarding Open Account Debt

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
treatment of open account debt between S corporations and their 
shareholders. These final regulations provide rules regarding the 
definition of open account debt and the adjustments in basis of any 
indebtedness of an S corporation to a shareholder under section 
1367(b)(2) of the Internal Revenue Code (Code) for shareholder advances 
and repayments on advances of open account debt. The regulations affect 
shareholders of S corporations and are necessary to provide guidance 
needed to comply with the applicable tax law.

DATES: 
    Effective Date: These regulations are effective on October 20, 
2008.
    Applicability Date: For dates of applicability, see Sec.  1.1367-3.

FOR FURTHER INFORMATION CONTACT: Stacy L. Short or Deane M. Burke, 
(202) 622-3070 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends Sec.  1.1367-2 of the Income Tax Regulations 
(26 CFR part 1) regarding the definition of open account debt and 
adjustments in basis of indebtedness for shareholder advances and 
repayments on advances of open account debt.
    Section 1367(a)(1) provides that the basis of each shareholder's 
stock in an S corporation is increased by the shareholder's pro rata 
share of the S corporation's income (separately and nonseparately 
computed items of income) and the excess of the deductions for 
depletion over the basis of the property subject to depletion. Section 
1367(a)(2) provides that the basis of each shareholder's stock in the S 
corporation is decreased by the shareholder's distributions not 
includible in income of the shareholder by reason of section 1368 
(nontaxable distributions), and the shareholder's pro rata share of the 
losses and deductions (separately and nonseparately computed losses), 
any expense of the corporation that is not deductible and not properly 
chargeable to capital account, and certain deductions for depletion for 
any oil and gas property held by the S corporation. Under section 
1367(b)(2)(A), if for any taxable year the amounts specified in section 
1367(a)(2) (other than distributions) exceed the amount which reduces 
the shareholder's basis to zero, such excess losses and deductions 
shall be applied to reduce (but not below zero) the shareholder's basis 
in any indebtedness of the S corporation to the shareholder. Section 
1367(b)(2)(B) provides that if a shareholder's basis in indebtedness is 
reduced for any taxable year, any net increase (the amount by which the 
items described in section 1367(a)(1) exceed the items described in 
section 1367(a)(2)) for any subsequent taxable year is applied to 
restore the reduction in basis in indebtedness before any of the excess 
is used to increase basis in stock.
    On January 3, 1994, the Treasury Department and the IRS published 
final regulations under section 1367 of the Code (TD 8508, 59 FR 12, 
amended on December 22, 1999 (TD 8852, 64 FR 71641)). Those final 
regulations relate, in part, to adjustments to basis in both stock of 
shareholders and indebtedness of an S corporation to its shareholders. 
Section 1.1367-2 of the Income Tax Regulations provides specific rules 
for required adjustments (reductions and restorations) to basis in any 
indebtedness of an S corporation to a shareholder. Section 1.1367-2(a) 
also provides that for purposes of adjustments to basis of indebtedness 
to shareholders, shareholder advances not evidenced by separate written 
instruments and repayments on the advances (open account debt) are 
treated as a single indebtedness. The basis adjustment rules under the 
final regulations apply to all indebtedness of an S corporation to a 
shareholder, whether the indebtedness is evidenced by a written 
instrument or is open account debt. Taxpayers should also remember that 
all advances to an S corporation by a shareholder are subject to the 
general tax principles for debt, whether evidenced by a written 
instrument or not.
    On August 25, 2005, the Tax Court issued its decision in Brooks v. 
Commissioner, TC Memo. 2005-204, involving open account debt. Under its 
interpretation of Sec.  1.1367-2, the court in Brooks held ``that the 
basis of the open account indebtedness is properly computed by netting 
at the close of the year advances of open account debt during the year 
and repayments of open account debt during the year.'' This allowed the 
taxpayer in Brooks to defer indefinitely the recognition of income on 
any repayment of his open account debt over the several years during 
which the taxpayer and the S corporation made advances and repayments, 
respectively.
    On April 12, 2007, the Treasury Department and the IRS published a 
notice of proposed rulemaking and a notice of public hearing (REG-
144859-04, 2007-20 IRB 1245) in the Federal Register (72 FR 18417) 
proposing amendments to the regulations relating to the treatment of 
open account debt between S corporations and their shareholders. A 
public hearing on the proposed regulations was scheduled for July 31, 
2007, but was cancelled because no one requested to speak. However, 
comments responding to the proposed regulations were received. After 
consideration of these comments, the proposed regulations are adopted 
as revised by this Treasury decision. These final regulations generally 
retain the provisions of the proposed regulations with the 
modifications discussed in the preamble.

Summary of Comments and Explanation of Revisions

1. Need for Regulatory Change

    All of the comments received in response to the proposed 
regulations suggested that the regulations were overly broad and should 
be withdrawn. Two commentators suggested that amending the regulations 
for open account debt is not an appropriate approach for the Treasury 
Department and the IRS to address concerns regarding transactions 
similar to that in Brooks. Instead, the commentators asserted, such 
concerns should be addressed through established judicial doctrines 
such as substance over form, business purpose, sham transaction, and 
economic substance. One commentator alternatively recommended a 
narrowly tailored anti-abuse rule targeting open account debt instead 
of broader rules that would apply to all such debt.
    The Treasury Department and the IRS continue to believe that 
regulatory guidance on open account debt is necessary. The Treasury 
Department and the IRS believe that the treatment of open account debt 
as interpreted in Brooks permits tax consequences that are inconsistent 
with the original purpose of Sec.  1.1367-2 and is not conducive to 
sound tax administration. Neither established judicial doctrines alone 
nor a narrowly tailored anti-abuse rule suggested by the commentators 
would adequately address these concerns, though the Treasury Department 
and the IRS continue to

[[Page 62200]]

recognize the applicability of the judicial doctrines in appropriate 
cases in addition to these final regulations.

2. Aggregate Principal Threshold Amount

    The proposed regulations defined open account debt as shareholder 
advances not evidenced by separate written instruments for which the 
principal amount of the aggregate advances (net of repayments on 
advances) did not exceed $10,000 per shareholder at the close of any 
day during the S corporation's taxable year. Shareholders were required 
to determine for open account debt purposes whether shareholder 
advances and repayments on the advances exceeded the $10,000 aggregate 
principal threshold on any day during the S corporation's taxable year. 
To make such a determination, shareholders were required to maintain a 
``running balance'' of shareholder advances and repayments on advances, 
and the outstanding principal amount of the open account debt. If the 
resulting aggregate principal of the running balance exceeded $10,000 
at the close of any day during the S corporation's taxable year, the 
entire principal amount of the indebtedness would no longer constitute 
open account debt effective at the close of that day.
    Commentators suggested that the proposed regulations' aggregate 
principal threshold of $10,000 was too low for most businesses. One 
commentator asserted that establishing any aggregate principal 
threshold dollar amount for open account debt in final regulations 
would be arbitrary and would impose a certain compliance burden on 
smaller businesses. However, that commentator also suggested that 
increasing the aggregate principal threshold dollar amount would 
mitigate the compliance burden. The commentators suggested that if the 
final regulations adopt any threshold dollar amount for open account 
debt, such a threshold amount should be increased to an amount ranging 
from $100,000 to $1 million.
    After considering the comments on the aggregate principal threshold 
dollar amount, and on recognizing customary business practices as noted 
by the commentators, the Treasury Department and the IRS have concluded 
that the aggregate principal threshold dollar amount for open account 
debt should be increased and that other changes are necessary. 
Therefore, the final regulations adopt a $25,000 aggregate principal 
threshold amount per shareholder for open account debt. For example, an 
S corporation with ten shareholders could receive up to $250,000 of 
open account debt as long as no single shareholder advanced more than 
$25,000. The Treasury Department and the IRS believe that the $25,000 
threshold, together with certain other changes noted below, balances 
concerns over deferral potential with normal business practices. Under 
the final regulations, for any particular shareholder advances and 
repayments on those advances for which, as of the specified 
determination date, the aggregate principal balance exceeds the $25,000 
aggregate principal threshold amount will no longer constitute open 
account debt, but instead will be treated as debt evidenced by a 
separate written instrument subject to the basis adjustment and 
repayment accounting rules applicable to S corporation shareholder debt 
generally.
    As noted in the preamble to the proposed regulations, the $10,000 
aggregate principal threshold amount for open account debt for purposes 
of Sec.  1.1367-2 was modeled after section 7872(c)(3) and the de 
minimis exception for corporation-shareholder loans in Sec.  1.7872-9 
of the proposed regulations. However, the Treasury Department and the 
IRS do not believe it is necessary that the threshold amount for open 
account debt be modeled after the rules under Sec.  1.7872-9 regarding 
corporate-shareholder loans. Nevertheless, despite the $25,000 
threshold amount for open account debt in these final regulations, the 
provisions under section 7872 and related regulations for corporate-
shareholder loans in excess of $10,000 separately apply to open account 
debt in excess of $10,000 for each advance if the corporation is not 
obligated to pay a market rate of interest on the advances.

3. Monitoring the Aggregate Principal Threshold Amount

    The proposed regulations effectively required day-to-day monitoring 
of open account debt. For purposes of determining compliance with the 
aggregate principal threshold amount for open account debt, the 
shareholder was required to maintain a daily running balance of 
shareholder advances and repayments on such advances, and the 
outstanding principal amount of the open account debt. Some of the 
commentators suggested that the daily monitoring requirement would 
impose an unreasonable burden on shareholders and recommended that the 
running balance requirement be tested quarterly, annually or when the 
corporation maintains and updates its other books and records. One 
commentator described the practice by many closely held corporations of 
reconciling and accounting only once a year and noted that only then 
would such an S corporation and its shareholder(s) know what payments 
are legitimately charged to the corporation as opposed to those 
appropriately charged to the shareholder(s).
    Another commentator suggested that with daily monitoring, a maximum 
threshold rule for open account debt is too harsh for shareholders 
insofar as it immediately changes the treatment of such debt the 
principal balance of which exceeds the threshold by a single cent on 
any day, resulting in a ``cliff'' effect. The commentator suggested 
that in order to mitigate this ``cliff'' effect, the final regulations 
should adopt a second prong to the aggregate principal threshold amount 
test so that advances would fail to meet the definition of open account 
debt only if both the aggregate principal of the running balance 
exceeded the applicable aggregate principal threshold dollar amount on 
any given day of the year and the balance at the end of the year 
exceeded the average of the daily balances throughout the year. The 
commentator provided examples of intended beneficiaries of such an 
``averaging'' rule, for example, shareholders who need to advance their 
S corporation more funds on a short-time basis but end the year with an 
outstanding principal amount of the open account debt below the 
threshold level.
    After careful consideration of these comments, the Treasury 
Department and the IRS have concluded that extending the period for 
which a shareholder determines whether shareholder advances and 
repayments exceed the aggregate principal threshold dollar amount for 
open account debt would reduce both the complexity of the regulations 
and any perceived burden on shareholders in making such determinations. 
In addition, such a modified rule should alleviate concerns over any 
potential ``cliff'' effect resulting from a day-to-day determination of 
threshold amount as required in the proposed regulations. The Treasury 
Department and the IRS also recognize that shareholder advances made to 
an S corporation and subsequently repaid during the same taxable year 
of the S corporation are not available for inclusion in the 
shareholder's basis in the indebtedness for purposes of passing through 
additional losses to the shareholder at the end of the taxable year.
    Therefore, the final regulations do not adopt a daily determination 
of whether shareholder advances and repayments on the advances exceed 
the $25,000 threshold amount. Instead, the final

[[Page 62201]]

regulations provide that a determination of whether the threshold 
balance of $25,000 is exceeded will be made at the end of the taxable 
year of the S corporation. Under these final regulations, however, if 
open account debt is disposed of in whole or in part before the end of 
the S corporation's taxable year, the determination of whether the 
advances and repayments have exceeded the designated aggregate 
principal threshold amount must be made immediately before the 
disposition of the debt during that taxable year. Moreover, if a 
shareholder with open account debt is no longer a shareholder at the 
end of the S corporation's taxable year, the determination must be made 
immediately before the shareholder's interest in the S corporation is 
terminated.

4. Character of Income/Gain Recognition

    One of the commentators suggested that the final regulations 
address the issue of how to characterize any income or gain that is 
recognized upon repayment of both open account debt and indebtedness 
evidenced by a written instrument. While recognizing the commentators' 
concerns, the Treasury Department and the IRS believe that the 
characterization issue is beyond the scope of these final regulations. 
However, the Treasury Department and the IRS intend to continue 
considering the characterization issue.

5. Effective Date Operation

    The effective date in the proposed regulations provided that the 
proposed rules for open account debt applied to any shareholder 
advances to the S corporation made on or after the date the regulations 
were published as final regulations and repayments on those advances by 
the S corporation. Thus, all open account debt (net of repayments) 
prior to the publication of the final regulation was outside the scope 
of the proposed regulations, irrespective of the outstanding principal 
amount.
    One of the commentators believed that the effective date language 
in the proposed regulations was subject to two interpretations. Under 
the first interpretation, the rules under these final regulations (New 
Rules) would apply only to open account debt created on or after the 
effective date, that is, shareholder advances made on or after the 
effective date and repayments on those same advances. The rules under 
the prior final regulations (as contained in the 26 CFR edition revised 
April 1, 2007) (Old Rules) would apply to open account debt created 
before the effective date, that is, shareholder advances with respect 
to pre-effective date open account debt and repayments on those prior 
advances. Accordingly, a shareholder could have open account debt, 
subject to the Old Rules, and open account debt, subject to the New 
Rules, to which new shareholder advances and repayments on those 
advances could be made after the effective date.
    Under the second interpretation, a shareholder could not make 
additional advances with respect to open account debt created before 
the effective date but could receive repayments on that debt under the 
Old Rules. Accordingly, the New Rules would apply to all shareholder 
advances on and after the effective date, as well as repayments on 
those advances, and the Old Rules would apply only to repayments on 
pre-effective date open account debt.
    The Treasury Department and the IRS intend that the rules under 
these final regulations (New Rules) apply to any and all shareholder 
advances made on and after the effective date. The rules under these 
final regulations (New Rules) also apply to repayments on such 
advances. However, if a shareholder has open account debt (net of prior 
repayments in the taxable year) outstanding prior to the effective date 
of these final regulations, the rules under the prior final regulations 
(Old Rules) apply to any repayments on such pre-effective date open 
account debt. Accordingly, that pre-effective date open account debt 
will not be subject to any aggregate principal threshold dollar amount. 
The shareholder may not make additional advances with respect to the 
pre-effective date open account debt (because all shareholder advances 
made on or after the effective date of these final regulations 
constitute new open account debt subject to these final regulations).
    For instance, assume that the effective date of these final 
regulations falls within the taxable year of shareholder A's S 
corporation. Also assume that, at the beginning of the S corporation's 
taxable year, A will have existing open account debt with an 
outstanding principal balance of $12,000. Assume further that A will 
make an additional advance of $3,000 to and will receive a $2,000 
repayment from his S corporation prior to the effective date. Thus, as 
of the effective date, A will have existing open account debt with an 
outstanding principal balance of $13,000 (A would net the pre-effective 
date advance and repayment for the taxable year and combine that net 
advance of $1,000 with the $12,000 outstanding aggregate principal 
balance of the then existing open account debt). This $13,000 pre-
effective date open account debt would not be subject to these final 
regulations and, thus, would not be subject to any aggregate principal 
threshold dollar amount and would be repaid under the rules of the 
prior final regulations. If, on or after the effective date of these 
final regulations, A were to both make an advance of $5,000 to his S 
corporation and receive a $1,000 repayment on that advance, the advance 
and repayment would constitute separate new open account debt subject 
to the rules under these final regulations.
    Shareholders also have the option to apply these rules to 
shareholder advances to the S corporation and repayments on those 
advances by the S corporation made before the effective date of these 
regulations. Using the example above, A would have the option to net 
the $5,000 advance and $1,000 repayment.

Effective/Applicability Date

    The regulations apply to any and all shareholder advances to the S 
corporation made on or after October 20, 2008, and repayments on those 
advances by the S corporation.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. Because these 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, the notice of proposed 
rulemaking that preceded these regulations was submitted to the Chief 
Counsel for Advocacy of the Small Business Administration for comment 
on its impact on small business.

Drafting Information

    The principal authors of these final regulations are Stacy L. Short 
and Deane M. Burke of the Office of the Associate Chief Counsel 
(Passthroughs and Special Industries). However, other personnel from 
the IRS and the Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

[[Page 62202]]

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1367-2 also issued under 26 U.S.C. 1367(b)(2). * * *


0
Par. 2. Section 1.1367-2 is amended as follows:
0
1. Paragraph (a) is revised. paragraph (a)(2) is added.
0
2. Paragraphs (c)(2) and (d)(1) are revised.
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3. Paragraph (d)(2) is redesignated as paragraph (d)(3) and new 
paragraph (d)(2) is added.
0
4. Paragraph (e) is amended by adding Examples 6, 7 and 8.
    The revisions and additions read as follows:


Sec.  1.1367-2  Adjustments to basis of indebtedness to shareholder.

    (a) In general--(1) Adjustments under section 1367. This section 
provides rules relating to adjustments required by subchapter S to the 
basis of indebtedness (including open account debt as described in 
paragraph (a)(2) of this section) of an S corporation to a shareholder. 
The basis of indebtedness of the S corporation to a shareholder is 
reduced as provided in paragraph (b) of this section and restored as 
provided in paragraph (c) of this section in accordance with the timing 
rules in paragraph (d) of this section.
    (2) Open Account Debt--(i) General rule. The term open account debt 
means shareholder advances not evidenced by separate written 
instruments and repayments on the advances, the aggregate outstanding 
principal of which does not exceed $25,000 of indebtedness of the S 
corporation to the shareholder at the close of the S corporation's 
taxable year. Advances and repayments on open account debt are treated 
as a single indebtedness.
    (ii) Exception. If the shareholder advances not evidenced by a 
separate written instrument, net of repayments, exceeds an aggregate 
outstanding principal amount of $25,000 at the close of the S 
corporation's taxable year, for any subsequent taxable year the 
aggregate principal amount of that indebtedness is treated in the same 
manner as indebtedness evidenced by a separate written instrument for 
purposes of this section. For any subsequent taxable year, that 
indebtedness is not open account debt and is subject to all basis 
adjustment rules applicable to basis of indebtedness of an S 
corporation to a shareholder in this section.
* * * * *
    (c) * * *
    (2) Multiple indebtedness. If a shareholder holds more than one 
indebtedness (including any open account debt and any debt treated as a 
single indebtedness under paragraph (a)(2)(ii) of this section) as of 
the beginning of an S corporation's taxable year, any net increase is 
applied first to restore the reduction of basis in any indebtedness 
repaid (in whole or in part) in that taxable year to the extent 
necessary to offset any gain that would otherwise be realized on the 
repayment. Any remaining net increase is applied to restore each 
outstanding indebtedness (including any open account debt and any debt 
treated as a single indebtedness under paragraph (a)(2)(ii) of this 
section) in proportion to the amount that the basis of each outstanding 
indebtedness has been reduced under section 1367(b)(2)(A) and paragraph 
(b) of this section and not restored under section 1367(b)(2)(B) and 
this paragraph (c).
    (d) Time at which adjustments to basis of indebtedness are 
effective--
    (1) In general. The amounts of the adjustments to basis of 
indebtedness (including open account debt) provided in section 
1367(b)(2) and this section are determined as of the close of the S 
corporation's taxable year, and the adjustments are generally effective 
as of the close of the S corporation's taxable year. However, if the 
shareholder is not a shareholder in the S corporation at that time, 
these adjustments are effective immediately before the shareholder 
terminates his or her interest in the S corporation. Except as provided 
in paragraph (d)(2) of this section, if a debt is disposed of or repaid 
in whole or in part before the close of the taxable year, the basis of 
that indebtedness is restored under paragraph (c) of this section, 
effective immediately before the disposition or the first repayment on 
the debt during the taxable year. To the extent any indebtedness of the 
S corporation to the shareholder is disposed of or repaid (in whole or 
in part) during the taxable year and the shareholder's basis in that 
indebtedness has been reduced under paragraph (b) of this section and 
is not restored completely under paragraph (c) of this section, the 
disposition or repayment is a recognition event effective immediately 
before the indebtedness is disposed of or repaid (in whole or in part).
    (2) Open account debt--(i) In general. All advances and repayments 
on open account debt (as described in paragraph (a)(2)(i) of this 
section) during the S corporation's taxable year are netted at the 
close of the S corporation's taxable year to determine the amount of 
any net advance or net repayment. The net advance or net repayment is 
combined with the outstanding aggregate principal balance of the 
existing open account debt and that amount is carried forward to the 
beginning of the subsequent taxable year as the outstanding aggregate 
principal amount of the open account debt (unless the aggregate 
principal amount meets the exception defined in paragraph (a)(2)(ii) of 
this section at the close of the taxable year). However, if the 
shareholder in the S corporation is not a shareholder of the S 
corporation at the close of the S corporation's taxable year, such 
advances and repayments on open account debt are netted, and the basis 
of that indebtedness is restored under paragraph (c) of this section, 
effective immediately before the shareholder terminates his or her 
interest in the S corporation. If any open account debt is disposed of 
before or upon the close of the taxable year, the disposition is 
effective at the close of the S corporation's taxable year, and all 
advances and repayments are netted immediately prior to the disposition 
and the basis of that indebtedness is restored under paragraph (c) of 
this section, effective at the close of the S corporation's taxable 
year.
    (ii) Exception. Shareholder indebtedness that is open account debt 
at the beginning of the taxable year but meets the exception defined in 
paragraph (a)(2)(ii) of this section at the close of the taxable year, 
adjustments to the basis of the indebtedness for that taxable year 
follow the provisions for open account debt. The resulting aggregate 
principal amount of indebtedness is treated as the principal amount of 
a debt evidenced by a separate written instrument for any subsequent 
taxable year, and is no longer subject to the open account debt 
provisions of this section.
* * * * *
    (e) * * *

    Example 6. The $25,000 Aggregate Principal Amount Applies to 
Each Shareholder. (i) A and B have been the two shareholders in 
Corporation S since 2000. As of the end of the 2008 taxable year, 
the bases of A's and B's stock are both zero. On June 1, 2009, A 
advances S $16,000, which is not evidenced by a written instrument. 
On August 1, 2009, B advances S $22,000, which

[[Page 62203]]

is not evidenced by a written instrument. Both the $16,000 advance 
and the $22,000 advance are open account debt and remain outstanding 
at those amounts during 2009. There is no net increase under 
paragraph (c) of this section in year 2009.
    (ii) At the close of the 2009 taxable year, A's open account 
debt does not exceed $25,000. A therefore carries forward to the 
beginning of the 2010 taxable year the $16,000 as open account debt.
    (iii) At the close of the 2009 taxable year, B's open account 
debt does not exceed $25,000. B therefore carries forward to the 
beginning of the 2010 taxable year the $22,000 as open account debt.
    Example 7. Treatment of open account debt. (i) The facts are the 
same as in Example 6, in addition to which, on December 31, 2009, 
A's basis in the open account debt is reduced under paragraph (b) of 
this section to $8,000. On April 1, 2010, S repays A $4,000 of the 
open account indebtedness. On September 1, 2010, A advances S an 
additional $1,000, which is not evidenced by a written instrument. 
There is no net increase under paragraph (c) of this section in year 
2010.
    (ii) The $4,000 April repayment S makes to A and A's $1,000 
September advance are netted to result in a net repayment of $3,000 
for the taxable year on A's $16,000 open account debt carried 
forward from 2009. Because there is no net increase in 2010, no 
basis of indebtedness is restored for the 2010 taxable year, and A 
realizes $1,500 of income on the $3,000 net repayment at the close 
of the 2010 taxable year.
    (iii) At close of the 2010 taxable year, A's open account debt 
does not exceed $25,000. The net repayment of $3,000 for the taxable 
year on A's $16,000 open account debt carried forward from 2009, 
leaves A with an open account debt of $13,000 to carry forward as 
open account debt to the beginning of the 2011 taxable year.
    Example 8. Treatment of shareholder indebtedness not evidenced 
by a written instrument which exceeds $25,000. (i) The facts are the 
same as in Example 7, in addition to which, on February 1, 2011, S 
repays $5,000 of the open account debt and on March 1, 2011, A 
advances S $20,000, which is not evidenced by a written instrument.
    (ii) At the close of the 2010 taxable year, A has an open 
account debt of $13,000 to carry forward as open account debt to the 
beginning of the 2011 taxable year.
    (iii) The 2011 advances and repayments are netted to result in a 
net advance of $15,000 on A's $13,000 open account debt carried 
forward from 2010, increasing A's open account debt to $28,000 as of 
the close of the 2011 taxable year. Because A's open account debt 
exceeds $25,000, for any subsequent taxable year the $28,000 
indebtedness will be treated in the same manner as indebtedness 
evidenced by a separate written instrument for the purposes of this 
section. Because there is no net increase in 2011, no basis of 
indebtedness is restored for the 2011 taxable year.


0
Par. 3. Section 1.1367-3 is revised to read as follows:


Sec.  1.1367-3  Effective/Applicability date.

    Section 1.1367-2(a), (c)(2), (d)(2), and (e) Example 6, Example 7, 
and Example 8 apply to any shareholder advances to the S corporation 
made on or after October 20, 2008 and repayments on those advances by 
the S corporation. The rules that apply with respect to shareholder 
advances to the S corporation made before October 20, 2008, are 
contained in Sec.  1.1367-3 in effect prior to October 20, 2008. (See 
26 CFR part 1 revised as of April 1, 2007.) Shareholders have the 
option to apply these rules to shareholder advances to the S 
corporation made before October 20, 2008, and repayments on those 
advances by the S corporation.

     Approved: September 25, 2008.
Linda E. Stuff,
Deputy Commissioner for Services and Enforcement.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E8-24926 Filed 10-17-08; 8:45 am]
BILLING CODE 4830-01-P