[Federal Register Volume 84, Number 117 (Tuesday, June 18, 2019)]
[Rules and Regulations]
[Pages 28214-28216]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-12639]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9868]
RIN 1545-BO93
Electing Small Business Trusts With Nonresident Aliens as
Potential Current Beneficiaries
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations regarding the
statutory expansion of the class of permissible potential current
beneficiaries (PCBs) of an electing small business trust (ESBT) to
include nonresident aliens (NRAs). In particular, the final regulations
ensure that the income of an S corporation will continue to be subject
to U.S. Federal income tax when an NRA is a deemed owner of a grantor
trust that elects to be an ESBT.
DATES: Effective Date: The final regulations are effective on June 18,
2019.
Applicability Date: The final regulations are applicable to all
ESBTs after December 31, 2017.
FOR FURTHER INFORMATION CONTACT: Cynthia Morton, (202) 317-5279.
SUPPLEMENTARY INFORMATION:
Background
This document contains final amendments to the Income Tax
Regulations (26 CFR part 1) under sections 641 and 1361 of the Internal
Revenue Code (Code).
Section 13541(a) of the Tax Cuts and Jobs Act, Public Law 115-97,
131 Stat. 2054, 2154 (TCJA) amended section 1361(c)(2)(B)(v) of the
Code to allow NRAs to be PCBs of ESBTs. As amended, section
1361(c)(2)(B)(v) provides that NRA PCBs will not be taken into account
for purposes of the S corporation shareholder-eligibility requirement
that otherwise prohibits NRA shareholders. See section 1361(b)(1)(C).
On April 19, 2019, the Department of the Treasury (Treasury
Department) and the IRS published a notice of proposed rulemaking (REG-
117062-18) in the Federal Register (84 FR 16415) proposing regulations
under sections 641 and 1361 (proposed regulations). No comments
addressing the proposed regulations were received in response to the
notice of proposed rulemaking. As no request for a public hearing was
received, no hearing was held.
Explanation of Provisions
This document adopts the proposed regulations with no change as
final regulations. Where an NRA is a deemed owner of a grantor trust
that has elected to be an ESBT, the final regulations ensure that such
ESBT's S corporation income will continue to be subject to U.S. Federal
income tax. Specifically, the final regulations modify the allocation
rules under Sec. 1.641(c)-1 to require that the S corporation income
of the ESBT be included in the S portion of the ESBT if that income
otherwise would have been allocated to an NRA deemed owner under the
grantor trust rules. Accordingly, such income will be taxed to the
domestic ESBT by providing that, if the deemed owner is an NRA, the
grantor portion of net
[[Page 28215]]
income must be reallocated from the grantor portion of the ESBT to the
ESBT's S portion.
The final regulations also implement Congress' amendment to section
1361(c)(2)(B)(v) by making conforming revisions to Sec. 1.1361-1(m).
For example, the final regulations update the description of PCBs in
Sec. 1.1361-1(m)(4)(i) to reflect the ability of NRAs to be PCBs of
ESBTs. The final regulations similarly update other provisions in Sec.
1.1361-1(m) to reflect that ability.
Effective/Applicability Date
Section 7805(b)(1)(A) and (B) of the Code generally provide that no
temporary, proposed, or final regulation relating to the internal
revenue laws may apply to any taxable period ending before the earliest
of (A) the date on which such regulation is filed with the Federal
Register, or (B) in the case of a final regulation, the date on which a
proposed or temporary regulation to which the final regulation relates
was filed with the Federal Register. However, section 7805(b)(2)
provides that regulations filed or issued within 18 months of the date
of the enactment of the statutory provision to which they relate are
not prohibited from applying to taxable periods prior to those
described in section 7805(b)(1). Furthermore, section 7805(b)(3)
provides that the Secretary may provide that any regulation may take
effect or apply retroactively to prevent abuse.
Accordingly, to prevent abuse of sections 641 and 1361, and the
final regulations thereunder, the final regulations apply to all ESBTs
after December 31, 2017.
Special Analyses
The final regulations are not subject to review under section 6(b)
of Executive Order 12866 pursuant to the Memorandum of Agreement (April
11, 2018) between the Treasury Department and the Office of Management
and Budget regarding review of tax regulations.
The final regulations do not impose a collection of information on
any entities, including small entities. Pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that the
final regulations would not have a significant economic impact on a
substantial number of small entities. This certification is based on
the fact that the final regulations would primarily affect
sophisticated ownership structures involving ESBTs that have NRAs as
PCBs.
Pursuant to section 7805(f), the proposed regulations preceding
these final regulations were submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact
on small business, and no comments were received.
Drafting Information
The principal author of the final regulations is Cynthia Morton of
the Office of 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.
Amendments to the Regulations
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 * * *
0
Par. 2. Section 1.641(c)-1 is amended by:
0
1. Revising paragraphs (b)(1) and (2).
0
2. In paragraph (k):
0
i. Revising the paragraph heading.
0
ii. Removing the language ``(l) Example 1'' and adding ``(l)(1)
(Example 1)'' in its place.
0
iii. Adding a sentence to the end of paragraph (k).
0
3. In paragraph (l), designating Examples 1 through 5 as paragraphs
(l)(1) through (5), respectively.
0
4. In newly designated paragraph (l)(1)(ii), adding a heading to the
table.
0
5. In newly designated paragraph (l)(1)(iii):
0
i. Designating the undesignated paragraph before the first table as
paragraph (l)(1)(iii)(A) and adding a heading for the table in newly
designated paragraph (l)(1)(iii)(A).
0
ii. Designating the undesignated paragraph before the second table as
paragraph (l)(1)(iii)(B) and adding a heading for the table in newly
designated paragraph (l)(1)(iii)(B).
0
iii. Designating the undesignated paragraph before the third table as
paragraph (l)(1)(iii)(C) and adding a heading for the table in newly
designated paragraph (l)(1)(iii)(C).
0
6. Adding headings for the tables in newly designated paragraphs
(l)(1)(v), (vi), and (vii).
0
7. In newly designated paragraph (l)(3)(i), removing the language
``Example 2'' and adding ``Example 2 in paragraph (l)(2) of this
section'' in its place.
0
8. Adding paragraph (l)(6).
The revision and additions read as follows:
Sec. 1.641(c)-1 Electing small business trust.
* * * * *
(b) * * *
(1) Grantor portion--(i) In general. Subject to paragraph
(b)(1)(ii) of this section, the grantor portion of an ESBT is the
portion of the trust that is treated as owned by the grantor or another
person under subpart E of the Code.
(ii) Nonresident alien deemed owner. If, pursuant to section
672(f)(2)(A)(ii), the deemed owner of a grantor portion of the ESBT is
a nonresident alien, as defined in section 7701(b)(1)(B) (NRA), the
items of income, deduction, and credit from that grantor portion must
be reallocated from the grantor portion to the S portion, as defined in
paragraph (b)(2) of this section, of the ESBT.
(2) S portion--(i) In general. Subject to paragraph (b)(2)(ii) of
this section, the S portion of an ESBT is the portion of the trust that
consists of S corporation stock and that is not treated as owned by the
grantor or another person under subpart E of the Code.
(ii) Nonresident alien (NRA) deemed owner of grantor portion. The S
portion of an ESBT also includes the grantor portion of the items of
income, deduction, and credit reallocated under paragraph (b)(1)(ii) of
this section from the grantor portion of the ESBT to the S portion of
the ESBT.
* * * * *
(k) Applicability date. * * * Paragraphs (b)(1) and (2) of this
section, and Example 6 in paragraph (l)(6) of this section, apply to
all ESBTs after December 31, 2017.
(l) * * *
(1) * * *
(ii) * * *
Table 1 to paragraph (l)(1)(ii)
* * * * *
(iii) * * *
(A) * * *
Table 2 to paragraph (l)(1)(iii)(A)
* * * * *
(B) * * *
Table 3 to paragraph (l)(1)(iii)(B)
* * * * *
(C) * * *
Table 4 to paragraph (l)(1)(iii)(C)
* * * * *
(v) * * *
Table 5 to paragraph (l)(1)(v)
* * * * *
(vi) * * *
Table 6 to paragraph (l)(1)(vi)
* * * * *
(vii) * * *
Table 7 to paragraph (l)(1)(vii)
* * * * *
[[Page 28216]]
(6) Example 6: NRA as potential current beneficiary. Domestic
Trust (DT) has a valid ESBT election in effect. DT owns S
corporation stock. The S corporation owns U.S. and foreign assets.
The foreign assets produce foreign source income. B, an NRA, is the
grantor and the only trust beneficiary and potential current
beneficiary of DT. B is not a resident of a country with which the
United States has an income tax treaty. Under section 677(a), B is
treated as the owner of DT because, under the trust documents,
income and corpus may be distributed only to B during B's lifetime.
Paragraph (b)(2)(ii) of this section requires that the S corporation
income of the ESBT that otherwise would have been allocated to B
under the grantor trust rules must be reallocated from B's grantor
portion to the S portion of DT. In the example in this paragraph
(l)(6), the S portion of DT is treated as including the grantor
portion of the ESBT, and thus all of DT's income from the S
corporation is taxable to DT.
0
Par. 3. Section 1.1361-1 is amended by:
0
1. Revising paragraph (m)(1)(ii)(D).
0
2. Revising paragraph (m)(2)(ii)(E)(2).
0
3. Adding two sentences to the end of paragraph (m)(4)(i).
0
4. Revising the second sentence of paragraph (m)(5)(iii).
0
5. In paragraph (m)(8), designating Examples 1 through 9 as paragraphs
(m)(8)(i) through (ix), respectively.
0
6. Redesignating paragraphs (m)(8)(i)(i) through (iii) as paragraphs
(m)(8)(i)(A) through (C), respectively.
0
7. Redesignating paragraphs (m)(8)(ii)(i) and (ii) as paragraphs
(m)(8)(ii)(A) and (B), respectively, and revising the second sentence
of newly redesignated paragraph (m)(8)(ii)(A).
0
8. In the first sentence of newly redesignated paragraph (m)(8)(ii)(B),
removing the language ``Example 2(i)'' and adding ``Example 2 in
paragraph (m)(8)(ii)(A) of this section'' in its place.
0
9. Redesignating paragraphs (m)(8)(vi)(i) through (iii) as paragraphs
(m)(8)(vi)(A) through (C), respectively, and revising the first
sentence of newly redesignated paragraph (m)(8)(vi)(B).
0
10. In the first sentence of newly redesignated paragraph
(m)(8)(vi)(C), removing the language ``paragraph (i) of this Example
6'' and adding ``Example 6 in paragraph (m)(8)(vi)(A) of this section''
in its place.
0
11. In paragraph (m)(9):
0
i. Removing the language ``Paragraphs (m)(2)(ii)(A), (m)(4)(iii) and
(vi), and (m)(8), Example 2, Example 5, Example 7, Example 8, and
Example 9'' from the second sentence and adding ``Paragraphs
(m)(2)(ii)(A) and (m)(4)(iii) and (vi) of this section and Examples 2,
5, and 7 through 9 in paragraphs (m)(8)(ii), (v), and (vii) through
(ix), respectively,'' in its place.
0
ii. Adding a sentence at the end of the paragraph.
The revisions and additions read as follows:
Sec. 1.1361-1 S corporation defined.
* * * * *
(m) * * *
(1) * * *
(ii) * * *
(D) Nonresident aliens. A nonresident alien (NRA), as defined in
section 7701(b)(1)(B), is an eligible beneficiary of an ESBT and an
eligible potential current beneficiary.
* * * * *
(2) * * *
(ii) * * *
(E) * * *
(2) All potential current beneficiaries of the trust meet the
shareholder requirements of section 1361(b)(1); for the purpose of this
paragraph (m)(2)(ii)(E)(2), an NRA potential current beneficiary does
not violate the requirement under section 1361(b)(1)(C) that an S
corporation cannot have an NRA as a shareholder.
* * * * *
(4) * * *
(i) * * * An NRA potential current beneficiary of an ESBT is
treated as a shareholder for purposes of the 100-shareholder limit
under section 1361(b)(1)(A). However, an NRA potential current
beneficiary of an ESBT is not treated as a shareholder in determining
whether a corporation is a small business corporation for purposes of
the NRA-shareholder prohibition under section 1361(b)(1)(C).
* * * * *
(5) * * *
(iii) * * * For example, the S corporation election will terminate
if a charitable remainder trust becomes a potential current beneficiary
of an ESBT. * * *
* * * * *
(8) * * *
(ii) * * *
(A) * * * On January 1, 2006, A, a partnership, becomes a potential
current beneficiary of Trust. * * *
* * * * *
(vi) * * *
(B) * * * Assume the same facts as Example 6 in paragraph
(m)(8)(vi)(A) of this section except that D is a charitable remainder
trust. * * *
* * * * *
(9) * * * Paragraphs (m)(1)(ii)(D), (m)(2)(ii)(E)(2), (m)(4)(i),
(m)(5)(iii), and (m)(8) of this section apply to all ESBTs after
December 31, 2017.
Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
Approved: June 10, 2019.
David J Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-12639 Filed 6-13-19; 4:15 pm]
BILLING CODE 4830-01-P