[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