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Final Sec. 1367 Regs. Address Open Account Debt Between S Corps and Their Shareholders

The Service has issued final regulations (T.D. 9428) amending the definition of open account debt, which may significantly affect when an S corporation shareholder recognizes gain on the repayment of such debt.

January 2009
by Laura MacDonough/The Tax Adviser

The Service has issued final regulations (T.D. 9428) amending the definition of open account debt, which may significantly affect when an S corporation shareholder recognizes gain on the repayment of such debt.

Under Sec. 1366(d)(1), the aggregate amount of passthrough losses and deductions that an S corporation shareholder may take into account for any tax year cannot exceed the shareholder’s adjusted basis in the corporation’s stock and loans made by the shareholder to the corporation.

Under Sec. 1367(a)(2), the basis of each shareholder’s stock in an S corporation is decreased (but not below zero) by, among other things, the shareholder’s pro-rata share of the corporation’s losses, deductions, and nondeductible, noncapital expenses. If these items reducing basis exceed the amount that reduces the shareholder’s stock basis to zero, such excess losses and deductions are applied to reduce (but not below zero) the shareholder’s basis in any indebtedness of the S corporation to the shareholder (Sec. 1367(b)(2)).

If an S corporation repays a loan from a shareholder in which the shareholder’s basis has been reduced under Sec. 1367(a)(2), the shareholder recognizes gain on the repayment.

This article has been excerpted from The Tax Adviser. Read the full article here. (PDF)