The IRS issued final regulations ( T.D. 9682) on July 23 relating to when S corporation shareholders have basis in indebtedness that the S corporation owes to the shareholders. The final regulations adopt the rules in the previously issued proposed regulations without substantive change.
In general, a shareholder has basis in any bona fide indebtedness that the S corporation owes to the shareholder (debt basis). Whether a loan constitutes bona fide indebtedness is determined under federal income tax principles. The proposed regulations addressed whether a shareholder would have debt basis in an S corporation (S1) if the shareholder first borrowed funds from a related corporation (S2) and loaned the proceeds to S1 (back-to-back loan). In the final regulations, the IRS stated that the shareholder will have debt basis in the back-to-back loan if the loan made by the shareholder to S1 constitutes bona fide indebtedness under general principles of tax law.
In a variation of a back-to-back loan, the final regulations address whether the shareholder will have debt basis in S1 in a loan structuring transaction when S2 is a creditor of S1 and S2 distributes its loan in S1 to the shareholder. The final regulations provide that the shareholder receives debt basis in S1 when the loan is restructured if the loan is considered bona fide indebtedness and if S1 is directly liable to the shareholder under local law.
In addition, the final regulations confirm that a mere guarantee by a shareholder doesn't create debt basis. The final regulations clarify that when a shareholder guarantees a loan made by some other party to an S corporation, the shareholder will receive debt basis only when the shareholder makes a payment on the loan pursuant to the guarantee.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
