2016-Issue 25 – On Monday, July 25, the IRS posted a revised version of a previously issued Chief Counsel Notice making it clear that any case in exam or litigation raising an issue under Internal Revenue Code Section 385 must be coordinated with the Associate Chief Counsel (ACC) offices. This increased IRS focus on related-party indebtedness should serve as a call to taxpayers to review all existing related-party debt to identify and remediate, where possible, any exposures. Even though preexisting debt will receive “grandfather” protection from challenge under the proposed Section 385 regulations, this new IRS audit procedure raises the risk of recast under preexisting case law.
Back on April 4, 2016, the IRS released controversial proposed regulations under Section 385 (“the proposed regulations”). In previous editions of Tax Advisor Weekly, we have discussed the implications of those regulations.
One potential implication that we have been advising our clients about is the possibility that IRS field agents will be led to focus on related-party indebtedness, and to challenge the validity of that indebtedness based on pre-existing case law, regardless of whether the proposed regulations are ever issued in final form.
Apparently the IRS national office shares our view on this possible side effect of the proposed regulations. The previous version of the Chief Counsel Notice listed Section 385(c) — dealing only with taxpayer-initiated recasts under Section 385 — as an issue requiring ACC review. The July 25 revision removed Subsection (c) from the listing, with the result that all 385 issues, including any such issues raised by the IRS, must now receive ACC review.
In addition to signaling that the IRS is preparing for the finalization of the proposed regulations, the July 25 posting corroborates our expectation that there will be more challenges of debt versus equity at the exam level under preexisting case law. In that regard, this new requirement for ACC review of all Section 385 controversies applies regardless of whether the proposed regulations are issued in final form.
Alvarez & Marsal Taxand says:
At Alvarez & Marsal Taxand, we have developed a systematic, diagnostic approach for reviewing related-party debt under preexisting case law. We would be happy to discuss how our approach might work for your company.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisers. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisers before determining if any information contained herein remains applicable to their facts and circumstances.
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