Section 385 Regulations - What You Need to Know and Do

On April 4, 2016, the U.S. Treasury Department and the IRS issued proposed regulations (REG-108060-15) under section 385 of the Internal Revenue Code that will impact any corporation that issues a purported debt instrument to related corporations or partnerships. Specifically, the proposed rules contain three major elements:

  • They treat certain related party interests in a corporation as indebtedness in part and stock in part for federal tax purposes;
  • They establish threshold documentation requirements, without which the instrument will be treated as stock for federal tax purposes; and
  • They treat as stock certain instruments issued to related parties as distributions, in connection with the acquisition of related-party stock or assets, or used to fund such distributions or acquisitions.

At least one Government representative has described these proposed regulations as “intended to be disruptive.” Almost every corporate taxpayer (including partnerships owning or owned by corporations) will be impacted in some way by these rules.

While the proposed rules generally will become effective upon the issuance of final regulations, certain aspects will be retroactive to April 4, 2016. Taxpayers will have only 90 days after the issuance of final regulations to ensure that instruments issued after April 4 comply.

For more background on the section 385 proposed regulations, read our April 2016 True Alert—New Regulations Addressing Inversions Impact Existing Capital Structures.

Recommended Action Steps

In light of the apparent imminence of the final rules and the limited transition period, True Partners recommends that companies should begin the compliance process immediately by taking the following steps:

  1. Inventory all existing intercompany advances and analyze them under the proposed regulations.
  2. Address any transactions that either lack documentation or could be affected by the per se rescharacterization rule or the funding rule. 
  3. Begin developing and documenting policies and procedures for Tax, Treasury, Accounting, Legal, IT, Internal Audit and other functions to comply with the final regulations going forward. 

We recognize that these steps will likely be time consuming and will require "heavy lifting" by your internal teams. True Partners Consulting has the people and expertise to step in and help wherever needed. 

Additional questions about Section 385 and how it may affect you? Contact any of the team members below. 

John V. Aksak, Managing Director
(631) 777-6310
John.Aksak@TPCtax.com

John P. Bennecke, Regional Managing Director and National Practice Leader
(312) 235-3337
John.Bennecke@TPCtax.com

Michael Chen, Managing Director
(408) 625-5088
Michael.Chen@TPCtax.com

Robert Gordon, Managing Director
(312) 235-3321
Robert.Gordon@TPCtax.com

Ron Tambasco, Managing Director
(813) 434-4001
Ron.Tambasco@TPCtax.com

Ross J. Valenza, Managing Director
(813) 434-4002
Ross.Valenza@TPCtax.com

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