Final Section 385 Regs: Navigating State and Local Tax Impact of New Debt-to-Equity Reclassification Rules

The IRS issued final regulations for Section 385 covering related-party debt transactions. While the Service responded to practitioner concerns regarding the reach of the rules, the final regulations will have a major impact on corporations that engage in debt transactions with related corporations. While the major focus of the final regulations is federal tax treatment of related-party debt, the new rules will likely impact state tax treatment of these transactions.

The final regulations permit the IRS to reclassify certain related-party debt as equity. The new rules may result in a number of common transactions subject to the regulations having interest deductions disallowed on the re-characterized “debt” instrument. Many states will likely follow federal treatment, and corp tax advisers will need to understand the possible state tax impact on their companies.

The new requirements will impose significant new documentation burdens for related-party debt instruments, both for federal and state tax purposes. Tax advisers should expect state revenue departments and auditors to apply the final regulations in some state and local tax examinations, even in states that do have federal tax conformity statutes.

Listen as our experienced panel of expert advisers provides a critical first look at the state and local tax impact of the final Section 385 regulations, offering detailed and practical tools to avoid serious tax consequences arising from the new debt-to-equity reclassification rules.

1. Final Section 385 regulations on related-party debt transactions
2. Equity recharacterization provisions
3. Definitions of “expanded group”
4. Documentation rules
5. SALT implications

The panel will discuss these and other important questions:

• Which commonly controlled entities are subject to the final Section 385 regulations?
• What types of intra-company debt transactions are at risk of reclassification under the new regulations?
• What are the specific documentation requirements that must accompany intra-company debt transactions?
• How will various state practices on conformity with federal tax law impact net income calculations under the new regulations?
• What steps should corporate taxpayers and their advisers take immediately to ensure that their intra-company debt structures will be respected under the final regulations?

Learning Objectives

After completing this course, you will be able to:

• Identify corporate structures that will be subject to the new Section 385 regulations on debt reclassification
• Determine the documentation requirements necessary to ensure that intra-company loan transactions will be respected as debt
• Discern the impact of a state’s rules on conformity to federal tax treatment on whether a debt transaction will be respected on the state tax level
• Recognize the differences in documentation requirements between state and federal practice under the new Section 385 regulations

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business or public firm experience at mid-level within the organization, preparing complex tax forms and schedules, supervising other preparers/accountants. Specific knowledge and understanding of intra-company debt transactions, multi-entity corporate structures, and state apportionment rules; familiarity with the bona fide debt obligation rules, familiarity with current and proposed regulations governing Section 385.

Strafford Publications, Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of Accountancy have final authority on the acceptance of individual courses for CPE Credits. Complaints regarding registered sponsons may be submitted to NASBA through its website: www.nasbaregistry.org.