The final rules offer significant relief for S corp community banks. On October 13th, the Treasury Department and IRS released final and temporary section 385 regulations. These regulations had been proposed on April 4, 2016.
A significant collateral effect of the Proposed 385 Regulations would have been that if debt issued by an “S Corporation” were recharacterized into equity, the deemed equity could invalidate the S Corporation’s “S Election” by being treated as a prohibited second class of stock. The Final 385 Regulations responded to comments requesting relief on this point by excluding S Corporations from the definition of an expanded group, thereby fully exempting debt issued by S Corporations from the section 385 rules. After much speculation and concern, the final product reflects a significant effort by Treasury and the IRS to limit the scope and burden of the 385 Regulations.
The Treasury stated, ” Because an S corporation cannot be owned by persons other than U.S. resident individuals, certain trusts, and certain exempt organizations, an S corporation cannot be controlled by members of an expanded group in a manner that implicates the policies underlying the final and temporary regulations. S corporations are therefore excluded from the definition of an expanded group member for all purposes of the final and temporary regulations.”