In July of 2017, the United States Treasury issued Notice 2017-36, which provides for a twelve month delay in the application of the “documentation requirements” of the Section 385 regulations.

The final regulations under Section 385 of the Internal Revenue Service (IRS) were published in the Federal Register on October 16, 2016. Section 385 was originally enacted in 1969 as a means for the Secretary of the Treasury to issue regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated as stock or indebtedness or part stock and part indebtedness.

The final regulations establish extensive documentation requirements that must be satisfied for a debt instrument to constitute indebtedness for federal tax purposes.

The Documentation Regulations in Reg. 1385-2 have two principal purposes. The first is to provide guidance regarding the documentation requirements to be used in the determination of whether an instrument subject to the documentation requirements will be treated as indebtedness for federal income tax purposes. The second is to establish certain operating rules, presumptions, and factors to be taken into account in the making of any such determination.

Ultimately, the requirements for documentation and information to be prepared and maintained with respect to each such factor include:

  • The documentation must state an unconditional obligation to pay a sum certain.
  • Information must be in writing and must establish that when issued there was a reasonable expectation that the issuer intended to and had the ability to meet its obligation(s).
  • Documentation establishing “creditor rights” evidencing that the holder has rights of enforcement.
  • Documentation must show actions evidencing a debtor-creditor relationship.

Additional factors that the IRS would consider in determining stock or indebtedness would include preferences, convertibility into stock and the relationship of the stock holding and the holding of debt.

The Treasury, in response to the concern expressed by taxpayers that the proposed regulations provided inadequate time to begin complying with the Documentation Regulations, the final documentation requirements were made applicable only with respect to interest issued or deemed issued on or after January 1, 2018.

Whisman Giordano believes that all interests regardless of when issued need to ultimately meet the Documentation Regulations.