Final Regs Provide Rules on Recapture of LIFO Benefits After Subchapter S Election

 [4830-01-u]

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations that describe the events that trigger the recapture of LIFO benefits under section 1363(d) when a C corporation elects to become an S corporation or transfers LIFO inventory to an S corporation in a tax-free reorganization. The final regulations reflect changes made to the law by the Revenue Act of 1987 and affect corporations that use the last-in, first-out (LIFO) method of accounting.

 DATES: These regulations are effective October 7, 1994.

 The provisions of section 1.1363-2(a)(1) apply to S elections made after December 17, 1987, except as provided in section 10227(b)(2) of the Revenue Act of 1987. The provisions of section 1.1363-2(a)(2) apply to transfers made after August 18, 1993.

 FOR FURTHER INFORMATION CONTACT: Jeffrey A. Erickson, 202-622-3040 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

BACKGROUND

On August 18, 1993, a notice of proposed rulemaking (PS-16-93) was published in the Federal Register (58 FR 43827) proposing amendments to the Income Tax Regulations (26 CFR part 1) under section 1363(d).

 Written comments responding to the notice were received. No public hearing was requested or held. After consideration of all the comments, the regulations proposed by PS-16-93 are adopted as revised by this Treasury decision.

EXPLANATION OF PROVISIONS

 Under the proposed regulations, a C corporation that transfers LIFO inventory to an S Corporation in a tax-free reorganization is subject to the LIFO recapture rules of section 1363(d) and must include the LIFO recapture amount in its gross income in its last taxable year of existence.

 One commentator asserted that the IRS appeared to have exceeded its authority by extending the application of section 1363(d) to situations in which an S corporation succeeds to LIFO inventory in a tax-free reorganization. The IRS and the Treasury Department believe that the regulations are a valid exercise of authority to prevent the circumvention of section 1363(d). Therefore, the final regulations retain the rule of the proposed regulations.

 Another commentator noted that the proposed regulations would apply to a transfer of LIFO inventory by a transferor C corporation that goes out of existence in a tax-free reorganization but would not apply to a transfer in connection with a tax-free reorganization under section 368(a)(1)(D) in which the transferor corporation remains in existence. The commentator suggested revising the regulations to require inclusion of the LIFO recapture amount in the year of the transfer of the LIFO inventory instead of the transferor corporation's last year of existence. The final regulations adopt this suggestion.

 The final regulations also clarify which corporation has the responsibility to pay the three succeeding installments of tax described in section 1363(d)(2).

 Commentators suggested expanding the scope of the regulations to deal with various related issues that arise from application of the LIFO recapture rules. The IRS and the Treasury Department believe that those issues are more appropriately dealt with in other forms of administrative guidance. Accordingly, these comments have not been adopted.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Jeffrey A. Erickson, Office of the Assistant Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS 26 CFR PART 1

 Income taxes, Reporting and recordkeeping requirements.

Treasury Decision 8567

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.1363-2 is added to read as follows:

SECTION 1.1363-2 RECAPTURE OF LIFO BENEFITS.

(a) IN GENERAL. A C corporation must include the LIFO recapture amount (as defined in section 1363(d)(3)) in its gross income--

(1) In its last taxable year as a C corporation if the corporation inventoried assets under the LIFO method for its last taxable year before its S corporation election becomes effective; or

(2) In the year of transfer by the C corporation to an S corporation of the LIFO inventory assets if paragraph (a)(1) of this section does not apply and the C corporation --

(i) Inventoried assets under the LIFO method during the taxable year of the transfer of those LIFO inventory assets; and

(ii) Transferred the LIFO inventory assets to the S corporation in a nonrecognition transaction (within the meaning of section 7701(a)(45)) in which the transferred assets constitute transferred basis property (within the meaning of section 7701(a)(43)).

(b) PAYMENT OF TAX. Any increase in tax caused by including the LIFO recapture amount in the gross income of the C corporation is payable in four equal installments. The C corporation must pay the first installment of this payment by the due date of its return, determined without regard to extensions, for the last taxable year it operated as a C corporation if paragraph (a)(1) of this section applies, or for the taxable year of the transfer if paragraph (a)(2) of this section applies. The three succeeding installments must be paid --

(1) For a transaction described in paragraph (a)(1) of this section, by the corporation (that made the election under section 1362(a) to be an S corporation) on or before the due date for the corporation's returns (determined without regard to extensions) for the succeeding three taxable years; and

(2) For a transaction described in paragraph (a)(2) of this section, by the transferee S corporation on or before the due date for the transferee corporation's returns (determined without regard to extensions) for the succeeding three taxable years.

(c) BASIS ADJUSTMENTS. Appropriate adjustments to the basis of inventory are to be made to reflect any amount included in income under this section.

(d) EFFECTIVE DATES. (1) The provisions of paragraph (a)(1) of this section apply to S elections made after December 17, 1987. For an exception, see section 10227(b)(2) of the Revenue Act of 1987.

(2) The provisions of paragraph (a)(2) of this section apply to transfers made after August 18, 1993.