or Treasury finally corrects a 31 year old "oops.”
On Wednesday, July 10, Treasury released a correcting amendment to Reg. section 1.52-1, firmly establishing that the regulation’s test for brother-sister groups is subject to the full constructive ownership rules of Reg. section 1.414(c)-4. The correction applies prospectively; it is effective on the date of its publication in the Federal Register. Treasury also indicated that the correction does not implicate positions previously taken by taxpayers for years beginning before the effective date.
This amendment rectifies a rather bizarre “oops” on the government’s part . . . one that dates back to the Reagan administration. Why taxpayers today should care about this correction (and presumably why Treasury is just now correcting this decades-old mistake) is because this once-obscure regulation now plays a key role in defining who qualifies for special small taxpayer rules sprinkled throughout the 2017 tax reform act. This correction is likely to affect many taxpayers who previously relied upon a narrow constructive ownership rule reflected in the published Code of Federal Regulations (CFR).
Staying as far out of the weeds as possible on this rather complicated issue, the following is a quick summary of the background behind this correction:
Part of the small taxpayer gross receipts test involves aggregating the receipts of all who are “single employers” under section 52(b) (and certain other sections not relevant to the topic at hand). One way that two or more business may constitute a single employer under section 52(b) is to have five or fewer common owners who meet certain ownership thresholds, forming a “brother-sister” group of trades or businesses under common control. The precise constructive ownership and family attribution rules that apply when testing whether common owners meet the necessary thresholds is the focus of the correcting amendment.
The regulations under section 52 were supposed to mirror their counterpart in the rules for controlled groups of corporations under section 1563: namely, a myriad of constructive ownership rules should apply for brother-sister groups. However, a few decades ago in an unknown corner of the Office of the Federal Register, someone missed their morning coffee.
Treasury issued the final section 1.52-1 regulations in March of 1988. However, when a correction to that regulation was necessary two months later, the Office of the Federal Register did not correctly incorporate the change into the published version of the CFR (i.e., someone made a fairly bad typo). The modified CFR incorporated the extremely narrow constructive ownership rule of “1.414(c)-4(b)(1))” that should have only applied to parent-subsidiary groups, not brother-sister. The correcting amendment released Wednesday clarifies that the constructive ownership rules for brother-sister groups includes all those found within the 1.414(c)-4 regulations (not just paragraph (b)(1)). This includes attribution of lower tier ownership to upper tier owners and attribution across certain familial relationships.
Acknowledging the “oops” factor on the government’s part, Treasury agreed not to challenge applications of either version of the regulations for any tax year that began prior to the publication of Wednesday’s correcting amendment in the Federal Register. This means calendar year taxpayers who relied upon the absence of constructive ownership for aggregation determinations can breathe easy for 2018 and for 2019 years that have already begun, but will need to reevaluate their position going forward.
This correction is likely to adversely affect the aggregation analysis supporting many organizations’ small taxpayer determinations.
To the extent this correction implicates a taxpayer’s current small taxpayer accounting method, that taxpayer may need to request a change in accounting method. Taxpayers in this situation should reach out to their tax advisor to assess the need for a change in accounting method.
In addition, organizations that relied upon the absence of constructive ownership rules when claiming the small taxpayer exception to section 163(j) should consult their tax advisor concerning future eligibility for the exception.