Expense Deferral with Related Parties

Facts

Taxpayer is a 10% owner of an accrual basis S-corporation.  The Taxpayer sold inventory to the S-corporation, but plans to defer receipt of income until after year end.  The S-corporation accrued an expense for the receipt of inventory.

Issue

Can the Taxpayer defer the receipt of income while the S-corporation accrues an expense for the receipt of inventory?

Conclusion

If the taxpayer does not meet the definition of a related party, then (s)he may defer income to the subsequent year.

Analysis

A corporation that uses the accrual method of accounting must observe a special rule when dealing with cash basis related parties.  If the corporation has an accrual outstanding at the end of any taxable year with respect to such a related party, it cannot claim a deduction until the recipient reports the amount as income (IRC §267(a)(2)).  This rule is most often encountered when a corporation deals with an individual who owns more than 50 percent of the corporation’s stock.

IRC §267 further clarifies that attribution rules apply in determining who qualifies as a related party.  IRC §267(b) defines related parties as:

  • Members of a family
  • An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual
  • Two corporations which are members of the same controlled group
  • A grantor and a fiduciary of any trust
  • A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts
  • A fiduciary of a trust and a beneficiary of such trust
  • A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts
  • A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust
  • A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual
  • A corporation and a partnership if the same persons own–
    • more than 50 percent in value of the outstanding stock of the corporation, and
    • more than 50 percent of the capital interest, or the profits interest, in the partnership
    • An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation
    • An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation
    • Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate

IRC §267(c) outlines constructive ownership of stock as follows:

  • Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries
  • An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family
  • An individual owning any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner
  • The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants