Section 1367 Regarding Open Account Debt, 18417-18422 [E7-6764]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 70 (Thursday, April 12, 2007)]
[Proposed Rules]
[Pages 18417-18422]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-6764]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-144859-04]
RIN 1545-BD72


Section 1367 Regarding Open Account Debt

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document proposes amendments to the regulations relating 
to the treatment of open account debt between S corporations and their 
shareholders. These proposed regulations provide rules regarding the 
definition of open account debt and the adjustments in basis of any 
indebtedness of an S corporation to a shareholder under section 
1367(b)(2) of the Internal Revenue Code (Code) for shareholder advances 
and repayments on advances of open account debt. The proposed 
regulations affect shareholders of S corporations and are necessary to 
provide guidance needed to comply with the applicable tax law. This 
document also provides notice of a public hearing.

DATES: Written or electronic comments and requests for a public hearing 
must be received by July 11, 2007. Outlines of topics to be discussed 
at the public hearing scheduled for July 31, 2007, at 10 a.m., must be 
received by July 10, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-144859-04), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions also may be hand-delivered Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR 
(REG-144859-04), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW., Washington, DC, or sent electronically, via 
the Federal eRulemaking Portal at https://

[[Page 18418]]

www.regulations.gov (IRS REG-144859-04). The public hearing will be 
held in the IRS Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Stacy L. Short or Deane M. Burke, (202) 622-3070; concerning 
submissions of comments, the hearing, and/or to be placed on the 
building access list to attend the hearing, Richard Hurst at (202) 622-
2949 (TDD Telephone) (not toll free numbers) and his e-mail address is 
Richard.A.Hurst@irscounsel.treas.gov, (202) 622-7180 (not toll-free 
numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507). Comments on the collections of information should be sent 
to the Office of Management and Budget, Attention: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attention: IRS Reports Clearance Officer, T:FP, Washington, DC 
20224.
    The recordkeeping requirement in these proposed regulations is in 
Sec.  1.1367-2(a)(2)(i). This information must be maintained by the 
shareholder to ensure that the indebtedness of the S corporation to the 
shareholder continues to meet the definition of open account debt found 
in Sec.  1.1367-2(a)(2)(i). The recordkeepers will be S corporation 
shareholders who have open account debt.
    The following estimates are an approximation of the average time 
expected to be necessary for a collection of information. They are 
based on the information that is available to the Internal Revenue 
Service. Individual recordkeepers may require greater or less time, 
depending on their particular circumstances.
    Estimated total annual recordkeeping burden: 250 hours.
    Estimated average annual burden: Hours per recordkeeper varies from 
.75 to 1.25 hours, depending on individual circumstances, with an 
estimated average of 1 hour.
    Estimated number of recordkeepers: 250.
    Estimated annual frequency of recordkeeping: On occasion.

Background

    This document proposes to amend Sec.  1.1367-2 of the Income Tax 
Regulations (26 CFR part 1) regarding the definition of open account 
debt and adjustments in basis of indebtedness for shareholder advances 
and repayments on advances of open account debt.
    Section 1367(a)(1) provides that the basis of each shareholder's 
stock in an S corporation is increased by the shareholder's pro rata 
share of the S corporation's income (separately and nonseparately 
computed items of income) and the excess of the deductions for 
depletion over the basis of the property subject to depletion. Section 
1367(a)(2) provides that the basis of each shareholder's stock in the S 
corporation is decreased by the shareholder's pro rata share of 
distributions not includible in income of the shareholder by reason of 
section 1368 (nontaxable distributions), losses and deductions 
(separately and non-separately computed losses), any expense of the 
corporation that is not deductible and not properly chargeable to 
capital account, and certain deductions for depletion for any oil and 
gas property held by the S corporation. Under section 1367(b)(2)(A), if 
for any taxable year the amounts specified in section 1367(a)(2) (other 
than distributions) exceed the amount which reduces the shareholder's 
basis to zero, such excess losses and deductions shall be applied to 
reduce (but not below zero) the shareholder's basis in any indebtedness 
of the S corporation to the shareholder. Section 1367(b)(2)(B) provides 
that if a shareholder's basis in indebtedness is reduced for any 
taxable year, any net increase (the amount by which the items described 
in section 1367(a)(1) exceed the items described in section 1367(a)(2)) 
for any subsequent taxable year is applied to restore the reduction in 
basis in indebtedness before any of the excess is used to increase 
basis in stock.
    On January 3, 1994, the Treasury Department and the IRS published 
final regulations under section 1367 of the Code (TD 8508, 59 FR 12, 
amended on December 22, 1999 (TD 8852, 64 FR 71641)). Those final 
regulations relate, in part, to adjustments to basis in both stock of 
shareholders and indebtedness of an S corporation to its shareholders. 
Section 1.1367-2 of the Income Tax Regulations provides specific rules 
for required adjustments (reductions and restorations) to basis in any 
indebtedness of an S corporation to a shareholder. Section 1.1367-2(a) 
also provides that for purposes of adjustments to basis of indebtedness 
to shareholders, shareholder advances not evidenced by separate written 
instruments and repayments on the advances (open account debt) are 
treated as a single indebtedness. Further, Sec.  1.1367-2(a) provides 
that the basis of indebtedness of the S corporation to a shareholder is 
reduced as provided in Sec.  1.1367-2(b) and restored as provided in 
Sec.  1.1367-2(c). Thus, the basis adjustment rules under the final 
regulations apply to all indebtedness of an S corporation to a 
shareholder, whether the indebtedness is evidenced by a written 
instrument or is open account debt.
    Section 1.1367-2(b) provides the rules for the reduction of basis 
of indebtedness of an S corporation to a shareholder. Generally, under 
Sec.  1.1367-2(b)(1), if the basis of a shareholder's stock in the S 
corporation has been reduced to zero under section 1367(a)(2), the 
excess of certain losses and deductions specified in section 1367(a)(2) 
is applied to reduce (but not below zero) the basis of any indebtedness 
of the S corporation to the shareholder held by the shareholder at the 
close of the S corporation's taxable year. Any indebtedness of the S 
corporation to the shareholder that has been satisfied by the S 
corporation, or disposed of or forgiven by the shareholder during the 
taxable year, is not held by the shareholder at the close of that year 
and is not subject to basis reduction. Further, Sec.  1.1367-2(b)(2) 
provides that if the interest of the shareholder in the S corporation 
is terminated during the taxable year, the rules in Sec.  1.1367-2(b) 
are applied to any indebtedness of the S corporation to the shareholder 
held by the shareholder immediately before the termination of the 
shareholder's interest in the S corporation. If a shareholder holds 
more than one indebtedness at the close of the taxable year (or, if 
applicable, immediately prior to the termination of the shareholder's 
interest in the corporation), the basis of each indebtedness is reduced 
under Sec.  1.1367-2(b)(3) in the same proportion that the basis of 
each indebtedness bears to the aggregate bases of the indebtedness of 
the S corporation to the shareholder.
    Section 1.1367-2(c) provides the rules for restoring basis of 
indebtedness of an S corporation to a shareholder. Generally, under 
Sec.  1.1367-2(c)(1), if, for any taxable year of the S corporation, 
there has been a reduction in the basis of an indebtedness of the S 
corporation to a shareholder, any net increase in any subsequent 
taxable year of the S corporation is applied to restore that reduction. 
For purposes of Sec.  1.1367-2, a

[[Page 18419]]

net increase is the amount by which the shareholder's pro rata share of 
S corporation items described in section 1367(a)(1) exceed the items 
described in section 1367(a)(2) for the taxable year. The restoration 
rules apply only to indebtedness held by the shareholder as of the 
beginning of the taxable year in which the net increase arises. 
Further, the reduction in basis of indebtedness must be restored before 
a net increase is used to restore the shareholder's basis in stock. The 
shareholder's basis in indebtedness may not be restored above the 
adjusted basis of the indebtedness under section 1016(a) (excluding any 
prior year's adjustments under section 1367), determined as of the 
beginning of the taxable year in which the net increase arises.
    Under Sec.  1.1367-2(c)(2), if a shareholder holds more than one 
indebtedness as of the beginning of an S corporation's taxable year, 
any net increase is applied first to restore the reduction of basis in 
any indebtedness repaid (in whole or in part) in that taxable year to 
the extent necessary to offset any gain that would otherwise be 
realized on the repayment. Any remaining net increase is applied to 
restore each outstanding indebtedness in proportion to the amount that 
the basis of each outstanding indebtedness has been reduced and not 
restored.
    Section 1.1367-2(d) provides rules for the time at which 
adjustments to basis of indebtedness under section 1367(b)(2) are 
effective. Generally, under Sec.  1.1367-2(d)(1) the amount of the 
adjustments to basis of indebtedness are determined and effective as of 
the close of an S corporation's taxable year. However, if the 
shareholder is not a shareholder in the S corporation at that time, the 
adjustments are effective immediately before the shareholder's interest 
in the S corporation is terminated. Moreover, if a debt is disposed of 
or repaid, in whole or in part, before the close of the taxable year, 
the basis of that debt is restored effective immediately before the 
disposition or the first repayment on the debt during the taxable year.
    On August 25, 2005, the Tax Court issued its decision in Brooks v. 
Commissioner, TC Memo. 2005-204. In Brooks, the taxpayer borrowed money 
from a bank and advanced that money as open account debt to his S 
corporation in one taxable year and reduced basis in that open account 
debt for losses passed through to the taxpayer at the end of that same 
year. In the first few weeks of the subsequent taxable year, the S 
corporation repaid the open account debt (the taxpayer then repaid his 
debt for the borrowed money). Late in that subsequent year, the 
taxpayer advanced additional money (again, amounts borrowed from a 
bank) in an amount that offset the repayment of advances to avoid the 
recognition of gain from repayment of the indebtedness. Also, the 
taxpayer's advances increased the shareholder's basis in the 
indebtedness and allowed losses for that year to pass through to the 
taxpayer shareholder. Taxpayer and the S corporation made these 
repayments and advances for several taxable years and deferred 
indefinitely the recognition of income on any repayment of his open 
account debt.
    The court in Brooks held ``that the basis of the open account 
indebtedness is properly computed by netting at the close of the year 
advances of open account debt during the year and repayments of open 
account debt during the year.''

Explanation of Provisions

    The Treasury Department and the IRS believe that the concept of 
``open account debt'' as defined in Sec.  1.1367-2(a) was intended to 
provide administrative simplicity for S corporations but was not 
intended to permit the deferral allowed in Brooks. The IRS and Treasury 
Department are proposing these amendments to narrow the definition of 
open account debt and to modify the rules for adjustments of basis in 
indebtedness for the more narrowly defined open account debt.
    In these proposed regulations, open account debt is defined as 
shareholder advances not evidenced by separate written instruments for 
which the principal amount of the aggregate advances (net of repayments 
on the advances) does not exceed $10,000 at the close of any day during 
the S corporation's taxable year. Included within that definition are 
separate advances under a line of credit agreement if the advances are 
not evidenced by a separate written instrument. Open account debt is 
treated as a single indebtedness. This $10,000 limitation on open 
account debt for the purposes of the Sec.  1.1367-2 regulations is 
modeled after section 7872(c)(3) and the Sec.  1.7872-9 proposed 
regulations, which provide a $10,000 de minimis exception to the 
treatment of loans with below-market interest rates for compensation-
related or corporation-shareholder loans.
    Under these proposed regulations, to determine whether shareholder 
advances and repayments on the advances exceed the $10,000 aggregate 
principal threshold on any day during the S corporation's taxable year 
for open account debt, the shareholder will have to maintain a 
``running balance'' of those advances and repayments, and the 
outstanding principal amount of the open account debt. If the resulting 
aggregate principal of the running balance does not exceed $10,000 at 
the close of any day during the S corporation's taxable year, the 
advances and repayments on advances would constitute open account debt, 
would be treated as a single indebtedness, and would be accounted for 
at the close of the taxable year (as explained in this preamble). 
However, if the resulting aggregate principal of the running balance 
exceeds $10,000 at the close of any day during the S corporation's 
taxable year, the entire principal amount of that indebtedness would no 
longer constitute open account debt effective at the close of the day 
on the date the amount of the running balance exceeds $10,000. This 
principal amount would be treated as indebtedness evidenced by a 
written instrument for that taxable year, and would be accounted for 
according to the timing rules in Sec.  1.1367-2(d) for that taxable 
year and subsequent taxable years. Any new shareholder advances not 
evidenced by a written instrument and repayments on those advances 
within the $10,000 aggregate principal threshold amount during the 
taxable year would constitute a new open account debt.
    The proposed regulations also modify the manner in which repayments 
on open account debt are accounted for under the existing final Sec.  
1.1367-2 regulations. These rules are separate from the maintenance of 
a running balance of the advances and repayments to determine if a 
shareholder has exceeded the $10,000 threshold amount. For purposes of 
accounting for open account debt, each shareholder, at the end of the S 
corporation's taxable year, must determine if that shareholder has made 
a net advance or received a net repayment on open account debt for that 
taxable year. To determine if a net advance or a net repayment has 
occurred, each shareholder, at the end of the S corporation's taxable 
year, must net all advances and repayments made during the year without 
regard to the outstanding principal amount of the open account debt. 
If, at the end of the taxable year, a net repayment exists, the net 
repayment must be taken into account effective at the close of the S 
corporation's taxable year under the general basis adjustment rules in 
the existing final Sec.  1.1367-2 regulations. If, at the end of the 
taxable year, a net advance exists, the net advance is combined with 
the outstanding

[[Page 18420]]

aggregate principal balance of the existing open account debt and that 
amount is carried forward to the beginning of the subsequent taxable 
year as the outstanding aggregate principal amount of the open account 
debt. If at any time during the taxable year the resulting aggregate 
principal of the running balance exceeds the $10,000 threshold amount 
so the entire principal amount of the indebtedness no longer 
constitutes open account debt, the running balance must be reconciled 
effective at the close of the day the balance exceeds $10,000 to 
determine the aggregate principal amount of the indebtedness, and for 
the remainder of the taxable year that principal amount is treated in 
the same manner as indebtedness evidenced by a written instrument for 
the purposes of this section.

Proposed Effective Date

    The regulations, as proposed, apply to any shareholder advances to 
the S corporation made on or after the date of publication of a 
Treasury decision adopting these rules as final regulations in the 
Federal Register and repayments on those advances by the S corporation.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
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) does not apply to these regulations. Because these 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The IRS and the Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for July 31, 2007, beginning at 
10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance area more than 30 minutes before the 
hearing starts. For information about having your name placed on the 
building access list to attend the hearing, see the ``FOR FURTHER 
INFORMATION CONTACT'' section of this preamble.
    The rules of 26 CFR 606.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit electronic or 
written comments and an outline of the topics to be discussed and time 
to be devoted to each topic (a signed original and eight (8) copies) by 
July 10, 2007. A period of 10 minutes will be allotted to each person 
for making comments. An agenda showing the scheduling of the speakers 
will be prepared after the deadline for receiving outlines has passed. 
Copies of the agenda will be available free of charge at the hearing.

Drafting Information

    The principal authors of these regulations are Stacy L. Short and 
Deane M. Burke of the Office of the Associate Chief Counsel 
(Passthroughs and Special Industries), IRS.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAX

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read in part as follows:

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

    Section 1.1367-2 also issued under 26 U.S.C. 1367(b)(2). * * *

    >Par. 2. Section 1.1367-2 is amended as follows:
    1. Paragraph (a) is revised.
    2. Paragraphs (c)(2) and (d)(1) are revised.
    3. Paragraph (d)(2) is redesignated as paragraph (d)(3).
    4. New paragraph (d)(2) is added.
    5. Paragraph (e) is amended by adding Examples 6 and 7.
    The revisions and additions read as follows:


Sec.  1.1367-2  Adjustments to basis of indebtedness to shareholder.

    (a) In general--(1) Adjustments under section 1367. This section 
provides rules relating to adjustments required by subchapter S to the 
basis of indebtedness (including open account debt as described in 
paragraph (a)(2) of this section) of an S corporation to a shareholder. 
The basis of indebtedness of the S corporation to a shareholder is 
reduced as provided in paragraph (b) of this section and restored as 
provided in paragraph (c) of this section in accordance with the timing 
rules in paragraph (d) of this section.
    (2) Open account debt--(i) General rule. The term open account debt 
means shareholder advances not evidenced by separate written 
instruments and repayments on the advances, the aggregate outstanding 
principal of which does not exceed $10,000 of indebtedness of the S 
corporation to the shareholder at the close of any day during the S 
corporation's taxable year. Advances and repayments on open account 
debt are treated as a single indebtedness. For purposes of determining 
if shareholder advances not evidenced by separate written instruments 
and repayments on those advances exceed an aggregate outstanding 
principal of $10,000, a shareholder must maintain a running daily 
balance of all advances and repayments on those advances and the 
outstanding principal amount of the open account debt at the close of 
each day during the S corporation's taxable year.
    (ii) Exception. If a shareholder's running balance exceeds an 
aggregate outstanding principal amount of $10,000 at the close of any 
day during the S corporation's taxable year, effective on the close of 
the day on which the shareholder's running balance exceeds $10,000, the 
running balance must be reconciled to determine the aggregate principal 
amount of indebtedness. For the remainder of the taxable year, that 
aggregate principal amount of indebtedness is treated in the same 
manner as indebtedness evidenced by a separate written instrument for 
purposes of this section. For the remainder of that taxable year and 
subsequent taxable years, the indebtedness is not open account debt and 
is subject to all basis adjustment rules applicable to basis of 
indebtedness of an S corporation to a shareholder in this section.
* * * * *
    (c) * * * (1) * * *
    (2) Multiple indebtedness. If a shareholder holds more than one

[[Page 18421]]

indebtedness (including any open account debt and any debt treated as a 
single indebtedness under paragraph (a)(2)(ii) of this section) as of 
the beginning of an S corporation's taxable year, any net increase is 
applied first to restore the reduction of basis in any indebtedness 
repaid (in whole or in part) in that taxable year to the extent 
necessary to offset any gain that would otherwise be realized on the 
repayment. Any remaining net increase is applied to restore each 
outstanding indebtedness (including any open account debt and any debt 
treated as a single indebtedness under paragraph (a)(2)(ii) of this 
section) in proportion to the amount that the basis of each outstanding 
indebtedness has been reduced under section 1367(b)(2)(A) and paragraph 
(b) of this section and not restored under section 1367(b)(2)(B) and 
this paragraph (c).
    (d) Time at which adjustments to basis of indebtedness are 
effective--(1) In general. Except as provided in paragraph (d)(2) of 
this section, the amounts of the adjustments to basis of indebtedness 
provided in section 1367(b)(2) and this section are determined as of 
the close of the S corporation's taxable year, and the adjustments are 
generally effective as of the close of the S corporation's taxable 
year. However, if the shareholder is not a shareholder in the S 
corporation at that time, these adjustments are effective immediately 
before the shareholder terminates his or her interest in the S 
corporation. If a debt (including any open account debt and any debt 
treated as a single indebtedness under paragraph (a)(2)(ii) of this 
section) is disposed of or repaid in whole or in part before the close 
of the taxable year, the basis of that indebtedness is restored under 
paragraph (c) of this section, effective immediately before the 
disposition or the first repayment on the debt (or the net repayment on 
open account debt) during the taxable year. To the extent any reduction 
of basis in indebtedness under paragraph (b) of this section that is 
disposed of or repaid (in whole or in part) during the taxable year is 
not restored completely under paragraph (c) of this section, gain is 
realized on the repayment effective immediately before the indebtedness 
is disposed of or repaid (in whole or in part).
    (2) Open account debt--(i) In general. All advances and repayments 
on open account debt (as described in paragraph (a)(2)(i) of this 
section) during the taxable year are netted continuously as the 
advances and repayments occur. The amount of any net advance or net 
repayment on open account debt for the S corporation's taxable year is 
determined at the close of the taxable year. If the shareholder 
advances, and repayments on the advances, during the S corporation's 
taxable year result in a net advance or net repayment, the basis of the 
open account debt is reduced as provided in paragraph (b) of this 
section and restored as provided in paragraph (c) of this section 
effective at the close of the taxable year. To the extent any reduction 
of basis of open account debt under paragraph (b) of this section that 
is disposed of or repaid (in whole or in part) during the taxable year 
is not restored completely under paragraph (c) of this section, income 
is realized on the net repayment at the close of the taxable year in 
which the open account debt is disposed of or repaid (in whole or in 
part).
    (ii) Exception. On the close of the day on which the shareholder's 
running balance exceeds an aggregate outstanding principal amount of 
$10,000, the shareholder's running balance is reconciled to determine 
an aggregate principal amount of indebtedness. The resulting aggregate 
principal amount of indebtedness is treated as the principal amount of 
a debt evidenced by a separate written instrument for the remainder of 
that taxable year and any subsequent taxable year, and is no longer 
subject to the open account debt provisions of this section.
* * * * *
    (e) * * *
* * * * *
    Example 6. Treatment of open account debt. (i) A has been the 
sole shareholder in Corporation S since 2000. In 2007, A advances S 
$8,000, which is not evidenced by a written instrument. The $8,000 
advance is open account debt and remains outstanding at that amount 
during 2007. On December 31, 2007, the basis of A's stock is zero; 
and the basis of the open account debt is reduced under paragraph 
(b) of this section to $4,000. On April 1, 2008, S repays $3,000 of 
the open account indebtedness. On September 1, 2008, A advances S an 
additional $2,000, which is not evidenced by a written instrument. 
There is no net increase under paragraph (c) of this section in year 
2007 or 2008.
    (ii) At no time during the 2007 taxable year does the running 
balance of A's open account debt exceed $10,000. As of December 31, 
2007, A's basis in the open account debt is reduced under paragraph 
(b) of this section to $4,000.
    (iii) At no time during the 2008 taxable year does the running 
balance of A's open account debt exceed $10,000. On April 1, 2008, 
S's $3,000 repayment is applied to A's running balance for open 
account debt carried forward from 2007 in the amount of $8,000 to 
reduce the running balance to $5,000. On September 1, 2008, A's 
advance to S of $2,000, which is not evidenced by a written 
instrument, is applied to A's running balance to bring A's aggregate 
outstanding principal on A's open account indebtedness to $7,000.
    (iv) At the close of the 2008 taxable year, the $3,000 April 
repayment S makes to A and A's $2,000 September advance are netted 
to result in a net repayment of $1,000 for the taxable year on A's 
$8,000 open account debt carried forward from 2007. Because there is 
no net increase in 2008, no basis of indebtedness is restored for 
the 2008 taxable year.
    Example 7. Treatment of shareholder indebtedness not evidenced 
by a written instrument which exceeds $10,000. (i) The facts are the 
same as in Example 6, in addition to which, on February 1, 2008, S 
repays $1,000 of the open account debt and on March 1, 2008, A 
advances S $5,000, which is not evidenced by a written instrument.
    (ii) At no time during the 2007 taxable year does the running 
balance of A's open account debt exceed $10,000. As of December 31, 
2007, the basis of the open account debt is reduced under paragraph 
(b) of this section to $4,000.
    (iii) The running balance of A's open account debt does exceed 
$10,000 during the 2008 taxable year. On February 1, 2008, S's 
$1,000 repayment is applied to A's running balance for open account 
debt carried forward from 2007 in the amount of $8,000 to reduce the 
running balance to $7,000. On March 1, 2008, A's advance to S of 
$5,000, which is not evidenced by a written instrument, is applied 
to A's running balance to bring A's aggregate outstanding principal 
on A's open account debt to $12,000. Because this amount exceeds the 
$10,000 threshold amount, effective at the close of the day on March 
1, 2008, A's running balance must be reconciled to determine an 
aggregate principal amount of indebtedness.
    (iv) As of March 1, 2008, S had made a $1,000 repayment on A's 
open account debt, and A had advanced an additional $5,000 which was 
not evidenced by a written instrument. To reconcile A's running 
balance, the $1,000 repayment and $5,000 advance are netted first to 
result in a $4,000 net advance that is then added with A's existing 
principal amount of open account debt of $8,000 to determine the 
aggregate principal amount of indebtedness of $12,000. As of March 
1, 2008, S's indebtedness to A that is not evidenced by a written 
instrument has a principal balance of $12,000 and a basis of $8,000 
($4,000 basis on December 31, 2007 + $4,000 net advance). On April 
1, 2008, S repays $3,000 of that new indebtedness.
    (v) On September 1, 2008, A advances S an additional $2,000, 
which is not evidenced by a written instrument. The $2,000 advance 
is considered new open account debt. On December 31, 2008, A's basis 
in his stock is zero and the outstanding principal in the two 
remaining debts are as follows:

[[Page 18422]]



----------------------------------------------------------------------------------------------------------------
                                                                 3/1/08       4/1/08       9/1/08      12/31/08
                                                               principal    repayment     advance     principal
----------------------------------------------------------------------------------------------------------------
Indebtedness treated as if evidenced by written instrument..      $12,000       $3,000  ...........       $9,000
Open account debt...........................................  ...........  ...........       $2,000        2,000
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    Par. 3. Section 1.1367-3 is amended as follows:
    1. The section heading is revised.
    2. The first sentence of the paragraph is revised.
    3. A new second and last sentence are added.
    The revisions and additions read as follows:


Sec.  1.1367-3  Effective dates and transitional rules.

    Section 1.1367-2(a), (c)(2), (d)(2), and (e) Example 6 and Example 
7 apply to any shareholder advances to the S corporation made on or 
after the date these regulations are published as final regulations in 
the Federal Register and repayments on those advances by the S 
corporation.

 Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E7-6764 Filed 4-11-07; 8:45 am]
BILLING CODE 4830-01-P