Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied under this rule, the rule will continue to apply even if the corporation's relationship with the person ends before the expense or interest is includible in the gross income of that person. These rules also deny the deduction of losses on the sale or exchange of property between related persons.
For purposes of this rule, the following persons are related to a corporation. Another corporation that is a member of the same controlled group as defined in section 267(f) of the Internal Revenue Code.
- An individual who owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation.
- A trust fiduciary when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.
- An S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation.
- A partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership.
- Any employee-owner if the corporation is a personal service corporation (defined later), regardless of the amount of stock owned by the employee-owner.
To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.
- Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust is treated as being owned proportionately by or for its shareholders, partners, or beneficiaries.
- An individual is treated as owning the stock owned, directly or indirectly, by or for his or her family. Family includes only brothers and sisters (including half brothers and half sisters), a spouse, ancestors, and lineal descendants.
- Any individual owning (other than by applying rule #2 any stock in a corporation is treated as owning the stock owned directly or indirectly by that individual's partner.
To apply rule (1), (2), or (3), stock constructively owned by a person under rule (1) is treated as actually owned by that person. But stock constructively owned by an individual under rule (2) or (3) is not treated as actually owned by the individual for applying either rule (2) or (3) to make another person the constructive owner of that stock.
For this purpose, a corporation is a personal service corporation if it meets all of the following requirements.
- It is not an S corporation.
- Its principal activity is performing personal services. Personal services are those performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and performing arts
- Its employee-owners substantially perform the services in (2).
- Its employee-owners own more than 10% of the fair market value of its outstanding stock.
Reallocation of Income and Deductions
Where it is necessary to clearly show income or prevent tax evasion, the IRS can reallocate gross income, deductions, credits, or allowances between two or more organizations, trades, or businesses owned or controlled directly, or indirectly, by the same interests.
The disallowance of losses from the sale or exchange of property between related persons does not apply to liquidating distributions.