§1375 — Tax imposed when passive investment income of corporation having accumulated earnings and profits exceeds 25 percent of gross receipts
20 citing cases
Statute Text — 26 U.S.C. §1375
If for the taxable year an S corporation has—
accumulated earnings and profits at the close of such taxable year, and
gross receipts more than 25 percent of which are passive investment income,
then there is hereby imposed a tax on the income of such corporation for such taxable year. Such tax shall be computed by multiplying the excess net passive income by the highest rate of tax specified in section 11(b).
For purposes of this section—
Except as provided in subparagraph (B), the term “excess net passive income” means an amount which bears the same ratio to the net passive income for the taxable year as—
the amount by which the passive investment income for the taxable year exceeds 25 percent of the gross receipts for the taxable year, bears to
the passive investment income for the taxable year.
The amount of the excess net passive income for any taxable year shall not exceed the amount of the corporation’s taxable income for such taxable year as determined under section 63(a)—
without regard to the deductions allowed by part VIII of subchapter B (other than the deduction allowed by section 248, relating to organization expenditures), and
without regard to the deduction under section 172.
The term “net passive income” means—
passive investment income, reduced by
the deductions allowable under this chapter which are directly connected with the production of such income (other than deductions allowable under section 172 and part VIII of subchapter B).
The terms “passive investment income” and “gross receipts” have the same respective meanings as when used in paragraph (3) of section 1362(d).
Notwithstanding paragraph (3), the amount of passive investment income shall be determined by not taking into account any recognized built-in gain or loss of the S corporation for any taxable year in the recognition period. Terms used in the preceding sentence shall have the same respective meanings as when used in section 1374.
No credit shall be allowed under part IV of subchapter A of this chapter (other than section 34) against the tax imposed by subsection (a).
If the S corporation establishes to the satisfaction of the Secretary that—
it determined in good faith that it had no accumulated earnings and profits at the close of a taxable year, and
during a reasonable period of time after it was determined that it did have accumulated earnings and profits at the close of such taxable year such earnings and profits were distributed,
the Secretary may waive the tax imposed by subsection (a) for such taxable year.
Treasury Regulations
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Treas. Reg. §1.1375-1Tax imposed when passive investment income of corporation having subchapter C earnings and profits exceed 25 percent of gross receipts
(a) General rule. For taxable years beginning after 1981, section 1375(a) imposes a tax on the income of certain S corporations that have passive investment income. In the case of a taxable year beginning during 1982, an electing small business corporation may elect to have the rules under this section not apply. See the regulations under section 1362 for rules on the election. For purposes of this section, the term S corporation shall include an electing small business corporation under prior law. This tax shall apply to an S corporation for a taxable year if the S corporation has—
(1) Subchapter C earnings and profits at the close of such taxable year, and
(2) Gross receipts more than 25 percent of which are passive investment income
If the S corporation has no subchapter C earnings and profits at the close of the taxable year (because, for example, such earnings and profits were distributed in accordance with section 1368), the tax shall not be imposed even though the S corporation has passive investment income for the taxable year. If the tax is imposed, the tax shall be computed by multiplying the excess net passive income (as defined in paragraph (b) of this section) by the highest rate of tax specified in section 11(b).
(b) Definitions—(1) Excess net passive income—(i) In general. The term excess net passive income is defined in section 1375(b)(1), and can be expressed by the following formula:
Where:
(ii) Limitation. The amount of the excess net passive income for any taxable year shall not exceed the corporation's taxable income for the taxable year (determined in accordance with section 1374(d) and § 1.1374-1(d)).
(2) Net passive income. The term net passive income means—
(i) Passive investment income, reduced by
(ii) The deductions allowable under chapter 1 of the Internal Revenue Code of 1954 which are directly connected (within the meaning of paragraph (b)(3) of this section) with the production of such income (other than deductions allowable under section 172 and part VIII of subchapter B).
(3) Directly connected—(i) In general. For purposes of paragraph (b)(2)(ii) of this section to be directly connected with the production of income, an item of deduction must have proximate and primary relationship to the income. Expenses, depreciation, and similar items attributable solely to such income qualify for deduction.
(ii) Allocation of deduction. If an item of deduction is attributable (within the meaning of paragraph (b)(3)(i) of this section) inpart to passive investment income and in part to income other than passive investment income, the deduction shall be allocated between the two types of items on a reasonable basis. The portion of any deduction so allocated to passive investment income shall be treated as proximately and primarily related to such income.
(4) Other definitions. The terms subchapter C earnings and profits, passive investment income, and gross receipts shall have the same meaning given these terms in section 1362(d)(3) and the regulations thereunder.
(c) Special rules—(1) Disallowance of credits. No credit is allowed under part IV of subchapter A of chapter 1 of the Code (other than section 34) against the tax imposed by section 1375(a) and this section.
(2) Coordination with section 1374. If any gain—
(i) Is taken into account in determining passive income for purposes of this section, and
(ii) Is taken into account under section 1374,
the amount of such gain taken into account under section 1374(b) and § 1.1374-1(b) (1) and (2) in determining the amount of tax shall be reduced by the portion of the excess net passive income for the taxable year which is attributable (on a pro rata basis) to such gain. For purposes of the preceding sentence, the portion of excess net passive income for the taxable year which is attributable to such capital gain is equal to the amount determined by multiplying the excess net passive income by the following fraction:
Where:
(d) Waiver of tax in certain cases—(1) In general. If an S corporation establishes to the satisfaction of the Commissioner that—
(i) It determined in good faith that it had no subchapter C earnings and profits at the close of the taxable year, and
(ii) During a reasonable period of time after it was determined that it did have subchapter C earnings and profits at the close of such taxable year such earnings and profits were distributed,
the Commissioner may waive the tax imposed by section 1375 for such taxable year. The S corporation has the burden of establishing that under the relevant facts and circumsances the Commissioner should waive the tax.
For example, if an S corporation establishes that in good faith and using due diligence it determined that it had no subchapter C earnings and profits at the close of a taxable year, but it was later determined on audit that it did have subchapter C earnings and profits at the close of such taxable year, and if the corporation establishes that it distributed such earnings and profits within a reasonable time after the audit, it may be appropriate for the Commissioner to waive the tax on passive income for such taxable year.
(2) Corporation's request for a waiver. A request for waiver of the tax imposed by section 1375 shall be made in writing to the district director and shall contain all relevant facts to establish that the requirements of paragraph (d)(1) of this section are met. Such request shall contain a description of how and on what date the S corporation in good faith and using due diligence determined that it had no subchapter C earnings and profits at the close of the taxable year, a description of how and on what date it was determined that the S corporation had subchapter C earnings and profits at the close of the year and a description (including dates) of any steps taken to distribute such earnings and profits. If the earnings and profits have not yet been distributed, the request shall contain a timetable for distribution and an explanation of why such timetable is reasonable. On the date the waiver is to become effective, all subchapter C earnings and profits must have been distributed.
(e) Reduction in pass-thru for tax imposed on excess net passive income. See section 1366(f)(3) for a special rule reducing each item of the corporation's passive investment income for purposes of section 1366(a) if a tax is imposed on the corporation under section 1375.
(f) Examples. The following examples illustrate the principles of this section:
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Treas. Reg. §1.1375-1(a)General rule.
General rule. For taxable years beginning after 1981, section 1375(a) imposes a tax on the income of certain S corporations that have passive investment income. In the case of a taxable year beginning during 1982, an electing small business corporation may elect to have the rules under this section not apply. See the regulations under section 1362 for rules on the election. For purposes of this section, the term S corporation shall include an electing small business corporation under prior law. This tax shall apply to an S corporation for a taxable year if the S corporation has—
(1) Subchapter C earnings and profits at the close of such taxable year, and
(2) Gross receipts more than 25 percent of which are passive investment income
If the S corporation has no subchapter C earnings and profits at the close of the taxable year (because, for example, such earnings and profits were distributed in accordance with section 1368), the tax shall not be imposed even though the S corporation has passive investment income for the taxable year. If the tax is imposed, the tax shall be computed by multiplying the excess net passive income (as defined in paragraph (b) of this section) by the highest rate of tax specified in section 11(b).
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Treas. Reg. §1.1375-1(b)Definitions—(1) Excess net passive income—(i) In general.
Definitions—(1) Excess net passive income—(i) In general. The term excess net passive income is defined in section 1375(b)(1), and can be expressed by the following formula:
Where:
(ii) Limitation. The amount of the excess net passive income for any taxable year shall not exceed the corporation's taxable income for the taxable year (determined in accordance with section 1374(d) and § 1.1374-1(d)).
(2) Net passive income. The term net passive income means—
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Treas. Reg. §1.1375-1(c)Special rules—(1) Disallowance of credits.
Special rules—(1) Disallowance of credits. No credit is allowed under part IV of subchapter A of chapter 1 of the Code (other than section 34) against the tax imposed by section 1375(a) and this section.
(2) Coordination with section 1374. If any gain—
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Treas. Reg. §1.1375-1(d)Waiver of tax in certain cases—(1) In general.
Waiver of tax in certain cases—(1) In general. If an S corporation establishes to the satisfaction of the Commissioner that—
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Treas. Reg. §1.1375-1(e)Reduction in pass-thru for tax imposed on excess net passive income.
Reduction in pass-thru for tax imposed on excess net passive income. See section 1366(f)(3) for a special rule reducing each item of the corporation's passive investment income for purposes of section 1366(a) if a tax is imposed on the corporation under section 1375.
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Treas. Reg. §1.1375-1(f)Examples.
Examples. The following examples illustrate the principles of this section:
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Treas. Reg. §1.1375-1(i)§1.1375-1(i)
It determined in good faith that it had no subchapter C earnings and profits at the close of the taxable year, and
(ii) During a reasonable period of time after it was determined that it did have subchapter C earnings and profits at the close of such taxable year such earnings and profits were distributed,
the Commissioner may waive the tax imposed by section 1375 for such taxable year. The S corporation has the burden of establishing that under the relevant facts and circumsances the Commissioner should waive the tax.
For example, if an S corporation establishes that in good faith and using due diligence it determined that it had no subchapter C earnings and profits at the close of a taxable year, but it was later determined on audit that it did have subchapter C earnings and profits at the close of such taxable year, and if the corporation establishes that it distributed such earnings and profits within a reasonable time after the audit, it may be appropriate for the Commissioner to waive the tax on passive income for such taxable year.
(2) Corporation's request for a waiver. A request for waiver of the tax imposed by section 1375 shall be made in writing to the district director and shall contain all relevant facts to establish that the requirements of paragraph (d)(1) of this section are met. Such request shall contain a description of how and on what date the S corporation in good faith and using due diligence determined that it had no subchapter C earnings and profits at the close of the taxable year, a description of how and on what date it was determined that the S corporation had subchapter C earnings and profits at the close of the year and a description (including dates) of any steps taken to distribute such earnings and profits. If the earnings and profits have not yet been distributed, the request shall contain a timetable for distribution and an explanation of why such timetable is reasonable. On the date the waiver is to become effective, all subchapter C earnings and profits must have been distributed.
20 Citing Cases
105 T.C. 227, 230 (1995). It is essentially a transactional provision, i.e., it deals with the tax treatment of particular activities. In 2 The exceptions are the taxes imposed on built-in gains under sec. 1374 and on excess net passive income under sec. 1375. 3 See infra pp. 20-22 for a discussion of the impact of other provisions of sec. 1371(b). - 7 - determining the existence of a PAL, section 469 treats each activity separately. Section 1371 was enacted in 1982 by section 2 of the Subchapte
to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The exceptions are the taxes imposed on built-in gains under sec. 1374 and on excess net passive income under sec. 1375. See infra pp. 58-59 for a discussion of the impact of other provisions of sec. 1371(b). See, e.g., sec. 170(d)(1) and (2) (charitable contributions); sec. 38(a) (business credit carryforwards and carrybacks); sec. 172 (net operating loss c
n installment obligation, within the meaning of section 453B.3 2 Although Sainte Claire elected to be an S corporation for its 1987 and 1988 taxable years, respondent determined that it was liable for tax on its excess net passive income pursuant to sec. 1375 for 1987 and on its net capital gain pursuant to sec. 1374 for 1988. 3 Petitioners object on grounds of relevance to entries in an exhibit prepared by respondent's agent that relate to payments of interest by James F. Boccardo to Sainte Cla
n installment obligation, within the meaning of section 453B.3 2 Although Sainte Claire elected to be an S corporation for its 1987 and 1988 taxable years, respondent determined that it was liable for tax on its excess net passive income pursuant to sec. 1375 for 1987 and on its net capital gain pursuant to sec. 1374 for 1988. 3 Petitioners object on grounds of relevance to entries in an exhibit prepared by respondent's agent that relate to payments of interest by James F. Boccardo to Sainte Cla