Limitation on Deduction for Business Interest Expense; Allocation of Interest Expense by Passthrough Entities; Dividends Paid by Regulated Investment Companies; Application of Limitation on Deduction for Business Interest Expense to United States Shareholders of Controlled Foreign Corporations and to Foreign Persons With Effectively Connected Income

• Published date: 14 September 2020
• Citation: 85 FR 56846
• Record Number: 2020-16532
• Section: Proposed rules
• Court: Internal Revenue Service,Treasury Department

56846

Federal Register / Vol. 85, No. 178 / Monday, September 14, 2020 / Proposed Rules

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG–107911–18]

RIN 1545–BP73

Limitation on Deduction for Business

Interest Expense; Allocation of Interest

Expense by Passthrough Entities;

Dividends Paid by Regulated

Investment Companies; Application of

Limitation on Deduction for Business

Interest Expense to United States

Shareholders of Controlled Foreign

Corporations and to Foreign Persons

With Effectively Connected Income

AGENCY

: Internal Revenue Service (IRS),

Treasury.

ACTION

: Notice of proposed rulemaking.

SUMMARY

: This notice of proposed

rulemaking provides rules concerning

the limitation on the deduction for

business interest expense after

amendment of the Internal Revenue

Code (Code) by the provisions

commonly known as the Tax Cuts and

Jobs Act, which was enacted on

December 22, 2017, and the Coronavirus

Aid, Relief, and Economic Security Act,

which was enacted on March 27, 2020.

Specifically, these proposed regulations

address application of the limitation in

contexts involving passthrough entities,

regulated investment companies (RICs),

United States shareholders of controlled

foreign corporations, and foreign

persons with effectively connected

income in the United States. These

proposed regulations also provide

guidance regarding the definitions of

real property development, real

property redevelopment, and a

syndicate. These proposed regulations

affect taxpayers that have business

interest expense, particularly

passthrough entities, their partners and

shareholders, as well as foreign

corporations and their United States

shareholders and foreign persons with

effectively connected income. These

proposed regulations also affect RICs

that have business interest income, RIC

shareholders that have business interest

expense, and members of a consolidated

group.

DATES

: Written or electronic comments

and requests for a public hearing must

be received by November 2, 2020, which

is 60 days after the date of filing for

public inspection with the Office of the

Federal Register.

ADDRESSES

: Commenters are strongly

encouraged to submit public comments

electronically. Submit electronic

submissions via the Federal

eRulemaking Portal at

www.regulations.gov (indicate IRS and

REG–107911–18) by following the

online instructions for submitting

comments. Once submitted to the

Federal eRulemaking Portal, comments

cannot be edited or withdrawn. The IRS

expects to have limited personnel

available to process public comments

that are submitted on paper through

mail. The Department of the Treasury

(Treasury Department) and the IRS will

publish for public availability any

comment submitted electronically, and

when practicable on paper, to its public

docket.

Send paper submissions to:

CC:PA:LPD:PR (REG–107911–18), Room

5203, Internal Revenue Service, P.O.

Box 7604, Ben Franklin Station,

Washington, DC 20044.

FOR FURTHER INFORMATION CONTACT

:

Concerning § 1.163(j)–1, Steven

Harrison, (202) 317–6842, Michael Chin,

(202) 317–6842 or John Lovelace, (202)

317–5363; concerning § 1.163(j)–2,

Sophia Wang, (202) 317–4890 or John

Lovelace, (202) 317–5363, concerning

§ 1.163–14, §1.163(j)–6, or § 1.469–9,

William Kostak, (202) 317–5279 or

Anthony McQuillen, (202) 317–5027;

concerning § 1.163–15, Sophia Wang,

(202) 317–4890; concerning § 1.163(j)–7

or § 1.163(j)–8, Azeka J. Abramoff, (202)

317–3800 or Raphael J. Cohen, (202)

317–6938, concerning § 1.1256(e)–2,

Sophia Wang, (202) 317–4890 or Pamela

Lew, (202) 317–7053; concerning

submissions of comments and/or

requests for a public hearing, Regina L.

Johnson, (202) 317–5177 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION

:

Background

This document contains proposed

amendments to the Income Tax

Regulations (26 CFR part 1) under

sections 163 (in particular section

163(j)), 469 and 1256(e) of the Code.

Section 163(j) was amended as part of

Public Law 115–97, 131 Stat. 2054

(December 22, 2017), commonly

referred to as the Tax Cuts and Jobs Act

(TCJA), and the Coronavirus Aid, Relief,

and Economic Security Act, Public Law

116–136 (2020) (CARES Act). Section

13301(a) of the TCJA amended section

163(j) by removing prior section

163(j)(1) through (9) and adding section

163(j)(1) through (10). The provisions of

section 163(j) as amended by section

13301 of the TCJA are effective for tax

years beginning after December 31,

2017. The CARES Act further amended

section 163(j) by redesignating section

163(j)(10), as amended by the TCJA, as

new section 163(j)(11), and adding a

new section 163(j)(10) providing special

rules for applying section 163(j) to

taxable years beginning in 2019 or 2020.

Section 163(j) generally limits the

amount of business interest expense

(BIE) that can be deducted in the current

taxable year (also referred to in this

Preamble as the current year). Under

section 163(j)(1), the amount allowed as

a deduction for BIE is limited to the sum

of (1) the taxpayer’s business interest

income (BII) for the taxable year; (2) 30

percent of the taxpayer’s adjusted

taxable income (ATI) for the taxable

year (30 percent ATI limitation); and (3)

the taxpayer’s floor plan financing

interest expense for the taxable year (in

sum, the section 163(j) limitation). As

further described later in this

Background section, section 163(j)(10),

as amended by the CARES Act, provides

special rules relating to the ATI

limitation for taxable years beginning in

2019 or 2020. Under section 163(j)(2),

the amount of any BIE that is not

allowed as a deduction in a taxable year

due to the section 163(j) limitation is

treated as business interest paid in the

succeeding taxable year.

The section 163(j) limitation applies

to all taxpayers, except for certain small

businesses that meet the gross receipts

test in section 448(c) and certain trades

or businesses listed in section 163(j)(7).

Section 163(j)(3) provides that the

section 163(j) limitation does not apply

to any taxpayer that meets the gross

receipts test under section 448(c), other

than a tax shelter prohibited from using

the cash receipts and disbursements

method of accounting under section

448(a)(3).

Section 163(j)(4) provides special

rules for applying section 163(j) in the

case of passthrough entities. Section

163(j)(4)(A) requires that the section

163(j) limitation be applied at the

partnership level, and that a partner’s

ATI be increased by the partner’s share

of excess taxable income, as defined in

section 163(j)(4)(C), but not by the

partner’s distributive share of income,

gain, deduction, or loss. Section

163(j)(4)(B) provides that the amount of

partnership BIE limited by section

163(j)(1) (EBIE) is carried forward at the

partner level. Section 163(j)(4)(B)(ii)

provides that EBIE allocated to a partner

and carried forward is available to be

deducted in a subsequent year only to

the extent that the partnership allocates

excess taxable income to the partner. As

further described later in this

Background section, section 163(j)(10),

as amended by the CARES Act, provides

a special rule for excess business

interest expense allocated to a partner in

a taxable year beginning in 2019.

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Section 163(j)(4)(B)(iii) provides rules

for the adjusted basis in a partnership of

a partner that is allocated EBIE. Section

163(j)(4)(D) provides that rules similar

to the rules of section 163(j)(4)(A) and

(C) apply to S corporations and S

corporation shareholders.

Section 163(j)(5) and (6) define

‘‘business interest’’ and ‘‘business

interest income,’’ respectively, for

purposes of section 163(j). Generally,

these terms include interest expense

and interest includible in gross income

that is properly allocable to a trade or

business (as defined in section 163(j)(7))

and do not include investment income

or investment expense within the

meaning of section 163(d). The

legislative history states that ‘‘a

corporation has neither investment

interest nor investment income within

the meaning of section 163(d). Thus,

interest income and interest expense of

a corporation is properly allocable to a

trade or business, unless such trade or

business is otherwise explicitly

excluded from the application of the

provision.’’ H. Rept. 115–466, at 386, fn.

688 (2017).

Under section 163(j)(7), the limitation

on the deduction for business interest

expense in section 163(j)(1) does not

apply to certain trades or businesses

(excepted trades or businesses). The

excepted trades or businesses are the

trade or business of providing services

as an employee, electing real property

businesses, electing farming businesses,

and certain regulated utility businesses.

Section 163(j)(8) defines ATI as the

taxable income of the taxpayer without

regard to the following: Items not

properly allocable to a trade or business;

business interest and business interest

income; net operating loss (NOL)

deductions; and deductions for

qualified business income under section

199A. ATI also generally excludes

deductions for depreciation,

amortization, and depletion with

respect to taxable years beginning before

January 1, 2022, and it includes other

adjustments provided by the Secretary

of the Treasury.

Section 163(j)(9) defines ‘‘floor plan

financing interest’’ as interest paid or

accrued on ‘‘floor plan financing

indebtedness.’’ These provisions allow

taxpayers incurring interest expense for

the purpose of securing an inventory of

motor vehicles held for sale or lease to

deduct the full expense without regard

to the section 163(j) limitation.

Under section 163(j)(10)(A)(i), the

amount of business interest that is

deductible under section 163(j)(1) for

taxable years beginning in 2019 or 2020

is computed using 50 percent, rather

than 30 percent, of the taxpayer’s ATI

for the taxable year (50 percent ATI

limitation). A taxpayer may elect not to

apply the 50 percent ATI limitation to

any taxable year beginning in 2019 or

2020, and instead apply the 30 percent

ATI limitation. This election must be

made separately for each taxable year.

Once the taxpayer makes the election,

the election may not be revoked without

the consent of the Secretary of the

Treasury or his delegate. See section

163(j)(10)(A)(iii).

Sections 163(j)(10)(A)(ii)(I) and

163(j)(10)(A)(iii) provide that, in the

case of a partnership, the 50 percent ATI

limitation does not apply to

partnerships for taxable years beginning

in 2019, and the election to not apply

the 50 percent ATI limitation may be

made only for taxable years beginning in

2020, and may be made only by the

partnership. Under section

163(j)(10)(A)(ii)(II), however, a partner

treats 50 percent of its allocable share of

a partnership’s excess business interest

expense for 2019 as a business interest

expense in the partner’s first taxable

year beginning in 2020 that is not

subject to the section 163(j) limitation

(50 percent EBIE rule). The remaining

50 percent of the partner’s allocable

share of the partnership’s excess

business interest expense remains

subject to the section 163(j) limitation

applicable to excess business interest

expense carried forward at the partner

level. A partner may elect out of the 50

percent EBIE rule.

Section 163(j)(10)(B)(i) allows a

taxpayer to elect to substitute its ATI for

the last taxable year beginning in 2019

(2019 ATI) for the taxpayer’s ATI for a

taxable year beginning in 2020 (2020

ATI) in determining the taxpayer’s

section 163(j) limitation for the taxable

year beginning in 2020.

Section 163(j)(11) provides cross-

references to provisions requiring that

electing farming businesses and electing

real property businesses excepted from

the section 163(j) limitation use the

alternative depreciation system (ADS),

rather than the general depreciation

system, for certain types of property.

The required use of ADS results in the

inability of these electing trades or

businesses to use the additional first-

year depreciation deduction under

section 168(k) for those types of

property.

On December 28, 2018, the

Department of the Treasury (Treasury

Department) and the IRS (1) published

proposed regulations under section

163(j), as amended by the TCJA, in a

notice of proposed rulemaking (REG–

106089–18) (2018 Proposed

Regulations) in the Federal Register (83

FR 67490), and (2) withdrew the notice

of proposed rulemaking (1991–2 C.B.

1040) published in the Federal Register

on June 18, 1991 (56 FR 27907 as

corrected by 56 FR 40285 (August 14,

1991)) to implement rules under section

163(j) before amendment by the TCJA.

The 2018 Proposed Regulations were

issued following guidance announcing

and describing regulations intended to

be issued under section 163(j). See

Notice 2018–28, 2018–16 I.R.B. 492

(April 16, 2018).

A public hearing on the 2018

Proposed Regulations was held on

February 27, 2019. The Treasury

Department and the IRS also received

written comments responding to the

2018 Proposed Regulations (available at

http://www.regulations.gov). In response

to certain comments, the Treasury

Department and the IRS are publishing

this notice of proposed rulemaking to

provide additional proposed regulations

(these Proposed Regulations) under

section 163(j).

Concurrently with the publication of

these Proposed Regulations, the

Treasury Department and the IRS are

publishing in the Rules and Regulations

section of this edition of the Federal

Register (RIN 1545–BO73) final

regulations under section 163(j) (the

Final Regulations).

On April 10, 2020, the Treasury

Department and the IRS released

Revenue Procedure 2020–22, 2020–18

I.R.B. 745, to provide the time and

manner of making a late election, or

withdrawing an election, under section

163(j)(7)(B) to be an electing real

property trade or business or section

163(j)(7)(C) to be an electing farming

business for taxable years beginning in

2018, 2019, or 2020. Revenue Procedure

2020–22 also provides the time and

manner of making or revoking elections

provided by the CARES Act under

section 163(j)(10) for taxable years

beginning in 2019 or 2020. As described

earlier in this Background section, these

elections are: (1) To not apply the 50

percent ATI limitation under section

163(j)(10)(A)(iii); (2) to use the

taxpayer’s 2019 ATI to calculate the

taxpayer’s section 163(j) limitation for

any taxable year beginning in 2020

under section 163(j)(10)(B); and (3) for

a partner to elect out of the 50 percent

EBIE rule under section

163(j)(10)(A)(ii)(II).

Explanation of Provisions

These Proposed Regulations would

provide guidance in addition to the

Final Regulations regarding the section

163(j) limitation. These Proposed

Regulations would also add or amend

regulations under certain other

provisions of the Code where necessary

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to provide conformity across the Income

Tax Regulations. A significant number

of the terms used throughout these

Proposed Regulations are defined in

§ 1.163(j)–1 of the Final Regulations and

discussed in the Explanation of

Provisions section of the 2018 Proposed

Regulations and the Summary of

Comments and Explanation of Revisions

section of the Final Regulations. Some

of these terms are further discussed in

this Explanation of Provisions section as

they relate to specific provisions of

these Proposed Regulations.

Part I of this Explanation of

Provisions describes proposed rules that

would allocate interest expense for

purposes of sections 469, 163(d), 163(h),

and 163(j) in connection with certain

transactions involving passthrough

entities. Part II provides proposed rules

relating to distributions of debt proceeds

from any taxpayer account or from cash

so that interest expense may be

allocated for purposes of sections 469,

163(d), 163(h), and 163(j). Part III

describes proposed modifications to the

definitions and general guidance in

§ 1.163(j)–1, including proposed rules

permitting taxpayers to apply a different

computational method in determining

adjustments to tentative taxable income

to address sales or other dispositions of

depreciable property, stock of a

consolidated group member, or interests

in a partnership, and proposed rules

allowing RIC shareholders to treat

certain RIC dividends as interest income

for purposes of section 163(j). Part IV

describes proposed modifications to

§ 1.163(j)–6, relating to the applicability

of the section 163(j) limitation to

passthrough entities, including

proposed rules on the applicability of

the section 163(j) limitation to trading

partnerships and publicly traded

partnerships, the application of the

section 163(j) limitation in partnership

self-charged lending transactions,

proposed rules relating to the treatment

of excess business interest expense in

tiered partnerships, proposed rules

relating to partnership basis adjustments

upon partner dispositions, proposed

rules regarding the election to substitute

2019 ATI for the partnership’s 2020 ATI

in determining the partnership’s section

163(j) limitation for a taxable year

beginning in 2020, and proposed rules

regarding excess business interest

expense allocated to a partner in a

taxable year beginning in 2019.

Part V discusses re-proposed rules

regarding the application of the section

163(j) limitation to foreign corporations

and United States shareholders (as

defined in section 951(b) (U.S.

shareholders) of controlled foreign

corporations (as defined in section

957(a)) (CFCs). Part VI discusses re-

proposed rules regarding the application

of the section 163(j) limitation to

nonresident alien individuals and

foreign corporations with effectively

connected income in the United States.

Part VII describes proposed

modifications to the definition of a real

property trade or business under

§ 1.469–9 for purposes of the passive

activity loss rules and the definition of

an electing real property trade or

business under section 163(j)(7)(B). Part

VIII describes proposed rules regarding

the definition of a ‘‘tax shelter’’ for

purposes of § 1.163(j)–2 and section

1256(e), as well as proposed rules

regarding the election to use 2019 ATI

in determining the taxpayer’s section

163(j) limitation for a taxable year

beginning in 2020. Part IX describes

proposed modifications regarding the

application of the corporate look-

through rules to tiered structures.

I. Proposed § 1.163–14: Allocation of

Interest Expense With Respect to

Passthrough Entities

Section 1.163–8T provides rules

regarding the allocation of interest

expense for purposes of applying the

passive activity loss limitation in

section 469, the investment interest

limitation in section 163(d), and the

personal interest limitation in section

163(h) (such purposes, collectively,

§ 1.163–8T purposes). Under §1.163–

8T, debt generally is allocated by tracing

disbursements of the debt proceeds to

specific expenditures and interest

expense associated with debt is

allocated for § 1.163–8T purposes in the

same manner as the debt to which such

interest expense relates. When debt

proceeds are deposited to the borrower’s

account, and the account also contains

unborrowed funds, § 1.163–8T(c)

provides that the debt generally is

allocated to expenditures by treating

subsequent expenditures from the

account as made first from the debt

proceeds to the extent thereof. The rules

further provide that if the proceeds of

two or more debts are deposited in the

account, the proceeds are treated as

expended in the order in which they

were deposited. In addition to these

rules, § 1.163–8T also provides specific

rules to address reallocation of debt,

repayments and refinancing.

The preamble to § 1.163–8T (52 FR

24996) stated that ‘‘interest expense of

partnerships and S corporations, and of

partners and S corporation

shareholders, is generally allocated in

the same manner as the interest expense

of other taxpayers.’’ The preamble

acknowledged the need for special rules

for debt financed distributions to

owners of partnerships and S

corporations, and for cases in which

taxpayers incur debt to acquire or

increase their capital interest in the

passthrough entity, but reserved on

these issues and requested comments.

In a series of notices, the Treasury

Department and the IRS provided

further guidance with respect to the

allocation of interest expense in

connection with certain transactions

involving passthrough entities and

owners of passthrough entities. See

Notice 88–20, 1988–1 C.B. 487, Notice

88–37, 1988–1 C.B. 522, and Notice 89–

35, 1989–1 C.B. 675. Specifically, Notice

89–35 provides, in part, rules

addressing the treatment of (1) a

passthrough entity owner’s debt

allocated to contributions to, or

purchases of, interests in a passthrough

entity (debt-financed contributions or

acquisitions), and (2) passthrough entity

debt allocated to distributions by the

entity to its owners (debt-financed

distributions).

In the case of a debt-financed

acquisition of an interest in a

passthrough entity by purchase (rather

than by way of a contribution to the

capital of the entity), Notice 89–35

provides that the interest expense of the

owner of the passthrough entity, for

§ 1.163–8T purposes, is allocated among

the assets of the entity using any

reasonable method. A reasonable

method for this purpose includes, for

example, allocating the debt among all

of the assets of the passthrough entity

based on the fair market value, the book

value, or the adjusted basis of the assets,

reduced by the amount of any debt of

the entity or the amount of any debt that

the owner of the entity allocates to such

assets. Notice 89–35 also provides that

interest expense on debt proceeds

allocated to a contribution to the capital

of a passthrough entity shall be

allocated using any reasonable method

for § 1.163–8T purposes. For this

purpose, any reasonable method

includes allocating the debt among the

assets of the passthrough entity or

tracing the debt proceeds to the

expenditures of the passthrough entity.

In the case of debt-financed

distributions, Notice 89–35 provides a

general allocation rule and an optional

allocation rule. The general allocation

rule applies the principles of § 1.163–8T

to interest expense associated with debt-

financed distributions by applying a

tracing approach to determine the

character of the interest expense for

§ 1.163–8T purposes. Under this

approach, the debt proceeds and the

associated interest expense related to a

debt-financed distribution are allocated

under § 1.163–8T in accordance with

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the use of the distributed debt proceeds

by the distributee owner of the

passthrough entity. To the extent an

owner’s share of a passthrough entity’s

interest expense related to the debt-

financed distribution exceeds the

entity’s interest expense on the portion

of the debt proceeds distributed to that

particular owner, Notice 89–35 provides

that the passthrough entity may allocate

such excess interest expense using any

reasonable method.

The optional allocation rule

applicable to debt-financed

distributions allows a passthrough

entity to allocate distributed debt

proceeds and the associated interest

expense to one or more expenditures,

other than distributions, of the entity

that are made during the same taxable

year of the entity as the distribution, to

the extent that debt proceeds, including

other distributed debt proceeds, are not

otherwise allocated to such

expenditures. Under the optional

allocation rule, distributed debt

proceeds are traced to the owner’s use

of the borrowed funds to the extent that

such distributed debt proceeds exceed

the entity’s expenditures, not including

distributions, for the taxable year to

which debt proceeds are not otherwise

allocated.

While the 2018 Proposed Regulations

did not include rules to further address

the application of § 1.163–8T to

passthrough entities, the Treasury

Department and the IRS received

comments indicating that, for purposes

of section 163(j), a tracing rule based on

how a passthrough entity owner uses

the proceeds of a debt-financed

distribution does not align well with the

statutory mandate in section 163(j)(4) to

apply section 163(j) at the passthrough

entity level. Based on these comments

and a review of the rules under § 1.163–

8T, the Treasury Department and the

IRS have determined that additional

rules, specific to passthrough entities

and their owners, are needed to clarify

how the rules under § 1.163–8T work

when applied to a passthrough entity

and to account for the entity-level

limitation under section 163(j)(4).

A. In General

The rules of § 1.163–8T generally

apply to partnerships, S corporations,

and their owners and the rules in

proposed § 1.163–14 would provide

additional rules for purposes of

applying the § 1.163–8T rules to

passthrough entities. As with the rules

under § 1.163–8T, proposed §1.163–14

would provide that interest expense on

a debt incurred by a passthrough entity

is allocated in the same manner as the

debt to which such interest relates is

allocated, and that debt is generally

allocated by tracing disbursements of

the debt proceeds to specific

expenditures.

The Treasury Department and the IRS

have determined that the scope of

§ 1.163–8T(a)(4) and (b) is not

appropriate in the passthrough entity

context. Section 1.163–8T(a)(4)

generally provides rules regarding the

treatment of interest expense allocated

to specific expenditures, which are

described in § 1.163–8T(b). However,

the list of expenditures described in

§ 1.163–8T(b) is based on an allocation

of interest for purposes of applying

sections 163(d), 163(h), and 469, and

does not adequately account for the uses

of debt proceeds by a passthrough entity

(for example, distributions to owners).

To more accurately account for the

types of expenditures made by

passthrough entities, proposed § 1.163–

14(b) would provide rules tailored to

passthrough entities. In addition, the

framework that proposed § 1.163–14(b)

would provide is needed for a

passthrough entity to determine how

much of its interest expense is allocable

to a trade or business for purposes of

applying section 163(j). These proposed

regulations would apply before a

passthrough entity applies any of the

rules in section 163(j) (including

§ 1.163(j)–10).

In application, a passthrough entity

would continue to apply the operative

rules in § 1.163–8T to allocate debt and

the interest expense associated with

such debt. However, instead of generally

tracing debt proceeds to the types of

expenditures described under § 1.163–

8T(b) and treating any interest expense

associated with such debt proceeds in

the manner described under § 1.163–

8T(a)(4), a passthrough entity would

generally trace debt proceeds to the

types of expenditures described under

proposed § 1.163–14(b)(2) and treat any

interest expense associated with such

debt proceeds in the manner provided

under proposed § 1.163–14(b)(1).

B. Debt Financed Distributions

Proposed § 1.163–14 would provide

that when debt proceeds of a

passthrough entity are allocated under

§ 1.163–8T to distributions to owners of

the entity, the debt proceeds distributed

to any owner and the associated interest

expense shall be allocated under

proposed § 1.163–14(d). In general,

proposed § 1.163–14(d) would adopt a

rule similar to Notice 89–35, but with

the following modifications. First,

instead of providing that passthrough

entities may use the optional allocation

rule, proposed § 1.163–14(d) would

generally provide that passthrough

entities are required to apply a rule that

is similar to the optional allocation rule.

Second, instead of providing that the

passthrough entity may allocate excess

interest expense using any reasonable

method, proposed § 1.163–14(d) would

generally provide that the passthrough

entity must allocate excess interest

expense based on the adjusted tax basis

of the passthrough entity’s assets.

Specifically, proposed § 1.163–

14(d)(1) would provide a rule based in

principle on the optional allocation rule

in Notice 89–35. Under this proposed

rule, distributed debt proceeds (debt

proceeds of a passthrough entity

allocated under § 1.163–8T to

distributions to owners of the entity)

would first be allocated under proposed

§ 1.163–14(d)(1)(i) to the passthrough

entity’s available expenditures.

Available expenditures are those

expenditures of a passthrough entity

made in the same taxable year as the

distribution, but only to the extent that

debt proceeds (including other

distributed debt proceeds) are not

otherwise allocated to such expenditure.

This approach is consistent with the

concept that money is fungible (a

passthrough entity may be fairly treated

as distributing non-debt proceeds rather

than debt proceeds and using debt

proceeds rather than non-debt proceeds

to finance its non-distribution

expenditures) and seeks to coordinate

the interest allocation rules with the

entity-level approach to passthroughs

adopted in section 163(j). Where the

distributed debt proceeds exceed the

passthrough entity’s available

expenditures, this excess amount of

distributed debt proceeds would be

allocated to distributions to owners of

the passthrough entity (debt financed

distributions) under proposed § 1.163–

14(d)(1)(ii).

After determining the amount of its

distributed debt proceeds allocated to

available expenditures and debt

financed distributions, a passthrough

entity would use this information to

determine the tax treatment of each

owner’s allocable interest expense (that

is, an owner’s share of interest expense

associated with the distributed debt

proceeds allocated under section 704(b)

or 1366(a)). To aid the passthrough

entity and owner in determining the tax

treatment of each owner’s allocable

interest expense, proposed § 1.163–

14(d)(2) would provide rules for

determining the portion of each owner’s

allocable interest expense that is (1)

debt financed distribution interest

expense, (2) expenditure interest

expense, and (3) excess interest

expense. These three categories of

allocable interest expense are mutually

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exclusive—e.g., a given dollar of

allocable interest expense cannot

simultaneously be both debt financed

distribution interest expense and

expenditure interest expense. The

computations in proposed § 1.163–

14(d)(2) would ensure this outcome.

Once a passthrough entity categorizes

each owner’s allocable interest expense

as described earlier, it would apply

proposed § 1.163–14(d)(3) to determine

the tax treatment of such interest

expense. The manner in which the tax

treatment of allocable interest expense

is determined depends on how such

allocable interest expense was

categorized under proposed § 1.163–

14(d)(2).

Conceptually, each of the three

categories described earlier, as well as

the prescribed tax treatment of interest

expense in each category, is discussed

in Notice 89–35. Debt financed

distribution interest expense is referred

to in Notice 89–35 as an owner’s share

of a passthrough entity’s interest

expense on debt proceeds allocated to

such owner. Similar to Notice 89–35,

proposed § 1.163–14(d)(3)(i) would

generally provide that such interest

expense is allocated under § 1.163–8T

in accordance with the owner’s use of

the debt proceeds. Further, expenditure

interest expense is referred to in Notice

89–35 as interest expense allocated

under the optional allocation rule.

Similar to Notice 89–35, proposed

§ 1.163–14(d)(3)(ii) would generally

provide that the tax treatment of such

interest expense is determined based on

how the distributed debt proceeds were

allocated among available expenditures.

Finally, both Notice 89–35 and

proposed § 1.163–14(d) would use the

term excess interest expense to refer to

an owner’s share of allocable interest

expense in excess of the entity’s interest

expense on the portion of the debt

proceeds distributed to that particular

owner. Unlike Notice 89–35, which

generally allows any reasonable method

for determining the tax treatment of

excess interest expense, proposed

§ 1.163–14(d)(3)(iii) would generally

provide that the tax treatment of excess

interest expense is determined by

allocating the distributed debt proceeds

among all the assets of the passthrough

entity, pro-rata, based on the adjusted

basis of such assets.

Proposed § 1.163–14(d)(4) also would

provide rules addressing the tax

treatment of the interest expense of a

transferee owner where the transferor

had previously been allocated debt

financed distribution interest expense.

In the case of a transfer of an interest in

a passthrough entity, any debt financed

distribution interest expense of the

transferor generally shall be treated as

excess interest expense by the

transferee. However, in the case of a

transfer of an interest in a passthrough

entity to a person who is related to the

transferor, any debt financed

distribution interest expense of the

transferor shall continue to be treated as

debt financed distribution interest

expense by the related party transferee,

and the tax treatment of such debt

financed distribution expense shall be

the same to the related party transferee

as it was to the transferor. The term

related party means any person who

bears a relationship to the taxpayer

which is described in section 267(b) or

707(b)(1).

The proposed regulations also would

include an anti-avoidance rule to

recharacterize arrangements entered

into with a principal purpose of

avoiding the rules of proposed § 1.163–

14(d), including the transfer of an

interest in a passthrough entity by an

owner who treated a portion of its

allocable interest expense as debt

financed distribution interest expense to

an unrelated party pursuant to a plan to

transfer the interest back to the owner

who received the debt financed

distribution interest expense or to a

party who is related to the owner who

received the debt financed distribution

interest expense.

C. Operational Rules

Proposed § 1.163–14 also would

include several operational rules that

clarify the application of certain rules

under § 1.163–8T as they apply to

passthrough entities. Proposed § 1.163–

14(e) would provide an ordering rule

applicable to repayment of debt by

passthrough entities similar to the rules

in § 1.163–8T(d)(1). Proposed §1.163–

14(g) would provide that any transfer of

an ownership interest in a passthrough

entity is not a reallocation event for

purposes of § 1.163–8T(j), except as

provided for in § 1.163–14(d)(4).

D. Debt-Financed Acquisitions

Proposed § 1.163–14(f) would adopt a

rule providing that the tax treatment of

an owner’s interest expense associated

with a debt financed acquisition (either

by purchase or contribution) will be

determined by allocating the debt

proceeds among the assets of the entity.

The owner would allocate the debt

proceeds (1) in proportion to the relative

adjusted tax basis of the entity’s assets

reduced by any debt allocated to such

assets, or (2) based on the adjusted basis

of the entity’s assets in accordance with

the rules in § 1.163(j)–10(c)(5)(i)

reduced by any debt allocated to such

assets. The Treasury Department and

the IRS request comments regarding

whether asset basis (either adjusted tax

basis or adjusted tax basis based on the

rules in § 1.163(j)–10(c)(5)(i)) less the

amount of debt allocated to assets under

§§ 1.163–14 and 1.163–8T is appropriate

as the sole method for allocating interest

expense in this context.

II. Proposed § 1.163–15: Debt Proceeds

Distributed From Any Taxpayer

Account or From Cash

Proposed § 1.163–15 supplements the

rules in § 1.163–8T regarding debt

proceeds distributed from any taxpayer

account or from cash proceeds. Section

1.163–8T(c)(4)(iii)(B) provides that a

taxpayer may treat any expenditure

made from an account within 15 days

after the debt proceeds are deposited in

such account as being made from such

proceeds, regardless of any other rules

in § 1.163–8T(c)(4). Under §1.163–

8T(c)(5)(i), if a taxpayer receives debt

proceeds in cash, the taxpayer may treat

any cash expenditure made within 15

days after receiving the cash as being

made from such debt proceeds, and may

treat such expenditure as being made on

the date the taxpayer received the cash.

Commenters have suggested that the 15-

day limit in § 1.163–8T could encourage

taxpayers to keep separate accounts,

rather than commingled accounts for

tracing purposes.

In Notice 88–20, 1988–1 C.B. 487, the

IRS announced the intention to issue

regulations providing that, for debt

proceeds deposited in an account on or

before December 31, 1987, taxpayers

could treat any expenditure made from

any account of the taxpayer or from cash

within 30 days before or after debt

proceeds are deposited in such account

or any other account of the taxpayer as

made from such proceeds. The Notice

states that the regulations also would

provide that for debt proceeds received

in cash on or before December 31, 1987,

taxpayers may treat any expenditure

made from any account of the taxpayer

or from cash within 30 days before or

after debt proceeds are received in cash

as made from such proceeds. Section VI

of Notice 89–35 adopts the standard

described in Notice 88–20 without the

date limitation, although no regulations

have been issued.

Consistent with Notice 89–35,

proposed § 1.163–15 provides that

taxpayers may treat any expenditure

made from an account of the taxpayer or

from cash within 30 days before or after

debt proceeds are deposited in any

account of the taxpayer or received in

cash as made from such proceeds.

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III. Proposed Modifications to

§ 1.163(j)–1(b): Definitions

A. Adjustments to Tentative Taxable

Income

Section 1.163(j)–1(b)(1) requires

taxpayers to make certain adjustments

to tentative taxable income in

computing ATI, including adjustments

to address certain sales or other

dispositions of depreciable property,

stock of a consolidated group member

(member stock), or interests in a

partnership. More specifically,

§ 1.163(j)–1(b)(1)(ii)(C) provides that, if

property is sold or otherwise disposed

of, the greater of the allowed or

allowable depreciation, amortization, or

depletion of the property for the

taxpayer (or, if the taxpayer is a member

of a consolidated group, the

consolidated group) for taxable years

beginning after December 31, 2017, and

before January 1, 2022 (such years, the

EBITDA period), with respect to such

property is subtracted from tentative

taxable income. Section 1.163(j)–

1(b)(1)(ii)(D) provides that, with respect

to the sale or other disposition of stock

of a member of a consolidated group by

another member, the investment

adjustments under § 1.1502–32 with

respect to such stock that are

attributable to deductions described in

§ 1.163(j)–1(b)(1)(ii)(C) are subtracted

from tentative taxable income. Section

1.163(j)–1(b)(1)(ii)(E) provides that, with

respect to the sale or other disposition

of an interest in a partnership, the

taxpayer’s distributive share of

deductions described in § 1.163(j)–

1(b)(1)(ii)(C) with respect to property

held by the partnership at the time of

such sale or other disposition is

subtracted from tentative taxable

income to the extent such deductions

were allowable under section 704(d).

See the preamble to the Final

Regulations for a discussion of the

rationale for these adjustments.

The preamble to the Final Regulations

noted that, in the 2018 Proposed

Regulations, § 1.163(j)–1(b)(1)(ii)(C)

incorporated a ‘‘lesser of’’ standard. In

other words, the lesser of (i) the amount

of gain on the sale or other disposition

of property, or (ii) the amount of

depreciation deductions with respect to

such property for the EBITDA period,

was required to be subtracted from

tentative taxable income to determine

ATI. As explained in the preamble to

the Final Regulations, commenters

raised several questions regarding this

‘‘lesser of’’ standard. The Final

Regulations removed the ‘‘lesser of’’

approach due in part to concerns that

this approach would be more difficult to

administer than the approach reflected

in the Final Regulations.

However, the Treasury Department

and the IRS recognize that, in certain

cases, the ‘‘lesser of’’ approach might

not create administrative difficulties for

taxpayers. Thus, these Proposed

Regulations permit taxpayers to choose

whether to compute the amount of their

adjustment using a ‘‘lesser of’’ standard.

While the 2018 Proposed Regulations

applied this standard solely to

dispositions of property, these Proposed

Regulations extend this standard to

dispositions of partnership interests and

member stock to eliminate the

discontinuity between the amount of the

adjustment for these different types of

dispositions. Taxpayers opting to use

this alternative computation method

must do so for all sales or other

dispositions that otherwise would be

subject to § 1.163(j)–1(b)(1)(ii)(C), (D), or

(E) when the taxpayer computes

tentative taxable income.

The Treasury Department and the IRS

request comments on the ‘‘lesser of’’

approach, including how such an

approach should apply to dispositions

of member stock and partnership

interests.

B. Dividends From Regulated

Investment Company (RIC) Shares

Some commenters on the 2018

Proposed Regulations recommended

that dividend income from a RIC be

treated as interest income for a

shareholder in a RIC, to the extent that

the income earned by the RIC is interest

income. Because a RIC is a subchapter

C corporation, section 163(j) applies at

the RIC level, and any BIE that is

disallowed at the RIC level is carried

forward to subsequent years at the RIC

level. Furthermore, because a RIC is a

subchapter C corporation, a shareholder

in a RIC generally does not take into

account a share of the RIC’s items of

income, deduction, gain, or loss. Thus,

if a RIC’s BII exceeds its BIE in a taxable

year, the RIC may not directly allocate

the excess amount to its shareholders

(unlike a partnership, which may

allocate excess BII to its partners).

Under part 1 of subchapter M and

other Code provisions, however, a RIC

that has certain items of income or gain

may pay dividends that a shareholder in

the RIC may treat in the same manner

(or a similar manner) as the shareholder

would treat the underlying items of

income or gain if the shareholder

realized the items directly. Although

this treatment differs fundamentally

from the passthrough treatment of

partners or trust beneficiaries, this

Explanation of Provisions refers to this

treatment as ‘‘conduit treatment.’’ For

example, under sections 871(k)(1) and

881(e)(1), a RIC that has qualified

interest income within the meaning of

section 871(k)(1)(E) may pay interest-

related dividends, and no tax generally

would be imposed under sections

871(a)(1)(A) or 881(a)(1) on an interest-

related dividend paid to a nonresident

alien individual or foreign corporation.

Section 871(k)(1) provides necessary

limits and procedures that apply to

interest-related dividends. The Code

provides similar conduit treatment for

capital gain dividends in section

852(b)(3), exempt-interest dividends in

section 852(b)(5), short-term capital gain

dividends in section 871(k)(2),

dividends eligible for the dividends

received deduction in section

854(b)(1)(A), and qualified dividend

income in section 854(b)(1)(B).

In response to comments, these

Proposed Regulations provide rules

under which a RIC that earns BII may

pay section 163(j) interest dividends. A

shareholder that receives a section

163(j) interest dividend may treat the

dividend as interest income for

purposes of section 163(j), subject to

holding period requirements and other

limitations. A section 163(j) interest

dividend that meets these requirements

is treated as BII if it is properly allocable

to a non-excepted trade or business of

the shareholder. A section 163(j) interest

dividend is treated as interest income

solely for purposes of section 163(j).

The rules under which a RIC may

report section 163(j) interest dividends

are based on the rules for reporting

exempt-interest dividends in section

852(b)(5) and interest-related dividends

in section 871(k)(1). The total amount of

a RIC’s section 163(j) interest dividends

for a taxable year is limited to the excess

of the RIC’s BII for the taxable year over

the sum of the RIC’s BIE for the taxable

year and the RIC’s other deductions for

the taxable year that are properly

allocable to the RIC’s BII. For some

types of income and gain to which

conduit treatment applies, the gross

amount of the RIC’s income or gain of

that type serves as the limit on the RIC’s

corresponding dividends. It would be

inconsistent with the purposes of

section 163(j) to permit a RIC to pay

section 163(j) interest dividends in an

amount based on the RIC’s gross BII,

unreduced by the RIC’s BIE. Further

reducing the limit on a RIC’s section

163(j) interest dividends by the amount

of the RIC’s other deductions that are

properly allocable to the RIC’s BII is

consistent with the provisions of the

Code that provide conduit treatment for

types of interest earned by a RIC. For

example, the limit on interest-related

dividends in section 871(k)(1)(D) is

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reduced by the deductions properly

allocable to the RIC’s qualified interest

income. Similarly, the limit on exempt-

interest dividends in section

852(b)(5)(A)(iv)(V) is reduced by the

amounts disallowed as deductions

under sections 265 and 171(a)(2).

Taking into account the appropriate

share of deductions also reduces the

likelihood that the sum of a RIC’s items

that are eligible for conduit treatment

and that are relevant to a particular

shareholder will exceed the amount of

the dividend distribution paid to the

particular shareholder.

These Proposed Regulations contain

an additional limit to prevent

inconsistent treatment of RIC dividends

by RIC shareholders. Revenue Ruling

2005–31, 2005–1 C.B. 1084, allows a

RIC to report the maximum amount of

capital gain dividends, exempt-interest

dividends, interest-related dividends,

short-term capital gain dividends,

dividends eligible for the dividends

received deduction, and qualified

dividend income for a taxable year, even

if the sum of the reported amounts

exceeds the amount of the RIC’s

dividends for the taxable year. The

ruling allows different categories of

shareholders (United States persons and

nonresident aliens) to report the

dividends they receive by giving effect

to the conduit treatment of the items

relevant to them. A single shareholder,

however, generally does not benefit

from the conduit treatment of amounts

in excess of the dividend paid to that

shareholder, because to do so would

require the shareholder to include in its

taxable income amounts exceeding the

dividend it received. Conduit treatment

of BII, however, differs from the conduit

treatment of other items, because a

section 163(j) interest dividend is

treated as interest income only for

purposes of section 163(j). Thus, absent

a limit, a RIC shareholder could obtain

an inappropriate benefit by treating a

portion of a RIC dividend as interest

income for purposes of section 163(j)

while treating the same portion of the

dividend as another non-interest type of

income, such as a dividend eligible for

the dividends received deduction under

sections 243 and 854(b). Therefore,

these Proposed Regulations limit the

amount of a section 163(j) interest

dividend that a shareholder may treat as

interest income for purposes of section

163(j) to the excess of the amount of the

RIC dividend that includes the section

163(j) interest dividend over the sum of

the portions of that dividend affected by

conduit treatment in the hands of that

shareholder, other than interest-related

dividends under section 871(k)(1)(C)

and section 163(j) interest dividends.

Under these Proposed Regulations, a

shareholder generally may not treat a

section 163(j) interest dividend as

interest income unless it meets certain

holding period and similar

requirements. The holding period

requirements do not apply to (i)

dividends paid by a RIC regulated as a

money market fund under 17 CFR

270.2a–7 or (ii) certain regular

dividends paid by a RIC that declares

section 163(j) interest dividends on a

daily basis and distributes such

dividends on a monthly or more

frequent basis. The Treasury

Department and the IRS request

comments on whether there are other

categories of section 163(j) interest

dividends for which the holding period

requirements should not apply or

should be modified. The Treasury

Department and the IRS also request

comments on whether any payments

that are substitutes for section 163(j)

interest dividends (for example, in a

securities lending or sale-repurchase

transaction with respect to RIC shares)

should be treated for purposes of section

163(j) as interest expense of taxpayers

making the payments or interest income

to taxpayers receiving the payments. Cf.

§ 1.163(j)–1(b)(22)(iii)(C) (addressing

certain payments that are substitutes for

interest).

These Proposed Regulations, to the

extent they concern the payment of

section 163(j) interest dividends by a

RIC and the treatment of such dividends

as interest by a RIC shareholder, are

proposed to apply to taxable years

beginning on or after the date that is 60

days after the date the Treasury decision

adopting these regulations as final

regulations is published in the Federal

Register. Solely in the case of section

163(j) interest dividends that would be

exempt from the holding period rules

under these Proposed Regulations, the

RIC paying such dividends and the

shareholders receiving such dividends

may rely on the provisions of these

Proposed Regulations pertaining to

section 163(j) interest dividends for

taxable years ending on or after

September 14, 2020, and beginning

before the date that is 60 days after the

date the Treasury decision adopting

these regulations as final regulations is

published in the Federal Register.

IV. Proposed § 1.163(j)–6: Application

of the Business Interest Expense

Deduction Limitations to Partnerships

and Subchapter S Corporations

A. Trading Partnerships

The preamble to the 2018 Proposed

Regulations states that the business

interest expense of certain passthrough

entities, including S corporations,

allocable to trade or business activities

that are described in section

163(d)(5)(A)(ii) (i.e., activities that are

per se non-passive under section 469 in

which the taxpayer does not materially

participate) and illustrated in Revenue

Ruling 2008–12, 2008–1 C.B. 520

(March 10, 2008) (trading activities),

will be subject to section 163(j) at the

entity level, even if the interest expense

is later subject to limitation under

section 163(d) at the individual partner

or shareholder level. Accordingly, at

least with respect to partnerships, to the

extent that interest expense from a

trading activity is limited under section

163(j) and becomes a carryover item of

partners who do not materially

participate in the trading activity, the

interest expense will be treated as

investment interest in the hands of

those partners for purposes of section

163(d) once the interest expense is no

longer limited under section 163(j). As

a result, the interest expense would be

subject to two section 163 limitations.

The Treasury Department and the IRS

received multiple comments

questioning this interpretation of

section 163(j)(5) and its interaction with

section 163(d)(5)(A)(ii). Specifically,

commenters stated that the

interpretation improperly results in the

application of section 163(j) to

partnerships engaged in a trade or

business activity of trading personal

property (including marketable

securities) for the account of owners of

interests in the activity, as described in

§ 1.469–1T(e)(6) (trading partnerships).

At issue is the extent to which BIE of

trading partnerships should be subject

to limitation under section 163(j). This

issue involves the definition of BIE

under section 163(j)(5) and, more

specifically, the second sentence of

section 163(j)(5), which generally

provides that BIE shall not include

investment interest within the meaning

of section 163(d).

The approach described in the

preamble to the 2018 Proposed

Regulations interprets section 163(j)(5)

as simply providing that interest

expense cannot be both BIE and

investment interest expense in the

hands of the same taxpayer. Under this

interpretation, section 163(j)(5) will

treat interest as investment interest

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where conflicting provisions may

otherwise subject an amount of interest

expense to limitation under both section

163(j) and section 163(d) with respect to

the same taxpayer (for example, interest

expense allocable to business assets

comprising ‘‘working capital’’ as that

term is used in section 469(e)(1)(B)). In

addition, this approach views the

partnership as an entity separate from

its partners for purposes of section

163(j) to the partnership and section

163(d) at the individual partner level.

Several commenters disagreed with this

interpretation of section 163(j)(5),

asserting that the second sentence of

section 163(j)(5) unequivocally provides

that interest expense can never be

subject to limitation under both section

163(j) and section 163(d) under any

circumstances. Based on these

comments, the Treasury Department

and the IRS considered three alternative

approaches for interpreting section

163(j)(5).

One approach would require a

partnership engaged in a trading activity

to apply section 163(j) at the partnership

level to all of the partnership’s interest

expense from the trading activity. Under

this approach, any deductible interest

expense from the partnership’s trading

activity would not be subject to any

further limitation under section 163(d)

at the individual partner level. This

interpretation would respect the

partnership as an entity separate from

its partners for purposes of section

163(j), but would treat section 163(j)(4)

and (5) as superseding section

163(d)(5)(A)(ii).

A second approach would require a

partnership engaged in a trading activity

to bifurcate its interest expense from a

trading activity between partners that

materially participate in the trading

activity and partners that are passive

investors in the activity, and subject

only the portion that is allocable to the

materially participating partners to

limitation under section 163(j). Under

this approach, to the extent any interest

expense is allocable to passive investors

in the trading activity, the interest

expense would be subject only to

section 163(d) at the partner level and

would never be subject to section 163(j)

at the partnership level.

A third approach would require a

partnership to treat all of the interest

expense from a trading activity as

investment interest under section

163(d), regardless of whether any

individual partners materially

participate in the trading activity. Under

this approach, the interest expense

properly allocable to materially

participating partners would never be

subject to limitation under section

163(j), even though interest expense

allocable to materially participating

partners would also not be subject to

limitation under section 163(d) at the

individual partner level.

After considering the comments,

Treasury Department and the IRS have

concluded that the approach described

in the preamble to the 2018 Proposed

Regulations is inconsistent with the

statutory language and intent of section

163(j)(5) because the second sentence of

section 163(j)(5) specifically states that

BIE shall not include investment

interest expense. In addition, the

Treasury Department and the IRS have

determined that the second alternative

approach, as described earlier, appears

to be the most consistent with the intent

of sections 163(d) and 163(j).

Accordingly, these Proposed

Regulations would interpret section

163(j)(5) as requiring a trading

partnership to bifurcate its interest

expense from a trading activity between

partners that materially participate in

the trading activity and partners that are

passive investors, and as subjecting only

the portion of the interest expense that

is allocable to the materially

participating partners to limitation

under section 163(j) at the partnership

level. The portion of interest expense

from a trading activity allocable to

passive investors will be subject to

limitation under section 163(d) at the

partner level, as provided in section

163(d)(5)(A)(ii).

In addition, these Proposed

Regulations require that a trading

partnership bifurcate all of its other

items of income, gain, loss and

deduction from its trading activity

between partners that materially

participate in the partnership’s trading

activity and partners that are passive

investors. The portion of the

partnership’s other items of income,

gain, loss or deduction from its trading

activity properly allocable to the passive

investors in the partnership will not be

taken into account at the partnership

level as items from a trade or business

for purposes of applying section 163(j)

at the partnership level. Instead, all

such partnership items properly

allocable to passive investors will be

treated as items from an investment

activity of the partnership, for purposes

of sections 163(j) and 163(d).

This approach, in order to be

effective, adopts the presumption that a

trading partnership generally will

possess knowledge regarding whether

its individual partners are material

participants in its trading activity. No

rules currently exist requiring a partner

to inform the partnership whether the

partner has grouped activities of the

partnership with other activities of the

partner outside of the partnership.

Therefore, the partnership might

possess little or no knowledge regarding

whether an individual partner has made

such a grouping. Without this

information, a trading partnership may

presume that an individual partner is a

passive investor in the partnership’s

trading activity based solely on the

partnership’s understanding as to the

lack of work performed by the partner

in that activity, whereas the partner may

in fact be treated as a material

participant in the partnership’s trading

activity by grouping that activity with

one or more activities of the partner in

which the partner materially

participates. In order to avoid this result

and the potential for abuse, a new rule

is proposed for the section 469 activity

grouping rules to provide that any

activity described in section

163(d)(5)(A)(ii) may not be grouped

with any other activity of the taxpayer,

including any other activity described

in section 163(d)(5)(A)(ii). The Treasury

Department and the IRS invite

comments regarding whether other

approaches may be feasible and

preferable to a special rule that prohibits

the grouping of trading activities with

other activities of a partner, such as

adoption of a rule or reporting regime

requiring all partners in the partnership

to annually certify or report to the

partnership whether they are material

participants in a grouped activity that

includes the partnership’s trading

activity.

The Treasury Department and the IRS

further invite comments regarding

whether similar rules should be adopted

with respect to S corporations that may

also be involved in trading activities,

and whether such rules would be

compatible with Subchapter S (for

example, whether the bifurcation of

items from the S corporation’s trading

activity between material participants

and passive investors would run afoul

of the second class of stock prohibition).

B. Fungibility of Publicly Traded

Partnerships

In order to be freely marketable, each

unit of a publicly traded partnership

(PTP), as defined in § 1.7704–1, must

have identical economic and tax

characteristics so that such PTP units

are fungible. For PTP units to be

fungible, the section 704(b) capital

account associated with each unit must

be economically equivalent to the

section 704(b) capital account of all

other units of the same class, and a PTP

unit buyer must receive equivalent tax

allocations regardless of the specific

unit purchased. In other words, from the

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perspective of a buyer, a PTP unit

cannot have variable tax attributes

depending on the identity of the PTP

unit seller. In general, to achieve

fungibility, a PTP (1) makes a section

754 election, pursuant to which a

purchaser can insulate itself from its

predecessor’s allocable section 704(c)

gain or loss through a section 743(b)

basis adjustment, and (2) adopts the

remedial allocation method under

section 704(c) for all of its assets.

Pursuant to § 1.704–3(d)(1), a

partnership adopts the section 704(c)

remedial allocation method to eliminate

distortions caused by the application of

the ceiling rule, as defined in § 1.704–

3(b)(1), under the section 704(c)

traditional method. A partnership

adopting the remedial allocation

method eliminates ceiling rule

distortions by creating remedial items

and allocating those items to its

partners. Under the remedial allocation

method, a partnership first determines

the amount of section 704(b) book items

under § 1.704–3(d)(2) and the partners’

section 704(b) distributive shares of

such items. The partnership then

allocates the corresponding tax items

recognized by the partnership, if any,

using the traditional method described

in § 1.704–3(b)(1). If the ceiling rule

causes the section 704(b) book

allocation of an item to a

noncontributing partner to differ from

the tax allocation of the same item to the

noncontributing partner, the partnership

creates a remedial item of income, gain,

loss, or deduction equal to the full

amount of the difference and allocates it

to the noncontributing partner. The

partnership simultaneously creates an

offsetting remedial item in an identical

amount and allocates it to the

contributing partner. In sum, by

coupling the remedial allocation

method with a section 754 election, PTP

units remain fungible from a net tax

perspective, regardless of the PTP unit

seller’s section 704(c) position.

However, even when the remedial

allocation method is coupled with a

section 754 election, the application of

section 163(j) in the partnership context

results in variable tax attributes for a

buyer depending upon the tax

characteristics of the interest held by the

seller. The Treasury Department and the

IRS have determined this is an

inappropriate result for PTPs because

PTPs, unlike other partnerships, always

require that tax attributes be

proportionate to economic attributes to

retain the fungibility of their units. The

Treasury Department and the IRS have

determined that the manner in which

section 163(j) applies in the partnership

context should not result in the non-

fungibility of PTP units. Accordingly,

these Proposed Regulations provide a

method, solely for PTPs, for applying

section 163(j) in a manner that does not

result in PTP units lacking fungibility.

Specifically, commenters identified

three ways in which the 2018 Proposed

Regulations may cause PTP units to be

non-fungible. First, the method for

allocating excess items may cause PTP

units to be non-fungible. In general,

under § 1.163(j)–6(f)(2), the allocation of

the components of ATI dictate the

allocation of a partnership’s deductible

BIE and section 163(j) excess items.

Consequently, the unequal sharing of

inside basis, including cost-recovery

deductions, amortization, gain, and loss

affects the ratio in which a partnership’s

section 163(j) excess items, as defined in

§ 1.163(j)–6(b)(6), are shared. A partner’s

share of section 163(j) excess items

affects the tax treatment and economic

consequences of the partner. For

example, a greater share of excess

taxable income enables a partner subject

to section 163(j) to deduct more interest.

The Treasury Department and the IRS

recognize that a non-pro rata sharing of

inside basis could result in a non-pro

rata allocation of excess items, which

may result in PTP units lacking

fungibility. Therefore, these Proposed

Regulations would amend § 1.163(j)–

6(f)(1)(iii) to provide that, solely for

purposes of section 163(j), a PTP

allocates section 163(j) excess items in

accordance with the partners’ shares of

corresponding section 704(b) items that

comprise ATI.

Second, the required adjustments to

partner ATI for partner basis items (e.g.,

section 743(b) income and loss) may

cause PTP units to lack fungibility. A

non-pro rata sharing of inside basis may

result in a different allocation of partner

basis items, as defined in § 1.163(j)–

6(b)(2), and section 704(c) remedial

items, as defined in § 1.163(j)–6(b)(3),

among partners. Pursuant to § 1.163(j)–

6(d)(2), partner basis items and remedial

items are not taken into account in

determining a partnership’s ATI under

§ 1.163(j)–1(b)(1). Instead, partner basis

items and section 704(c) remedial items

affect the tax treatment and economic

consequences of the partner. Similar to

the disproportionate sharing of excess

items discussed earlier, the

disproportionate sharing of partner basis

items and section 704(c) remedial items

among partners may cause PTP units to

lack fungibility.

The Treasury Department and the IRS

recognize that a non-pro rata sharing of

inside basis could result in different

partner basis items and remedial items

being allocated to different partners.

Therefore, these Proposed Regulations

would amend § 1.163(j)–6(e)(2)(ii) to

provide that, solely for the purpose of

determining remedial items under

section 163(j), a PTP either allocates

gain or loss that would otherwise be

allocated under section 704(c) to a

specific partner to all partners based on

each partner’s section 704(b) sharing

ratio, or, for purposes of allocating cost

recovery deductions under section

704(c), determines each partner’s

remedial items based on an allocation of

the partnership’s inside basis items

among its partners in proportion to their

share of corresponding section 704(b)

items, rather than applying the

traditional method as described in

§ 1.704–3(b).

Third, the treatment of section 704(c)

remedial income allocations for taxable

years beginning before 2022 may cause

PTP units to lack fungibility. For taxable

years beginning before January 1, 2022,

when tentative taxable income is not

reduced by depreciation and

amortization deductions for purposes of

determining ATI, a buyer acquiring PTP

units with section 704(c) remedial

income allocations (and an offsetting

section 743(b) adjustment) will have an

increase to its ATI that exceeds that of

a buyer of the same number of otherwise

fungible units that is not stepping into

section 704(c) remedial income (with no

corresponding section 743(b)

deduction). While the net amount of the

section 743(b) and section 704(c)

remedial items is the same to both

buyers, for taxable years beginning

before January 1, 2022, different units

would affect a buyer’s ATI differently.

The section 704(c) remedial income of

a buyer of units with section 704(c)

remedial income would be included in

its ATI, while the section 743(b)

deductions would not. Thus, a buyer of

units with section 704(c) remedial

income would increase its ATI each

year (before 2022). A buyer of units with

no section 704(c) remedial income,

however, would add back any remedial

depreciation and amortization

deductions before 2022, and its ATI

would be unaffected by the remedial

deductions for such years.

The Treasury Department and the IRS

recognize that, before 2022, a buyer of

PTP units with inherent section 704(c)

gain would include any remedial

income and would not include section

743(b) deductions in its ATI. Therefore,

these Proposed Regulations would

amend § 1.163(j)–6(d)(2)(ii) to provide

that, solely for purposes of section

163(j), a PTP treats the amount of any

section 743(b) adjustment of a purchaser

of a partnership unit that relates to a

remedial item that the purchaser

inherits from the seller as an offset to

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the related section 704(c) remedial item.

The Treasury Department and the IRS

request comments as to whether the

approaches outlined adequately resolves

the fungibility issues created by section

163(j).

C. Treatment of Business Interest

Income and Business Interest Expense

With Respect to Lending Transactions

Between a Partnership and a Partner

(Self-Charged Lending Transactions)

The 2018 Proposed Regulations

reserved on the treatment of BII and BIE

with respect to lending transactions

between a partnership and a partner

(self-charged lending transactions). The

preamble to the 2018 Proposed

Regulations requested comments

regarding self-charged lending

transactions. One commenter

recommended the final regulations

include rules under § 1.163(j)–6(n) akin

to those contained in § 1.469–7 to

identify self-charged interest income

and expense and further allow such self-

charged interest income and expense to

be excluded from the definition of BIE

and BII under section 163(j)(5) and (6),

respectively. The same commenter

recommended that the final regulations

retain the rule in § 1.163(j)–3(b)(4), as

set forth in the 2018 Proposed

Regulations, which applies the section

163(j) limitation prior to the application

of the passive activity loss rules of

section 469. Other commenters

recommended the Final Regulations

exclude BIE and BII from the section

163(j) calculation where a partner or S-

corporation shareholder lends to, or

borrows from, a passthrough entity.

These commenters recommended that

the amount excluded be based on the

amount of income or expense

recognized by partners or shareholders

that are lenders or borrowers, as well as

partners or shareholders that are related

to a lender or borrower partner within

the meaning of section 267(b) because it

would be appropriate to exclude the BII

and BIE realized by the related parties

for purposes of the section 163(j)

calculation.

In response to these comments, the

Treasury Department and the IRS

propose adding a rule in proposed

§ 1.163(j)–6(n) to provide that, in the

case of a lending transaction between a

partner (lending partner) and

partnership (borrowing partnership) in

which the lending partner owns a direct

interest (self-charged lending

transaction), any BIE of the borrowing

partnership attributable to the self-

charged lending transaction is BIE of the

borrowing partnership for purposes of

§ 1.163(j)–6. If in a given taxable year

the lending partner is allocated EBIE

from the borrowing partnership and has

interest income attributable to the self-

charged lending transaction (interest

income), the lending partner shall treat

such interest income as an allocation of

excess business interest income (EBII)

from the borrowing partnership in such

taxable year, but only to the extent of

the lending partner’s allocation of EBIE

from the borrowing partnership in such

taxable year. To prevent the double

counting of BII, the lending partner

includes interest income that was re-

characterized as EBII pursuant to

proposed § 1.163(j)–6(n) only once

when calculating the lending partner’s

own section 163(j) limitation. In cases

where the lending partner is not a C

corporation, to the extent that any

interest income exceeds the lending

partner’s allocation of EBIE from the

borrowing partnership for the taxable

year, and such interest income

otherwise would be properly treated as

investment income of the lending

partner for purposes of section 163(d)

for that year, such excess amount of

interest income will continue to be

treated as investment income of the

lending partner for that year for

purposes of section 163(d).

The Treasury Department and the IRS

generally agree that lending partners

should not be adversely affected by the

fact that, without special rules, the

interest income received at the partner

level from such lending transactions

generally will be treated as investment

income if the partner is not engaged in

the trade or business of lending money,

while the BIE of the partnership will be

subject to section 163(j) and potentially

limited at the partner level as EBIE. This

situation would create a mismatch

between the character of the interest

income and of the interest expense at

the partner level from the same lending

transaction. These proposed rules

would apply only to items of interest

income attributable to the lending

transaction and EBIE from the same

partnership that arise in the same

taxable year of the lending partner. By

applying these proposed rules only to

correct a mismatch in character that

may occur at the partner level during a

single taxable year, these proposed rules

otherwise ensure that a partnership

engaged in a self-charged lending

transaction will be subject to the rules

of section 163(j) to the same extent

regardless of the sources of its loans.

These proposed rules will not apply

in the case of an S corporation because

BIE of an S corporation is carried over

by the S corporation as a corporate-level

attribute rather than immediately passed

through to its shareholders. In the year

such disallowed BIE is deductible at the

corporate level, it is not separately

stated, and it is not subject to further

limitation under section 163(j) at either

the S corporation or shareholder level.

Therefore, a limited self-charged rule to

ensure proper matching of the character

of interest income and BIE at the

shareholder level is not necessary. This

approach is consistent with the

treatment of S corporations as separate

entities from their owners, both

generally and specifically with respect

to section 163(j).

However, the Treasury Department

and the IRS recognize that issues

analogous to the issues faced by

partnerships in self-charged lending

transactions exist with respect to

lending transactions between S

corporations and their shareholders.

The Treasury Department and the IRS

request comments on whether a similar

rule is appropriate for S corporations in

light of section 163(j)(4)(B) not applying

and, if so, how such rule should be

structured.

D. Partnership Basis Adjustments Upon

Partner Dispositions

In general, a partnership’s disallowed

BIE is allocated to its partners as EBIE

rather than carried forward at the

partnership level in order to prevent the

trafficking of deductions for BIE

carryforwards in the partnership

context. To achieve this, section

163(j)(4)(B)(iii)(I) provides that the

adjusted basis of a partner in a

partnership interest is reduced (but not

below zero) by the amount of EBIE

allocated to the partner. If a partner

disposes of a partnership interest,

section 163(j)(4)(B)(iii)(II) provides that

the adjusted basis of the partner in the

partnership interest is increased

immediately before the disposition by

the amount of any EBIE that was not

treated as BIE paid or accrued by the

partner prior to the disposition. Further,

under section 163(j)(4)(B)(iii)(II), no

deduction shall be allowed to the

transferor or transferee for any EBIE

resulting in a basis increase.

The Treasury Department and the IRS

have determined that the basis increase

required by section 163(j)(4)(B)(iii)(II) is

not fully descriptive of what is

occurring when a partner with EBIE

disposes of its partnership interest. If

EBIE is not treated as BIE paid or

accrued by the partner pursuant to

§ 1.163(j)–6(g) prior to the partner

disposing of its partnership interest

(nondeductible EBIE), section

163(j)(4)(B)(iii)(II) treats such

nondeductible EBIE as though it were a

nondeductible expense of the

partnership.

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This nondeductible expense is not a

nondeductible, non-capitalizable

expense under section 705(a)(2)(B). If it

were, the partner’s basis in its

partnership interest at the time of the

disposition would already reflect such

an expense. Instead, section

163(j)(4)(B)(iii)(II) requires the partner to

increase its basis immediately before the

disposition—in effect, treating the

partner as though the partnership made

a payment that decreased the value of

the partnership interest but did not

affect the partner’s basis in its

partnership interest. Thus, upon a

disposition, section 163(j)(4) treats

nondeductible EBIE as though it were a

nondeductible, capitalizable expense of

the partnership.

While the statute is clear that a

partner increases the basis in its

partnership interest immediately prior

to a disposition by any nondeductible

EBIE, it does not specifically state that

there must also be a corresponding

increase to the basis of partnership

assets to account for the nondeductible,

capitalized expense (i.e., the

nondeductible EBIE). The absence of a

corresponding increase to the

partnership’s basis immediately before

the partner’s disposition would create

distortions that are inconsistent with the

intent of both section 163(j) and

subchapter K of the Code.

For example, the basis increase

attributable to nondeductible EBIE

immediately before a liquidating

distribution results in less gain

recognized under section 731(a)(1) (or

more loss recognized under section

731(a)(2)) for the partner disposing of its

partnership interest. Consequently,

following a liquidating distribution to a

partner with EBIE, section

163(j)(4)(B)(iii)(II) causes a reduced

section 734(b) adjustment if the

partnership has a section 754 election in

effect (versus the partner basis increase

not occurring), resulting in basis

disparity between the partnership’s

basis in its assets and the aggregate

outside basis of the remaining partners.

To illustrate, consider the following

example. In Year 1, A, B, and C formed

partnership PRS by each contributing

$1,000 cash. PRS borrowed $900,

causing each partner’s basis in PRS to

increase by $300. Also in Year 1, PRS

purchased Capital Asset X for $200. In

Year 2, PRS pays $300 of BIE, all of

which is disallowed and treated as

EBIE. PRS allocated the $300 of EBIE to

its partners, $100 each. Pursuant to

§ 1.163(j)–6(h)(2), each partner reduced

its outside basis by its $100 allocation

of EBIE to $1,200. In Year 3, when the

fair market value of Capital Asset X is

$3,200 and no partner’s basis in PRS has

changed, PRS distributed $1,900 to C in

complete liquidation of C’s partnership

interest. PRS has a section 754 election

in effect in Year 3.

Pursuant to § 1.163(j)–6(h)(3), C

increases the adjusted basis of its

partnership interest by $100

immediately before the disposition.

Thus, C’s section 731(a)(1) gain

recognized on the disposition of its

partnership interest is $900 (($1,900

cash + $300 relief of liabilities)¥($1,200

outside basis + $100 EBIE add-back)).

Because the election under section 754

is in effect, PRS has a section 734(b)

increase to the basis of its assets of $900

(the amount of section 731(a)(1) gain

recognized by C). Under section 755, the

entire adjustment is allocated to Capital

Asset X. As a result, PRS’s basis for

Capital Asset X is $1,100 ($200 + $900

section 734(b) adjustment). Following

the liquidation of C, PRS’s basis in its

assets ($1,500 of cash + $1,100 of

Capital Asset X) does not equal the

aggregate outside basis of partners A

and B ($2,700).

The Treasury Department and the IRS

have determined that basis disparity

resulting from the absence of a

corresponding inside basis increase, as

described earlier, is an inappropriate

result. Accordingly, these Proposed

Regulations would provide for a

corresponding inside basis increase that

would serve as the partnership analog of

section 163(j)(4)(B)(iii)(II). Specifically,

proposed § 1.163(j)–6(h)(5) would

provide that if a partner (transferor)

disposes of its partnership interest, the

partnership shall increase the adjusted

basis of partnership property by an

amount equal to the amount of the

increase required under § 1.163(j)–

6(h)(3), if any, to the adjusted basis of

the partnership interest being disposed

of by the transferor. Such increase in the

adjusted basis of partnership property

(§ 1.163(j)–6(h)(5) basis adjustment)

shall be allocated among partnership

properties in the same manner as a

positive section 734(b) adjustment.

Because a § 1.163(j)–6(h)(5) basis

adjustment is taken into account when

determining the gain or loss upon a sale

of the asset, a § 1.163(j)–6(h)(5) basis

adjustment prevents the shifting of

built-in gain to the remaining partners.

These Proposed Regulations would

adopt an approach that treats the

increase in the adjusted basis of any

partnership property resulting from a

§ 1.163(j)–6(h)(5) basis adjustment as

not depreciable or amortizable under

any section of the Code, regardless of

whether the partnership property

allocated such § 1.163(j)–6(h)(5) basis

adjustment is otherwise generally

depreciable or amortizable. This

approach perceives EBIE as a deduction

that was disallowed to the partnership

(consistent with section

163(j)(4)(B)(iii)(II)), and thus should not

result in a depreciable section 734(b)

basis adjustment.

The Treasury Department and the IRS

request comments on this approach. An

alternative approach considered by the

Treasury Department and the IRS would

treat a § 1.163(j)–6(h)(5) basis

adjustment as depreciable or

amortizable if it is allocated to

depreciable or amortizable property.

However, section 163(j)(4)(B)(iii)(II)

provides that no deduction shall be

allowed to the transferor or transferee

for any EBIE resulting in a basis increase

to the partner that disposed of its

interest. If a § 1.163(j)–6(h)(5) basis

adjustment were depreciable or

amortizable, a partnership—which can

arguably be viewed as a transferee in a

transaction in which a partner receives

a distribution in complete liquidation of

its partnership interest—could

effectively deduct an expense that

section 163(j)(4)(B)(iii)(II) states is

permanently disallowed. The Treasury

Department and the IRS request

comments on whether treating a

§ 1.163(j)–6(h)(5) basis adjustment as

potentially depreciable or amortizable is

consistent with section

163(j)(4)(B)(iii)(II).

E. Treatment of Excess Business Interest

Expense in Tiered Partnerships

1. Entity Approach

The preamble to the 2018 Proposed

Regulations reserved and requested

comments on the application of section

163(j)(4) to tiered partnership structures.

Specifically, the preamble to the 2018

Proposed Regulations requested

comments regarding whether, in a tiered

partnership structure, EBIE should be

allocated through an upper-tier

partnership to the partners of upper-tier

partnership. Additionally, comments

were requested regarding how and when

the basis of an upper-tier partnership

partner should be adjusted when a

lower-tier partnership has BIE that is

limited under section 163(j).

In response, commenters

recommended approaches that, in

general, either (1) allocated EBIE

through upper-tier partnership to the

partners of upper-tier partnership

(Aggregate Approach), or (2) did not

allocate EBIE through upper-tier

partnership to the partners of upper-tier

partnership (Entity Approach).

Commenters stated that both approaches

reasonably implement Congressional

intent of applying section 163(j) at the

partnership level; however, the Entity

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Approach reflects a stronger allegiance

to entity treatment of partnerships for

purposes of section 163(j). Commenters

noted that the ultimate determination of

which approach is more appropriate

should rest, in large part, on whether

partnerships or partners are more able to

comply with the provision. The Entity

Approach places more of that burden on

partnerships, and the Aggregate

Approach places more of the burden on

partners. Commenters recommended

that partnerships are better able to

comply with an Entity Approach than

partners are able to comply with an

Aggregate Approach. Further, because

the Entity Approach centers a

significant portion of the compliance

effort with partnerships, the Entity

Approach may increase compliance and

simplify Service review.

The Treasury Department and the IRS

have concluded that an Entity Approach

is the most consistent with the approach

taken to partnerships under section

163(j)(4). Further, the Treasury

Department and the IRS agree with

commenters that partnerships are better

able to comply with section 163(j) tiered

partnership rules than partners.

Accordingly, proposed § 1.163(j)–6(j)(3)

would provide that if lower-tier

partnership allocates excess business

interest expense to upper-tier

partnership, then upper-tier partnership

reduces its basis in lower-tier

partnership pursuant to § 1.163(j)–

6(h)(2). Upper-tier partnership partners

do not, however, reduce the bases of

their upper-tier partnership interests

pursuant to § 1.163(j)–6(h)(2) until

upper-tier partnership treats such excess

business interest expense as business

interest expense paid or accrued

pursuant to § 1.163(j)–6(g).

Although proposed § 1.163(j)–6(j)(3)

would provide that EBIE allocated from

a lower-tier partnership to an upper-tier

partnership is not subject to further

allocation by the upper-tier partnership,

such EBIE necessarily reflects a

reduction in the value of lower-tier

partnership by the amount of the

economic outlay that resulted in such

EBIE. Accordingly, proposed § 1.163(j)–

6(j)(2) would provide that if lower-tier

partnership pays or accrues business

interest expense and allocates such

business interest expense to upper-tier

partnership, then both upper-tier

partnership and any direct or indirect

partners of upper-tier partnership shall,

solely for purposes of section 704(b) and

the regulations thereunder, treat such

business interest expense as a section

705(a)(2)(B) expenditure. Any section

704(b) capital account reduction

resulting from such treatment occurs

regardless of whether such business

interest expense is characterized under

this section as excess business interest

expense or deductible business interest

expense by lower-tier partnership. If

upper-tier partnership subsequently

treats any excess business interest

expense allocated from lower-tier

partnership as business interest expense

paid or accrued pursuant to § 1.163(j)–

6(g), the section 704(b) capital accounts

of any direct or indirect partners of

upper-tier partnership are not further

reduced.

2. Basis and Carryforward Component of

EBIE

Some commenters stated that an

Entity Approach—that is, the approach

these Proposed Regulations would

adopt—would result in basis disparity

between upper-tier partnership’s basis

in its assets and the aggregate basis of

the upper-tier partners’ interests in

upper-tier partnership. The Treasury

Department and the IRS do not agree.

EBIE is neither an item of deduction nor

a section 705(a)(2)(B) expense. If an

allocation of EBIE from lower-tier

partnership results in a reduction of the

upper-tier partnership’s basis in its

lower-tier partnership interest, there is

not a net reduction in the tax attributes

of the upper-tier partnership. Rather, in

such an event, upper-tier partnership

merely exchanges one tax attribute (tax

basis in its lower-tier partnership

interest) for a different tax attribute

(EBIE, which, in a subsequent year,

could result in either a deduction or a

basis adjustment). Thus, basis is

preserved in this exchange.

Accordingly, proposed § 1.163(j)–

6(j)(4) would provide that if lower-tier

partnership allocates excess business

interest expense to upper-tier

partnership and such excess business

interest expense is not suspended under

section 704(d), then upper-tier

partnership shall treat such excess

business interest expense (UTP EBIE) as

a nondepreciable capital asset, with a

fair market value of zero and basis equal

to the amount by which upper-tier

partnership reduced its basis in lower-

tier partnership pursuant to § 1.163(j)–

6(h)(2) due to the allocation of such

excess business interest expense. The

fair market value of UTP EBIE,

described in the preceding sentence, is

not adjusted by any revaluations

occurring under § 1.704–1(b)(2)(iv)(f).

In addition to generally treating UTP

EBIE as having a basis component in

excess of fair market value and, thus,

built-in loss property, proposed

§ 1.163(j)–6(j)(4) would also provide that

upper-tier partnership shall also treat

UTP EBIE as having a carryforward

component associated with it. The

carryforward component of UTP EBIE

shall equal the amount of excess

business interest expense allocated from

lower-tier partnership to upper-tier

partnership under § 1.163(j)–6(f)(2) that

is treated as such under § 1.163(j)–

6(h)(2) by upper-tier partnership.

The carryforward component of UTP

EBIE and the basis component of such

UTP EBIE will always be equal

immediately following the allocation of

such EBIE from lower-tier partnership to

upper-tier partnership if, at the time of

such allocation, upper-tier partnership

was required to reduce its section 704(b)

capital account pursuant to proposed

§ 1.163(j)–6(j)(2) due to such allocation.

However, subsequent to such initial

allocation of EBIE from lower-tier

partnership to upper-tier partnership,

disparities between the carryforward

component of UTP EBIE and the basis

component of such UTP EBIE may arise

as a result of proposed § 1.163(j)–6(j)(7).

Similar to the treatment of partner

basis items (which do not affect the ATI

of a partnership), proposed § 1.163(j)–

6(j)(7)(i) would provide that negative

basis adjustments under sections 734(b)

and 743(b) allocated to UTP EBIE do not

affect the carryforward component of

such UTP EBIE; rather, negative basis

adjustments under sections 734(b) and

743(b) affect only the basis component

of such UTP EBIE. Although section

734(b) adjustments do affect a

partnership’s computation of ATI, the

Treasury Department and the IRS have

determined that negative section 734(b)

adjustments, if allocated to UTP EBIE,

should not reduce the carryforward

component of such UTP EBIE. The

purpose of proposed § 1.163(j)–6(j)(7)—

in addition to preventing the

duplication of loss—is to make partners

indifferent for section 163(j) purposes as

to whether a partner exiting upper-tier

partnership sells its interest or receives

a liquidating distribution from upper-

tier partnership. Excluding negative

section 734(b) adjustments from

proposed § 1.163(j)–6(j)(7) would

frustrate this purpose.

3. UTP EBIE Conversion Events

Proposed § 1.163(j)–6(j)(4) would

further provide that if an allocation of

excess business interest expense from

lower-tier partnership is treated as UTP

EBIE of upper-tier partnership, upper-

tier partnership shall treat such

allocation of excess business interest

expense from lower-tier partnership as

UTP EBIE until the occurrence of an

UTP EBIE conversion event described in

proposed § 1.163(j)–6(j)(5). In the non-

tiered context, EBIE generally has two

types of conversion events. The first

EBIE conversion event is when EBIE is

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treated as BIE paid or accrued pursuant

to § 1.163(j)–6(g). The second EBIE

conversion event is the basis addback

that occurs pursuant to proposed

§ 1.163(j)–6(h)(3) when a partner

disposes of its interest in a partnership.

Proposed § 1.163(j)–6(j)(5)(i) and (ii),

respectively, would provide guidance

regarding these two types of conversion

events in the tiered partnership context.

a. First Type of Conversion Event—UTP

EBIE Treated as Paid or Accrued

Regarding the first type of conversion

event, proposed § 1.163(j)–6(j)(5)(i)

would provide that to the extent upper-

tier partnership is allocated excess

taxable income (or excess business

interest income) from lower-tier

partnership, or § 1.163(j)–6 (m)(3)

applies, upper-tier partnership shall

apply proposed § 1.163(j)–6(j)(5)(i)(A)

through (C).

First, proposed § 1.163(j)–6(j)(5)(i)(A)

requires upper-tier partnership to apply

the rules in § 1.163(j)–6(g) to its UTP

EBIE, using any reasonable method

(including, for example, FIFO and LIFO)

to determine which UTP EBIE is treated

as business interest expense paid or

accrued pursuant § 1.163(j)–6(g). If

§ 1.163(j)–6(m)(3) applies, upper-tier

partnership shall treat all of its UTP

EBIE from lower-tier partnership as paid

or accrued.

Proposed § 1.163(j)–6(j)(5)(i)(A) would

provide that upper-tier partnership must

determine which of its UTP EBIE is

treated as paid or accrued, as opposed

to just providing that upper-tier

partnership reduces its UTP EBIE,

because UTP EBIE is not necessarily a

unified tax attribute of upper-tier

partnership. UTP EBIE of upper-tier

partnership could have been allocated

in different years, have different bases,

and have different specified partners

(defined in the next paragraph). For

example, assume $30 of UTP EBIE was

allocated a negative $10 section 734(b)

adjustment, resulting in the aggregate of

upper-tier partnership’s UTP EBIE

having a carryforward component of $30

and basis component of $20. Thus, such

UTP EBIE could, at most, result in $20

of deduction (the basis of such UTP

EBIE). However, upper-tier partnership

does not necessarily need $100 of ETI

(or $30 of EBII) to deduct such $20.

Rather, if upper-tier partnership was

allocated $20 of EBII, upper-tier

partnership could deduct $20 of

business interest expense if, using a

reasonable method, it determined the

$20 of UTP EBIE with full basis was the

UTP EBIE treated as business interest

expense paid or accrued pursuant to

§ 1.163(j)–6(j)(5)(i)(A). Following such

treatment, upper-tier partnership would

still have $10 of UTP EBIE with $0 basis

remaining (that is, $10 of carryforward

component and $0 of basis component).

Second, with respect to any UTP EBIE

treated as business interest expense paid

or accrued in proposed § 1.163(j)–

6(j)(5)(i)(A), proposed § 1.163(j)–

6(j)(5)(i)(B) would require upper-tier

partnership to allocate any business

interest expense that was formerly such

UTP EBIE to its specified partner. For

purposes of proposed § 1.163(j)–6(j), the

term specified partner refers to the

partner of upper-tier partnership that,

due to the initial allocation of excess

business interest expense from lower-

tier partnership to upper-tier

partnership, was required to reduce its

section 704(b) capital account pursuant

to proposed § 1.163(j)–6(j)(2). Similar

principles apply if the specified partner

of such business interest expense is

itself a partnership.

Proposed § 1.163(j)–6(j)(6) would

provide rules if a specified partner

disposes of its interest. Specifically,

proposed § 1.163(j)–6(j)(6)(i) would

provide that if a specified partner

(transferor) disposes of an upper-tier

partnership interest (or an interest in a

partnership that itself is a specified

partner), the portion of any UTP EBIE to

which the transferor’s status as specified

partner relates is not reduced pursuant

to proposed § 1.163(j)–6(j)(5)(ii). Stated

otherwise, if a partner of an upper-tier

partnership disposes of its interest in

the upper-tier partnership, an interest in

the lower-tier partnership held by

upper-tier partnership is not deemed to

have been similarly disposed of for

purposes of proposed § 1.163(j)–

6(j)(5)(ii). See Rev. Rul. 87–115. Rather,

such UTP EBIE attributable to the

interest disposed of is retained by

upper-tier partnership and the

transferee is treated as the specified

partner for purposes of proposed

§ 1.163(j)–6(j) with respect to such UTP

EBIE. Thus, upper-tier partnership must

allocate any business interest expense

that was formerly such UTP EBIE to the

transferee.

Additionally, proposed § 1.163(j)–

6(j)(6)(ii) would provide special rules

regarding the specified partner of UTP

EBIE following certain nonrecognition

transactions. Proposed § 1.163(j)–

6(j)(6)(ii)(A) would provide that if a

specified partner receives a distribution

of property in complete liquidation of

an upper-tier partnership interest, the

portion of UTP EBIE of upper-tier

partnership attributable to the

liquidated interest shall not have a

specified partner. If a specified partner

(transferee) receives a distribution of an

interest in upper-tier partnership in

complete liquidation of a partnership

interest, the transferee is the specified

partner with respect to UTP EBIE of

upper-tier partnership only to the same

extent it was prior to the distribution.

Similar principles apply where an

interest in a partnership that is a

specified partner is distributed in

complete liquidation of a transferee’s

partnership interest.

Proposed § 1.163(j)–6(j)(6)(ii)(B)

would further provide that if a specified

partner (transferor) contributes an

upper-tier partnership interest to a

partnership (transferee), the transferee is

treated as the specified partner for

purposes of proposed § 1.163(j)–6(j)

with respect to the portion of the UTP

EBIE attributable to the contributed

interest. Following the transaction, the

transferor continues to be the specified

partner with respect to the UTP EBIE

attributable to the contributed interest.

Similar principles apply where an

interest in a partnership that is a

specified partner is contributed to a

partnership.

Finally, after determining the

specified partner of the UTP EBIE

treated as business interest expense paid

or accrued in proposed § 1.163(j)–

6(j)(5)(i)(A) and allocating such business

interest expense to its specified partner

pursuant to proposed § 1.163(j)–

6(j)(5)(i)(B), proposed § 1.163(j)–

6(j)(5)(i)(C) would require upper-tier

partnership to, in the manner provided

in proposed § 1.163(j)–6(j)(7)(ii) (or (iii),

as the case may be), take into account

any negative basis adjustments under

section 734(b) previously made to the

UTP EBIE treated as business interest

expense paid or accrued in (A) earlier.

Additionally, persons treated as

specified partners with respect to the

UTP EBIE treated as business interest

expense paid or accrued in (A) earlier

shall take any negative basis

adjustments under section 743(b) into

account in the manner provided in

proposed § 1.163(j)–6(j)(7)(ii) (or (iii), as

the case may be).

Proposed § 1.163(j)–6(j)(7)(ii) would

provide that if UTP EBIE that was

allocated a negative section 734(b)

adjustment is subsequently treated as

deductible business interest expense,

then such deductible business interest

expense does not result in a deduction

to the upper-tier partnership or the

specified partner of such deductible

business interest expense. If UTP EBIE

that was allocated a negative section

743(b) adjustment is subsequently

treated as deductible business interest

expense, the specified partner of such

deductible business interest expense

recovers any negative section 743(b)

adjustment attributable to such

deductible business interest expense

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(effectively eliminating any deduction

for such deductible business interest

expense).

Proposed § 1.163(j)–6(j)(7)(iii) would

provide that if UTP EBIE that was

allocated a negative section 734(b) or

743(b) adjustment is subsequently

treated as excess business interest

expense, the specified partner’s basis

decrease in its upper-tier partnership

interest required under proposed

§ 1.163(j)–6(h)(2) is reduced by the

amount of the negative section 734(b) or

743(b) adjustment previously made to

such excess business interest expense. If

such excess business interest expense is

subsequently treated as business interest

expense paid or accrued by the

specified partner, no deduction shall be

allowed for any of such business

interest expense. If the specified partner

of such excess business interest expense

is a partnership, such excess business

interest expense is considered UTP EBIE

that was previously allocated a negative

section 734(b) adjustment for purposes

of proposed § 1.163(j)–6(j).

b. Second Type of Conversion Event—

UTP EBIE Reduction

Regarding the second type of

conversion event, proposed § 1.163(j)–

6(j)(5)(ii) would provide that if upper-

tier partnership disposes of a lower-tier

partnership interest (transferred

interest), upper-tier partnership shall

apply proposed § 1.163(j)–6(j)(5)(ii)(A)

through (C).

First, proposed § 1.163(j)–6(j)(5)(ii)(A)

would require upper-tier partnership to

apply the rules in § 1.163(j)–6(h)(3)

(except as provided in (B) and (C) later),

using any reasonable method

(including, for example, FIFO and LIFO)

to determine which UTP EBIE is

reduced pursuant to § 1.163(j)–6(h)(3).

Stated otherwise, proposed § 1.163(j)–

6(j)(5)(ii)(A) would require upper-tier

partnership to apply all of the rules in

§ 1.163(j)–6(h)(3), except for the rule

that determines the amount of the basis

increase immediately before the

disposition to the disposed of interest

(the first sentence of § 1.163(j)–6(h)(3)).

In lieu of applying the first sentence of

§ 1.163(j)–6(h)(3), upper-tier partnership

would apply proposed § 1.163(j)–

6(j)(5)(ii)(B) and (C) to determine the

amount of such basis increase.

Second, proposed § 1.163(j)–

6(j)(5)(ii)(B) would require upper-tier

partnership to increase the adjusted

basis of the transferred interest

immediately before the disposition by

the total amount of the UTP EBIE that

was reduced in (A) earlier (the amount

of UTP EBIE proportionate to the

transferred interest). For example, if

upper-tier partnership disposed of half

of its lower-tier partnership interest

while it held $40 of UTP EBIE allocated

from lower tier partnership, upper-tier

partnership would increase the adjusted

basis of the disposed of lower-tier

partnership interest by $20. However,

immediately before the disposition,

such $20 increase may be reduced

pursuant to proposed § 1.163(j)–

6(j)(5)(ii)(C).

Third, proposed § 1.163(j)–

6(j)(5)(ii)(C) would require upper-tier

partnership to, in the manner provided

in proposed § 1.163(j)–6(j)(7)(iv), take

into account any negative basis

adjustments under sections 734(b) and

743(b) previously made to the UTP EBIE

that was reduced in (A) earlier.

Proposed § 1.163(j)–6(j)(7)(iv) would

provide that if UTP EBIE that was

allocated a negative section 734(b) or

743(b) adjustment is reduced pursuant

to proposed § 1.163(j)–6(j)(5)(ii)(A), the

amount of upper-tier partnership’s basis

increase under proposed § 1.163(j)–

6(j)(5)(ii)(B) to the disposed of lower-tier

partnership interest is reduced by the

amount of the negative section 734(b) or

743(b) adjustment previously made to

such UTP EBIE.

Continuing with the previous

example, assume that $5 of the $20 of

UTP EBIE reduced pursuant to proposed

§ 1.163(j)–6(j)(5)(ii)(A) was previously

allocated a $5 negative section 743(b)

adjustment. Pursuant to proposed

§ 1.163(j)–6(j)(5)(ii)(C), upper-tier

partnership would reduce the $20

increase it determined under proposed

§ 1.163(j)–6(j)(5)(ii)(B) by $5. Thus, the

adjusted basis of the lower-tier

partnership interest being disposed of

would be increased by $15 immediately

before the disposition. Consequently,

lower-tier partnership would have a

corresponding § 1.163(j)–6(h)(5) basis

adjustment to its property of $15.

4. Anti-Loss Trafficking Rules

Proposed § 1.163(j)–6(j) generally

relies on negative sections 734(b) and

743(b) adjustments to prevent a partner

from deducting business interest

expense that was formerly UTP EBIE if

such partner did not bear the economic

cost of such business interest expense

payment. To the extent a negative

section 734(b) or 743(b) adjustment fails

to prohibit such a deduction (or basis

increase under proposed § 1.163(j)–

6(j)(5)(ii)), the anti-loss trafficking rules

in proposed § 1.163(j)–6(j)(8) would

prohibit such a deduction (or basis

addback under proposed § 1.163(j)–

6(j)(5)(ii)).

The anti-loss trafficking rule under

proposed § 1.163(j)–6(j)(8)(i) would

prohibit the trafficking of business

interest expense by providing that no

deduction shall be allowed to any

transferee specified partner for any

business interest expense derived from

a transferor’s share of UTP EBIE. For

purposes of proposed § 1.163(j)–6(j), the

term transferee specified partner refers

to any specified partner that did not

reduce its section 704(b) capital account

upon the initial allocation of excess

business interest expense from lower-

tier partnership to upper-tier

partnership pursuant to proposed

§ 1.163(j)–6(j)(2). However, the

transferee described in proposed

§ 1.163(j)–6(j)(ii)(B) is not a transferee

specified partner for purposes of

proposed § 1.163(j)–6(j).

Proposed § 1.163(j)–6(j)(8)(i) would

also provide the mechanism for

disallowing such BIE. Proposed

§ 1.163(j)–6(j)(8)(i) would provide that

if, pursuant to proposed § 1.163(j)–

6(j)(5)(i)(B), a transferee specified

partner is allocated business interest

expense derived from a transferor’s

share of UTP EBIE (business interest

expense to which the partner’s status as

transferee specified partner relates), the

transferee specified partner is deemed to

recover a negative section 743(b)

adjustment with respect to, and in the

amount of, such business interest

expense and takes such negative section

743(b) adjustment into account in the

manner provided in proposed

§ 1.163(j)–6(j)(7)(ii) (or (iii), as the case

may be), regardless of whether a section

754 election was in effect or a

substantial built-in loss existed at the

time of the transfer by which the

transferee specified partner acquired the

transferred interest. However, to the

extent a negative section 734(b) or

743(b) adjustment was previously made

to such business interest expense, the

transferee specified partner does not

recover an additional negative section

743(b) adjustment pursuant to this

paragraph.

Additionally, the anti-loss trafficking

rule under proposed § 1.163(j)–6(j)(8)(ii)

would prohibit the trafficking of BIE

that was formerly the UTP EBIE of a

specified partner that received a

distribution in complete liquidation of

its upper-tier partnership interest.

Specifically, proposed § 1.163(j)–

6(j)(8)(ii) would provide that if UTP

EBIE does not have a specified partner

(as the result of a transaction described

in proposed § 1.163(j)–6(j)(6)(ii)(A)),

upper-tier partnership shall not allocate

any business interest expense that was

formerly such UTP EBIE to its partners.

Rather, for purposes of applying

§ 1.163(j)–6(f)(2), upper-tier partnership

shall treat such business interest

expense as the allocable business

interest expense (as defined in

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§ 1.163(j)–6(f)(2)(ii)) of a §1.163(j)–

6(j)(8)(ii) account.

Any deductible business interest

expense and excess business interest

expense allocated to a § 1.163(j)–

6(j)(8)(ii) account at the conclusion of

the eleven-step computation set forth in

§ 1.163(j)–6(f)(2) is not tracked in future

years. Treating such business interest

expense as the allocable business

interest expense of a separate account

for purposes of applying § 1.163(j)–

6(f)(2)(ii) ensures that partners of upper-

tier partnership do not support a

deduction for such business interest

expense (for which no deduction will be

allowed) using their shares of allocable

ATI and allocable business interest

income before supporting a deduction

for their own shares of allocable

business interest expense (for which a

deduction may be allowed).

Additionally, if UTP EBIE that does

not have a specified partner (as the

result of a transaction described in

proposed § 1.163(j)–6(j)(6)(ii)(A)) is

treated as paid or accrued pursuant to

§ 1.163(j)–6(g), upper-tier partnership

shall make a § 1.163(j)–6(h)(5) basis

adjustment to its property in the amount

of the adjusted basis (if any) of such

UTP EBIE at the time such UTP EBIE is

treated as business interest expense paid

or accrued pursuant to § 1.163(j)–6(g).

The purpose of this § 1.163(j)–6(h)(5)

basis adjustment is to preserve basis in

the system.

Thus, any time upper-tier partnership

treats UTP EBIE as business interest

expense paid or accrued pursuant to

proposed § 1.163(j)–6(j)(5)(i)(A) it must

apply proposed § 1.163(j)–6(j)(8)(i) and

(ii). In application, upper-tier

partnership would generally undertake

the following analysis when applying

proposed § 1.163(j)–6(j)(8)(i) and (ii).

With respect to any UTP EBIE treated as

business interest expense paid or

accrued pursuant to proposed

§ 1.163(j)–6(j)(5)(i)(A) (UTP BIE), upper-

tier partnership must first determine

whether such UTP BIE has a specified

partner. If it does not have a specified

partner, upper-tier partnership must

apply proposed § 1.163(j)–6(j)(8)(ii),

which, in general, requires upper-tier

partnership to capitalize the basis (if

any) of such UTP BIE into the basis of

upper-tier partnership property via a

§ 1.163(j)–6(h)(5) basis adjustment.

If UTP BIE does have a specified

partner, upper-tier partnership must

next determine whether the specified

partner of such UTP BIE reduced its

section 704(b) capital account upon the

initial allocation of such excess business

interest expense from lower-tier

partnership to upper-tier partnership

pursuant to proposed § 1.163(j)–6(j)(2).

If the specified partner did reduce its

section 704(b) capital account upon

such initial allocation, then any

deduction for such UTP BIE is not

disallowed under proposed § 1.163(j)–

6(j)(8)(i). However, if the specified

partner did not reduce its section 704(b)

capital account upon such initial

allocation, upper-tier partnership must

next determine whether such specified

partner is a transferee described in

proposed § 1.163(j)–6(j)(6)(ii)(B). If it is,

then any deduction for such UTP BIE is

not disallowed under proposed

§ 1.163(j)–6(j)(8)(i). However, if the

specified partner is not a transferee

described in proposed § 1.163(j)–

6(j)(6)(ii)(B), then it is a transferee

specified partner, as defined in

proposed § 1.163(j)–6(j)(8)(i). As a

result, any deduction for such UTP BIE

is disallowed under proposed § 1.163(j)–

6(j)(8)(i). If there are multiple tiers of

partnerships, each tier must apply these

rules.

Finally, proposed § 1.163(j)–6(j)(8)(iii)

would provide a similar mechanism to

proposed § 1.163(j)–6(j)(8)(i) for

disallowing basis addbacks under

§ 1.163(j)–6(h)(3) for certain UTP EBIE.

Specifically, proposed § 1.163(j)–

6(j)(8)(iii) would provide that no basis

increase under proposed § 1.163(j)–

6(j)(5)(ii) shall be allowed to upper-tier

partnership for any disallowed UTP

EBIE. For purposes of § 1.163(j)–6, the

term disallowed UTP EBIE refers to any

UTP EBIE that has a specified partner

that is a transferee specified partner (as

defined in proposed § 1.163(j)–6(j)(8)(i))

and any UTP EBIE that does not have

a specified partner (as the result of a

transaction described in proposed

§ 1.163(j)–6(j)(6)(ii)(A)). For purposes of

applying proposed § 1.163(j)–6(j)(5)(ii),

upper-tier partnership shall treat any

disallowed UTP EBIE in the same

manner as UTP EBIE that has previously

been allocated a negative section 734(b)

adjustment. However, upper-tier

partnership does not treat disallowed

UTP EBIE as though it were allocated a

negative section 734(b) adjustment

pursuant to this paragraph to the extent

a negative section 734(b) or 743(b)

adjustment was previously made to

such disallowed UTP EBIE.

5. Foundational Determinations

In general, the rules under proposed

§ 1.163(j)–6(j) are derived from the

following three foundational

determinations made by the Treasury

Department and the IRS. First, basis is

preserved when upper-tier partnership

exchanges basis in its lower-tier

partnership for EBIE allocated from

lower-tier partnership (UTP EBIE).

Thus, upper-tier partnership generally

must treat UTP EBIE in the same

manner as built-in loss property.

Second, UTP EBIE has two

components—a basis component and a

carryforward component. In general,

negative basis adjustments under

section 734(b) and 743(b) reduce the

basis component of UTP EBIE (and thus,

any possible deduction for UTP EBIE),

but do not reduce the carryforward

component of UTP EBIE; only the two

conversion events in proposed

§ 1.163(j)–6(j)(5) are capable of reducing

the carryforward component of UTP

EBIE. Third, upper-tier partnership

must allocate any business interest

expense that was formerly UTP EBIE to

its specified partner—that is, the partner

that reduced its section 704(b) capital

account at the time of the initial

allocation of the UTP EBIE from lower-

tier partnership to upper-tier

partnership. If there is a transfer of a

partnership interest, the transferor

generally steps into the shoes of the

transferee’s status as specified partner,

but may not deduct any business

interest expense derived from the

transferor’s share of UTP EBIE.

The Treasury Department and the IRS

request comments on this approach.

Specifically, the Treasury Department

and the IRS request comments on

whether further guidance on the

treatment of UTP EBIE under the rules

of subchapter K of the Code is

necessary.

F. Partner Basis Adjustments Upon a

Distribution

Under the 2018 Proposed Regulations,

if a partner disposed of all or

substantially all of its partnership

interest, the adjusted basis of the

partnership interest was increased

immediately before the disposition by

the entire amount of the EBIE not

previously treated as paid or accrued by

the partner. If a partner disposed of less

than substantially all of its interest in a

partnership, the partner could not

increase its basis by any portion of the

EBIE not previously treated as paid or

accrued by the partner. The Treasury

Department and the IRS requested

comments on this approach in the

preamble to the 2018 Proposed

Regulations.

As discussed in the preamble to Final

Regulations, commenters cited multiple

concerns with the approach adopted in

the 2018 Proposed Regulations and

recommended that the Final Regulations

adopt a proportionate approach. Under

such an approach, a partial disposition

of a partnership interest would trigger a

proportionate EBIE basis addback and

corresponding decrease in such

partner’s EBIE carryover. The Treasury

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Department and the IRS agreed with

commenters. Accordingly, § 1.163(j)–

6(h)(3) provides for a proportionate

approach.

In general, a distribution from a

partnership is either a current

distribution or a liquidating

distribution; the concept of a

redemptive distribution does not exist

in the partnership context. Accordingly,

proposed § 1.163(j)–6(h)(4) would

provide that, for purposes of § 1.163(j)–

6(h)(3), a disposition includes a

distribution of money or other property

by the partnership to a partner in

complete liquidation of the partner’s

interest in the partnership. Proposed

§ 1.163(j)–6(h)(4) would further provide

that, for purposes of § 1.163(j)–6(h)(3), a

current distribution of money or other

property by the partnership to a

continuing partner is not a disposition

for purposes of § 1.163(j)–6(h)(3). The

Treasury Department and the IRS

request comments on whether a current

distribution of money or other property

by the partnership to a continuing

partner as consideration for an interest

in the partnership should also trigger an

addback and, if so, how to determine

the appropriate amount of the addback.

G. Allocable ATI and Allocable Business

Interest Income of Upper-Tier

Partnership Partners

Section 1.163(j)–6(f)(2) provides an

eleven-step computation necessary for

properly allocating a partnership’s

deductible BIE and section 163(j) excess

items among its partners. Pursuant to

§ 1.163(j)–6(f)(2)(ii), a partnership must

determine each of its partner’s allocable

share of each section 163(j) item under

section 704(b) and the regulations under

section 704 of the Code, including any

allocations under section 704(c), other

than remedial items. Further, § 1.163(j)–

6(f)(2)(ii) provides that the term

allocable ATI means a partner’s

distributive share of the partnership’s

ATI (that is, a partner’s distributive

share of gross income and gain items

comprising ATI less such partner’s

distributive share of gross loss and

deduction items comprising ATI), and

the term allocable business interest

income means a partner’s distributive

share of the partnership’s business

interest income.

In general, if a partnership is not a

partner in a partnership, each dollar of

taxable income that is properly allocable

to a trade or business will have a

corresponding dollar of ATI associated

with it. Accordingly, in the non-tiered

partnership context, if a partner’s share

of gross income and gain items

comprising ATI less such partner’s

share of gross loss and deduction items

comprising ATI equals $1, such partner

will have $1 of allocable ATI for

purposes of § 1.163(j)–6(f)(2)(ii).

However, if a partnership is a partner

in a partnership, each dollar of taxable

income that is properly allocable to a

trade or business may not have a full

dollar of ATI associated with it. Section

163(j)(4)(A)(ii)(I) provides that the ATI

of a partner in a partnership is

determined without regard to such

partner’s distributive share of any items

of income, gain, deduction, or loss of

such partnership. Further, section

163(j)(4)(A)(ii)(II) provides that a partner

only increases its ATI by its distributive

share of a partnership’s ETI.

To illustrate, consider the following

example. LTP has $100 of income and

$100 of loss properly allocable to a trade

or business. Thus, LTP has $0 of ATI.

LTP specially allocates the $100 of

income to partner UTP. Under section

163(j)(4)(A)(ii)(I), UTP does not treat

such $100 of income as ATI.

Additionally, UTP has $300 of income

properly allocable to a trade or business,

which UTP properly treats as ATI. Here,

UTP’s taxable income that is properly

allocable to a trade or business ($400)

does not equal the amount of its ATI

($300).

The Treasury Department and the IRS

recognize that a special rule is necessary

to coordinate situations like the one

illustrated earlier with the general

requirement under § 1.163(j)–6(f)(2)(ii)

for partnerships to determine a partner’s

allocable ATI based on such partner’s

allocation of items comprising the ATI

of the partnership. Accordingly,

proposed § 1.163(j)–6(j)(9) would

provide that, when applying § 1.163(j)–

6(f)(2)(ii), an upper-tier partnership

determines the allocable ATI and

allocable business interest income of

each of its partners in the manner

provided in proposed § 1.163(j)–6(j)(9).

Specifically, if an upper-tier

partnership’s net amount of tax items

that comprise (or have ever comprised)

ATI is greater than or equal to its ATI,

upper-tier partnership applies the rules

in paragraph (j)(9)(ii)(A) to determine

each partner’s allocable ATI. However,

if an upper-tier partnership’s net

amount of tax items that comprise (or

have ever comprised) ATI is less than its

ATI, upper-tier partnership applies the

rules in proposed § 1.163(j)–6(j)(9)(ii)(B)

to determine each partner’s allocable

ATI. To determine each partner’s

allocable business interest income, an

upper-tier partnership applies the rules

in proposed § 1.163(j)–6(j)(9)(iii).

H. Qualified Expenditures

The 2018 Proposed Regulations

provided that partnership ATI is

reduced by deductions claimed under

sections 173 (relating to circulation

expenditures), 174(a) (relating to

research and experimental

expenditures), 263(c) (relating to

intangible drilling and development

expenditures), 616(a) (relating to mine

development expenditures), and 617(a)

(relating to mining exploration

expenditures) (collectively ‘‘qualified

expenditures’’). As a result, deductions

for qualified expenditures reduced the

amount of business interest expense a

partnership could potentially deduct.

A partner may elect to capitalize its

distributive share of any qualified

expenditures of a partnership under

section 59(e)(4)(C) or may be required to

capitalize a portion of its distributive

share of certain qualified expenditures

of a partnership under section 291(b).

As a result, the taxable income reported

by a partner in a taxable year

attributable to the ownership of a

partnership interest may exceed the

amount of taxable income reported to

the partner on a Schedule K–1.

Commenters on the 2018 Proposed

Regulations recommended that a

distributive share of partnership

deductions capitalized by a partner

under section 59(e) or section 291(b)

increase the ATI of the partner because

qualified expenditures reduce both

partnership ATI and excess taxable

income, but may not reduce the taxable

income of a partner. Two different

approaches for achieving this result

were suggested: (1) Adjust the excess

taxable income of the partnership,

resulting in an increase to partner ATI,

and (2) increase the ATI of the partner

directly, without making any

adjustments to partnership excess

taxable income.

The Treasury Department and IRS

agree that a distributive share of

partnership deductions capitalized by a

partner under section 59(e) should

increase the ATI of the partner and

adopt the recommended approach of

increasing the ATI of the partner

directly, without making any

adjustments to partnership excess

taxable income. The approach of

increasing partner ATI by adjusting

partnership excess taxable income is

rejected, as it would result in

partnerships with more excess taxable

income than ATI—a result not possible

under the current statutory conceptual

framework. The Treasury Department

and IRS have the authority to adjust

ATI, but do not have a similar grant of

authority to make adjustments to

partnership excess taxable income,

which is explicitly defined by statute.

Accordingly, proposed § 1.163(j)–

6(e)(6) would provide that the ATI of a

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partner is increased by the portion of

such partner’s allocable share of

qualified expenditures (as defined in

section 59(e)(2)) to which an election

under section 59(e) applies. Any

deduction allowed under section

59(e)(1) would be taken into account in

determining a partner’s ATI pursuant to

§ 1.163(j)–1(b). Proposed §1.163(j)–

6(l)(4)(iv) would provide a similar rule

in the S corporation context.

The Treasury Department and IRS are

aware that a similar issue exists in the

context of depletion and request

comments as to whether a similar

partner level add-back is appropriate.

The Treasury Department and IRS are

also aware that a partner may be

required to capitalize certain qualified

expenditures of a partnership under

section 291(b) and request comments as

to whether a similar partner level add-

back is appropriate.

I. CARES Act Partnership Rules

As stated in the Background section of

this preamble, section 163(j)(10), as

enacted by the CARES Act, provides

special rules for partners and

partnerships for taxable years beginning

in 2019 or 2020. Under sections

163(j)(10)(A)(i) and 163(j)(10)(A)(ii)(I),

for partnerships, the amount of business

interest that may be deductible under

section 163(j)(1) for taxable years

beginning in 2020 is computed using

the 50 percent ATI limitation. The 50

percent ATI limitation does not apply to

partnerships for taxable years beginning

in 2019. See section 163(j)(10)(A)(ii)(I).

Under section 163(j)(10)(A)(iii), a

partnership may elect to not apply the

50 percent ATI limitation and, instead,

to apply the 30 percent ATI limitation.

This election is made by the

partnership.

Under section 163(j)(10)(A)(ii)(II), a

partner treats 50 percent of its allocable

share of a partnership’s excess business

interest expense for 2019 as a business

interest expense in the partner’s first

taxable year beginning in 2020 that is

not subject to the section 163(j)

limitation (50 percent EBIE rule). The

remaining 50 percent of the partner’s

allocable share of the partnership’s 2019

excess business interest expense

remains subject to the section 163(j)

limitation applicable to excess business

interest expense carried forward at the

partner level. A partner may elect out of

the 50 percent EBIE rule. Proposed

§ 1.163(j)–6(g)(4) provides further

guidance on the 50 percent EBIE rule.

Additionally, section 163(j)(10)(B)(i)

allows a taxpayer to elect to substitute

its 2019 ATI for the taxpayer’s 2020 ATI

in determining the taxpayer’s section

163(j) limitation for any taxable year

beginning in 2020. Section 1.163(j)–

2(b)(3) and (4) of the Final Regulations

provide general rules regarding this

election. Proposed § 1.163(j)–6(d)(5)

provides further guidance on this

election in the partnership context. The

Treasury Department and the IRS

request comments on these proposed

rules and on whether further guidance

is necessary.

V. Proposed § 1.163(j)–7: Application of

the Section 163(j) Limitation to Foreign

Corporations and United States

Shareholders

Proposed § 1.163(j)–7 in these

Proposed Regulations (Proposed

§ 1.163(j)–7) provides general rules

regarding the application of the section

163(j) limitation to foreign corporations

and U.S. shareholders of CFCs. This

section V describes proposed § 1.163(j)–

7 contained in the 2018 Proposed

Regulations, the comments received on

proposed § 1.163(j)–7 contained in the

2018 Proposed Regulations, and

Proposed § 1.163(j)–7.

A. Overview of Proposed § 1.163(j)–7

Contained in the 2018 Proposed

Regulations

1. General Application of Section 163(j)

Limitation to Applicable CFCs

The 2018 Proposed Regulations

clarify that, consistent with § 1.952–2,

section 163(j) and the section 163(j)

regulations apply to determine the

deductibility of an applicable CFC’s BIE

in the same manner as these provisions

apply to determine the deductibility of

a domestic C corporation’s BIE. The

2018 Proposed Regulations define an

applicable CFC as a CFC in which at

least one U.S. shareholder owns stock

within the meaning of section 958(a).

However, in certain cases, the 2018

Proposed Regulations allow certain

applicable CFCs to make a CFC group

election and be treated as part of a CFC

group for purposes of computing the

applicable CFC’s section 163(j)

limitation.

2. Limitation on Amount of Business

Interest Expense of a CFC Group

Member Subject to the Section 163(j)

Limitation

Under the 2018 Proposed Regulations,

if a CFC group election is in effect, the

amount of BIE of a CFC group member

that is subject to the section 163(j)

limitation is limited to the amount of

the CFC group member’s allocable share

of the CFC group’s applicable net BIE

(which is equal to the sum of the BIE of

all CFC group members, reduced by the

BII of all CFC group members). Thus, for

example, if a CFC group has no debt

other than loans between CFC group

members, no portion of the BIE of a CFC

group member would be subject to the

section 163(j) limitation. A CFC group

member’s allocable share is computed

by multiplying the applicable net BIE of

the CFC group by a fraction, the

numerator of which is the CFC group

member’s net BIE (computed on a

separate company basis), and the

denominator of which is the sum of the

amounts of the net BIE of each CFC

group member with net BIE (computed

on a separate company basis).

After applying the CFC group rules to

determine each CFC group member’s

allocable share of the CFC group’s

applicable net BIE, each CFC group

member that has BIE is required to

perform a stand-alone section 163(j)

calculation to determine whether any

BIE is disallowed under the section

163(j) limitation.

3. Membership in a CFC Group

Under the 2018 Proposed Regulations,

in general, a CFC group means two or

more applicable CFCs if at least 80

percent of the value of the stock of each

applicable CFC is owned, within the

meaning of section 958(a), by a single

U.S. shareholder or, in the aggregate, by

related U.S. shareholders that own stock

of each member in the same proportion.

The 2018 Proposed Regulations also

generally treat a controlled partnership

(in general, a partnership in which CFC

group members own, in the aggregate, at

least 80 percent of the interests) as a

CFC group member. For purposes of

identifying a CFC group, members of a

consolidated group are treated as a

single person, as are individuals filing a

joint return, and stock owned by certain

passthrough entities is treated as owned

proportionately by the owners or

beneficiaries of the passthrough entity.

The 2018 Proposed Regulations

exclude from the definition of a CFC

group member an applicable CFC that

has any income that is effectively

connected with the conduct of a trade

or business in the United States. In

addition, if one or more CFC group

members conduct a financial services

business, those entities are treated as

comprising a separate subgroup.

Under the 2018 Proposed Regulations,

a CFC group election is made by

applying the rules applicable to CFC

groups for purposes of computing each

CFC group member’s deduction for BIE.

Once made, the CFC group election is

irrevocable.

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1

Section 1.952–2(b) generally provides that the

taxable income for a foreign corporation is

determined by treating the foreign corporation as a

Continued

4. Roll-Up of CFC Excess Taxable

Income to Other CFC Group Members

and U.S. Shareholders

Under the 2018 Proposed Regulations,

if a CFC group election is in effect with

respect to a CFC group, then an upper-

tier CFC group member takes into

account a proportionate share of any

‘‘CFC excess taxable income’’ of a lower-

tier CFC group member in which it

directly owns stock for purposes of

computing the upper-tier member’s ATI.

The meaning of the term ‘‘CFC excess

taxable income’’ is analogous to the

meaning of the term ‘‘excess taxable

income’’ in the context of a partnership

and S corporation, and, in general,

means the amount of a CFC group

member’s ATI in excess of the amount

needed to prevent any BIE of the CFC

group member from being disallowed

under section 163(j).

Under the 2018 Proposed Regulations,

a U.S. shareholder is not permitted to

include in its ATI amounts included in

gross income under section 951(a)

(subpart F inclusions), section 951A(a)

(GILTI inclusions), or section 78

(section 78 inclusions) that are properly

allocable to a non-excepted trade or

business (collectively, deemed income

inclusions). However, the 2018

Proposed Regulations provide that a

portion of CFC excess taxable income of

the highest-tier applicable CFC is

permitted to be used to increase the ATI

of its U.S. shareholders. That portion is

equal to the U.S. shareholder’s interest

in the highest-tier applicable CFC

multiplied by its specified ETI ratio.

The numerator of the specified ETI ratio

is the sum of the U.S. shareholder’s

income inclusions under sections 951(a)

and 951A(a) with respect to the

specified highest-tier member and

specified lower-tier members, and the

denominator is the sum of the taxable

income of the specified highest-tier

member and specified lower-tier

members.

B. Summary of Comments on Proposed

§ 1.163(j)–7 Contained in the 2018

Proposed Regulations

The Treasury Department and the IRS

requested comments in the preamble to

the 2018 Proposed Regulations

regarding whether it would be

appropriate to further modify the

application of section 163(j) to

applicable CFCs and whether there are

particular circumstances in which it

may be appropriate to exempt an

applicable CFC from the application of

section 163(j). Some commenters

recommended that section 163(j) not

apply to applicable CFCs. Those

comments are addressed in part VIII of

the Summary of Comments and

Explanation of Revisions section in the

Final Regulations.

A number of commenters broadly

requested changes to the roll-up of CFC

excess taxable income. Many of these

commenters expressed concern about

the administrability of rolling up CFC

excess taxable income. Some

commenters suggested that the CFC

group election be available to a stand-

alone applicable CFC in order to allow

its CFC excess taxable income to be

used to increase the ATI of a U.S.

shareholder, or that an applicable CFC

be permitted to use any CFC excess

taxable income to increase the ATI of a

shareholder without regard to whether it

is a CFC group member. Furthermore,

some commenters asserted that the

nature of the roll-up compels

multinationals to restructure their

operations in order to move CFCs with

relatively high amounts of ATI and low

amounts of interest expense to the

bottom of the ownership chain and

CFCs with relatively low amounts of

ATI and high amounts of interest

expense to the top of the ownership

chain, in order to maximize the benefits

of the roll-up of CFC excess taxable

income.

Some commenters asserted that

because multinational organizations

may own hundreds of CFCs, applying

the section 163(j) limitation on a CFC-

by-CFC basis, without regard to whether

a CFC group election has been made

under the 2018 Proposed Regulations,

represents a significant administrative

burden. Many comments suggested that

CFC groups should be permitted to

apply section 163(j) on a group basis,

with a single group-level section 163(j)

calculation similar to the rules

applicable to a consolidated group. A

few commenters suggested that this rule

should be applied in addition to the

roll-up of CFC excess taxable income,

but most commenters recommended

that the group rule be applied instead of

the roll-up.

A number of commenters asserted

that the requirements to be a member of

a CFC group under the 2018 Proposed

Regulations are overly restrictive. Some

of these commenters recommended that

the 80-percent ownership threshold be

replaced with the ownership

requirements of affiliated groups under

section 1504(a), the rules of which are

well-known and understood. Others

recommended that the 80-percent

ownership requirement be reduced to 50

percent, consistent with the standard for

treatment of a foreign corporation as a

CFC. Still others asserted that U.S.

shareholders owning stock in applicable

CFCs should not each be required to

own the same proportion of stock in

each applicable CFC in order for their

ownership interests to count towards

the 80-percent ownership requirement,

or that the attribution rules of section

958(b), rather than section 958(a),

should apply for purposes of

determining whether the ownership

requirements are met. Finally, some of

these commenters requested that a CFC

group election be permitted when one

applicable CFC meets the ownership

requirements for other applicable CFCs,

even if no U.S. shareholder meets the

ownership requirements for a highest-

tier applicable CFC.

Some commenters requested the CFC

financial services subgroups not be

segregated from the CFC group and their

BIE and BII be included in the general

CFC group.

Some commenters requested that an

applicable CFC with effectively

connected income be permitted to be a

member of a CFC group and that only

its effectively connected income items

should be excluded. Alternatively,

commenters requested a de minimis

rule that would permit an applicable

CFC to be a member of a CFC group if

the applicable CFC’s effectively

connected income is below a certain

threshold of total income, such as 10

percent.

Some commenters requested that the

CFC group election be revocable. The

commenters proposed either making the

CFC group election an annual election

or providing that the election applies for

a certain period, for example, three or

five years, before it can be revoked.

Finally, commenters requested a safe

harbor or exclusion providing that if a

CFC group would not be limited under

section 163(j) either because the CFC

group has no net BIE or because its BIE

does not exceed 30 percent of the CFC

group’s ATI, a U.S. shareholder would

not have to apply section 163(j) for the

applicable CFC or be subject to

applicable CFC section 163(j) reporting

requirements.

C. Proposed § 1.163(j)–7

1. Overview

As noted in the preamble to the Final

Regulations, the Treasury Department

and the IRS have determined, based on

a plain reading of section 163(j) and

§ 1.952–2, that section 163(j) applies to

foreign corporations where relevant

under current law and has applied to

such corporations since the effective

date of the new provision.

1

Congress

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domestic corporation but with certain enumerated

exceptions. Section 1.952–2(c) provides for a

number of exceptions, but none of the exceptions

affects the application of section 163(j).

2

For purposes of Proposed §1.163(j)–7, the term

effectively connected income (or ECI) means

income or gain that is ECI, as defined in §1.884–

1(d)(1)(iii), and deduction or loss that is allocable

to, ECI, as defined in §1.884–1(d)(1)(iii).

expressly provided that section 163(j)

should not apply to certain small

businesses or to certain excepted trades

or businesses. Nothing in the Code or

legislative history indicates that

Congress intended to except other

persons with trades or businesses, as

defined in section 163(j)(7), from the

application of section 163(j).

Accordingly, the Treasury Department

and the IRS have determined that,

consistent with a plain reading of

section 163(j) and § 1.952–2, it is

appropriate for section 163(j) to apply to

applicable CFCs and other foreign

corporations whose taxable income is

relevant for Federal tax purposes (other

than by reason of having ECI or income

described in section 881 (FDAP))

(relevant foreign corporations).

2

In the

case of CFCs with ECI, see proposed

§ 1.163(j)–8. For further discussion of

the Treasury Department and the IRS’s

determination that there is not a

statutory basis for exempting applicable

CFCs from the application of section

163(j), see part VIII of the Summary of

Comments and Explanation of Revisions

section of the Final Regulations.

A number of comments were received

asserting that there are other

mechanisms that eliminate the policy

need for section 163(j) to apply to limit

leverage in CFCs. For example, some

commenters have cited tax rules in

foreign jurisdictions limiting interest

deductions, including thin

capitalization rules (or similar rules

intended to implement the Organisation

for Economic Co-operation and

Development (OECD) recommendations

under Action 4 of the Base Erosion and

Profits Shifting Project). The Treasury

Department and the IRS disagree with

these assertions. The Treasury

Department and the IRS note that these

rules are not universally applied in

other jurisdictions, that many

jurisdictions do not have any

meaningful interest expense limitation

rules, and that some jurisdictions have

no interest expense limitation rules of

any kind.

Even if some CFCs owned by a U.S.

shareholder are in foreign jurisdictions

with meaningful thin capitalization

rules, in the absence of section 163(j), it

would still be possible to use leverage

to reduce or eliminate a U.S.

shareholder’s global intangible low-

taxed income (GILTI) under section

951A for these CFCs. This is because for

purposes of computing a U.S.

shareholder’s GILTI under section 951A,

tested income of CFCs may be offset by

tested losses of CFCs owned by the U.S.

shareholder. See section 951A(c). The

ability to deduct interest without

limitation under section 163(j) would

result in tested losses in CFCs with

significant leverage. Because of this

aggregation, one overleveraged CFC in a

single jurisdiction that does not have

rules limiting interest expense can,

without the application of section

163(j), reduce or eliminate tested

income from all CFCs owned by a U.S.

shareholder regardless of jurisdiction.

Other comments suggested that, to the

extent that debt of a CFC is held by a

related party, transfer pricing principles

would discipline the amount of interest

expense. Comments also note that to the

extent that debt of a CFC is held by a

third party, market forces would

discipline the leverage present in the

CFC. While both of these concepts may

discipline the amount of leverage

present in a CFC, they would also

discipline the amount of leverage in any

entity. If Congress believed that market

forces and transfer pricing principles

were sufficient disciplines to prevent

overleverage, section 163(j) would not

have been amended as part of TCJA to

clearly apply to interest expense paid or

accrued to both third parties and related

parties. In addition, if transfer pricing

were sufficient to police interest

expense in the related party context, old

section 163(j) (as enacted in 1989 and

subsequently revised prior to TCJA)

would not have been necessary.

However, the Treasury Department

and the IRS also have determined that

it is appropriate, while still carrying out

the provisions of the statute and the

policies of section 163(j), to reduce the

administrative and compliance burdens

of applying section 163(j) to applicable

CFCs. Accordingly, Proposed § 1.163(j)–

7 allows for an election to be made to

apply section 163(j) on a group basis

with respect to applicable CFCs that are

‘‘specified group members’’ of a

‘‘specified group.’’ If the election is

made, the specified group members are

referred to as ‘‘CFC group members’’

and all of the CFC group members

collectively are referred to as a ‘‘CFC

group.’’ The rules for determining a

specified group and specified group

members are discussed in part V.C.3. of

this Explanation of Provisions section.

The rules and procedures for treating

specified group members as CFC group

members and for determining a CFC

group are discussed in part V.C.4. of this

Explanation of Provisions section.

In addition, Proposed § 1.163(j)–7

provides a safe harbor election that

exempts certain applicable CFCs from

application of section 163(j). The safe-

harbor election is available for stand-

alone applicable CFCs (which is an

applicable CFC that is not a specified

group member of a specified group) and

CFC group members. The election is not

available for an applicable CFC that is

a specified group member but not a CFC

group member because a CFC group

election is not in effect. See part V.C.7.

of this Explanation of Provisions

section.

Proposed § 1.163(j)–7 also provides an

anti-abuse rule that increases ATI in

certain circumstances.

Finally, Proposed § 1.163(j)–7 allows

a U.S. shareholder of a stand-alone

applicable CFC or a CFC group member

of a CFC group to include a portion of

its deemed income inclusions

attributable to the applicable CFC in the

U.S. shareholder’s ATI. This rule does

not apply with respect to an applicable

CFC that is a specified group member

but not a CFC group member because a

CFC group election is not in effect. See

part V.C.9. of this Explanation of

Provisions section.

The Treasury Department and the IRS

anticipate that, in many instances,

Proposed § 1.163(j)–7 will significantly

reduce the administrative and

compliance burdens of applying section

163(j) to applicable CFCs relative to the

2018 Proposed Regulations.

Unlike Proposed § 1.163(j)–8, which

provides rules for allocating disallowed

BIE to ECI and non-ECI, Proposed

§ 1.163(j)–7 does not allocate disallowed

BIE among classes of income. The

Treasury Department and the IRS

request comments on appropriate

methods of allocating disallowed BIE

among classes of income, such as

subpart F income, as defined in section

952, and tested income, as defined in

section 951A(c)(2)(A) and § 1.951A–

2(b)(1), as well as comments on whether

and the extent to which rules

implementing such methods may be

necessary.

In addition, the Treasury Department

and the IRS request comments on

appropriate methods of allocating

disallowed BIE for other purposes,

including between items described in

§ 1.163(j)–1(b)(22)(i) and other items

described in § 1.163(j)–1(b)(22) (defining

interest), as well as comments on

whether and the extent to which rules

implementing such methods may be

necessary.

The Treasury Department and the IRS

do not anticipate that section 163(j) will

affect the tax liability of a passive

foreign investment company, within the

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For example, assume a U.S. multinational group

parented by a consolidated group with a taxable

year that is the calendar year includes applicable

CFCs with November 30 taxable years and other

applicable CFCs with calendar year taxable years.

In this case, as discussed in more detail in part

V.C.3.b. of the Explanation of Provisions section,

the specified period of the CFC group for 2020

would begin on January 1, 2020, and end on

December 31, 2020. Furthermore, the specified

taxable year of a CFC group member with a taxable

year that is the calendar year is its taxable year

ending December 31, 2020, and the specified

taxable year of a CFC group member with a

November 30 taxable year is its taxable year ending

November 30, 2020 (the taxable years that end with

or within the specified period). A CFC group

member can also have multiple taxable years with

respect to a specified period. For example, a CFC

group member may have a short taxable year due

to an election under §1.245A–5T(e)(3)(i) (elective

exception to close a CFC’s taxable year in the case

of an extraordinary reduction).

meaning of section 1297(a) (PFIC), or its

shareholders, solely because the PFIC is

a relevant foreign corporation. See

§ 1.163(j)–4(c)(1) (providing that section

163(j) does not affect earnings and

profits). The Treasury Department and

the IRS request comments on whether

any additional guidance is needed to

reduce the compliance burden of

section 163(j) on PFICs and their

shareholders.

2. Application of Section 163(j) to CFC

Group Members

a. Single Section 163(j) Limitation for a

CFC Group

Proposed § 1.163(j)–7(c) provides

rules for applying section 163(j) to CFC

group members of a CFC group. Under

the Proposed Regulations, a single

section 163(j) limitation is computed for

a CFC group. See proposed § 1.163(j)–

7(c)(2). For this purpose, the current-

year BIE, disallowed BIE carryforwards,

BII, floor plan financing interest

expense, and ATI of a CFC group are

equal to the sums of the current-year

amounts of such items for each CFC

group member for its specified taxable

year with respect to the specified

period. (The terms ‘‘specified taxable

year’’ and ‘‘specified period’’ are

discussed in part V.C.3. of this

Explanation of Provisions section.) A

CFC group member’s current-year BIE,

BII, floor plan financing interest

expense, and ATI for a specified taxable

year are generally determined on a

separate-company basis before being

included in the CFC group calculation.

b. Allocation of CFC Group’s Section

163(j) Limitation to Business Interest

Expense of CFC Group Members

The extent to which a CFC group’s

section 163(j) limitation is allocated to

a particular CFC group member’s

current-year BIE and disallowed BIE

carryforwards is determined using the

rules that apply to consolidated groups

under § 1.163(j)–5(a)(2) and (b)(3)(ii)

(consolidated BIE rules), subject to

certain modifications. See proposed

§ 1.163(j)–7(c)(3)(i). Because many CFC

groups will be owned by consolidated

groups, many taxpayers will be familiar

with the consolidated BIE rules.

If the sum of the CFC group’s current-

year BIE and disallowed BIE

carryforwards exceeds the CFC group’s

section 163(j) limitation, then current-

year BIE is deducted first. If the CFC

group’s current-year BIE exceeds the

CFC group’s section 163(j) limitation,

then each CFC group member deducts

the amount of its current-year BIE not in

excess of the sum of its BII and floor

plan financing interest expense, if any.

Then, if the CFC group has any section

163(j) limitation remaining for the

current year, each applicable CFC with

remaining current-year BIE deducts a

pro rata portion thereof.

If the CFC group’s section 163(j)

limitation exceeds its current-year BIE,

then CFC group members may deduct

all of their current-year BIE and may

deduct disallowed BIE carryforwards

not in excess of the CFC group’s

remaining section 163(j) limitation. The

disallowed BIE carryforwards are

deducted in the order of the taxable

years in which they arose, beginning

with the earliest taxable year, and

disallowed BIE carryforwards that arose

in the same taxable year are deducted

on a pro rata basis. This taxable year

ordering rule is consistent with the

consolidated BIE rules. However,

Proposed § 1.163(j)–7 provides special

rules for disallowed BIE carryforwards

when CFC group members have

different taxable years, or a CFC group

member has multiple taxable years with

respect to the specified period of the

CFC group. Unlike members of a

consolidated group, not all CFC group

members will have the same taxable

years, and not all CFC group members

will have the same taxable year as the

parent of the CFC group. As discussed

in part V.C.3 of this Explanation of

Provisions section, a CFC group member

is included in a CFC group for its entire

taxable year that ends with or within a

specified period.

3

c. Limitation on Pre-Group Disallowed

Business Interest Expense

Carryforwards

The disallowed BIE carryforwards of

a CFC group member when it joins a

CFC group (pre-group disallowed BIE

carryforwards) are subject to the same

CFC group section 163(j) limitation and

are deducted pro rata with other CFC

group disallowed BIE carryforwards.

However, pre-group disallowed BIE

carryforwards are subject to additional

limitations, similar to the limitations on

deducting the disallowed BIE

carryforwards of a consolidated group

arising in a SRLY, as defined in

§ 1.1502–1(f), or treated as arising in a

SRLY under the principles of § 1.1502–

21(c) and (g). The policy of the

limitation imposed on pre-group BIE

carryforwards is analogous to the policy

of the SRLY limitation for consolidated

groups.

The rules and principles of § 1.163(j)–

5(d)(1)(B), which applies SRLY

subgroup principles to disallowed BIE

carryforwards of a consolidated group,

apply to pre-group subgroups. If a CFC

group member with pre-group

disallowed BIE carryforwards (loss

member) leaves one CFC group (former

group) and joins another CFC group

(current group), the loss member and

each other CFC group member that left

the former group and joined the current

group for a specified taxable year with

respect to the same specified period

consists of a ‘‘pre-group subgroup.’’

Unlike SRLY subgroups, it is not

required that all members of a pre-group

subgroup join the CFC group at the same

time, since each applicable CFC that

joins a CFC group is treated as joining

on the first day of its taxable year. As

a result, even if multiple applicable

CFCs are acquired on the same day in

a single transaction, they would join the

CFC group on different days if they have

different taxable years.

d. Special Rules for Specified Periods

Beginning in 2019 or 2020

Proposed § 1.163(j)–7(c)(5) provides

special rules for applying section

163(j)(10) to CFC groups. The proposed

regulations provide that elections under

section 163(j)(10) are made for a CFC

group (rather than for each CFC group

member). For a specified period of a

CFC group beginning in 2019 or 2020,

unless the election described in

§ 1.163(j)–2(b)(2)(ii)(A) is made, the CFC

group section 163(j) limitation is

determined by using 50 percent (rather

than 30 percent) of the CFC group’s ATI

for the specified period, without regard

to whether the taxable years of CFC

group members begin in 2019 or 2020.

If the election described in § 1.163(j)–

2(b)(2)(ii)(A) is made for a specified

period of a CFC group, the CFC group

section 163(j) limitation is determined

by using 30 percent (rather than 50

percent) of the CFC group’s ATI for the

specified period, without regard to

whether the taxable years of CFC group

members begin in 2019 or 2020. The

election is made for the CFC group by

each designated U.S. person.

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The election under § 1.163(j)–

2(b)(3)(i) to use 2019 ATI (that is, ATI

for the last taxable year beginning in

2019) rather than 2020 ATI (that is, ATI

for a taxable year beginning in 2020) is

made for a specified period of a CFC

group beginning in 2020 (2020 specified

period) and applies to the specified

taxable years of CFC group members

with respect to the 2020 specified

period. Accordingly, if a specified

taxable year of a CFC group member

with respect to a CFC group’s 2020

specified period begins in 2020, then

the election is applied to such taxable

year using the CFC group member’s ATI

for its last taxable year beginning in

2019. In some cases, the specified

taxable year of a CFC group member

with respect to a CFC group’s 2020

specified period will begin in 2019 or

2021. If the specified taxable year of the

CFC group member begins in 2019, then

the election is applied to such taxable

year using the CFC group member’s ATI

for its last taxable year beginning in

2018; if the specified taxable year of the

CFC group member begins in 2021, then

the election is applied to such taxable

year using the CFC group member’s ATI

for its last taxable year beginning in

2020.

For example, assume a CFC group has

two CFC group members, CFC1 and

CFC2, and has a specified period that is

the calendar year. CFC1 has a taxable

year that is the calendar year, and CFC2

has a taxable year that ends November

30. The election under § 1.163(j)–

2(b)(3)(i) is in effect for the specified

period beginning January 1, 2020, and

ending December 31, 2020 (which is the

2020 specified period). As a result, the

ATI of the CFC group for the 2020

specified period is determined by

reference to the specified taxable year of

CFC1 beginning January 1, 2019, and

ending December 31, 2019 (the last

taxable year beginning in 2019), and the

specified taxable year of CFC2

beginning December 1, 2018, and

ending November 30, 2019 (the last

taxable year beginning in 2018).

Alternatively, assume (i) the same

CFC group instead has a 2020 specified

period that begins on December 1, 2020,

and ends on November 30, 2021; (ii) in

2019 and 2020, CFC1 has a taxable year

that is the calendar year, but in 2021,

CFC1 has a short taxable year that

begins on January 1, 2021, and ends on

June 30, 2021; and (iii) CFC2 has a

taxable year ending November 30 (for all

years). Further assume that the election

under § 1.163(j)–2(b)(3)(i) is in effect for

the 2020 specified period. In this case,

the election applies to the specified

taxable year of CFC1 that begins on

January 1, 2020, and ends on December

31, 2020; the specified taxable year of

CFC1 that begins on January 1, 2021,

and ends on June 30, 2021; and the

specified taxable year of CFC2 that

begins on December 1, 2020, and ends

on November 30, 2021. As a result of the

election, the ATI of the CFC group for

the 2020 specified period is determined

by reference to the specified taxable

year of CFC1 beginning January 1, 2019,

and ending December 31, 2019, the

specified taxable year of CFC1

beginning January 1, 2020, and ending

December 31, 2020, and the specified

taxable year of CFC2 beginning

December 1, 2019, and ending

November 30, 2020.

If the election under § 1.163(j)–

2(b)(3)(i) to use 2019 ATI rather than

2020 ATI is made for a CFC group, the

CFC group’s ATI for the 2020 specified

period is determined by reference to the

2019 ATI of all CFC group members

(except to the extent that 2018 or 2020

ATI is used, as described earlier),

including any CFC group member that

joins the CFC group during the 2020

specified period. Therefore, a CFC

group’s ATI for the 2020 specified

period may be determined by reference

to a prior taxable year of a new CFC

group member even though the CFC

group member was not a CFC group

member in the prior taxable year. If a

CFC group member leaves the CFC

group during the 2020 specified period,

the ATI of the CFC group for the 2020

specified period is determined without

regard to the ATI of the departing CFC

group member.

As stated in the Background section of

this preamble, Revenue Procedure

2020–22 generally provides the time

and manner of making or revoking

elections under section 163(j)(10),

including elections with respect to

applicable CFCs. References in Revenue

Procedure 2020–22 to CFC groups and

CFC group members are to CFC groups

and applicable CFCs for which a CFC

group election is made under the 2018

Proposed Regulations. The rules

described in this part V.C.2.d of this

Explanation of Provisions section and

proposed § 1.163(j)–7(c)(5) modify the

application of Revenue Procedure 2020–

22 and the elections under section

163(j)(10) for CFC groups and applicable

CFCs for which a CFC group election is

made under Proposed § 1.163(j)–7.

Thus, for example, if a CFC group has

two designated U.S. persons that are

U.S. corporations, pursuant to proposed

§ 1.163(j)–7(c)(5), the election to not

apply the 50 percent ATI limitation to

the CFC group for a specified period

beginning in 2020 is made for the

specified period of the CFC group by

each designated U.S. person, and

pursuant to Revenue Procedure 2020–

22, section 6.01(2), the election to not

apply the 50 percent ATI limitation is

made by the each designated U.S.

person timely filing a Federal income

tax return, including extensions, using

the 30 percent ATI limitation for

purposes of determining the taxable

income of the CFC group.

For purposes of applying § 1.964–1(c),

the elections described in proposed

§ 1.163(j)–7(c)(5) are treated as if made

for each CFC group member. Thus, the

requirements to provide a statement and

written notice as provided under

§ 1.964–1(c)(3)(i)(B) and (C) apply.

3. Specified Groups and Specified

Group Members

a. In General

Proposed § 1.163(j)–7(d) provides

rules for determining a specified group

and specified group members. The

determination of a specified group and

specified group members is the basis for

determining a CFC group and CFC

group members. This is because a CFC

group member is a specified group

member of a specified group for which

a CFC group election is in effect, and a

CFC group consists of all the CFC group

members. See proposed § 1.163(j)–

7(e)(2).

b. Specified Group

Under proposed § 1.163(j)–7(d)(2), a

specified group includes one or more

chains of applicable CFCs connected

through stock ownership with a

specified group parent, but only if the

specified group parent owns stock

meeting the requirements of section

1504(a)(2)(B) (pertaining to value) in at

least one applicable CFC, and stock

meeting the requirements of section

1504(a)(2)(B) in each of the applicable

CFCs (except the specified group parent)

is owned by one or more of the other

applicable CFCs or the specified group

parent.

Unlike the general rules in section

1504, in order to avoid breaking

affiliation with a partnership or foreign

trust or foreign estate, for purposes of

determining whether stock in an

applicable CFC meeting the

requirements of section 1504(a)(2)(B) is

owned by the specified group parent or

other applicable CFCs, proposed

§ 1.163(j)–7(d)(2) takes into account

both stock owned directly and stock

owned indirectly under section

318(a)(2)(A) through a domestic or

foreign partnership or under section

318(a)(2)(A) or (a)(2)(B) through a

foreign estate or trust (the look-through

rule). For example, assume CFC1 and

CFC2 is each an applicable CFC and a

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For example, assume a specified group parent

with a specified period that is the calendar year

acquires all of the stock of CFC1, an applicable CFC,

on June 30, Year 1, and sells all of the stock of CFC1

on June 30, Year 3. CFC1 has a November 30 taxable

year, and the specified period is the calendar year.

CFC1 is included in the specified group on

November 30, Year 1, and November 30, Year 2 (but

not November 30, Year 3). As a result, CFC1 is a

specified group member for its taxable year ending

November 30, Year 1, with respect to the specified

period ending December 31, Year 1, and for its

taxable year ending November 30, Year 2, with

respect to the specified period ending December 31,

Year 2. Solely for purposes of applying the

§1.1502–75(d) principles, CFC1 is treated as

affiliated with the specified group parent from the

beginning to the end of the specified period ending

December 31, Year 1, and from the beginning to the

end of the specified period ending December 31,

Year 2. In other words, CFC1 is treated as affiliated

with the specified group parent from January 1,

Year 1, to December 31, Year 2.

5

For example, assume CFC1, an applicable CFC,

has a taxable year beginning December 1, Year 1,

and ending November 30, Year 2, and a specified

group has a specified period beginning January 1,

Year 2, and ending December 31, Year 2. If CFC1

is included in the specified group on November 30,

Year 2, then CFC1 is a specified group member with

respect to the specified period for its entire taxable

year ending November 30, Year 2. This is the case

even if CFC1 is not included in the specified group

during part of its taxable year ending November 30,

Year 2 (for example, because all of the stock of

CFC2 is purchased by the specified group on June

1, Year 2, and its taxable year does not close as a

result of joining the specified group), or if CFC1

ceases to be included in the specified group after

November 30, Year 2, but before December 31, Year

2 (for example, because all of the stock of CFC1 is

Continued

specified group member of a specified

group. If CFC1 and CFC2 each own 50

percent of the capital and profits

interests in a partnership, and the

partnership wholly owns CFC3, an

applicable CFC, then, by reason of the

look-through rule, CFC3 is also included

in the specified group, although the

partnership is not.

The specified group rules also differ

from the affiliated group rules in section

1504 in that they require only that 80

percent of the total value (pursuant to

section 1504(a)(2)(B)), not 80 percent of

both vote and value (pursuant to section

1504(a)(2)(A) and (a)(2)(B)), of an

applicable CFC be owned by the

specified group parent or other

applicable CFCs in the specified group

in order for the applicable CFC to be

included in the specified group. The

Treasury Department and the IRS

determined that limiting the 80-percent

threshold to value is appropriate to

prevent taxpayers from breaking

affiliation by diluting voting power

below 80 percent.

The specified group has a single

specified group parent, which may be

either a qualified U.S. person or an

applicable CFC. However, the specified

group parent is included in the

specified group only if it is an

applicable CFC. For this purpose, a

qualified U.S. person means a U.S.

person that is a citizen or resident of the

United States or a domestic corporation.

For purposes of determining the

specified group parent, members of a

consolidated group are treated as a

single corporation and individuals

whose filing status is ‘‘married filing

jointly’’ are treated as a single

individual (aggregation rule). The

Treasury Department and the IRS have

determined that the aggregation rule is

appropriate because all deemed

inclusions with respect to applicable

CFCs included in gross income of

members of a consolidated group or of

individuals filing a joint return, as

applicable, are reported on a single U.S.

tax return. The Treasury Department

and the IRS determined that it is

appropriate for an S corporation to be a

qualified U.S. person because an S

corporation can have only a single class

of stock and therefore the economic

rights of its shareholders in all

applicable CFCs owned by the S

corporation are proportionate to share

ownership. On the other hand, the

Treasury Department and the IRS have

determined that it is not appropriate for

a domestic partnership to be a qualified

U.S. person because of the ability of

partnerships to make disproportionate

or special allocations and therefore the

economic rights of partners in the

partnership with respect to all

applicable CFCs owned by a partnership

will not necessarily be proportionate to

ownership. However, if, for example, a

domestic partnership wholly owns an

applicable CFC, which wholly owns

multiple other applicable CFCs, and no

qualified U.S. person owns stock in the

top-tier CFC meeting the requirements

of section 1504(a)(2)(B), taking into

account the look-through rule, then the

applicable CFCs are included in a

specified group of which the top-tier

CFC is the specified group parent.

The Treasury Department and the IRS

request comments regarding whether,

and to what extent, the definition of a

‘‘qualified U.S. person’’ should be

expanded to include domestic estates

and trusts or whether and to what extent

the look-through rule should apply if

stock of applicable CFCs is owned by

domestic estates and trusts.

Each specified group has a specified

period. A specified period is similar to

a taxable year but determined with

respect to a specified group. A specified

group does not have a taxable year

because the specified group members

may not have the same taxable year. If

the specified group parent is a qualified

U.S. person, the specified period

generally ends on the last day of the

taxable year of the specified group

parent and begins on the first day after

the last day of the prior specified

period. Thus, for example, if the

specified group parent is a domestic

corporation with a calendar year taxable

year, the specified period generally

begins on January 1 and ends on

December 31. If the specified group

parent is an applicable CFC, the

specified period generally ends on the

last day of the required year of the

specified group parent, determined

under section 898(c)(1), without regard

to section 898(c)(2), and begins on the

first day after the last day of the prior

specified period. However, a specified

period never begins before the first day

on which the specified group exists or

ends after the last day on which the

specified group exists. Like a taxable

year, a specified period can never be

longer than 12 months.

The principles of § 1.1502–75(d)(1),

(d)(2)(i) through (d)(2)(ii), and (d)(3)(i)

through (d)(3)(iv) (regarding when a

consolidated group remains in

existence) (§ 1.1502–75(d) principles)

apply for purposes of determining when

a specified group ceases to exist. Solely

for purposes of applying the § 1.1502–

75(d) principles, each applicable CFC

that is treated as a specified group

member for a taxable year of the

applicable CFC with respect to a

specified period is treated as affiliated

with the specified group parent from the

beginning to the end of the specified

period, without regard to the beginning

or end of its taxable year. This rule does

not affect the general rule that, for

purposes other than § 1.1502–75(d)

(such as the application of section 163(j)

to a CFC group), an applicable CFC is

a specified group member with respect

to a specified period for its taxable year

ending with or within the specified

period.

4

The Treasury Department and the IRS

request comments as to whether any

modifications to the § 1.1502–75(d)

principles should be made for specified

groups.

c. Specified Group Members

Proposed § 1.163(j)–7(d)(3) provides

rules for determining specified group

members with respect to a specified

group. The determination as to whether

an applicable CFC is a specified group

member is made with respect to a

taxable year of the applicable CFC and

specified period of a specified group.

Specifically, if the applicable CFC is

included in a specified group on the last

day of its taxable year that ends with or

within the specified period, the

applicable CFC is a specified group

member with respect to the specified

period for the entire taxable year.

5

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sold by the specified group on December 15, Year

2).

The Treasury Department and the IRS

are concerned about the potential for

abuse that may arise if taxpayers cause

an applicable CFC that otherwise would

be treated as a specified group member

and a CFC group member to avoid being

treated as a CFC group member. For

example, the Treasury Department and

the IRS have determined that it is not

appropriate for taxpayers to prevent an

applicable CFC with high ATI and low

BIE from being part of a CFC group with

a goal of increasing its CFC excess

taxable income and its U.S.

shareholders’ ATI inclusions, rather

than allowing the applicable CFC’s ATI

to be used by the CFC group. The

Treasury Department and the IRS

request comments on appropriate

methods of preventing an applicable

CFC from avoiding being a CFC group

member for purposes of increasing the

ATI of its U.S. shareholders. The

Treasury Department and the IRS also

request comments on whether a rule

similar to the rule in section 1504(a)(3),

which prevents domestic corporations

from rejoining a consolidated group for

60 months, should apply to prevent

applicable CFCs from rejoining a CFC

group.

4. CFC Groups and CFC Group Members

a. In General

Proposed § 1.163(j)–7(e) provides

rules and procedures for treating

specified group members as CFC group

members and for determining a CFC

group. A CFC group member means a

specified group member of a specified

group for which a CFC group election is

in effect. The specified group member is

a CFC group member for a specified

taxable year with respect to a specified

period. A CFC group means all CFC

group members for their specified

taxable years with respect to a specified

period. See proposed § 1.163(j)–7(e)(2)

(defining CFC group and CFC group

member). Thus, if a CFC group election

is in place, the terms ‘‘specified group

members,’’ ‘‘CFC group members,’’ and

a ‘‘CFC group’’ refer to the same

applicable CFCs. The term ‘‘specified

group,’’ which is determined at any

moment in time, may not necessarily

refer to the exact same applicable CFCs.

Once a CFC group election is made,

the CFC group continues until the CFC

group election is revoked or until the

end of the last specified period with

respect to the specified group. See

proposed § 1.163(j)–7(e)(3). When a CFC

group election is in effect, if an

applicable CFC becomes a specified

group member with respect to a

specified period of the specified group,

the CFC group election applies to the

applicable CFC and it becomes a CFC

group member. When an applicable CFC

ceases to be a specified group member

with respect to a specified period of a

specified group, the CFC group election

terminates solely with respect to the

applicable CFC. See proposed

§ 1.163(j)–7(e)(4) (joining or leaving a

CFC group).

b. Making or Revoking a CFC Group

Election

Proposed § 1.163(j)–7(e)(5) provides

rules for making and revoking a CFC

group election. Proposed § 1.163(j)–

7(e)(5)(i) provides that a CFC group

election applies with respect to a

specified period of a specified group.

Accordingly, the CFC group election

applies to each specified group member

for its entire specified taxable year that

ends with or within the specified

period. In response to comments to the

2018 Proposed Regulations, the CFC

group election is not irrevocable.

Instead, once made, a CFC group

election cannot be revoked with respect

to any specified period of the specified

group that begins during the 60-month

period following the last day of the first

specified period for which the election

was made. Similarly, once revoked, a

CFC group election cannot be made

again with respect to any specified

period of the specified group that begins

during the 60-month period following

the last day of the first specified period

for which the election was revoked.

The Treasury Department and the IRS

request comments regarding whether a

specified group that does not make a

CFC group election when it first comes

into existence (or for the first specified

period following 60 days after the date

of publication of the Treasury decision

adopting these regulations as final in the

Federal Register) should be prohibited

from making the CFC group election for

any specified period beginning during

the 60-month period following that

specified period.

Thus, under the Proposed

Regulations, in the case of a specified

group, taxpayers choose to apply section

163(j) to specified group members on a

CFC group basis or on a stand-alone

basis for no less than a 60-month period.

The Treasury Department and the IRS

have determined that a 60-month period

is an appropriate balance between

making the choice irrevocable and

providing an annual election, the latter

of which may facilitate inappropriate

tax planning (in this regard, see, for

example, the discussion in part C.7 of

this part V of the Explanation of

Provisions section).

c. Specified Financial Services

Subgroup Rules

In response to comments, Proposed

§ 1.163(j)–7 does not provide for CFC

financial services subgroups. Instead,

applicable CFCs that otherwise qualify

as CFC group members are treated as

part of the same CFC group.

d. Interaction of the CFC Group Election

in Proposed § 1.163(j)–7 With the CFC

Group Election in the 2018 Proposed

Regulations

The CFC group election can be made

only in accordance with the method

prescribed in proposed § 1.163(j)–

7(e)(5). The 2018 Proposed Regulations

also contained an election called a ‘‘CFC

group election’’ (old CFC group

election). The old CFC group election is

a different election than the CFC group

election contained in Proposed

§ 1.163(j)–7. Accordingly, the old CFC

group election may be relied on only for

taxable years in which the taxpayer

relies on the 2018 Proposed Regulations.

Whether an old CFC group election was

made under the 2018 Proposed

Regulations has no effect on whether a

CFC group election under proposed

§ 1.163(j)–7(e)(5) is in effect for any

taxable year in which the taxpayer relies

on Proposed § 1.163(j)–7.

5. Exclusion of ECI From Application of

Section 163(j) to a CFC Group

In response to comments, proposed

§ 1.163(j)–7 provides that an applicable

CFC with ECI is not precluded from

being a CFC group member. However,

under proposed § 1.163(j)–7(f), only the

ATI, BII, BIE, and floor plan financing

of the applicable CFC that are not

attributable to ECI are included in the

CFC group’s section 163(j) calculations.

The ECI items of the applicable CFC are

not included in the CFC group

calculations. Instead, the ECI of the

applicable CFC is treated as income of

a separate CFC, an ‘‘ECI deemed

corporation,’’ that has the same taxable

year and shareholders as the applicable

CFC, but that is not a CFC group

member. The ECI deemed corporation

must do a separate section 163(j)

calculation for its ECI in accordance

with Proposed § 1.163(j)–8. See

Proposed § 1.163(j)–8 and part VI of this

Explanation of Provisions section for

rules applicable to foreign corporations

with ECI.

6. Treatment of Foreign Taxes for

Purposes of Computing ATI

Proposed § 1.163(j)–7(g)(3) provides

that, for purposes of computing its ATI,

tentative taxable income of a relevant

foreign corporation is determined by

taking into account a deduction for

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For example, assume that, before taking into

account BIE, a stand-alone applicable CFC has net

income of $0x, consisting of $100x of subpart F

income, a $100x loss attributable to foreign oil and

gas extraction income, as defined in section

907(c)(1). It also has $20x of BIE, no BII, and no

floor plan financing interest expense. The ATI of

the CFC is zero and the section 163(j) limitation

would be zero. However, the eligible amount of the

CFC is $100x. Thus, absent a rule limiting the safe

harbor to 30 percent of qualified tentative taxable

income, the CFC would be permitted to deduct its

$20x of business interest expense under the safe

harbor, even though none of the BIE would be

deductible under the section 163(j) limitation.

foreign taxes. This rule is consistent

with § 1.952–2, which provides that the

taxable income of a foreign corporation

for any taxable year is determined by

treating the foreign corporation as a

domestic corporation, and section

164(a), which allows a deduction for

foreign taxes. The Treasury Department

and the IRS request comments regarding

whether, and the extent to which, the

ATI of a relevant foreign corporation

should be determined by adding to

tentative taxable income any deductions

for foreign income taxes.

7. Anti-Abuse Rule

The Treasury Department and the IRS

are concerned that, in certain situations,

U.S. shareholders may inappropriately

affirmatively plan to limit BIE

deductions as part of a tax-planning

transaction, including by not making a

CFC group election for purposes of

increasing the disallowed BIE of a

specified group member or of a

partnership substantially owned by

specified group members of the same

specified group. For example, in a

taxable year in which a U.S. shareholder

would otherwise have foreign tax

credits in the section 951A category in

excess of the section 904 limitation, a

U.S. shareholder might inappropriately

cause one specified group member to

pay interest to another specified group

member in an amount in excess of the

borrowing specified group member’s

section 163(j) limitation. As a result, the

U.S. shareholder’s pro rata share of

tested income of the borrowing

specified group member for the taxable

year would be increased without

increasing the U.S. shareholder’s

Federal income tax because excess

foreign tax credits in the section 951A

category in the taxable year that cannot

be carried forward to a future taxable

year would offset the Federal income

tax on the incremental increase in the

U.S. shareholder’s pro rata share of

tested income, while also enabling the

borrowing specified group member to

generate a disallowed BIE carryforward

that may be used in a subsequent

taxable year.

Accordingly, under proposed

§ 1.163(j)–7(g)(4), if certain conditions

are met, when one specified group

member or applicable partnership

(specified borrower) pays interest to

another specified group member or

applicable partnership (specified

lender), and the payment is BIE to the

specified borrower and income to the

specified lender, then the ATI of the

specified borrower is increased by the

amount necessary such that the BIE of

the specified borrower is not limited

under section 163(j). This amount is

determined by multiplying the lesser of

the payment amount or the disallowed

BIE (computed without regard to this

ATI adjustment) by 3

1

⁄

3

(or by 2, in the

case of taxable years or specified taxable

years with respect to a specified period

for which the section 163(j) limitation is

determined by reference to 50 percent of

ATI). A partnership is an applicable

partnership if at least 80 percent of the

capital or profits interests is owned, in

aggregate, by direct or direct partners

that are specified group members of the

same specified group. The conditions

for this rule to apply are as follows: (i)

The BIE is incurred with a principal

purpose of reducing the Federal income

tax liability of a U.S. shareholder

(including over multiple taxable years);

(ii) the effect of the specified borrower

treating the payment amount as

disallowed BIE would be to reduce the

Federal income tax of a U.S.

shareholder; and (iii) either no CFC

group election is in effect or the

specified borrower is an applicable

partnership.

8. The Safe-Harbor Election

Proposed § 1.163(j)–7(h) provides a

safe-harbor election for stand-alone

applicable CFCs and CFC groups. If the

safe-harbor election is in effect for a

taxable year, no portion of the BIE of the

stand-alone applicable CFC or of each

CFC group member, as applicable, is

disallowed under the section 163(j)

limitation. The safe-harbor election is an

annual election. If the election is made,

then no portion of any CFC excess

taxable income is included in a U.S.

shareholder’s ATI. See proposed

§ 1.163(j)–7(j)(2)(iv).

The safe-harbor election cannot be

made with respect to any foreign

corporation that is not a stand-alone

applicable CFC or a CFC group member.

As a result, if a CFC group election is

not in effect for a specified period, a

specified group member of the specified

group is not eligible for the safe-harbor

election.

In the case of a stand-alone applicable

CFC, the safe-harbor election may be

made for a taxable year of the stand-

alone applicable CFC if its BIE does not

exceed 30 percent of the lesser of (i) its

tentative taxable income attributable to

non-excepted trades or businesses

(referred to as ‘‘qualified tentative

taxable income’’), and (ii) its ‘‘eligible

amount’’ for the taxable year. In the case

of a CFC group, the safe-harbor election

may be made for the specified taxable

years of each CFC group member with

respect to a specified period if the CFC

group’s BIE does not exceed 30 percent

of the lesser of (i) the sum of the

qualified tentative taxable income of

each CFC group member, and (ii) the

sum of the eligible amounts of each CFC

group member. For taxable years of a

stand-alone applicable CFC or specified

periods of a CFC group beginning in

2019 or 2020, the 30 percent limitation

is replaced with a 50 percent limitation,

consistent with the change in the

section 163(j) limitation to take into

account 50 percent, rather than 30

percent, of ATI for such taxable years or

specified periods.

The ‘‘eligible amount’’ is a CFC-level

determination. In general, the eligible

amount is the sum of the applicable

CFC’s subpart F income plus the

approximate amount of GILTI

inclusions its U.S. shareholders would

have were the applicable CFC wholly

owned by domestic corporations that

had no tested losses and that were not

subject to the section 250(a)(2)

limitation on the section 250(a)(1)

deduction. Amounts used in the

determination of the eligible amount are

computed without regard to the

application of section 163(j) and the

section 163(j) regulations. While the

eligible amount of an applicable CFC

cannot be negative, qualified tentative

taxable income can be negative. Thus,

limiting the safe-harbor to 30 percent of

qualified tentative taxable income

ensures that losses of a stand-alone

applicable CFC or a CFC group are taken

into account in determining whether the

stand-alone applicable CFC or the CFC

group qualifies for the safe-harbor.

6

The safe-harbor election does not

apply to EBIE, as described in

§ 1.163(j)–6(f)(2), and EBIE is not taken

into account for purposes of

determining whether the safe-harbor

election is available for a stand-alone

applicable CFC or a CFC group, until

such business interest expense is treated

as paid or accrued by an applicable CFC

in a succeeding year (that is, until the

applicable CFC is allocated excess

taxable income or excess business

interest income from such partnership

in accordance with § 1.163(j)–6(g)(2)(i)).

The safe-harbor election is intended

to reduce the compliance burden on

applicable CFCs that would not have

disallowed BIE if they applied the

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The Treasury Department and the IRS anticipate

that a domestic partnership’s gross income

inclusions under sections 951(a) and 951A(a) will

virtually always be investment income to the

partnership. See section 163(j)(5), excluding

‘‘investment interest’’ subject to section 163(d) from

the definition of business interest, and sections

163(d)(3)(A) and (d)(5), treating as investment

interest any interest properly allocable to ‘‘property

which produces income of a type described in

section 469(e)(1).’’ See also §1.469–2T(c)(3).

8

For example, assume a U.S. shareholder wholly

owns CFC1, which wholly owns CFC2. CFC1 and

CFC2 each have $100x of ATI and no business

interest income or floor plan financing interest

expense. CFC1 and CFC2 have not made a CFC

group election. If CFC1 and CFC2 each have $35x

of business interest expense, under section 163(j),

CFC1 and CFC2 could each deduct $30x of business

interest expense and have a $5x disallowed

business interest expense carryforward. Neither

CFC1 nor CFC2 would have CFC excess taxable

income. As a result, the U.S. shareholder would

have no ATI inclusion from CFC1 or CFC2.

However, if the CFCs move all of CFC2’s debt to

CFC1, CFC1 would deduct $30x of business interest

expense and have a $40x disallowed business

interest expense carryforward. Absent rules

providing otherwise, CFC2 would have $100x of

CFC excess taxable income and $100x of ATI,

allowing the U.S. shareholder to include in its ATI

its CFC income inclusion attributable to CFC2 (to

the extent attributable to a non-excepted trade or

business and not attributable to section 78 ‘‘gross-

up’’ inclusions).

section 163(j) calculation. However, the

Treasury Department and the IRS are

concerned that the safe-harbor election

might be used to deduct pre-group

disallowed BIE carryforwards that

would be limited under proposed

§ 1.163(j)–7(c)(3)(iv) (rules similar to the

consolidated SRLY rules). Accordingly,

the proposed regulations provide that a

safe-harbor election cannot be made for

a CFC group that has pre-group

disallowed BIE carryforward. The

Treasury Department and the IRS

request comments on whether the safe-

harbor election should be available for

CFC groups with pre-group disallowed

BIE carryforwards and, if so, appropriate

methods of preventing pre-group

disallowed BIE carryforwards that

would be limited under proposed

§ 1.163(j)–7(c)(3)(iv) from being

deductible by CFC group members of

CFC groups that apply the safe-harbor

election.

The Treasury Department and the IRS

also request comments on appropriate

modifications, if any, to the safe-harbor

election that would further the goal of

reducing the compliance burden on

stand-alone applicable CFCs and CFC

groups that would not have disallowed

BIE if they applied the section 163(j)

limitation.

9. Increase in Adjusted Taxable Income

of U.S. Shareholders

As a general matter, a U.S.

shareholder does not include in its ATI

any portion of its specified deemed

inclusions. Specified deemed inclusions

include the U.S. shareholder’s deemed

income inclusions attributable to an

applicable CFC and a non-excepted

trade or business of the U.S.

shareholder. See § 1.163(j)–1(b)(2)(ii)(G).

Specified deemed inclusions also

include amounts included in a domestic

C corporation’s allocable share of a

domestic partnership’s gross income

inclusions under sections 951(a) and

951A(a) with respect to an applicable

CFC that are investment income to the

partnership, to the extent that such

amounts are treated as properly

allocable to a non-excepted trade or

business of the domestic C corporation

under §§ 1.163(j)–4(b)(3) and 1.163(j)–

10.

7

However, consistent with

comments received, proposed

§ 1.163(j)–7(j) allows a U.S. shareholder

to include in its ATI a portion of its

specified deemed inclusions that are

attributable to either a stand-alone

applicable CFC or a CFC group member,

except to the extent attributable to

section 78 ‘‘gross-up’’ inclusions. That

portion is equal to the ratio of the

applicable CFC’s CFC excess taxable

income over its ATI.

In the case of a stand-alone applicable

CFC, CFC excess taxable income is

equal to an amount that bears the same

ratio to the applicable CFC’s ATI as (i)

the excess of 30 percent of the

applicable CFC’s ATI over the amount,

if any, by which its BIE exceeds its BII

and floor plan financing interest

expense, bears to (ii) 30 percent of its

ATI. In the case of a CFC group, each

applicable CFC’s CFC excess taxable

income is determined by calculating the

excess taxable income of the CFC group

and allocating it to each CFC group

member pro rata on the basis of the CFC

group member’s ATI. For any taxable

year or specified period to which the 50

percent (rather than 30 percent)

limitation applies under section

163(j)(10), the formula for calculating

CFC excess taxable income is adjusted

accordingly.

The Treasury Department and the IRS

are concerned that taxpayers may

inappropriately attempt to aggregate

debt in certain specified group members

for which a CFC group election is not

in effect, thereby overleveraging some

specified group members and artificially

creating CFC excess taxable income in

other specified group members for

purposes of increasing the ATI of a U.S.

shareholder.

8

Accordingly, the Treasury

Department and the IRS have

determined that any excess taxable

income of a specified group member

should not become available to increase

the ATI of a U.S. shareholder unless a

CFC group election is in effect and the

CFC group has not exceeded its section

163(j) limitation. Accordingly, under

proposed § 1.163(j)–7(j)(4)(ii), only U.S.

shareholders of stand-alone applicable

CFCs and CFC group members can

increase their ATI for a portion of their

specified deemed inclusion. To the

extent that a CFC group election is not

in effect, a U.S. shareholder may not

increase its ATI for any portion of its

specified deemed inclusion attributable

to a specified group member of the

specified group.

In addition, if a safe-harbor election is

in effect with respect to the taxable year

of a stand-alone applicable CFC or the

specified period of a CFC group, CFC

excess taxable income is not calculated

for the stand-alone applicable CFC or

the CFC group members. As a result,

proposed § 1.163(j)–7(j)(4)(i) provides

that a U.S. shareholder of a stand-alone

applicable CFC or of a CFC group

member for which the safe-harbor

election is in effect does not increase its

ATI for any portion of its specified

deemed inclusion attributable to the

stand-alone applicable CFC or CFC

group member.

VI. Section 1.163(j)–8: Application of

the Business Interest Deduction

Limitation to Foreign Persons With

Effectively Connected Income

A. Proposed § 1.163(j)–8 Contained in

the 2018 Proposed Regulations

The 2018 Proposed Regulations under

§ 1.163(j)–8 provide rules for how

section 163(j) applies to a nonresident

alien individual or foreign corporation

that is not an applicable CFC (specified

foreign person) with ECI. Although the

regulations under section 163(j)

generally apply to specified foreign

persons, a number of the general rules

under section 163(j) need to be adjusted

to take into account the fact that a

specified foreign person is taxed only on

its ECI rather than all of its income.

Accordingly, the definitions for ATI,

BIE, BII, and floor plan financing

interest expense are modified to limit

such amounts to items that are, or are

allocable to, ECI. The 2018 Proposed

Regulations also modify § 1.163(j)–10(c)

to provide that a specified foreign

person’s interest expense and interest

income are only allocable to excepted or

non-excepted trades or businesses that

have ECI.

Under the 2018 Proposed Regulations,

a specified foreign person that is a

partner in a partnership that has ECI

(specified foreign partner) is required to

modify the application of the general

allocation rules in § 1.163(j)–6 with

respect to ETI, EBIE, and EBII of the

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For purposes of Proposed §1.163(j)–8, the term

effectively connected income (or ECI) means income

or gain that is ECI, as defined in §1.884–1(d)(1)(iii),

and deduction or loss that is allocable to, ECI, as

defined in §1.884–1(d)(1)(iii).

partnership to take into account only

the partnership’s items that are, or are

allocable to, ECI. Although the section

163(j) limitation is determined on an

entity basis by a partnership, the

Treasury Department and the IRS

determined that excess items of a

partnership should only be used by the

specified foreign partner to the extent

that the excess items arise from

partnership items that are ECI with

respect to the specified foreign partner.

The amount of ETI and EBIE to be used

by a specified foreign partner was

determined by multiplying the amount

of the ETI or the EBIE allocated under

§ 1.163(j)–6 to the specified foreign

partner by a fraction, the numerator of

which is the ATI of the partnership,

with the adjustments described

previously to limit such amount to only

items that are ECI, and the denominator

of which is the ATI of the partnership

determined under § 1.163(j)–6(d). The

amount of EBII that could be used by a

specified foreign partner was limited to

the amount of allocable BII that is ECI

from the partnership that exceeds

allocable BIE that is allocable to income

that is ECI from the partnership.

Lastly, the 2018 Proposed Regulations

provide that an applicable CFC that has

ECI must first apply the general rules of

section 163(j) and the section 163(j)

regulations to determine how section

163(j) applies to the applicable CFC. If

the applicable CFC has disallowed BIE,

the applicable CFC then must apportion

a part of its disallowed BIE to BIE

allocable to income that is ECI. The

amount of disallowed BIE allocable to

income that is ECI is equal to the

disallowed BIE multiplied by a fraction,

the numerator of which is the applicable

CFC’s ECI ATI, and the denominator of

which is the CFC’s ATI.

No comments were received on the

2018 Proposed Regulations under

§ 1.163(j)–8. Nonetheless, the Treasury

Department and the IRS have become

aware of certain distortions that can

result under the 2018 Proposed

Regulations. Accordingly, proposed

§ 1.163(j)–8 has been revised, and re-

proposed, to alleviate these distortions

and to provide additional guidance and

clarity on the manner in which these

rules apply to specified foreign partners

and CFCs with ECI.

B. Proposed § 1.163(j)–8 in the Proposed

Regulations

Proposed § 1.163(j)–8 in the Proposed

Regulations (Proposed § 1.163(j)–8)

provides rules concerning the

application of section 163(j) to foreign

persons with ECI.

9

Similar to proposed

§ 1.163(j)–8(b) in the 2018 Proposed

Regulations, proposed § 1.163(j)–

8(b)(1)–(5) provides that, for purposes of

applying section 163(j) and the section

163(j) regulations to a specified foreign

person, certain definitions (ATI, BIE,

BII, and floor plan financing interest

expense) are modified to take into

account only ECI items. Additionally,

proposed § 1.163(j)–8(b)(6) provides

that, for purposes of applying § 1.163(j)–

10(c) to a specified foreign person, only

ECI items and assets that are U.S. assets

are taken into account in determining

the amount of interest income and

interest expense allocable to a trade or

business.

Proposed § 1.163(j)–8(c) determines

the portion of a specified foreign

partner’s allocable share of ETI, EBIE,

and EBII (as determined under

§ 1.163(j)–6) that is treated as ECI and

the portion that is not treated as ECI.

The portion of the specified foreign

partner’s allocable share of ETI that is

ECI is equal to its allocable share of ETI

multiplied by a fraction, the specified

ATI ratio (which compares the specified

foreign partner’s distributive share of

the partnership’s ECI to its distributive

share of the partnership’s total income).

The remainder of the specified foreign

partner’s allocable share of ETI is not

ECI. See proposed § 1.163(j)–8(c)(1).

Similar to ETI, the portion of the

specified foreign partner’s allocable

share of EBII that is ECI is equal to its

allocable share of EBII multiplied by a

fraction, the specified BII ratio (which

compares the specified foreign partner’s

allocable share of BII that is ECI to its

allocable share of total BII). See

proposed § 1.163(j)–8(c)(4).

The portion of the specified foreign

partner’s allocable share of EBIE that is

ECI is determined by subtracting the

portion of the specified foreign partner’s

allocable share of deductible BIE that is

characterized as ECI from the amount of

the specified foreign partner’s allocable

share of BIE that is characterized as ECI.

See proposed § 1.163(j)–8(c)(2). A

similar rule applies for purposes of

determining the portion of EBIE that is

not ECI. A specified foreign partner’s

allocable share of deductible BIE that is

characterized as ECI or not ECI is

determined by allocating the deductible

BIE pro rata between the respective

amounts of deductible BIE that the

specified foreign partner would have if

the specified foreign partner’s allocable

share of the ECI items of the partnership

and the non-ECI items of the

partnership were treated as separate

partnerships and a 163(j) limitation was

applied to each hypothetical

partnership. However, no more

deductible BIE can be characterized as

ECI or not ECI than the specified foreign

partner’s allocable share of BIE that is

ECI or the specified foreign partner’s

allocable share of BIE that is not ECI,

respectively. Any deductible BIE in

excess of the hypothetical partnership

limitations is characterized as ECI or not

ECI pro rata in proportion to the

remaining amounts of the specified

foreign partner’s allocable share of BIE

that is ECI and not ECI.

Proposed § 1.163(j)–8(d) determines

the portion of deductible and

disallowed BIE of a relevant foreign

corporation (as defined in § 1.163(j)–

1(b)(33)) that is characterized as ECI or

not ECI. These rules are similar to the

rules in proposed § 1.163(j)–8(c) for

characterizing a specified foreign

partner’s allocable share of excess items

of a partnership as ECI or not ECI in that

they calculate the hypothetical section

163(j) limitation for two hypothetical

foreign corporations—a foreign

corporation with ECI and a foreign

corporation with non-ECI—and allocate

the deductible BIE between the two

hypothetical limitations. The portion of

the relevant foreign corporation’s

disallowed BIE that is ECI is determined

by subtracting the portion of the

relevant foreign corporation’s

deductible BIE that is characterized as

ECI from the relevant foreign

corporation’s BIE that is ECI. A similar

rule applies for purposes of determining

the portion of disallowed BIE that is

characterized as not ECI.

Proposed § 1.163(j)–8(e) provides

rules regarding disallowed BIE. These

rules provide that disallowed BIE is

characterized as ECI or not ECI in the

year in which it arises and retains its

characterization in subsequent years.

Additionally, an ordering rule

determines the EBIE that is treated as

paid or accrued by a specified foreign

partner in a subsequent year.

Specifically, the specified foreign

partner’s allocable share of EBIE is

treated as paid or accrued by the

specified foreign partner in a

subsequent year pursuant to § 1.163(j)–

6(g)(2)(i) in the order of the taxable

years in which the allocable EBIE arose

and pro rata between the specified

foreign partner’s allocable share of EBIE

that is ECI and not ECI that arose in the

same taxable year.

Proposed § 1.163(j)–8(e)(2) provides

that, for purposes of characterizing

deductible BIE and EBIE as ECI or not

ECI, a specified foreign partner’s BIE is

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deemed to include its allocable share of

EBIE of partnerships in which it is a

direct or indirect partner. As a result,

EBIE of both top-tier partnerships and

lower-tier partnerships is characterized

as ECI or not ECI in the year in which

it arises, even if it is not included in the

specified foreign partner’s allocable

share of EBIE.

Proposed § 1.163(j)–8(f) provides rules

coordinating the application of section

163(j) with § 1.882–5 and similar rules

and with the branch profits tax.

Proposed § 1.163(j)–8(f)(1)(i) provides

that a foreign corporation first

determines its interest expense on

liabilities that are allocable to ECI under

§ 1.882–5 before applying section 163(j).

Similarly, interest expense, as defined

in § 1.163(j)–1(b)(23), that is not

allocable to ECI under § 1.882–5 must be

allocable to income that is ECI under the

regulations under section 861 before

section 163(j) is applied.

Proposed § 1.163(j)–8(f)(1)(ii) provides

rules for determining the portion of a

specified foreign partner’s BIE that is

ECI, as determined under § 1.882–5(b)

through (d) or § 1.882–5(e) (§1.882–5

interest expense), that is treated as

attributable to a partner’s allocable share

of interest expense of a partnership. As

a general matter, the determination as to

whether a partnership’s items of income

and expense are allocable to ECI is made

by the partnership. However, the

determination as to the amount of

interest expense that is allocable to ECI

is made by a partner, not the

partnership. Because section 163(j)

applies separately to partnerships and

their partners, a determination must be

made as to the source of § 1.882–5

interest expense. If the BIE is

attributable to BIE of the partnership, it

is subject to the rules of §§ 1.163(j)–6

and 1.163(j)–8(c).

The § 1.882–5 interest expense is first

treated as attributable to interest

expense on U.S. booked liabilities,

determined under § 1.882–5(d)(2)(vii),

of the partner or a partnership. Any

remaining § 1.882–5 interest expense

(excess § 1.882–5 interest expense) is

treated as attributable to interest

expense on liabilities of the partner in

proportion to its U.S. assets (other than

partnership interests) over all of its U.S.

assets, and as attributable to interest

expense on liabilities of the partner’s

direct or indirect partnership interests

in proportion to the portion of the

partnership interest that is a U.S. asset

over all of the partner’s U.S. assets. The

total amount of § 1.882–5 interest

expense attributed to the partner or a

partnership (taking into account both

interest expense on U.S. booked

liabilities and excess § 1.882–5 interest

expense) and interest expense on a

liability described in § 1.882–

5(a)(1)(ii)(A) or (B) (direct allocations)

may never exceed the amount of the

partner’s interest expense on liabilities

or the partner’s allocable share of the

partnership’s interest expense on

liabilities (the interest expense

limitation). The interest expense

limitation prevents more § 1.882–5

interest expense from being attributed to

the partner or the partner’s allocable

share of interest expense of a

partnership than the actual amount of

such interest expense. Any excess

§ 1.882–5 interest expense that would

have been attributed to the partner or a

partnership, but for the interest expense

limitation, is re-attributed in accordance

with these attribution rules.

When excess § 1.882–5 interest

expense has been attributed to all of the

interest expense on liabilities of the

foreign corporation and its allocable

share of partnership interests that have

U.S. assets, the remaining excess

§ 1.882–5 interest expense, if any, is first

attributed to interest expense on

liabilities of the foreign corporation (but

not in excess of the interest expense

limitation), and then, pro rata, to its

allocable share of interest expense on

liabilities of its partnership interests

that do not have U.S. assets, subject to

the interest expense limitation. See

proposed § 1.163(j)–8(f)(1)(iii). These

rules merely characterize interest

expense of the foreign corporation and

its partnership interests as ECI or not

ECI. These rules do not change the

amount of interest expense of the

foreign corporation or its partnership

interests.

The rule in proposed § 1.163(j)–8(f)(1)

of 2018 Proposed Regulations providing

that the disallowance and carryforwards

of BIE does not affect effectively

connected earnings and profits of a

foreign corporation is not retained in

Proposed § 1.163(j)–8. This rule is not

necessary in Proposed § 1.163(j)–8

because the general rule regarding the

effect of section 163(j) on earnings and

profits in § 1.163(j)–4(c)(1) applies to

effectively connected earnings and

profits.

VII. Proposed § 1.469–9: Definition of

Real Property Trade or Business

Section 469(c)(7)(C) defines real

property trade or business by reference

to eleven undefined terms. The Final

Regulations amended § 1.469–9 to

define two of the eleven terms—

management and operations. In

response to questions received about the

application of section 469(c)(7)(C) to

timberlands, these proposed regulations

would provide definitions for two

additional terms—development and

redevelopment—to further clarify what

constitutes a real property trade or

business.

The Treasury Department and IRS

have determined that real property

development and redevelopment trades

or businesses should be defined to

include business activities that involve

the preservation, maintenance, and

improvement of forest-covered areas

(timberland). Congress most likely

intended and expected that such

business activities would be excepted

from section 163(j), through election,

similar to other real property and

farming businesses. However, because

timber is specifically excluded from the

definition of farming under other Code

provisions (such as section 464(e)), the

Treasury Department and IRS have

determined that such business activities

are more properly described by and

should be included in the definition of

real property trade or business for this

purpose. These proposed regulations

would clarify that ‘‘real property

development’’ is the maintenance and

improvement of raw land to make the

land suitable for subdivision, further

development, or construction of

residential or commercial buildings, or

to establish, cultivate, maintain or

improve timberlands (generally defined

as parcels of land covered by forest).

Similarly, these proposed regulations

would clarify that ‘‘real property

redevelopment’’ is the demolition,

deconstruction, separation, and removal

of existing buildings, landscaping, and

infrastructure on a parcel of land to

return the land to a raw condition or

otherwise prepare the land for new

development or construction, or for the

establishment and cultivation of new

timberlands.

VIII. Proposed § 1.163(j)–2 and

§ 1.1256(e)–2: Section 1256 and

Determination of Tax Shelter Status;

Election To Use 2019 ATI To Determine

2020 Section 163(j) Limitation

A. Section 1256 and Determination of

Tax Shelter Status

Several commenters raised questions

regarding the exclusion of ‘‘a tax shelter

that is not permitted to use a cash

method of accounting’’ from the small

business exemption provided in section

163(j)(3). Section 448 and § 1.448–1T

describe limitations on the use of the

cash method of accounting, including

an explicit prohibition on the use of the

cash method of accounting by a tax

shelter. Section 448(d)(3) defines a tax

shelter by cross reference to section

461(i)(3), which defines a tax shelter, in

part, as a syndicate within the meaning

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of section 1256(e)(3)(B). Under § 1.448–

1T(b)(3), a syndicate is defined as an

entity that is not a C corporation if more

than 35 percent of the losses of such

entity during the taxable year are

allocated to limited partners or limited

entrepreneurs. Section 1256(e)(3)(B)

refers instead to losses that are allocable

to limited partners or limited

entrepreneurs. As a result, the scope of

the small business exemption in section

163(j)(3) is unclear. To provide clarity,

and to make these rules consistent, the

Treasury Department and the IRS would

define the term syndicate for purposes

of section 1256 using the actual

allocation rule from the definition in

§ 1.448–1T(b)(3). This proposed

definition is also consistent with the

definition of a syndicate used in a

number of private letter rulings that

were issued under section 1256. See

proposed § 1.1256(e)–2(a).

One commenter asked for clarification

on how to compute the amount of losses

to be allocated for purposes of

determining syndicate status under

section 1256(e)(3)(A). The commenter

provided a particular fact pattern in

which a small business would be caught

in an iterative loop of (a) having net

losses due to an interest deduction, (b)

which would trigger disallowance of the

exemption in section 163(j)(3), (c) which

would trigger the application of section

163(j)(1) to reduce the amount of the

interest deduction, (d) which would

then lead to the taxpayer having no net

losses and therefore being eligible for

the application of section 163(j)(3). To

address this fact pattern, the Treasury

Department and the IRS have added

rules providing that, for purposes of

section 1256(e)(3)(B), losses are

determined without regard to section

163(j). See proposed §§ 1.163(j)–2(d)(3)

and 1.1256(e)–2(b).

Several commenters requested that

the exemption in section 163(j)(3) be

broadened to apply to all small

businesses without regard to the

parenthetical that denies the section

163(j)(3) exemption for a small business

that is ‘‘a tax shelter that is not

permitted to use a cash method of

accounting.’’ See section 163(j)(3). One

commenter specifically requested that,

for a small business meeting the gross

receipts test in section 448(c), all

interests held by limited partners or

limited entrepreneurs be treated as held

by owners actively managing the

business even if those interests would

not qualify for the active management

exception under section 1256(e)(3)(C).

After considering the comments, the

Treasury Department and the IRS have

determined that the requests are

contrary to both the statutory language

in section 163(j)(3) and the

accompanying legislative history and

therefore decline to adopt the

comments.

B. Election To Use 2019 ATI To

Determine 2020 Section 163(j)

Limitation

As stated in the Background section of

this preamble, section 163(j)(10)(B)(i)

allows a taxpayer to elect to use its 2019

ATI in determining the taxpayer’s

section 163(j) limitation for its taxable

year beginning in 2020. Section

1.163(j)–2(b)(3) and (4) of the Final

Regulations provide general rules

regarding this election.

These proposed regulations clarify

that, if the acquiring corporation in a

transaction to which section 381 applies

makes an election under section

163(j)(10)(B)(i), the acquiring

corporation’s 2019 ATI for purposes of

section 163(j)(10)(B)(i) is its ATI for its

last taxable year beginning in 2019

(subject to the limitation for short

taxable years in section 163(j)(10)(B)(ii)).

For example, assume that T’s 2019 ATI

is $100 and A’s 2019 ATI is $200. If T

merges into A during A’s 2020 taxable

year in a transaction described in

section 368(a)(1)(A), and if A makes an

election under section 163(j)(10)(B)(i),

A’s 2019 ATI for purposes of this

election is $200. Similarly, these

proposed regulations clarify that a

consolidated group’s 2019 ATI for

purposes of section 163(j)(10)(B)(i) is the

consolidated group’s ATI for its last

taxable year beginning in 2019 (subject

to the limitation in section

163(j)(10)(B)(ii)). The Treasury

Department and the IRS request

comments on these proposed rules. The

Treasury Department and the IRS also

request comments on (1) whether the

2019 ATI of an acquired corporation in

a transaction to which section 381

applies should be included in the

acquiring corporation’s 2019 ATI for

purposes of section 163(j)(10)(B)(i) and

(2) how such a rule would address more

complex fact patterns, such as situations

where the acquiring corporation is

acquired in a subsequent transaction

described in section 381, or where the

acquired corporation and the acquiring

corporation have different tax years.

IX. Proposed § 1.163(j)–10: Application

of Corporate Look-Through Rules to

Tiered Structures

For purposes of determining the

extent to which a shareholder’s basis in

the stock of a domestic non-

consolidated C corporation or CFC is

allocable to an excepted or non-

excepted trade or business, § 1.163(j)–

10(c)(5)(ii)(B) provides several look-

through rules whereby the shareholder

‘‘looks through’’ to the corporation’s

basis in its assets.

A commenter pointed out that the

application of these look-through rules

may produce distortive results in certain

situations. For example, assume

Corporation X’s basis in its assets is

split equally between X’s excepted and

non-excepted trades or businesses, and

that (as a result) X has a 50 percent

exempt percentage applied to its interest

expense. However, rather than operate

its excepted trade or business directly,

X operates its excepted trade or business

through a wholly owned, non-

consolidated subsidiary (Corporation Y),

and each of X and Y borrows funds from

external lenders. Assuming for purposes

of this example that neither the anti-

avoidance rule in § 1.163(j)–2(h) nor the

anti-abuse rule in § 1.163(j)–10(c)(8)

applies, Y’s interest expense would not

be subject to the section 163(j)

limitation because Y is engaged solely

in an excepted trade or business.

Moreover, a portion of X’s interest

expense also would be allocable to an

excepted trade or business by virtue of

the application of the look-through rule

in proposed § 1.163(j)–10(c)(5)(ii)(B)(2)

to X’s basis in Y’s stock.

The anti-avoidance rule in proposed

§ 1.163(j)–2(h) and the anti-abuse rule in

proposed § 1.163(j)–10(c)(8) would

preclude the foregoing result in certain

circumstances. However, these

proposed regulations would modify the

look-through rule for domestic non-

consolidated C corporations and CFCs

to limit the potentially distortive effect

of this look-through rule on tiered

structures in situations to which the

anti-avoidance and anti-abuse rules do

not apply. More specifically, these

proposed regulations would modify the

look-through rule for non-consolidated

C corporations to provide that, for

purposes of determining a taxpayer’s

basis in its assets used in excepted and

non-excepted trades or businesses, any

such corporation whose stock is being

looked through may not itself apply the

look-through rule.

For example, P wholly and directly

owns S1, which wholly and directly

owns S2. Each of these entities is a non-

consolidated C corporation to which the

small business exemption does not

apply. In determining the extent to

which its interest expense is subject to

the section 163(j) limitation, S1 may

look through the stock of S2 for

purposes of allocating S1’s basis in its

S2 stock between excepted and non-

excepted trades or businesses. However,

in determining the extent to which P’s

interest expense is subject to the section

163(j) limitation, S1 may not look

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through the stock of S2 for purposes of

allocating P’s basis in its S1 stock

between excepted and non-excepted

trades or businesses.

However, the Treasury Department

and the IRS are aware that taxpayers are

organized into multi-tiered structures

for legitimate, non-tax reasons. The

Treasury Department and the IRS

request comments on the proposed

limitation on the application of the

corporate look-through rules. The

Treasury Department and the IRS also

request comments on whether there are

other situations in which the look-

through rules for domestic non-

consolidated C corporations or CFCs

should apply and whether there are

other approaches for addressing the

distortions that these proposed rules are

intended to minimize.

Proposed Applicability Dates

These Proposed Regulations are

proposed to apply to taxable years

beginning on or after 60 days after the

date the Treasury Decision adopting

these rules as final regulations is

published in the Federal Register.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b)(1), may rely on § 1.163–14,

§ 1.163–15, §1.163(j)–2(d)(3), or

§ 1.1256(e)–2 of these Proposed

Regulations for a taxable year beginning

after December 31, 2017, and before 60

days after the date the Treasury

Decision adopting these rules as final

regulations is published in the Federal

Register, provided taxpayers and their

related parties consistently follow all of

the rules of the relevant section of the

Proposed Regulations for that taxable

year and for each subsequent taxable

year. Taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply § 1.163–14, 1.163–15, 1.163(j)–

2(d)(3), or 1.1256(e)–2 of the final

version of these Proposed Regulations

for a taxable year beginning after

December 31, 2017, and before 60 days

after the date the Treasury Decision

adopting these rules as final regulations

is published in the Federal Register,

provided that taxpayers and their

related parties consistently apply all of

the rules of the relevant section, as

applicable, to that taxable year and each

subsequent taxable year. See also

§§ 1.163–14(i), 1.163–15(b), 1.163(j)–

2(k)(2), and 1.1256(e)–2(d) of these

Proposed Regulations.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b)(1), who apply the Final

Regulations (as defined in the

Explanation of Provisions) published

elsewhere in this issue of the Federal

Register to a taxable year beginning after

December 31, 2017, and before 60 days

after the Treasury Decision adopting

these rules as final regulations is

published in the Federal Register may

rely on §§ 1.163(j)–1(b)(1)(iv)(B) and

1.163(j)–1(b)(1)(iv)(E) of these Proposed

Regulations for a taxable year beginning

after December 31, 2017, and before 60

days after the Treasury Decision

adopting these rules as final regulations

is published in the Federal Register,

provided that taxpayers and their

related parties consistently apply the

rules of both §§ 1.163(j)–1(b)(1)(iv)(B)

and 1.163(j)–1(b)(1)(iv)(E) of these

Proposed Regulations, and, if

applicable, §§ 1.263A–9, 1.263A–15,

1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–

5, 1.382–6, 1.382–7, 1.383–0, 1.383–1,

1.469–9, 1.469–11, 1.704–1, 1.882–5,

1.1362–3, 1.1368–1, 1.1377–1, 1.1502–

13, 1.1502–21, 1.1502–36, 1.1502–79,

1.1502–91 through 1.1502–99 (to the

extent they effectuate the rules of

§§ 1.382–2, 1.382–5, 1.382–6, and

1.383–1), and 1.1504–4, to that taxable

year and each subsequent taxable year

See also § 1.163(j)–1(c)(4)(i) of these

Proposed Regulations.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b)(1), who apply the Final

Regulations published elsewhere in this

issue of the Federal Register to a taxable

year beginning after December 31, 2017,

and before 60 days after the Treasury

Decision adopting these rules as final

regulations is published in the Federal

Register, may rely on the rules in

§ 1.163(j)–2(b)(3)(iii) and (iv) of these

Proposed Regulations for such taxable

year, provided that taxpayers and their

related parties consistently follow the

rules of both § 1.163(j)–2(b)(3)(iii) and

(iv) for that taxable year and for each

subsequent taxable year beginning

before 60 days after the Treasury

Decision adopting these rules as final

regulations is published in the Federal

Register. Taxpayers not applying the

Final Regulations to taxable years

beginning before November 13, 2020

may not rely on the rules in § 1.163(j)–

2(b)(3)(iii) and (iv) of these Proposed

Regulations for those taxable years. See

also § 1.163(j)–2(k)(2) of these Proposed

Regulations.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b), who apply the Final

Regulations published elsewhere in this

issue of the Federal Register to a taxable

year beginning after December 31, 2017,

and before 60 days after the Treasury

Decision adopting these rules as final

regulations is published in the Federal

Register may rely on the rules in

§ 1.163(j)–10(c)(5)(ii)(D)(2), 1.469–

4(d)(6), or 1.469–9(b)(2) of these

Proposed Regulations for a taxable year

beginning after December 31, 2017, and

before 60 days after the Treasury

Decision adopting these rules as final

regulations is published in the Federal

Register, provided that taxpayers and

their related parties consistently follow

the rules of § 1.163(j)–10(c)(5)(ii)(D)(2),

1.469–4(d)(6), or 1.469–9(b)(2) of these

Proposed Regulations, as applicable,

and, if applicable, §§ 1.263A–9, 1.263A–

15, 1.381(c)(20)–1, 1.382–1, 1.382–2,

1.382–5, 1.382–6, 1.382–7, 1.383–0,

1.383–1, 1.469–4, 1.469–9, 1.469–11,

1.704–1, 1.882–5, 1.1362–3, 1.1368–1,

1.1377–1, 1.1502–13, 1.1502–21,

1.1502–36, 1.1502–79, 1.1502–91

through 1.1502–99 (to the extent they

effectuate the rules of §§ 1.382–2, 1.382–

5, 1.382–6, and 1.383–1), and 1.1504–4,

for that taxable year and for each

subsequent taxable year. See also

§§ 1.163(j)–10(f)(2) and 1.469–11(a)(1)

and (4) of these Proposed Regulations.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b), may rely on the rules in

§ 1.163(j)–6 of these Proposed

Regulations for a taxable year beginning

after December 31, 2017, and before 60

days after the Treasury Decision

adopting these rules as final regulations

is published in the Federal Register,

provided that taxpayers and their

related parties also apply the rules of

§ 1.163(j)–6 in the Final Regulations and

consistently follow all of those rules for

that taxable year and for each

subsequent taxable year. See also

§ 1.163(j)–6(p)(2) of these Proposed

Regulations.

Taxpayers and their related parties,

within the meaning of sections 267(b)

and 707(b)(1), who apply the Final

Regulations published elsewhere in this

issue of the Federal Register to a taxable

year beginning after December 31, 2017,

and before 60 days after the date the

Final Regulations are published in the

Federal Register, may rely on

§§ 1.163(j)–7 and 1.163(j)–8 of these

Proposed Regulations for that taxable

year, provided the taxpayers and their

related parties also rely on §§ 1.163(j)–

7 and 1.163(j)–8 of these Proposed

Regulations and apply the Final

Regulations for each subsequent taxable

year. Taxpayers who choose not to

apply the Final Regulations to a taxable

year beginning after December 31, 2017,

and before 60 days after the date the

Final Regulations are published in the

Federal Register may not rely on either

§ 1.163(j)–7 or 1.163(j)–8 of these

Proposed Regulations for that taxable

year. For any taxable year beginning on

or after 60 days after the date the Final

Regulations are published in the

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A trading partnership is a partnership engaged

in the per se non-passive activity of trading

personal property (including market securities) for

the account of owners of interests in the activity,

as described in section 1.469–1T(e)(6) (trading

partnerships).

Federal Register and before 60 days

after the date the Treasury Decision

adopting these Proposed Regulations as

final regulations is published in the

Federal Register, taxpayers and their

related parties, within the meaning of

sections 267(b) and 707(b)(1), may rely

on §§ 1.163(j)–7 and 1.163(j)–8 of these

Proposed Regulations provided they

consistently follow all of the rules of

§§ 1.163(j)–7 and 1.163(j)–8 for such

taxable year and for each subsequent

taxable year beginning before 60 days

after the Treasury Decision adopting

these Proposed Regulations as final

regulations is published in the Federal

Register. See also §§ 1.163(j)–7(m) and

1.163(j)–8(j) of these Proposed

Regulations. Taxpayers and their related

parties who rely on § 1.163(j)–7 of these

Proposed Regulations for any taxable

year ending before November 13, 2020

can make a CFC group election or a safe-

harbor election even if the deadline

provided in § 1.163(j)–7(e)(5)(iii) or

(h)(5)(i) of these Proposed Regulations

has passed. Such taxpayers and their

related parties are permitted to make the

election on an amended Federal income

tax return filed on or before the due date

(taking into account extensions, if any)

of the original Federal income tax return

for the first taxable year ending after

November 13, 2020.

See part III.B of the Explanation of

Provisions for rules concerning reliance

on these Proposed Regulations with

respect to section 163(j) interest

dividends.

Special Analyses

I. Regulatory Planning and Review—

Economic Analysis

Executive Orders 13771, 13563, and

12866 direct agencies to assess costs and

benefits of available regulatory

alternatives and, if regulation is

necessary, to select regulatory

approaches that maximize net benefits,

including potential economic,

environmental, public health and safety

effects, distributive impacts, and equity.

Executive Order 13563 emphasizes the

importance of quantifying both costs

and benefits, reducing costs,

harmonizing rules, and promoting

flexibility. The Executive Order 13771

designation for any final rule resulting

from these proposed regulations will be

informed by comments received. The

preliminary Executive Order 13771

designation for this proposed rule is

regulatory.

These proposed regulations have been

designated by the Office of Information

and Regulatory Affairs as subject to

review under Executive Order 12866

pursuant to the Memorandum of

Agreement (MOA, April 11, 2018)

between the Treasury Department and

the Office of Management and Budget

(OMB) regarding review of tax

regulations. OMB has designated the

proposed regulations as economically

significant under section 1(c) of the

MOA. Accordingly, the proposed

regulations have been reviewed by

OMB’s Office of Information and

Regulatory Affairs.

A. Background and Need for These

Proposed Regulations

Section 163(j), substantially revised

by the Tax Cuts and Jobs Act (TCJA),

provides a set of relatively complex

statutory rules that impose a limitation

on the amount of business interest

expense that a taxpayer may deduct for

Federal tax purposes. This limitation

does not apply to businesses with gross

receipts of $25 million or less (inflation

adjusted). This provision has the general

effect of putting debt-financed

investment by businesses on a more

equal footing with equity-financed

investment, a treatment that Congress

believed will lead to a more efficient

capital structure for firms. See Senate

Budget Explanation of the Bill as Passed

by SFC (2017–11–20) at pp. 163–4.

As described in the Background

section earlier, the Coronavirus Aid,

Relief, and Economic Security Act

(CARES Act) amended section 163(j) to

provide special rules relating to the

adjusted taxable income (ATI) limitation

for taxable years beginning in 2019 or

2020.

Because this limitation on deduction

for business interest expense is new,

taxpayers would benefit from

regulations that explain key terms and

calculations. The Treasury Department

and the IRS published proposed

regulations in December 2018 (2018

Proposed Regulations) and are issuing

final regulations simultaneously with

the current proposed regulations. This

current set of proposed regulations

covers topics that were reserved in the

2018 Proposed Regulations, were raised

by commenters to the proposed

regulations, or need to be re-proposed.

B. Overview of the Proposed Regulations

The proposed regulations provide

guidance on the definition of interest as

it relates to income flowing through

regulated investment companies (RICs);

debt-financed distributions from pass-

through entities; the treatment of

business interest expense for publicly

traded partnerships and trading

partnerships

10

; the application of the

section 163(j) limitation in the context

of self-charged interest; and the

treatment of excess business interest

expense in tiered-partnership structures.

The proposed regulations also modify

the definition of real property

development and real property

redevelopment in section 1.469–9 of the

regulations and the definition of

syndicate for purposes of applying the

small business exception in section

163(j)(3). The proposed regulations also

re-propose rules regarding the

application of the interest limitation to

foreign corporations (including

controlled foreign corporations as

defined in section 957(a)) and United

States shareholders of controlled foreign

corporations, and the applicability of

the section 163(j) limitation to foreign

persons with U.S. effectively connected

income.

C. Economic Analysis

1. Baseline

The Treasury Department and the IRS

have assessed the benefits and costs of

these proposed regulations relative to a

no-action baseline that reflects

anticipated Federal income tax-related

behavior in the absence of these

regulations.

2. Summary of Economic Effects

The proposed regulations provide

certainty and clarity to taxpayers

regarding terms and calculations that

are contained in section 163(j), which

was substantially modified by TCJA. In

the absence of this clarity, the

likelihood that different taxpayers

would interpret the rules regarding the

deductibility of business interest

expense differently would be

exacerbated. In general, overall

economic performance is enhanced

when businesses face more uniform

signals about tax treatment. Certainty

and clarity over tax treatment also

reduce compliance costs for taxpayers.

For those situations where taxpayers

would generally adopt similar

interpretations of the statute even in the

absence of guidance, the proposed

regulations provide value by helping to

ensure that those interpretations are

consistent with the intent and purpose

of the statute. For example, the

proposed regulations may specify a tax

treatment that few or no taxpayers

would adopt in the absence of specific

guidance.

The Treasury Department and the IRS

project that the proposed regulations

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Interest deductions in tax year 2013 for

corporations, partnerships, and sole proprietorships

were approximately $800 billion.

12

See E. Zwick and J. Mahon, ‘‘Tax Policy and

Heterogeneous Investment Behavior,’’ at American

Economic Review 2017, 107(1): 217–48 and articles

cited therein.

will have an annual economic effect

greater than $100 million ($2019). This

determination is based on the

substantial volume of business interest

payments in the economy

11

and the

general responsiveness of business

investment to effective tax rates,

12

one

component of which is the deductibility

of interest expense. Based on these two

magnitudes, even modest changes in the

deductibility of interest payments (and

in the certainty of that deductibility)

provided by the proposed regulations,

relative to the no-action baseline, can be

expected to have annual effects greater

than $100 million. This claim is

particularly likely to hold for the first

set of general section 163(j) guidance

that is promulgated following major

legislation, such as TCJA, and for other

major guidance, which we have

determined includes these proposed

regulations.

Regarding the nature of the economic

effects, the Treasury Department and the

IRS project that the proposed

regulations will increase investment in

the United States and increase the

proportion that is debt-financed, relative

to the no-action baseline. We have

further determined that these effects are

consistent with the intent and purpose

of the statute. Because taxpayer

favorable provisions will lead to a

decrease in Federal tax revenue relative

to the no-action baseline, there may be

an increase in the Federal deficit

relative to the no-action baseline. This

may lead to a decrease in investment by

taxpayers not directly affected by these

proposed regulations, relative to the no-

action baseline. This effect should be

weighed against the enhanced efficiency

arising from the clarity and enhanced

consistency with the intent and purpose

of the statute provided by these

regulations. The Treasury Department

and the IRS have determined that the

proposed regulations provide a net

benefit to the U.S. economy.

The Treasury Department and the IRS

have not undertaken more precise

quantitative estimates of these effects

because many of the definitions and

calculations under 163(j) are new and

many of the economic decisions that are

implicated by these proposed

regulations involve highly specific

taxpayer circumstances. We do not have

readily available data or models to

estimate with reasonable precision the

types and volume of different financing

arrangements that taxpayers might

undertake under the proposed

regulations versus the no-action

baseline.

In the absence of such quantitative

estimates, the Treasury Department and

the IRS have undertaken a qualitative

analysis of the economic effects of the

proposed regulations relative to the no-

action baseline and relative to

alternative regulatory approaches. This

analysis is presented in Part I.C.3 of this

Special Analyses.

The Treasury Department and the IRS

solicit comments on these findings and

more generally on the economic effects

of these proposed regulations. The

Treasury Department and the IRS

particularly solicit data, other evidence,

or models that could be used to enhance

the rigor of the process by which the

final regulations might be developed.

3. Economic Effects of Specific

Provisions

a. Definition of Interest

The final regulations set forth several

categories of amounts and transactions

that generate interest for purposes of

section 163(j). The proposed regulations

provide further guidance on the

definition of interest relevant to the

calculation of interest expense and

interest income. In particular, the

proposed regulations provide rules

under which the dividends paid by a

RIC that earns net business interest

income (referred to as section 163(j)

interest dividends) are to be treated as

interest income by the RIC’s

shareholders. That is, under the

proposed regulations, certain interest

income earned by the RIC and paid to

a shareholder as a dividend is treated as

if the shareholder earned the interest

income directly for purposes of section

163(j).

To the extent that taxpayers believed,

in the absence of the proposed

regulations, that dividends paid by RICs

are not treated as business interest

income for the purposes of the section

163(j) limitation, then taxpayers will

likely respond to the proposed

regulations by reducing their holding of

other debt instruments and increasing

investment in RICs. The Treasury

Department and the IRS have

determined that this treatment is

consistent with the intent and purpose

of the statute.

Number of Affected Taxpayers. The

Treasury Department and the IRS have

determined that the rules regarding

section 163(j) interest dividends will

potentially affect approximately 10,000

RICs. The Treasury Department and the

IRS do not have readily available data

on the number of RIC shareholders that

would receive section 163(j) interest

dividends that the shareholder could

treat as business interest income for

purposes of the shareholder’s section

163(j) limitation.

b. Provisions Related to Partnerships

i. Trading Partnerships

Section 163(j) limits the deductibility

of interest expense at the partnership

level. These proposed regulations

address commenter concerns about the

interaction between this section 163(j)

limitation and the section 163(d) partner

level limitation on interest expense that

existed prior to TJCA. Under logic

described in the preamble to the 2018

Proposed Regulations, section 163(j)

limitations would apply at the

partnership level while section 163(d)

limitations would apply at the partner

level and these tests would be applied

independently. Commenters suggested

and Treasury has agreed that the correct

interpretation of the statute is to exempt

interest expense that is limited at the

partner level by section 163(d) from the

partnership level section 163(j)

limitation in accordance with the

language of section 163(j)(5).

These proposed regulations provide

that interest expense at the partnership

level that is allocated to non-materially

participating partners subject to section

163(d) is not included in the section

163(j) limitation calculation of the

partnership. Generally, the section

163(d) limitation is more generous than

the section 163(j) limitation. Relative to

the 2018 Proposed Regulations, this

change may encourage these partners to

incur additional interest expense

because they will be less likely to be

limited in their ability to use it to offset

other income. Commenters argued that

exempting from section 163(j) any

interest expense allocated to non-

materially participating partners subject

to section 163(d) will treat this interest

expense in the same way as the interest

expense generated through separately

managed accounts, which are not

subject to section 163(j) limitations.

The Treasury Department and the IRS

project that these proposed regulations

will result in additional investment in

trading partnerships and generally

higher levels of debt in any given

trading partnership relative to the 2018

Proposed Regulations. Because

investments in trading partnerships may

be viewed as economically similar to

investments in separately managed

accounts arrangements, we further

project that the proposed regulations, by

making the tax treatments of these two

arrangements generally similar, will

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improve U.S. economic performance

relative to the no-action baseline.

Number of Affected Taxpayers. The

Treasury Department and the IRS have

determined that the rules regarding

trading partnerships will potentially

affect approximately 275,000 taxpayers.

This number was reached by

determining, using data for the 2017

taxable year, the number of Form 1065

and Form 1065–B filers that (1)

completed Schedule B to Form 1065

and marked box b, c, or d in question

1 to denote limited partnership, limited

liability company, or limited liability

partnership status; and (2) have a North

American Industry Classification

System (NAICS) code starting with 5231

(securities and commodity contracts

intermediation and brokerage), 5232

(securities and commodity exchanges),

5239 (other financial investment

activities), or 5259 (other investment

pools and funds).

Additionally, the Treasury

Department and the IRS have

determined that the rules regarding

publicly traded partnerships will

potentially affect approximately 80

taxpayers. This number was reached by

determining, using data for the 2017

taxable year, the number of Form 1065

and 1065–B filers with gross receipts

exceeding $25 million that answered

‘‘yes’’ to question 5 on Schedule B to

Form 1065 denoting that the entity is a

publicly traded partnership. The

Treasury Department and the IRS do not

have readily available data on the

number of filers that are tax shelters that

are potentially affected by these

provisions.

ii. Debt-Financed Distributions

Prior to TCJA, partners were

responsible for determining the

applicability of any limitations on the

use of proceeds from debt because

limitations on interest expense

deductibility were determined at the

partner level. Under section 163(j) as

amended by TCJA, the partnership is

required to complete a calculation to

determine its limitation on trade or

business interest expense. These

proposed regulations provide guidance

on the method that partnerships and

partners should use to allocate interest

expense in cases where a partner

receives a distribution financed from

debt. The Treasury Department and the

IRS project that this guidance will

reduce taxpayer uncertainty regarding

the application of section 163(j) in this

situation relative to the no-action

baseline.

The proposed regulations require that

partnerships allocate the interest

expense of the partners not receiving a

debt-financed distribution first. This

interest expense is allocated to trade or

business expense to the extent of the

partnership’s expenses. The character of

any remaining interest expense is

determined based on the partnership’s

asset basis. Next, the proposed

regulations allocate the interest expense

of the partner receiving the debt-

financed distribution. If there is any

remaining business expense that was

not used by the other partners it is used

first to allocate the interest expense.

Then the partner receiving the debt

financed distribution looks to the use of

the proceeds of the distribution to

determine the character of any

additional interest expense.

This procedure provides lower

compliance costs relative to alternative

regulatory approaches. Any alternative

method that required information on the

partner’s use of the proceeds to

determine the partnership level section

163(j) limitation would have increased

compliance costs for partnerships and

partners because it would require a new

reporting from partners to partnerships.

In cases of tiered partnerships, this

reporting could become extremely

complex. The method outlined in these

proposed regulations avoids the need

for partnerships and other partners to

have information about the use the debt-

financed distribution proceeds.

However, it maintains that interest

expense allocated to the partner

receiving the debt-financed distribution

could still be subject to other limitations

besides section 163(j) based on the use

of the proceeds. For example, proceeds

used for personal expenditures would

still be subject to section 163(h)

limitations on interest expense, which

may be seen as an important existing

anti-abuse provision.

The proposed procedure bases the

allocation rules on optional and general

allocation rules outlined in a previously

issued notice, Notice 89–35, which will

minimize compliance costs to

partnerships (relative to the no-action

baseline) to the extent that they are

already familiar with allocating interest

expense first to the partnership’s

business expenses and subsequently

based on assets. Relative to the no-

action baseline, the Treasury

Department and the IRS expect these

proposed regulations will reduce

taxpayer uncertainty regarding the

application of section 163(j). Treasury

and IRS expect that this resolution of

uncertainty itself will reduce taxpayer

compliance costs and encourage

similarly situated taxpayers to interpret

section 163(j) similarly.

Number of Affected Taxpayers. The

Treasury Department and the IRS are

not currently able to determine the

number of taxpayers affected by rules

regarding debt financed distributions

because debt financed distributions are

not separately identified on tax forms,

and therefore using the numbers of

entities reporting interest on a Form K–

1, Schedule C or Schedule E would

produce overly broad results.

iii. Tiered Partnerships

Section 163(j) does not explicitly

address how the interest deduction

limitation should be applied to tiered

partnerships. The 2018 Proposed

Regulations requested comments on the

treatment of tiered partnership

structures. Suppose that an upper-tier

partnership (UTP) is a partner of a

lower-tier partnership (LTP), and that

the LTP has business interest expense

that is limited under section 163(j).

Under the 2018 Proposed Regulations,

the UTP would receive an excess

business interest expense (EBIE)

carryforward from the LTP. In response

to comments received, these proposed

regulations adopt the Entity Approach

and specify that this EBIE carryforward

should not be allocated to the partners

of the UTP for purposes of section

163(j).

While some commenters favored the

Entity Approach that these proposed

regulations adopt, others favored an

alternative under which the EBIE

carryforward would be allocated to the

UTP’s partners (Aggregate Approach).

Additionally, if the UTP’s partner were

itself a partnership, the EBIE would

again be allocated to that partnership’s

partners. This would continue until the

EBIE is eventually allocated to a non-

partnership partner. Relative to the

Entity Approach, the Aggregate

Approach generally places greater

compliance burden on partners. Under

the Aggregate Approach, partners would

be required to keep records linking

separate amounts of EBIE to the

partnerships that generated them. In

simple partnership structures, this is not

onerous; however, in a partnership

structure with many tiers and many

partners, this would prove cumbersome.

In contrast, under the Entity Approach,

only the UTP keeps a record of the EBIE

carryforward.

In summary, the Treasury Department

and the IRS project lower record-

keeping requirements, higher

compliance rates, and easier compliance

monitoring of tiered partnerships under

the Entity Approach relative to the

Aggregate Approach, with no

meaningful difference in the economic

decisions that taxpayers would make

under the two approaches.

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Moreover, relative to the no-action

baseline, the Treasury Department and

the IRS expect these proposed

regulations for tiered partnerships will

reduce taxpayer uncertainty regarding

the application of section 163(j).

Treasury and IRS expect that this

resolution of uncertainty itself will

reduce taxpayer compliance costs and

encourage similarly situated taxpayers

to interpret section 163(j) similarly.

iv. Self-Charged Lending

The 2018 Proposed Regulations

requested comments on the treatment of

lending transactions between a

partnership and a partner (self-charged

lending transactions). Suppose that a

partnership receives a loan from a

partner and allocates the resulting

interest expense to that partner. Prior to

the TCJA, the interest income and

interest expense from this loan would

net precisely to zero on the lending

partner’s tax return. Under section

163(j) as revised by TCJA, however, the

partnership’s interest expense

deduction may now be limited.

Therefore, in absence of specific

regulatory guidance, the lending partner

may receive interest income from the

partnership accompanied by less-than-

fully-offsetting interest expense. Instead,

the lending partner would receive EBIE,

which would not be available to offset

his personal interest income. This

outcome has the effect of increasing the

cost of lending transactions between

partners and their partnerships relative

to otherwise similar financing

arrangements.

To avoid this outcome, these

proposed regulations treat the lending

partner’s interest income from the loan

as excess business interest income (EBII)

from the partnership, but only to the

extent of the partner’s share of any EBIE

from the partnership for the taxable

year. This allows the interest income

from the loan to be offset by the EBIE.

The business interest expense (BIE) of

the partnership attributable to the

lending transaction will thus be treated

as BIE of the partnership for purposes of

applying section 163(j) to the

partnership.

The Treasury Department and the IRS

expect that these proposed regulations

will lead a higher proportion of self-

charged lending transactions in

partnership financing, relative to the no-

action baseline. We further project that

these proposed regulations will increase

the proportion of partnership financing

that is debt-financed relative to the no-

action baseline. We have determined

that these effects are consistent with the

intent and purpose of the statute.

Number of Affected Taxpayers. The

Treasury Department and the IRS do not

have readily available data to determine

the number of taxpayers affected by

rules regarding self-charged interest

because no reporting modules currently

connect these payments by and from

partnerships.

c. Provisions Related to Controlled

Foreign Corporations (CFCs)

i. How To Apply Section 163(j) When

CFCs Have Shared Ownership

The Final Regulations clarify that

section 163(j) and the section 163(j)

regulations apply to determine the

deductibility of a CFC’s business

interest expense for tax purposes in the

same manner as these provisions apply

to a domestic corporation. These

proposed regulations provide further

rules and guidance on how section

163(j) applies to CFCs when CFCs have

shared ownership and are eligible to be

members of CFC groups.

The Treasury Department and the IRS

considered three options with respect to

the application of section 163(j) to CFC

groups. The first option was to apply the

163(j) limitation to CFCs on an

individual basis, regardless of whether

CFCs have shared ownership. However,

if section 163(j) is applied on an

individual basis, business interest

deductions of individual CFCs may be

limited by section 163(j) even when, if

calculated on a group basis, business

interest deductions would not be

limited. Taxpayers could restructure or

‘‘self-help’’ to mitigate the effects of the

section 163(j) limitation, but that option

involves economically restructuring

costs for the taxpayer (relative to the

third option, described subsequently)

with no corresponding economically

productive activity.

The second option, which was

proposed in the 2018 Proposed

Regulations, was to allow an election to

treat related CFCs and their U.S.

shareholders as a group. Under this

option, while the section 163(j) rules

would still be computed at the

individual CFC level, the ‘‘excess

taxable income’’ of a CFC could be

passed up from lower-tier CFCs to

upper-tier CFCs and U.S. shareholders

in the same group. Excess taxable

income is the amount of income by

which a CFC’s adjusted taxable income

(ATI) exceeds the threshold amount of

ATI below which there would be

disallowed business expense.

Many comments suggested that

computing a section 163(j) limitation for

each CFC and rolling up CFC excess

taxable income would be burdensome

for taxpayers, especially since some

multinational organizations have

hundreds of CFCs. In addition,

comments noted that the ability to pass

up excess taxable income would

encourage multinational organizations

to restructure such that CFCs with low

interest payments and high ATI are

lower down the ownership chain and

CFCs with high interest payments and

low ATI are higher up in the chain of

ownership. Similar to the first option,

this restructuring would be expensive to

taxpayers without any corresponding

productive economic activity.

The third option was to allow

taxpayers to elect to apply the section

163(j) rules to CFC groups on an

aggregate basis, similar to the rules

applicable to U.S. consolidated groups.

This option was suggested by many

comments and is the approach taken in

the proposed regulations. Under this

option, a single 163(j) limitation is

computed for a CFC group by summing

the items necessary for this computation

(e.g., current-year business interest

expense and ATI) across all CFC group

members. The CFC group’s limitation is

then allocated to each CFC member

using allocation rules similar to those

that apply to U.S. consolidated groups.

This option reduces the compliance

burden on taxpayers in comparison to

applying the section 163(j) rules on an

individual CFC basis and calculating the

excess taxable income to be passed up

from lower tier CFCs to higher tier

CFCs. In comparison to the first and

second options, this option also

removes the incentive for taxpayers to

undertake costly restructuring, since the

location of interest payments and ATI

among CFC group members will not

affect the interest disallowance for the

group.

The proposed regulations also set out

a number of rules to govern membership

in a CFC group. These rules specify

which CFCs can be members of the

same CFC group, how CFCs with U.S.

effectively connected income (ECI)

should be treated, and the timing for

making or revoking a CFC group

election. These rules provide clarity and

certainty to taxpayers regarding the CFC

group election for section 163(j). In the

absence of these regulations, taxpayers

would face uncertainty regarding CFC

group membership, and may make

financing decisions or undertake

restructuring that would be inefficient

relative to the proposed regulations.

Number of Affected Taxpayers. The

population affected by this proposed

rule includes any taxpayer with

ownership in a CFC group, consisting of

two or more CFCs that has average gross

receipts over a three year period in

excess of $25 million. The Treasury

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Department and the IRS estimate that

there are approximately 7,500 taxpayers

with two or more CFCs based on counts

of e-filed tax returns for tax years 2015–

2017. This estimate includes C

corporations, S corporations,

partnerships, and individuals with CFC

ownership.

ii. CFC Excess Taxable Income and ATI

of U.S. Shareholders

Generally, for the purposes of

computing interest expense disallowed

under section 163(j), deemed income

inclusions, such as subpart F and GILTI

inclusions, are excluded from a U.S.

shareholder’s ATI under the Final

Regulations. The proposed regulations

allow a U.S. shareholder to add back to

its ATI a percentage of its deemed

income inclusions attributable to an

applicable CFC. That percentage is

equal to the ratio of the CFC’s excess

taxable income to its ATI.

The Treasury Department and the IRS

considered three options with respect to

the addition of deemed income

inclusions to a U.S. shareholder’s ATI.

The first option is to allow such

inclusions to be added to ATI with

respect to any of a taxpayer’s applicable

CFCs regardless of whether a CFC group

election is made. However, under this

option, taxpayers with a number of

highly leveraged CFCs would have the

incentive to not make a CFC group

election and concentrate debt in certain

CFCs. The taxpayer could thereby

reduce the leverage of other CFCs in

order to create excess taxable income in

those CFCs. This excess taxable income

could be then passed up to increase the

U.S. shareholder’s ATI. This incentive

could lead to costly debt shifting among

CFCs with no corresponding productive

economic activity.

The second option considered was to

allow such income inclusions to be

added to ATI with respect to CFC group

members only. Deemed income

attributable to CFCs that are not

members of groups would not be

allowed to be added to a U.S.

shareholder’s ATI. This would remove

the incentive for taxpayers to aggregate

debt in certain CFCs, since if CFCs are

treated as members of a group, then the

distribution of interest payments across

members will not affect the total excess

taxable income of the group. However,

comments noted that this option would

not allow deemed income from stand-

alone CFCs, which do not meet the

requirements to join a CFC group, to

increase shareholders’ ATI.

The third option, which is proposed

by the Treasury Department and the

IRS, is to allow such income inclusions

to be added to ATI with respect to both

CFC group members and stand-alone

CFCs. Under this option, if CFCs are

eligible to be members of a CFC group,

then the group election must be made in

order for deemed inclusions attributable

to these CFCs to increase shareholder

ATI. The ATI of a U.S. shareholder can

also be increased with respect to CFCs

that are not eligible to be members of

CFC groups. In this way, the rule does

not penalize, relative to shareholders of

CFC groups, shareholders which own

only one CFC or own CFCs which for

other reasons are not eligible for group

membership.

Number of Affected Taxpayers. The

population of affected taxpayers

includes any taxpayer with a CFC since

the proposed rule affects both stand-

alone CFCs as well as CFC groups. The

Treasury Department and the IRS

estimate that there are approximately

10,000 to 11,000 affected taxpayers

based on a count of e-filed tax returns

for tax years 2015–2017. These counts

include C corporations, S corporations,

partnerships, and individuals with CFC

ownership that meet a $25 million

three-year average gross receipts

threshold. The Treasury Department

and the IRS do not have readily

available data on the number of filers

that are tax shelters that are potentially

affected by these provisions.

d. Election To Use 2019 ATI To

Determine 2020 Section 163(j)

Limitation for Consolidated Groups

The proposed regulations provide that

if a taxpayer filing as a consolidated

group elects to substitute its 2019 ATI

for its 2020 ATI, that group can use the

consolidated group ATI for the 2019

taxable year, even if membership of the

consolidated group changed in the 2020

taxable year. For example, suppose

consolidated group C has three members

in the 2019 taxable year, P, the common

parent of the consolidated group, and S1

and S2, which are both wholly owned

by P. In the 2019 taxable year, each

member of consolidated group C had

$100 of ATI on a stand-alone basis, for

a total of $300 of ATI for the

consolidated group C. In the 2020

taxable year, consolidated group C sells

all of the stock of S2 and acquires all of

the stock of a new member, S3. In the

2019 taxable year, S3 had $50 in ATI on

a stand-alone basis. Under the proposed

regulations, consolidated group C may

elect to use $300 in ATI from 2019 as

a substitute for its ATI in the 2020

taxable year.

The Treasury Department and the IRS

considered as an alternative basing the

2019 ATI on the membership of the

consolidated group in the 2020 taxable

year. In the example in the previous

paragraph, this approach would subtract

out the $100 in ATI from S2 and add the

$50 in ATI from S3, for a total of $250

in 2019 ATI that could potentially be

substituted for 2020 ATI for

consolidated group C. This approach

would add burden to taxpayers relative

to the proposed regulations by requiring

additional calculations and tracking of

ATI on a member-by-member basis to

determine the amount of 2019 ATI that

can be used in the 2020 taxable year

without providing any general economic

benefit.

In addition, the 2019 tax year will

have closed for many taxpayers by the

time these proposed regulations will be

published. This implies that proposed

rule of basing the consolidated group

composition on the 2019 taxable year to

calculate the amount of 2019 ATI that

can be used in the 2020 taxable year

will, relative to the alternative approach

of using the composition in the 2020

taxable year, reduce the incentive for

taxpayers to engage in costly mergers,

acquisitions, or divestures to achieve a

favorable tax result.

Number of Affected Taxpayers. The

Treasury Department and the IRS

estimate that approximately 34,000

corporate taxpayers filed a consolidated

group tax return for tax year 2017. This

represents an upper-bound of the

number of taxpayers affected by the

proposed rule as not all consolidated

groups would need to calculate the

amount of section 163(j) interest

limitation in tax years 2019 and 2020.

D. Paperwork Reduction Act

The collection of information in these

Proposed Regulations has 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(d)). An agency

may not conduct or sponsor, and a

person is not required to respond to, a

collection of information unless it

displays a valid OMB control number.

The collection of information in these

Proposed Regulations has 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(d)).

Books or records relating to a

collection of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and return information are

confidential, as required by section

6103.

1. Collections of Information

The collections of information subject

to the Paperwork Reduction Act in these

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Proposed Regulations are in proposed

§§ 1.163(j)–6(d)(5), 1.163(j)–6(g)(4), and

1.163(j)–7.

The collections of information in

proposed §§ 1.163(j)–6(d)(5) and

1.163(j)–6(g)(4) are required to make two

elections relating to changes made to

section 163(j) by the CARES Act. The

election under proposed § 1.163(j)–

6(d)(5) is for a passthrough taxpayer to

use the taxpayer’s ATI for the last

taxable year beginning in 2019 as its

ATI for any taxable year beginning in

2020, in accordance with section

163(j)(10)(B). The election under

proposed § 1.163(j)–6(g)(4) relates to

excess business interest expense of a

partnership for any taxable year

beginning in 2019 that is allocated to a

partner. Section 163(j)(10)(A)(ii)(II)

provides that, unless the partner elects

out, in 2020, the partner treats 50

percent of the excess business interest

expense as not subject to the section

163(j) limitation. If the partner elects

out, the partner treats all excess

business interest expense as subject to

the same limitations as other excess

business interest expense allocated to

the partner.

Revenue Procedure 2020–22 describes

the time and manner for making these

elections. For both elections, taxpayers

make the election by timely filing a

Federal income tax return or Form 1065,

including extensions, an amended

Federal income tax return, amended

Form 1065, or administrative

adjustment request, as applicable. More

specifically, taxpayers complete the

Form 8990, ‘‘Limitation on Business

Interest Expense under Section 163(j),’’

using the taxpayer’s 2019 ATI and/or

not applying the rule in section

163(j)(10)(ii)(II), as applicable. No

formal statements are required to make

these elections. Accordingly, the

reporting burden associated with the

collections of information in proposed

§ 1.163(j)–6(d)(5) and –6(g)(4) will be

reflected in the IRS Form 8990

Paperwork Reduction Act Submissions

(OMB control number 1545–0123).

The collections of information in

proposed § 1.163(j)–7 are required for

taxpayers to make an election to apply

section 163(j) to a CFC group (CFC

group election) or an annual election to

exempt a CFC or CFC group from the

section 163(j) limitation (safe-harbor

election). The elections are made by

attaching a statement to the US

shareholder’s annual return. The CFC

group election remains in place until

revoked and may not be revoked for any

period beginning prior to 60 months

following the period for which it is

made. The safe-harbor election is made

on an annual basis.

Under § 1.964–1(c)(3)(i), no election

of a foreign corporation is effectuated

unless the controlling domestic

shareholder provides a statement with

their return and notice of the election to

the minority shareholders under

§ 1.964–1(c)(3)(ii) and (iii). See also,

§ 1.952–2(b)–(c). These collections are

necessary to ensure that the election is

properly effectuated, and that taxpayers

properly report the amount of interest

that is potentially subject to the

limitation.

2. Future Modifications to Forms To

Collect Information

At this time, no modifications to any

forms, including the Form 8990,

‘‘Limitation on Business Interest

Expense IRC 163(j),’’ are proposed with

regard to the elections under section

163(j)(10), or the CFC group or safe-

harbor elections. The Treasury

Department and the IRS are considering

revisions to the Instructions for Form

8990 to reflect changes made to section

163(j)(10) regarding the elections under

proposed §§ 1.163(j)–6(d)(5) and

1.163(j)–6(g)(4). For purposes of the

Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)), the reporting burden of

Form 8990 is associated with OMB

control number 1545–0123. In the 2018

Proposed Regulations, Form 8990 was

estimated to be required by fewer than

92,500 taxpayers.

If an additional information collection

requirement is imposed through these

regulations in the future, for purposes of

the Paperwork Reduction Act, any

reporting burden associated with these

regulations will be reflected in the

aggregated burden estimates and the

OMB control numbers for general

income tax forms or the Form 8990,

‘‘Limitation on Business Interest

Expense Under Section 163(j)’’.

The forms are available on the IRS

website at:

Form OMB No. IRS website link

Form 1040 ............. 1545–0074 https://www.irs.gov/pub/irs-pdf/f1040.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/i1040gi.pdf).

Form 1120 ............. 1545–0123 https://www.irs.gov/pub/irs-pdf/f1120.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/i1120.pdf).

Form 1120S ........... https://www.irs.gov/pub/irs-pdf/f1120s.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/i1120s.pdf).

Form 1065 ............. https://www.irs.gov/pub/irs-pdf/f1065.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/i1065.pdf).

Form 1120–REIT ... https://www.irs.gov/pub/irs-prior/f1120rei--2018.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/

i1120rei.pdf).

Form 8990 ............. https://www.irs.gov/pub/irs-access/f8990_accessible.pdf (Instructions: https://www.irs.gov/pub/irs-pdf/

i8990.pdf).

In addition, when available, drafts of

IRS forms are posted for comment at

https://apps.irs.gov/app/picklist/list/

draftTaxForms.htm. IRS forms are

available at https://www.irs.gov/forms-

instructions. Forms will not be finalized

until after they have been approved by

OMB under the PRA.

3. Burden Estimates

The following estimates for the

collections of information in these

proposed regulations are based on the

most recently available Statistics of

Income (SOI) tax data.

For the collection of income in

proposed § 1.163(j)–6(d)(5), where a

passthrough taxpayer elects to use the

taxpayer’s ATI for the last taxable

beginning in 2019 as the taxpayer’s ATI

for any taxable year beginning in 2020,

the most recently available 2017 SOI tax

data indicates that, on the high end, the

estimated number of respondents is

49,202. This number was determined by

examining, for the 2017 tax year, Form

1065 and Form 1120–S filers with

greater than $26 million in gross

receipts that have reported interest

expense, and do not have an NAICS

code that is associated with a trade or

business that normally would be

excepted from the section 163(j)

limitation.

For the collection of information

under § 1.163(j)–6(g)(4), in which a

partner elects out of treating 50 percent

of any excess business interest expense

allocated to the partner in 2019 as not

subject to a limitation in 2020, the

Treasury Department and the IRS

estimate that only taxpayers that

actively want to reduce their deductions

will make this election. The application

of the base erosion minimum tax under

section 59A depends, in part, on the

amount of a taxpayer’s deductions.

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Accordingly, the Treasury Department

and the IRS estimate that taxpayers that

are subject to both the base erosion

minimum tax under section 59A and

section 163(j) are the potential filers of

this election. Using the 2017 SOI tax

data, the Treasury Department estimate

that 1,182 firms will make the election.

This estimate was determined by

examining three criteria: First, the

number of taxpayers subject to section

59A, namely, C corporations with at

least $500,000,000 in gross receipts,

second, the portion of those taxpayers

that do not have an NAICS code

associated with a trade or business that

is generally not subject to the section

163(j) limitation (2211 (electric power

generation, transmission and

distribution), 2212 (natural gas

distribution), 2213 (water, sewage and

other systems), 111 or 112 (farming),

531 (real property)), and, third, the

portion of taxpayers satisfying the first

two criteria that received a Form K–1,

‘‘Partner’s Share of Income, Deductions,

Credits, etc.’’

For the collections of information in

proposed § 1.163(j)–7, namely the CFC

and safe-harbor elections, and the

corresponding notice under § 1.964–

1(c)(3)(iii), the most recently available

2017 SOI tax data indicates that, on the

high end, the estimated number of

respondents is 4,980 firms. This number

was determined by examining, for the

2017 tax year, Form 1040, Form 1120,

Form 1120–S, and Form 1065 filers with

greater than $26 million in gross

receipts that filed a Form 5471,

Information Return of U.S. Persons With

Respect to Certain Foreign Corporations,

where an interest expense amount was

reported on Schedule C of the Form

5471.

The estimated number of respondents

that could be subject to the collection of

information for the CFC group or safe-

harbor election is 4,980. The estimated

annual burden per respondent/

recordkeeper varies from 0 to 30

minutes, depending on individual

circumstances, with an estimated

average of 15 minutes. The estimated

total annual reporting and/or

recordkeeping burden is 1,245 hours

(4,980 respondents × 15 minutes). The

estimated annual cost burden to

respondents is $95 per hour.

Accordingly, we expect the total annual

cost burden for the CFC group election

and safe-harbor election statements to

be $118,275 (4,980 * .25 * $95).

The Treasury Department and the IRS

request comment on the assumptions,

methodology, and burden estimates

related to this information collection.

Comments on the collection of

information should be sent to the Office

of Management and Budget, Attn: Desk

Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503, with copies to the Internal

Revenue Service, Attn: IRS Reports

Clearance Officer,

SE:W:CAR:MP:T:T:SP, Washington, DC

20224. Comments on the collection of

information should be received by

November 2, 2020, which is 60 days

after the date of filing for public

inspection with the Office of the Federal

Register.

Comments are specifically requested

concerning—

Whether the proposed collection of

information is necessary for the proper

performance of the functions of the IRS,

including whether the information will

have practical utility;

The accuracy of the estimated burden

associated with the proposed collection

of information;

How the quality, utility, and clarity of

the information to be collected may be

enhanced;

How the burden of complying with

the proposed collection of information

may be minimized, including through

the application of automated collection

techniques or other forms of information

technology; and

Estimates of capital or start-up costs

and costs of operation, maintenance,

and purchase of services to provide

information.

II. Regulatory Flexibility Act

It is hereby certified that these

Proposed Regulations, if adopted as

final, will not have a significant

economic impact on a substantial

number of small entities.

This certification can be made

because the Treasury Department and

the IRS have determined that the

number of small entities that are

affected as a result of the regulations is

not substantial. These rules do not

disincentivize taxpayers from their

operations, and any burden imposed is

not significant because the cost of

implementing the rules, if any, is low.

As discussed in the 2018 Proposed

Regulations, section 163(j) provides

exceptions for which many small

entities will qualify. First, under section

163(j)(3), the limitation does not apply

to any taxpayer, other than a tax shelter

under section 448(a)(3), which meets

the gross receipts test under section

448(c) for any taxable year. A taxpayer

meets the gross receipts test under

section 448(c) if the taxpayer has

average annual gross receipts for the 3-

taxable year period ending with the

taxable year that precedes the current

taxable year that do not exceed

$26,000,000. The gross receipts

threshold is indexed annually for

inflation. Because of this threshold, the

Treasury Department and the IRS

project that entities with 3-year average

gross receipts below $26 million will

not be affected by these regulations

except in rare cases.

Section 163(j) provides that certain

trades or businesses are not subject to

the limitation, including the trade or

business of performing services as an

employee, electing real property trades

or businesses, electing farming

businesses, and certain utilities as

defined in section 163(j)(7)(A)(iv).

Under the 2018 Proposed Regulations,

taxpayers that otherwise qualified as

real property trades or businesses or

farming businesses that satisfied the

small business exemption in section

448(c) were not eligible to make an

election to be an electing real property

trade or business or electing farming

business. Under the Final Regulations,

however, those taxpayers are eligible to

make an election to be an electing real

property trade or business or electing

farming business. Additionally, the

Final Regulations provide that certain

utilities not otherwise excepted from the

limitation can elect for a portion of their

non-excepted utility trade or business to

be excepted from the limitation. Any

economic impact on any small entities

as a result of the requirements in these

Proposed Regulations, not just the

requirements that impose a Paperwork

Reduction Act burden, is not expected

to be significant because the cost of

implementing the rules, if any, is low.

The Treasury Department and the IRS

do not have readily available data on the

number of filers that are tax shelters, as

defined in section 448(a)(3), that are

potentially affected by these provisions.

As described in more detail earlier in

this Preamble, these Proposed

Regulations cover several topics,

including, but not limited to, debt

financed distributions from passthrough

entities, self-charged interest, the

treatment of section 163(j) in relation to

trader funds, the impact of section 163(j)

on publicly traded partnerships, and the

application of section 163(j) to United

States shareholders of controlled foreign

corporations and to foreign persons with

effectively connected income in the

United States.

The Treasury Department and the IRS

do not have readily available data to

determine the number of taxpayers

affected by rules regarding self-charged

interest because no reporting modules

currently connect these payments by

and from partnerships.

The Treasury Department and the IRS

likewise do not have precise data on the

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number of taxpayers affected by rules

regarding debt financed distributions.

The Treasury Department and the IRS

estimate that the number of taxpayers

affected by the rules regarding debt-

financed distributions is 50,036. This

number was reached first by adding the

number of Form 1065 filers that

reported code W on line 13b of schedule

K of the Form 1065, or approximately

410,996 using 2018 taxable year data,

and the number of Form 1120–S filers

that reported code S on line 12d of

schedule K of the Form 1120–S, or

approximately 89,367 using 2018

taxable year data. Those codes are used

to report interest expense allocated to

debt financed distributions. Using the

result of the two numbers, 500,363

(410,996 + 89,367), produces overly

broad results because the codes

referenced above are used to report

more than just interest expense

allocated to debt financed distributions.

Code W on line 13b of schedule K of the

Form 1065 also is used to report at least

nine other items, including, but not

limited to, itemized deductions that

Form 1040 or 1040–SR filers report on

Schedule A, soil and water conservation

expenditures, and the domestic

productions activities deductions. Code

S on line 12d of schedule K of the Form

1120–S also is used to report at least

eleven other items, including, but not

limited to, itemized deductions that

Form 1040 or 1040–SR filers report on

Schedule A, expenditures for the

removal of architectural and

transportation barriers for the elderly

and disabled that the corporation

elected to treat as a current expense, and

film, television, and live theatrical

production expenses. Considering the

number of other items reported under

those codes, the Treasury Department

and the IRS estimate that approximately

10% of the filers using those codes

report interest expense allocated to debt

financed distributions (500,363 * 0.10 =

50,036).

Despite not having precise data, these

rules do not impose a significant

paperwork or implementation cost

burden on taxpayers. Under Notice 89–

35, taxpayers have been required to

maintain books and records to properly

report the tax treatment of interest

associated with debt financed

acquisitions and contributions by

partners, and debt financed

distributions to partners. Additional

reporting requirements are needed to

allow passthrough entities and their

owners to comply with the interest

tracing rules under § 1.163–8T. Without

additional reporting, the mechanism for

determining the tax treatment of interest

under § 1.163–8T is burdensome and

unclear. For example, in some cases,

partners would need to report back to

the partnership how they used debt

financed distribution to allow the

partnership to properly report its

interest expense. This notice of

proposed rules would provide

consistent reporting and compliance by

passthrough entities and their owners,

which would reduce their overall

burden. The estimated time to

determine whether a distribution is a

debt financed distribution and to

comply with these rules would be 0

minutes to 30 minutes per taxpayer,

depending on individual circumstances,

for an average of 15 minutes. The 2018

monetization rates for this group of

filers is $57.53. According, the Treasury

Department and the IRS estimate the

burden to be $719,642.77 (50,036

respondents * 0.25 hours * $57.53).

The Treasury Department and the IRS

have determined that, on the high end,

the rules regarding trading partnerships

might affect approximately 309 small

entities. This number was reached by

determining, using data for the 2017

taxable year, the number of Form 1065

and Form 1065–B filers, with more than

$26 million in gross receipts, that (1)

completed Schedule B to Form 1065

and marked box b, c, or d in question

1 to denote limited partnership, limited

liability company or limited liability

partnership status; (2) have a North

American Industry Classification

System (NAICS) code starting with

5231, 5232, 5239 or 5259, and (3) do not

have gross receipts exceeding the small

business thresholds for the various

NAICS codes. The following table

provides a breakdown of the potentially

affected taxpayers by NAICS code.

NAICS code Titles Gross

receipts

threshold

Number of

respondents

5231 ............. Securities and Commodity Contracts Intermediation and Brokerage, including Investment

Bank and Securities Dealing; Securities Brokerage; Commodity Contract Dealing; Com-

modity Contracts Brokerage.

$41.5M 42

5232 ............. Securities and Commodities Exchanges ...................................................................................... 41.5M 0

5239 ............. Other Financial Investment Activities, including Miscellaneous Intermediation; Portfolio Man-

agement; Investment Advice; Trust, Fiduciary, and Custody Activities; Miscellaneous Finan-

cial Investment Activities.

41.5M 267

5259 ............. Other Investment Pools and Funds, including Open-End Investment Funds; Trusts, Estates,

and Agency Accounts; Other Financial Vehicles. 35M [d]

Total Re-

spond-

ents.

309

Source: SOI Partnership Study, 2017.

[d] Data is suppressed based on disclosure rules detailed in Publication 1075.

Additionally, the Treasury

Department and the IRS have

determined that the rules regarding

publicly traded partnerships might

affect approximately 83 taxpayers. This

number was reached by determining,

using data for the 2017 taxable year, the

number of Form 1065 and 1065–B filers

with gross receipts exceeding $25

million that answered ‘‘yes’’ to question

5 on Schedule B to Form 1065 denoting

that the entity is a publicly traded

partnership.

As noted earlier, these Proposed

Regulations do not impose any new

collection of information on these

entities. These Proposed Regulations

actually assist small entities in meeting

their filing obligations by providing

definitive advice on which they can

rely.

For the section 163(j)(10) elections for

passthrough taxpayers under proposed

§§ 1.163(j)–6(d)(5) and 1.163(j)–6(g)(4),

most small taxpayers do not need to

make the elections because, as

discussed earlier, they are not subject to

the section 163(j) limitation. For small

taxpayers that are subject to the

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limitation, the cost to implement the

election is low. Pursuant to Revenue

Procedure 2020–22, these passthrough

taxpayers simply complete the Form

8990 as if the election has been made.

Accordingly, the burden of complying

with the elections, if needed, is no

different than for taxpayers who do not

make the elections.

The persons potentially subject to

proposed § 1.163(j)–7 are U.S.

shareholders in one or more CFCs for

which BIE is reported, and that (1) have

average annual gross receipts for the 3-

taxable year period ending with the

taxable year that precedes the current

taxable year exceeding $26,000,000, and

(2) want to make the CFC group election

or safe-harbor election. Proposed

§ 1.163(j)–7 requires such taxpayers to

attach a statement to their return

providing basic information regarding

the CFC group or standalone CFC.

As discussed in the Paperwork

Reduction Act section of this Preamble,

the reporting burden for both statements

is estimated at 0 to 30 minutes,

depending on individual circumstances,

with an estimated average of 15 minutes

for all affected entities, regardless of

size. The estimated monetized burden

for compliance is $95 per hour.

For these reasons, the Treasury

Department and the IRS have

determined that these Proposed

Regulations will not have a significant

economic impact on a substantial

number of small entities.

Notwithstanding this certification, the

Treasury Department and the IRS invite

comments from interested members of

the public on both the number of small

entities affected and the economic

impact on those small entities.

E. Unfunded Mandates Reform Act

Section 202 of the Unfunded

Mandates Reform Act of 1995 requires

that agencies assess anticipated costs

and benefits and take certain other

actions before issuing a final rule that

includes any Federal mandate that may

result in expenditures in any one year

by a state, local, or tribal government, in

the aggregate, or by the private sector, of

$100 million in 1995 dollars, updated

annually for inflation. In 2019, that

threshold was approximately $154

million. These Proposed Regulations do

not include any Federal mandate that

may result in expenditures by state,

local, or tribal governments, or by the

private sector in excess of that

threshold.

F. Executive Order 13132: Federalism

Executive Order 13132 (entitled

‘‘Federalism’’) prohibits an agency from

publishing any rule that has federalism

implications if the rule either imposes

substantial, direct compliance costs on

state and local governments, and is not

required by statute, or preempts state

law, unless the agency meets the

consultation and funding requirements

of section 6 of the Executive Order.

These Proposed Regulations do not have

federalism implications and do not

impose substantial direct compliance

costs on state and local governments or

preempt state law within the meaning of

the Executive Order.

Comments and Requests for a Public

Hearing

Before these proposed amendments to

the regulations are adopted as final

regulations, consideration will be given

to comments that are submitted timely

to the IRS as prescribed in the preamble

under the

ADDRESSES

section. The

Treasury Department and the IRS

request comments on all aspects of the

proposed regulations. Any electronic

comments submitted, and to the extent

practicable any paper comments

submitted, will be made available at

www.regulations.gov or upon request.

A public hearing will be scheduled if

requested in writing by any person who

timely submits electronic or written

comments. Requests for a public hearing

are also encouraged to be made

electronically. If a public hearing is

scheduled, notice of the date and time

for the public hearing will be published

in the Federal Register. Announcement

2020–4, 2020–17 I.R.B. 667 (April 20,

2020), provides that until further notice,

public hearings conducted by the IRS

will be held telephonically. Any

telephonic hearing will be made

accessible to people with disabilities.

Drafting Information

The principal authors of these

regulations are Susie Bird, Charles

Gorham, Jaime Park, Joanna Trebat and

Sophia Wang (Income Tax &

Accounting), Anthony McQuillen,

Adrienne M. Mikolashek, and William

Kostak (Passthroughs and Special

Industries), Azeka J. Abramoff

(International), Russell Jones, and John

Lovelace (Corporate), and Pamela Lew,

Steven Harrison, and Michael Chin

(Financial Institutions & Products).

Other personnel from the Treasury

Department and the IRS participated in

their development.

Effect on Other Documents

Notice 89–35, 1989–1 C.B. 675, is

proposed to be obsoleted.

Statement of Availability of IRS

Documents

IRS Revenue Procedures, Revenue

Rulings notices, and other guidance

cited in this document are published in

the Internal Revenue Bulletin (or

Cumulative Bulletin) and are available

from the Superintendent of Documents,

U.S. Government Publishing Office,

Washington, DC 20402, or by visiting

the IRS website at http://www.irs.gov.

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 TAXES

■Paragraph 1. The authority citation

for part 1 continues to read in part as

follows:

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

■Par. 2. Section 1.163–14 is added to

read as follows:

§ 1.163–14 Allocation of interest expense

among expenditures—Passthrough

Entities.

(a) In general—(1) Application. This

section prescribes rules for allocating

interest expense associated with debt

proceeds of a partnership or S

corporation (a passthrough entity). In

general, interest expense on a debt of a

passthrough entity is allocated in the

same manner as the debt to which such

interest expense relates is allocated.

Debt is allocated by tracing

disbursements of the debt proceeds to

specific expenditures. This section

prescribes rules for tracing debt

proceeds to specific expenditures of a

passthrough entity.

(2) Cross-references. This paragraph

provides the general manner in which

interest expense of a passthrough entity

is allocated. See paragraph (b) of this

section for the treatment of interest

expense allocated under the rules of this

section, paragraph (c) for the manner in

which debt proceeds of a passthrough

entity are allocated and the manner in

which interest expense allocated under

this section is treated, paragraph (d) for

rules relating to debt allocated under the

rules of § 1.163–8T to distributions to

owners of a passthrough entity,

paragraph (e) for rules relating to debt

repayments, paragraph (f) for rules

relating to debt allocated under the rules

of § 1.163–8T to expenditures for

interests in passthrough entities,

paragraph (g) for change of ownership

rules for interest expense allocation

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purposes, and paragraph (h) for

examples.

(b) Treatment of interest expense—(1)

General rule. Except as otherwise

provided in section § 1.163(j)-8T(m),

interest expense allocated under the

rules of this section is treated in the

following manner:

(i) Interest expense allocated to trade

or business expenditures (as defined in

paragraph (b)(2)(v) of this section) is

taken into account under section 163(j)

by the passthrough entity;

(ii) Interest expense allocated to other

trade or business expenditures (as

defined in paragraph (b)(2)(ii) of this

section) is taken into account under the

rules of § 1.163–8T, as applicable, by the

passthrough entity owner allocated such

interest expense;

(iii) Interest expense allocated to

rental expenditures (as defined in

paragraph (b)(2)(iv) of this section) is

taken into account under the rules of

§ 1.163–8T, as applicable, by the

passthrough entity owner allocated such

interest expense;

(iv) Interest expense allocated to

investment expenditures (as defined in

paragraph (b)(2)(i) of this section) is

taken into account under the rules of

§ 1.163–8T, as applicable, by the

passthrough entity owner allocated such

interest expense;

(v) Interest expense allocated to

personal expenditures (as defined in

paragraph (b)(2)(iii) of this section) is

taken into account under the rules of

§ 1.163–8T, as applicable, by the

passthrough entity owner allocated such

interest expense;

(vi) Interest expense allocated to

distributions to owners of a passthrough

entity is taken into account in the

manner provided under paragraph (d) of

this section.

(2) Definitions. For purposes of this

section—

(i) Investment expenditure means an

expenditure defined in § 1.163–8T(b)(3),

including any expenditure made with

respect to a trade or business described

in section 163(d)(5)(A)(ii) to the extent

such expenditure is properly allocable

under section 704(b) to partners that do

not materially participate (within the

meaning and for purposes of section

469) in the trade or business.

(ii) Other trade or business

expenditure means an expenditure

made with respect to any activity

described in § 1.469–4(b)(1)(ii) and (iii).

(iii) Personal expenditure means an

expenditure (other than a distribution)

not described in paragraphs (b)(2)(i), (ii),

(iv) and (v) of this section.

(iv) Rental expenditure means an

expenditure made with respect to any

activity described in § 1.469–4(b)(2) that

is not a trade or business, as defined in

§ 1.163(j)–1(b)(44).

(v) Trade or business expenditure

means an expenditure made with

respect to a trade or business, as defined

in § 1.163(j)–1(b)(44), except for an

expenditure made with respect to a

trade or business described in section

163(d)(5)(A)(ii) to the extent such

expenditure is properly allocable under

section 704(b) to partners that do not

materially participate (within the

meaning and for purposes of section

469) in the trade or business.

(c) Allocation of debt and interest

expense. Except as otherwise provided

in this section, the rules of § 1.163–8T

apply to partnerships, S Corporations,

and their owners.

(d) Debt allocated to distributions by

passthrough entities—(1) Allocation of

distributed debt proceeds—(i) Available

expenditures. To the extent a

passthrough entity has available

expenditures (as defined in paragraph

(d)(5)(ii) of this section), the

passthrough entity shall first allocate

distributed debt proceeds (as defined in

paragraph (d)(5)(iii) of this section) to

such available expenditures. If a

passthrough entity has multiple

available expenditures, the passthrough

entity shall allocate distributed debt

proceeds to such available expenditures

in proportion to the amount of each

expenditure.

(ii) Debt financed distributions. If a

passthrough entity’s distributed debt

proceeds exceeds its available

expenditures, the passthrough entity

shall allocate such excess amount of

distributed debt proceeds to

distributions to owners of the

passthrough entity (debt financed

distributions).

(2) Allocation of interest expense—(i)

Interest expense allocated to debt

financed distributions. If distributed

debt proceeds are allocated to

distributions to owners of the

passthrough entity (pursuant to

paragraph (d)(1)(ii) of this section), the

passthrough entity shall determine the

portion of each passthrough entity

owner’s allocable interest expense that

is debt financed distribution interest

expense. The amount of a passthrough

entity owner’s debt financed

distribution interest expense equals the

lesser of such passthrough entity

owner’s allocable interest expense (as

defined in paragraph (d)(5)(i) of this

section) or the product of—

(A) The portion of the debt proceeds

distributed to that particular

passthrough entity owner; multiplied by

(B) A fraction, the numerator of which

is the portion of the passthrough entity’s

distributed debt proceeds allocated to

debt financed distributions (determined

under paragraph (d)(1)(ii) of this

section), and the denominator of which

is the passthrough entity’s total amount

of distributed debt proceeds; multiplied

by

(C) The distributed debt proceeds

interest rate (as defined in paragraph

(d)(5)(iv) of this section).

(ii) Interest expense allocated to

available expenditures. If distributed

debt proceeds are allocated to available

expenditures (pursuant to paragraph

(d)(1)(i) of this section), the passthrough

entity shall determine the portion of

each passthrough entity owner’s

allocable interest expense that is

expenditure interest expense. The

amount of a passthrough entity owner’s

expenditure interest expense equals the

product of—

(A) The portion of the passthrough

entity’s distributed debt proceeds

allocated to available expenditures

(determined under paragraph (d)(1)(i) of

this section); multiplied by

(B) The distributed debt proceeds

interest rate; multiplied by

(C) A fraction, the numerator of which

is the excess of that particular

passthrough entity owner’s allocable

interest expense over its debt financed

distribution interest expense

(determined under paragraph (d)(2)(i) of

this section) (remaining interest

expense), and the denominator of which

is aggregate of all the passthrough

owners’ remaining interest expense

amounts.

(iii) Excess interest expense. To the

extent a passthrough entity owner’s

allocable interest expense is not treated

as either debt financed distribution

interest expense (determined under

paragraph (d)(2)(i) of this section) or

expenditure interest expense

(determined under paragraph (d)(2)(ii)

of this section), such allocable interest

expense is excess interest expense.

(3) Tax treatment of interest

expense—(i) Debt financed distribution

interest expense. The tax treatment of a

passthrough entity owner’s debt

financed distribution interest expense

(determined under paragraph (d)(2)(i) of

this section), if any, shall be determined

by the passthrough entity owner under

the rules of § 1.163–8T, as applicable, in

accordance with such passthrough

entity owner’s use of its portion of the

passthrough entity’s distributed debt

proceeds. The passthrough entity shall

separately state the amount of each

owner’s debt financed distribution

interest expense. Debt financed

distribution interest expense is not

treated as interest expense of the entity

for purposes of this section.

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(ii) Expenditure interest expense. The

tax treatment of a passthrough entity

owner’s expenditure interest expense

(determined under paragraph (d)(2)(ii)

of this section), if any, shall be

determined based on how the

distributed debt proceeds were allocated

among available expenditures (pursuant

to paragraph (d)(1)(i) of this section).

For example, if distributed debt

proceeds are allocated to a rental

activity under paragraph (d)(1)(i) of this

section, the interest expense associated

with such debt should be taken into

account by the passthrough entity in

computing income or loss from the

rental activity that is reported to the

owner.

(iii) Excess interest expense. The tax

treatment of a passthrough entity

owner’s excess interest expense

(determined under paragraph (d)(2)(iii)

of this section), if any, shall be

determined by allocating the distributed

debt proceeds among all the assets of

the passthrough entity, pro-rata, based

on the adjusted basis of such assets. For

purposes of the preceding sentence, the

passthrough entity shall use either the

adjusted tax bases of its assets reduced

by any debt of the passthrough entity

allocated to such assets, or determine its

adjusted basis in its assets in accordance

with the rules in § 1.163(j)–10(c)(5)(i),

reduced by any debt of the passthrough

entity allocated to such assets. Once a

passthrough entity chooses a method for

determining its adjusted basis in its

assets for this purpose, the passthrough

entity must consistently apply the same

method in all subsequent tax years. Any

assets purchased in the same taxable

year as the distribution (such that the

expenditure for those assets was taken

into account in § 1.163–14(b)(1)) are not

included in this allocation.

(4) Treatment of transfers of interests

in a passthrough entity by an owner that

received a debt financed distribution—

(i) In general. In the case of a transfer

of an interest in a passthrough entity,

any debt financed distribution interest

expense of the transferor shall be treated

as excess interest expense by the

transferee. However, in the case of a

transfer of an interest in a passthrough

entity to a person who is related to the

transferor, any debt financed

distribution interest expense of the

transferor shall continue to be treated as

debt financed distribution interest

expense by the related party transferee,

and the tax treatment of such debt

financed distribution expense under

paragraph (d)(3) of this section shall be

the same to the related party transferee

as it was to the transferor. The term

related party means any person who

bears a relationship to the taxpayer

which is described in section 267(b) or

707(b)(1).

(ii) Anti-avoidance rule.

Arrangements entered into with a

principal purpose of avoiding the rules

of this paragraph, including the transfer

of an interest in a passthrough entity by

an owner who treated a portion of its

allocable interest expense as debt

financed distribution interest expense to

an unrelated party pursuant to a plan to

transfer the interest back to the owner

who received the debt financed

distribution interest expense or to a

party who is related to the owner who

received the debt financed distribution

interest expense, may be disregarded or

recharacterized by the Commissioner of

the IRS to the extent necessary to carry

out the purposes of this paragraph.

(5) Definitions. For purposes of this

paragraph—

(i) Allocable interest expense means a

passthrough entity owner’s share of

interest expense associated with the

distributed debt proceeds allocated

under section 704 or section 1366(a).

(ii) Available expenditure means an

expenditure of a passthrough entity

described in paragraph (b)(2) of this

section made in the same taxable year

of the entity as the distribution, to the

extent that debt proceeds (including

other distributed debt proceeds) are not

otherwise allocated to such expenditure.

(iii) Distributed debt proceeds means

debt proceeds of a passthrough entity

that are allocated under § 1.163–8T and

this section to distributions to owners of

the passthrough entity in a taxable year.

If debt proceeds from multiple

borrowings are allocated under § 1.163–

8T to distributions to owners of the

passthrough entity in a taxable year,

then all such borrowings are treated as

a single borrowing for purposes of this

section.

(iv) Distributed debt proceeds interest

rate means a fraction, the numerator of

which is the amount of interest expense

associated with distributed debt

proceeds, and the denominator of which

is the amount of distributed debt

proceeds.

(e) Repayment of passthrough entity

debt—(1) In general. If any portion of

passthrough entity debt is repaid at a

time when such debt is allocated to

more than one expenditure, the debt is

treated for purposes of this section as

repaid in the following order:

(i) Amounts allocated to one or more

expenditures described in paragraph

(b)(2)(iii);

(ii) Amounts allocated to one or more

expenditures described in paragraph

(b)(2)(i) (relating to investment

expenditures as defined in § 1.163–

8T(b)(3));

(iii) Amounts allocated to one or more

expenditures described in paragraphs

(b)(2)(ii) and (iv) (relating to

expenditures with respect to any

activities described in § 1.469–4(b)(1)(ii)

and (iii), and § 1.469–4(b)(2)); and

(iv) Amounts allocated to one or more

expenditures described in paragraph

(b)(2)(v) (generally relating to

expenditures made with respect to a

trade or business as defined in

§ 1.163(j)–1(b)(44)).

(2) Repayment of debt used to finance

a distribution. Any repayment of debt of

a passthrough entity that has been

allocated to debt financed distributions

under paragraph (d)(1)(ii) of this section

and to one or more available

expenditures under paragraph (d)(1)(i)

of this section may, at the option of the

passthrough entity, be treated first as a

repayment of the portion of the debt that

had been allocated to such debt

financed distributions.

(f) Debt allocated to expenditures for

interests in passthrough entities. In the

case of debt proceeds allocated under

the rules of § 1.163–8T and this section

to contributions to the capital of or to

the purchase of an interest in a

passthrough entity, the character of the

debt proceeds and any associated

interest expense shall be determined by

allocating the debt proceeds among the

adjusted tax bases of the entity’s assets.

For purposes of this paragraph, the

owner must allocate the debt proceeds

either in proportion to the relative

adjusted tax basis of the entity’s assets

reduced by any debt allocated to such

assets, or based on the adjusted basis of

the entity’s assets in accordance with

the rules in § 1.163(j)–10(c)(5)(i)

reduced by any debt allocated to such

assets. Once the owner chooses a

method for allocating the debt proceeds

for this purpose, the owner must

consistently apply the same method in

all subsequent tax years. Individuals

shall report interest expense paid or

incurred in connection with debt-

financed acquisitions on their

individual income tax return in

accordance with the asset to which the

interest expense is allocated under this

paragraph.

(g) Change in ownership. Any transfer

of an ownership interest in a

passthrough entity is not a reallocation

event for purposes of § 1.163–8T(j),

except as provided for in paragraph

(d)(4) of this section.

(h) Examples—(1) Example 1—(i) Facts. A

(an individual) and B (an individual) are

partners in partnership PRS. PRS conducts

two businesses; a manufacturing business,

which is a trade or business as defined in

§ 1.163(j)–1(b)(44) (manufacturing), and a

separate commercial real estate leasing

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business, which is an activity described in

§ 1.469–4(b)(2) (leasing). In Year 1, PRS

borrowed $100,000 from an unrelated third-

party lender (the loan). Other than the loan,

PRS does not have any outstanding debt.

During Year 1, PRS paid $80,000 in

manufacturing expenses, $120,000 in leasing

expenses, and made a $100,000 distribution

to A, the proceeds of which A used to make

a personal expenditure. Under § 1.163–8T,

PRS treated the $100,000 of loan proceeds as

having been distributed to A. As a result, in

Year 1 PRS had $200,000 of available

expenditures (as defined in paragraph

(d)(5)(ii) of this section) and $100,000 of

distributed debt proceeds (as defined in

paragraph (d)(5)(iii) of this section). PRS paid

$10,000 in interest expense that accrued

during Year 1 on the loan, and allocated such

interest expense under section 704(b) equally

to A and B ($5,000 each). Thus, A and B each

had $5,000 of allocable interest expense (as

defined in paragraph (d)(5)(i) of this section).

(ii) Applicability. Because PRS treated all

$100,000 of the loan proceeds as having been

distributed under § 1.163–8T, PRS allocated

all $10,000 of the interest expense associated

with the loan to the distribution. Thus,

pursuant to paragraph (b)(1)(vi) of this

section, PRS must determine the tax

treatment of such $10,000 of interest expense

in the manner provided in paragraph (d) of

this section.

(iii) Debt allocated to distributions. Under

paragraph (d)(1)(i) of this section, to the

extent PRS has available expenditures (as

defined under paragraph (d)(5)(ii) of this

section), it must allocate any distributed debt

proceeds (as defined under paragraph

(d)(5)(iii) of this section) to such available

expenditures. Here, PRS has distributed debt

proceeds of $100,000 and available

expenditures of $200,000 (manufacturing

expenditures of $80,000, plus leasing

expenditures of $120,000). Thus, PRS

allocates all $100,000 of the distributed debt

proceeds to available expenditures as

follows: $40,000 to manufacturing

expenditures ($100,000 × ($80,000/

$200,000)) and $60,000 to leasing

expenditures ($100,000 × ($120,000/

$200,000)). Because the amount of PRS’s

distributed debt proceeds is less than its

available expenditures, none of the

distributed debt proceeds are allocated to

debt financed distributions pursuant to

paragraph (d)(1)(ii) of this section.

(iv) Allocation of interest expense. Because

all of PRS’s distributed debt proceeds are

allocated to available expenditures (pursuant

to paragraph (d)(1)(i) of this section), A and

B each treat all $5,000 of their allocable

interest expense as expenditure interest

expense.

(v) Tax treatment of interest expense.

Pursuant to paragraph (d)(3)(ii) of this

section, each partner treats its expenditure

interest expense (determined under

paragraph (d)(2)(ii) of this section) in the

same manner as the distributed debt

proceeds that were allocated to available

expenditures under paragraph (d)(1)(i) of this

section. Thus, A’s $5,000 of expenditure

interest expense comprises of $2,000 of

business interest expense ($5,000 × ($40,000/

$100,000)) and $3,000 of interest expense

allocated to rental expenditures ($5,000 ×

($60,000/$100,000)). B’s $5,000 of

expenditure interest expense similarly

comprises of $2,000 of business interest

expense and $3,000 of interest expense

allocated to rental expenditures. As a result,

$4,000 of interest expense associated with

the distributed debt proceeds (A’s $2,000

plus B’s $2,000 of expenditure interest

expense treated as business interest expense)

is business interest expense of PRS, subject

to section 163(j) at the PRS level.

T

ABLE

1

TO

P

ARAGRAPH

(h)(2)(vii)

Partner A Partner B

Allocable interest expense:

Debt financed distribution interest expense:

N/A ............................................................................................................................................................. $0 $0

Expenditure interest expense:

Business interest (to PRS) ........................................................................................................................ 2,000 2,000

Rental activity interest expense ................................................................................................................ 3,000 3,000

Excess interest expense:

N/A ............................................................................................................................................................. 0 0

Total ................................................................................................................................................... 5,000 5,000

(2) Example 2—(i) Facts. The facts are the

same as in Example 1 in paragraph (h)(1)(i)

of this section, except PRS did not have any

rental expenditures in Year 1. As a result, in

Year 1 PRS had $80,000 of available

expenditures (as defined in paragraph

(d)(5)(ii) of this section) and $100,000 of

distributed debt proceeds (as defined in

paragraph (d)(5)(iii) of this section).

(ii) Applicability. Because PRS treated all

$100,000 of the loan proceeds as having been

distributed to A under § 1.163–8T, PRS

allocated all $10,000 of the interest expense

associated with the loan to the distribution.

Thus, pursuant to paragraph (b)(1)(vi) of this

section, PRS must determine the tax

treatment of such $10,000 of interest expense

in the manner provided in paragraph (d) of

this section.

(iii) Debt allocated to distributions. Under

paragraph (d)(1)(i) of this section, to the

extent PRS has available expenditures (as

defined under paragraph (d)(5)(ii) of this

section), it must allocate any distributed debt

proceeds (as defined under paragraph

(d)(5)(i) of this section) to such available

expenditures. Here, PRS has distributed debt

proceeds of $100,000 and available

expenditures of $80,000. Thus, $80,000 of the

distributed debt proceeds are allocated to

such available expenditures. Pursuant to

paragraph (d)(1)(ii) of this section, PRS

allocates the remaining $20,000 of the

distributed debt proceeds to debt financed

distributions.

(iv) Allocation of interest expense—debt

financed distribution interest expense.

Pursuant to paragraph (d)(2)(i) of this section,

A treats $2,000 of its allocable interest

expense as debt financed distribution interest

expense, which is the lesser of $5,000 or

$2,000 ((A) the portion of debt proceeds

distributed to A ($100,000), multiplied by (B)

a fraction, the numerator of which is the

portion of PRS’s distributed debt proceeds

allocated to debt financed distributions

pursuant to paragraph (d)(1)(ii) of this section

($20,000), and the denominator of which is

PRS’s total amount of distributed debt

proceeds ($100,000), multiplied by (C) the

distributed debt proceeds interest rate, as

defined in paragraph (d)(5)(iii) of this

section, of 10% (the amount of interest

expense associated with distributed debt

proceeds ($10,000), divided by the amount of

distributed debt proceeds ($100,000))) and B

treats $0 of its allocable interest expense as

debt financed distribution interest expense,

which is the lesser of $5,000 or $0 ((A) $0

× (B) 20% × (C) 10%).

BILLING CODE 4830–01–P

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(v) Allocation of interest expense—

expenditure interest expense. Pursuant to

paragraph (d)(2)(ii) of this section, A treats

$3,000 of its allocable interest expense as

expenditure interest expense ((A) the portion

of PRS’s distributed debt proceeds allocated

to available expenditures pursuant to

paragraph (d)(1)(i) of this section ($80,000),

multiplied by (B) the distributed debt

proceeds interest rate (10%), multiplied by

(C) a fraction, the numerator of which is A’s

remaining interest expense (that is, the

excess of A’s allocable interest expense

($5,000) over its debt financed distribution

interest expense as determined under

paragraph (d)(2)(i) of this section ($2,000)),

and the denominator of which is the

aggregate of A’s and B’s remaining interest

expense amounts ($3,000 + $5,000)) and B

treats $5,000 of its allocable interest expense

as expenditure interest expense ((A) $80 × (B)

10% × (C) 62.5%).

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(vi) Allocation of interest expense—excess

interest expense. Neither partner treats any of

its allocable interest expense as excess

interest expense under paragraph (d)(2)(iii) of

this section.

(vii) Tax treatment of interest expense.

Pursuant to paragraph (d)(3)(i) of this section,

each partner determines the tax treatment of

its debt financed distribution interest

expense (determined under paragraph

(d)(2)(i) of this section) based on its use of

the distributed debt proceeds. Because A

used its $100,000 of distributed debt

proceeds on a personal expenditure, A’s

$2,000 of debt financed distribution interest

expense is personal interest subject to section

163(h) at A’s level. Pursuant to paragraph

(d)(3)(ii) of this section, each partner treats its

expenditure interest expense (determined

under paragraph (d)(2)(ii) of this section) in

the same manner as the distributed debt

proceeds that were allocated to available

expenditures under paragraph (d)(1)(i) of this

section. Thus, all $3,000 of A’s expenditure

interest expense and all $5,000 of B’s

expenditure interest expense is business

interest expense. As a result, $8,000 interest

expense associated with the distributed debt

proceeds (A’s $3,000 plus B’s $5,000 of

expenditure interest expense treated as

business interest expense) is business interest

expense of PRS, subject to section 163(j) at

the PRS level.

T

ABLE

6

TO

P

ARAGRAPH

(h)(2)(vii)

Partner A Partner B

Allocable interest expense;

Debt financed distribution interest expense:

Personal interest ....................................................................................................................................... $2,000 $0

Expenditure interest expense:

Business interest (to PRS) ........................................................................................................................ 3,000 5,000

Excess interest expense:

N/A ............................................................................................................................................................. 0 0

Total ................................................................................................................................................... 5,000 5,000

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(3) Example 3—(i) Facts. The facts are the

same as in Example 2 in paragraph (h)(2)(i)

of this section, except PRS paid $20,000 in

manufacturing expenses, made a distribution

of $75,000 to A (the proceeds of which A

used on a personal expenditure), and made

a distribution of $25,000 to B (the proceeds

of which B used on a trade or business

expenditure). As a result, in Year 1 PRS had

$20,000 of available expenditures (as defined

in paragraph (d)(5)(ii) of this section) and

$100,000 of distributed debt proceeds (as

defined in paragraph (d)(5)(iii) of this

section). The $20,000 manufacturing

expenditure was to acquire assets used in

PRS’s manufacturing business. At the end of

Year 1, the adjusted tax basis of PRS’s assets

used in manufacturing was $720,000 and the

adjusted tax basis of PRS’s assets used in

leasing was $200,000. In addition, at the end

of Year 1, the adjusted basis of PRS’s assets

held for investment (within the meaning of

section 163(d)(5)) was $100,000.

(ii) Applicability. Because PRS treated all

$100,000 of the loan proceeds as having been

distributed under § 1.163–8T, PRS allocated

all $10,000 of the interest expense associated

with the loan to the distribution. Thus,

pursuant to paragraph (b)(1)(vi) of this

section, PRS must determine the tax

treatment of such $10,000 of interest expense

in the manner provided in paragraph (d) of

this section.

(iii) Debt allocated to distributions. Under

paragraph (d)(1)(i) of this section, to the

extent PRS has available expenditures (as

defined under paragraph (d)(5)(ii) of this

section), it must allocate any distributed debt

proceeds (as defined under paragraph

(d)(5)(i) of this section) to such available

expenditures. Here, PRS has distributed debt

proceeds of $100,000 and available

expenditures of $20,000. Thus, PRS allocates

$20,000 of the distributed debt proceeds to

available expenditures. Pursuant to

paragraph (d)(1)(ii) of this section, PRS

allocates the remaining $80,000 of

distributed debt proceeds to debt financed

distributions.

(iv) Allocation of interest expense—debt

financed distribution interest expense.

Pursuant to paragraph (d)(2)(i) of this section,

A treats $5,000 of its allocable interest

expense as debt financed distribution interest

expense, which is the lesser of $5,000 or

$6,000 ((A) $75,000 × (B) 80% × (C) 10%) and

B treats $2,000 of its allocable interest

expense as debt financed distribution interest

expense, which is the lesser of $5,000 or

$2,000 ((A) $25,000 × (B) 80% × (C) 10%).

(v) Allocation of interest expense—

expenditure interest expense. Pursuant to

paragraph (d)(2)(ii) of this section, A does not

treat any of its allocable interest expense as

expenditure interest expense ((A) $20,000 ×

(B) 10% × (C) 0%) and B treats $2,000 of its

allocable interest expense as expenditure

interest expense ((A) $20,000 × (B) 10% × (C)

100%).

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BILLING CODE 4830–01–C

(vi) Allocation of interest expense—excess

interest expense. Pursuant to paragraph

(d)(2)(iii) of this section, A does not treat any

of its allocable interest expense as excess

interest expense ($5,000 of allocable interest

expense, less $5,000 of debt financed

distribution interest expense, less $0 of

expenditure interest expense) and B treats

$1,000 of its allocable interest expense as

excess interest expense ($5,000 of allocable

interest expense, less $2,000 of debt financed

distribution interest expense, less $2,000 of

expenditure interest expense).

(vii) Tax treatment of interest expense.

Pursuant to paragraph (d)(3)(i) of this section,

each partner determines the tax treatment of

its debt financed distribution interest

expense based on its use of the distributed

debt proceeds. A used its share of the

distributed debt proceeds to make personal

expenditures. Thus, A’s $5,000 of debt

financed distribution interest expense is

subject to section 163(h) at A’s level. B used

its share of the distributed debt proceeds to

make trade or business expenditures. Thus,

B’s $2,000 of debt financed distribution

interest expense is subject to section 163(j) at

B’s level. Pursuant to paragraph (d)(3)(ii) of

this section, B treats its $2,000 of expenditure

interest expense in the same manner as the

distributed debt proceeds were allocated to

available expenditures under paragraph

(d)(1)(i) of this section. Thus, B’s $2,000 of

expenditure interest expense is business

interest expense, subject to section 163(j) at

the level of PRS. Pursuant to paragraph

(d)(3)(iii) of this section, B determines the tax

treatment of its $1,000 of excess interest

expense by allocating distributed debt

proceeds among the adjusted basis of PRS’s

assets, reduced by any debt allocated to such

assets. For purposes of paragraph (d)(3)(iii) of

this section, PRS’s has $700,000

($720,000¥$20,000 debt proceeds allocated

to such assets) of basis in its manufacturing

assets, $200,000 of basis in its leasing assets,

and $100,000 of basis in its assets held for

investment. Thus, B’s $1,000 of excess

interest expense is treated as $700 of

business interest expense subject to 163(j) at

the PRS level, $200 of interest expense

related to a rental activity, and $100 of

investment interest expense.

T

ABLE

11

TO

P

ARAGRAPH

(h)(3)(vii)

Partner A Partner B

Allocable interest expense:

Debt financed distribution interest expense:

Personal interest: ...................................................................................................................................... $5,000 $0

Business interest (but not to PRS) ........................................................................................................... 0 2,000

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ABLE

11

TO

P

ARAGRAPH

(h)(3)(vii)—Continued

Partner A Partner B

Expenditure interest expense:

Business interest (to PRS) ........................................................................................................................ 0 2,000

Excess interest expense:

Business interest (to PRS): ....................................................................................................................... 0 700

Rental activity interest expense ................................................................................................................ 0 200

Investment interest expense ..................................................................................................................... 0 100

Total ................................................................................................................................................... 5,000 5,000

(4) Example 4. The facts are the same as

in Example 2 in paragraph (h)(2)(i) of this

section. In Year 2, A sells its interest in PRS

to C. C is not related to either A or B under

the rules of either section 267(b) or section

707(b)(1). No facts have changed with respect

to PRS’s loan. Under these facts, and only for

purposes of this section, C’s share of the debt

financed distribution interest expense will be

treated as excess interest expense pursuant to

paragraph (d)(4)(i) of this section.

Accordingly, C will determine the character

of its share of this interest expense by

allocating the debt proceeds associated with

this interest expense among the assets of PRS

under paragraph (d)(3)(iii) of this section.

(5) Example 5. The facts are the same as

in Example 4 in paragraph (h)(4) of this

section, except that C is a party that is related

to A under the rules of either section 267(b)

or section 707(b)(1). Under these facts, and

only for purposes of this section, A’s $2,000

of debt financed distribution interest expense

shall, pursuant to paragraph (d)(4)(i) of this

section, continue to be treated as debt

financed distribution interest expense of C,

subject to the same tax treatment as it was

to the transferor (personal interest expense).

(6) Example 6. The facts are the same as

in Example 2 in paragraph (h)(2)(i) of this

section, except that in Year 2 B sells its

interest in PRS to D. D is not related to either

A or B under the rules of either section

267(b) or section 707(b)(1). No other facts

have changed with respect to PRS’s loan.

Under these facts, the tax treatment of the

expenditure interest expense does not change

with respect to PRS or any of the partners as

a result of the ownership change pursuant to

paragraph (g) of this section. Accordingly, the

tax treatment of the expenditure interest

expense allocable to D under section 704(b)

is identical to the expenditure interest

expense that had been allocable to B prior to

the sale.

(7) Example 7—(i) Facts. A (an individual)

and B (an individual) are equal shareholders

in S corporation X. X conducts a

manufacturing business, which is a trade or

business as defined in § 1.163(j)–1(b)(44)

(manufacturing). In Year 1, X borrowed

$100,000 from an unrelated third-party

lender (the loan). Other than the loan, X does

not have any outstanding debt. During Year

1, X paid $100,000 in manufacturing

expenses and made a $50,000 distribution to

each of its shareholders, A and B, which each

shareholder used to make a personal

expenditure. Under § 1.163–8T, X treated all

$100,000 of the loan proceeds as having been

distributed to A and B. As a result, in Year

1 X had $100,000 of available expenditures

(as defined in paragraph (d)(5)(ii) of this

section) and $100,000 of distributed debt

proceeds (as defined in paragraph (d)(5)(iii)

of this section). X paid $10,000 in interest

expense that accrued during Year 1 on the

loan, and allocated such interest expense

under section 1366(a) equally to A and B

($5,000 each). Thus, A and B each had $5,000

of allocable interest expense (as defined in

paragraph (d)(5)(i) of this section).

(ii) Applicability. Because X treated all

$100,000 of the loan proceeds as having been

distributed to A and B under § 1.163–8T, PRS

allocated all $10,000 of the interest expense

associated with the loan to the distributions.

Thus, pursuant to paragraph (b)(1)(vi) of this

section, PRS must determine the tax

treatment of such $10,000 of interest expense

in the manner provided in paragraph (d) of

this section.

(iii) Debt allocated to distributions. Under

paragraph (d)(1)(i) of this section, to the

extent X has available expenditures (as

defined under paragraph (d)(5)(ii) of this

section), it must allocate any distributed debt

proceeds (as defined under paragraph

(d)(5)(iii) of this section) to such available

expenditures. Here, X has distributed debt

proceeds of $100,000 and available

expenditures of $100,000. Thus, PRS

allocates all $100,000 of the distributed debt

proceeds to available expenditures

(iv) Allocation of interest expense. Because

all of X’s distributed debt proceeds are

allocated to available expenditures (pursuant

to paragraph (d)(1)(i) of this section), A and

B each treat all $5,000 of their allocable

interest expense as expenditure interest

expense.

(v) Tax treatment of interest expense.

Pursuant to paragraph (d)(3)(ii) of this

section, each partner treats its expenditure

interest expense (determined under

paragraph (d)(2)(ii) of this section) in the

same manner as the distributed debt

proceeds that were allocated to available

expenditures under paragraph (d)(1)(i) of this

section. Thus, A’s $5,000 of expenditure

interest expense and B’s $5,000 of

expenditure interest expense is treated as

business interest expense of X, subject to

section 163(j) at X’s level.

T

ABLE

12

TO

P

ARAGRAPH

(h)(7)(v)

Partner A Partner B

Allocable interest expense:

Debt financed distribution interest expense:

N/A ............................................................................................................................................................. $0 $0

Expenditure interest expense:

Business interest (to X) ............................................................................................................................. 5,000 5,000

Excess interest expense:

N/A ............................................................................................................................................................. 0 0

Total ................................................................................................................................................... 5,000 5,000

(h) Applicability date. This section

applies to taxable years beginning on or

after [DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules of this section to a

taxable year beginning after December

31, 2017, and before [DATE 60 DAYS

AFTER DATE OF PUBLICATION OF

THE FINAL RULE IN THE FEDERAL

REGISTER], provided that they

consistently apply the rules of this

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section to that taxable year and each

subsequent taxable year.

■Par. 3. Section 1.163–15 is added to

read as follows:

§ 1.163–15 Debt Proceeds Distributed from

Any Taxpayer Account or from Cash.

(a) In general. Regardless of

paragraphs (c)(4) and (5) of § 1.163–8T,

in the case of debt proceeds deposited

in an account, a taxpayer that is

applying § 1.163–8T or §1.163–14 may

treat any expenditure made from any

account of the taxpayer, or from cash,

within 30 days before or 30 days after

debt proceeds are deposited in any

account of the taxpayer as made from

such proceeds to the extent thereof.

Similarly, in the case of debt proceeds

received in cash, a taxpayer that is

applying § 1.163–8T or §1.163–14 may

treat any expenditure made from any

account of the taxpayer, or from cash,

within 30 days before or 30 days after

debt proceeds are received in cash as

made from such proceeds to the extent

thereof. For purposes of this section,

terms used have the same meaning as in

§ 1.163–8T(c)(4) and (5).

(b) Applicability date. This section

applies to taxable years beginning on or

after [DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules of this section to a

taxable year beginning after December

31, 2017, and before [DATE 60 DAYS

AFTER DATE OF PUBLICATION OF

THE FINAL RULE IN THE FEDERAL

REGISTER], provided that they

consistently apply the rules of this

section to that taxable year and each

subsequent taxable year.

■Par. 4. As added in a final rule

published elsewhere in this issue of the

Federal Register, effective November

13, 2020, § 1.163(j)–0 is amended by:

■1. Revising the entries for § 1.163(j)–

1(b)(1)(iv)(B), (b)(22)(iii)(F), and (b)(35);

■2. Adding entries for §§ 1.163(j)–

1(b)(1)(iv)(E), (c)(4), and (c)(4)(i) and (ii);

■3. Adding an entry for § 1.163(j)–

2(d)(3);

■4. Revising the entries for §§ 1.163(j)–

2(k) and 1.163(j)–6(c)(1) and (2);

■5. Adding an entry for § 1.163(j)–

6(d)(3), (4), and (5) and (e)(5);

■6. Revising the entries for §§ 1.163(j)–

6(f)(1)(iii), (g)(4), (h)(4) and (5), (j), and

(n) and 1.163(j)–7;

■7. Adding an entry for § 1.163(j)–8;

■8. Revising the entries for § 1.163(j)–

10(c)(5)(ii)(D) and (f).

The revisions and additions read as

follows:

§ 1.163(j)–0 Table of Contents.

* * * * *

§ 1.163(j)–1 Definitions.

* * * * *

(b) * * *

(1) * * *

(iv) * * *

(B) Deductions by members of a

consolidated group.

(1) In general.

(2) Application of the alternative

computation method.

* * * * *

(E) Alternative computation method.

(1) Alternative computation method for

property dispositions.

(2) Alternative computation method for

dispositions of member stock.

(3) Alternative computation method for

dispositions of partnership interests.

* * * * *

(22) * * *

(iii) * * *

(F) Section 163(j) interest dividends.

(1) In general.

(2) Limitation on amount treated as interest

income.

(3) Conduit amounts.

(4) Holding period.

(5) Exception to holding period

requirement for money market funds and

certain regularly declared dividends.

* * * * *

(35) Section 163(j) interest dividend.

(i) In general.

(ii) Reduction in the case of excess

reported amounts.

(iii) Allocation of excess reported amount.

(A) In general.

(B) Special rule for noncalendar year RICs.

(iv) Definitions.

(A) Reported section 163(j) interest

dividend amount.

(B) Excess reported amount.

(C) Aggregate reported amount.

(D) Post-December reported amount.

(E) Excess section 163(j) interest income.

(v) Example.

* * * * *

(c) * * *

* * * * *

(4) Alternative computation for certain

adjustments to tentative taxable income, and

section 163(j) interest dividends.

(i) Alternative computation for certain

adjustments to tentative taxable income.

(ii) Section 163(j) interest dividends.

* * * * *

§ 1.163(j)–2 Deduction for business interest

expense limited.

* * * * *

(b) * * *

* * * * *

(3) * * *

* * * * *

(iii) Transactions to which section 381

applies.

(iv) Consolidated groups.

* * * * *

(d) * * *

* * * * *

(3) Determining a syndicate’s loss amount.

* * * * *

(k) Applicability dates.

(1) In general.

(2) Paragraphs (b)(iii), (b)(iv), and (d)(3).

§ 1.163(j)–6 Application of the business

interest deduction limitation to

partnerships and subchapter S

Corporations

* * * * *

(c) * * *

(1) Modification of business interest

income for partnerships.

(2) Modification of business interest

expense for partnerships.

* * * * *

(d) * * *

* * * * *

(3) Section 743(b) adjustments and

publicly traded partnerships.

(4) Modification of adjusted taxable income

for partnerships.

(5) Election to use 2019 adjusted taxable

income for taxable years beginning in 2020.

* * * * *

(e) * * *

* * * * *

(5) Partner basis items, remedial items, and

publicly traded partnerships.

(6) Partnership deductions capitalized by a

partner.

* * * * *

(f) * * *

(1) * * *

(iii) Exception applicable to publicly

traded partnerships.

* * * * *

(g) * * *

(4) Special rule for taxable years beginning

in 2019 and 2020.

* * * * *

(h) * * *

(4) Partner basis adjustments upon

liquidating distribution.

(5) Partnership basis adjustments upon

partner dispositions.

* * * * *

(j) Tiered partnerships.

(1) Purpose.

(2) Section 704(b) capital account

adjustments.

(3) Basis adjustments of upper-tier

partnership.

(4) Treatment of excess business interest

expense allocated by lower-tier partnership

to upper-tier partnership.

(5) UTP EBIE conversion events.

(i) Allocation to upper-tier partnership by

lower-tier partnership of excess taxable

income (or excess business interest income).

(ii) Upper-tier partnership disposition of

lower-tier partnership interest.

(6) Disposition of specified partner’s

partnership interest.

(i) General rule.

(ii) Special rules.

(A) Distribution in liquidation of a

specified partner’s partnership interest.

(B) Contribution of a specified partner’s

partnership interest.

(7) Effect of basis adjustments allocated to

UTP EBIE.

(i) In general.

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(ii) UTP EBIE treated as deductible

business interest expense.

(iii) UTP EBIE treated as excess business

interest expense.

(iv) UTP EBIE reduced due to a

disposition.

(8) Anti-loss trafficking.

(i) Transferee specified partner.

(ii) UTP EBIE without a specified partner.

(iii) Disallowance of addback.

(9) Determining allocable ATI and

allocable business interest income of upper-

tier partnership partners.

(i) In general.

(ii) Upper-tier partner’s allocable ATI.

(iii) Upper-tier partner’s allocable business

interest income.

(l) * * *

* * * * *

(4) * * *

(iv) S corporation deductions capitalized

by an S corporation shareholder.

* * * * *

(n) Treatment of self-charged lending

transactions between partnerships and

partners.

(o) * * *

* * * * *

§ 1.163(j)–7 Application of the section

163(j) limitation to foreign corporations

and United States shareholders.

(a) Overview.

* * * * *

(c) Application of section 163(j) to CFC

group members of a CFC group.

(1) Scope.

(2) Calculation of section 163(j) limitation

for a CFC group for a specified period.

(i) In general.

(ii) Certain transactions between CFC

group members disregarded.

(iii) CFC group treated as a single C

corporation for purposes of allocating items

to an excepted trade or business.

(iv) CFC group treated as a single taxpayer

for purposes of determining interest.

(3) Deduction of business interest expense.

(i) CFC group business interest expense.

(A) In general.

(B) Modifications to relevant terms.

(ii) Carryforwards treated as attributable to

the same taxable year.

(iii) Multiple specified taxable years of a

CFC group member with respect to a

specified period.

(iv) Limitation on pre-group disallowed

business interest expense carryforward.

(A) General rule.

(1) CFC Group member pre-group

disallowed business interest expense

carryforward.

(2) Subgrouping.

(B) Deduction of pre-group disallowed

business interest expense carryforwards.

(4) Currency translation.

(5) Special rule for specified periods

beginning in 2019 or 2020.

(i) 50 percent ATI limitation applies to a

specified period of a CFC group.

(ii) Election to use 2019 ATI applies to a

specified period of a CFC group.

(A) In general.

(B) Specified taxable years that do not

begin in 2020.

(d) Determination of a specified group and

specified group members.

(1) Scope.

(2) Rules for determining a specified group.

(i) Definition of a specified group.

(ii) Indirect ownership.

(iii) Specified group parent.

(iv) Qualified U.S. person.

(v) Stock.

(vi) Options treated as exercised.

(vii) When a specified group ceases to

exist.

(3) Rules for determining a specified group

member.

(e) Rules and procedures for treating a

specified group as a CFC group.

(1) Scope.

(2) CFC group and CFC group member.

(i) CFC group.

(ii) CFC group member.

(3) Duration of a CFC group.

(4) Joining or leaving a CFC group.

(5) Manner of making or revoking a CFC

group election.

(i) In general.

(ii) Revocation by election.

(iii) Timing.

(iv) Election statement.

(v) Effect of prior CFC group election.

(f) Treatment of a CFC group member that

has ECI.

(1) In general.

(2) Ordering rule.

(g) * * *

* * * * *

(3) Treatment of certain taxes.

(4) Anti-abuse rule.

(i) In general.

(ii) ATI adjustment amount.

(A) In general.

(B) Special rule for taxable years or

specified periods beginning in 2019 or 2020.

(iii) Applicable partnership.

(h) Election to apply safe-harbor.

(1) In general.

(2) Eligibility for safe-harbor election.

(i) Stand-alone applicable CFC.

(ii) CFC group.

(A) In general.

(B) Currency translation.

(3) Eligible amount.

(i) In general.

(ii) Amounts properly allocable to a non-

excepted trade or business.

(4) Qualified tentative taxable income.

(5) Manner of making a safe-harbor

election.

(i) In general.

(ii) Election statement.

(6) Special rule for taxable years or

specified periods beginning in 2019 or 2020.

* * * * *

(j) Rules regarding the computation of ATI

of certain United States shareholders of

applicable CFCs.

(1) In general.

(2) Rules for determining CFC excess

taxable income.

(i) In general.

(ii) Applicable CFC is a stand-alone

applicable CFC.

(iii) Applicable CFC is a CFC group

member.

(iv) ATI percentage.

(3) Cases in which an addition to tentative

taxable income is not allowed.

(4) Special rule for taxable years or

specified periods beginning in 2019 or 2020.

(k) Definitions.

(1) Applicable partnership.

(2) Applicable specified taxable year.

(3) ATI adjustment amount.

(4) ATI percentage.

(5) CFC excess taxable income.

(6) CFC group.

(7) CFC group election.

(8) CFC group member.

(9) CFC-level net deemed tangible income

return.

(i) In general.

(ii) Amounts properly allocable to a non-

excepted trade or business.

(10) Cumulative section 163(j) pre-group

carryforward limitation.

(11) Current group.

(12) Designated U.S. person.

(13) ECI deemed corporation.

(14) Effectively connected income.

(15) Eligible amount.

(16) Former group.

(17) Loss member.

(18) Payment amount.

(19) Pre-group disallowed business interest

expense carryforward.

(20) Qualified tentative taxable income.

(21) Qualified U.S. person.

(22) Relevant period.

(23) Safe-harbor election.

(24) Specified borrower.

(25) Specified group.

(26) Specified group member.

(27) Specified group parent.

(28) Specified lender.

(29) Specified period.

(i) In general.

(ii) Short specified period.

(30) Specified taxable year.

(31) Stand-alone applicable CFC.

(32) Stock.

(l) Examples.

(m) Applicability dates.

(1) General applicability date.

(2) Exception.

§ 1.163(j)–8 Application of the section

163(j) limitation to foreign persons with

effectively connected income.

(a) Overview.

(b) Application to a specified foreign

person with ECI.

(1) In general.

(2) Modification of adjusted taxable

income.

(3) Modification of business interest

expense.

(4) Modification of business interest

income.

(5) Modification of floor plan financing

interest expense.

(6) Modification of allocation of interest

expense and interest income that is allocable

to a trade or business.

(c) Rules for a specified foreign partner.

(1) Characterization of excess taxable

income.

(i) In general.

(ii) Specified ATI ratio.

(iii) Distributive share of ECI.

(iv) Distributive share of non-ECI.

(2) Characterization of excess business

interest expense.

(i) Allocable ECI excess BIE.

(ii) Allocable non-ECI excess BIE.

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(3) Characterization of deductible business

interest expense.

(i) In general.

(ii) Allocation between allocable ECI

deductible BIE and allocable non-ECI

deductible BIE.

(A) Allocation to hypothetical deductible

amounts.

(1) In general.

(2) Limitation.

(B) Allocation of remaining deductible

amounts.

(iii) Hypothetical partnership deductible

business interest expense.

(A) Hypothetical partnership ECI

deductible BIE.

(B) Hypothetical partnership non-ECI

deductible BIE.

(4) Characterization of excess business

interest income.

(i) In general.

(ii) Specified BII ratio.

(iii) Allocable ECI BII.

(5) Rules for determining ECI.

(d) Characterization of disallowed business

interest expense by a relevant foreign

corporation with ECI.

(1) Scope.

(2) Characterization of disallowed business

interest expense.

(i) FC ECI disallowed BIE.

(ii) FC non-ECI disallowed BIE.

(3) Characterization of deductible business

interest expense.

(i) In general.

(ii) Allocation between FC ECI deductible

BIE and FC non-ECI deductible BIE.

(A) Allocation to hypothetical deductible

amounts.

(1) In general.

(2) Limitation.

(B) Allocation of remaining deductible

amounts.

(iii) Hypothetical FC deductible business

interest expense.

(A) Hypothetical FC ECI deductible BIE.

(B) Hypothetical FC non-ECI deductible

BIE.

(e) Rules regarding disallowed business

interest expense.

(1) Retention of character in a succeeding

taxable year.

(2) Deemed allocation of excess business

interest expense of a partnership to a

specified foreign partner.

(3) Ordering rule for conversion of excess

business interest expense to business interest

expense paid or accrued by a partner.

(4) Allocable ECI excess BIE and allocable

non-ECI excess BIE retains its character when

treated as business interest expense paid or

accrued in a succeeding taxable year.

(f) Coordination of the application of

section 163(j) with § 1.882–5 and similar

provisions and with the branch profits tax.

(1) Coordination of section 163(j) with

§ 1.882–5 and similar provisions.

(i) Ordering rule.

(ii) Treatment of excess business interest

expense.

(iii) Attribution of certain § 1.882–5

interest expense among the foreign

corporation and its partnership interests.

(A) In general.

(B) Attribution of interest expense on U.S.

booked liabilities.

(C) Attribution of excess § 1.882–5 three-

step interest expense.

(1) In general.

(2) Attribution of excess § 1.882–5 three-

step interest expense to the foreign

corporation.

(3) Attribution of excess § 1.882–5 three-

step interest expense to partnerships.

(i) In general.

(ii) Direct and indirect partnership

interests.

(4) Limitation on attribution of excess

§ 1.882–5 three-step interest expense.

(2) Coordination with the branch profits

tax.

(g) Definitions.

(1) § 1.882–5 and similar provisions.

(2) § 1.882–5 three-step interest expense.

(3) Allocable ECI BIE.

(4) Allocable ECI BII.

(5) Allocable ECI deductible BIE.

(6) Allocable ECI excess BIE.

(7) Allocable non-ECI BIE.

(8) Allocable non-ECI deductible BIE.

(9) Allocable non-ECI excess BIE.

(10) Distributive share of ECI.

(11) Distributive share of non-ECI.

(12) Effectively connected income.

(13) Excess § 1.882–5 three-step interest

expense.

(14) FC ECI BIE.

(15) FC ECI deductible BIE.

(16) FC ECI disallowed BIE.

(17) FC non-ECI BIE.

(18) FC non-ECI deductible BIE.

(19) FC non-ECI disallowed BIE.

(20) Hypothetical partnership ECI

deductible BIE.

(21) Hypothetical partnership non-ECI

deductible BIE.

(22) Hypothetical FC ECI deductible BIE.

(23) Hypothetical FC non-ECI deductible

BIE.

(24) Specified ATI ratio.

(25) Specified BII ratio.

(26) Specified foreign partner.

(27) Specified foreign person.

(28) Successor.

(h) Examples.

(i) [Reserved]

(j) Applicability date.

§ 1.163(j)–10 Allocation of interest expense,

interest income, and other items of

expense and gross income to an

excepted trade or business.

* * * * *

(c) * * *

(5) * * *

(ii) * * *

(D) Limitations on application of look-

through rules.

(1) Inapplicability of look-through rule to

partnerships or non-consolidated C

corporations to which the small business

exemption applies.

(2) Limitation on application of look-

through rule to C corporations.

* * * * *

(f) Applicability dates.

(1) In general.

(2) Paragraph (c)(5)(ii)(D)(2).

■Par. 5.As added in a final rule

published elsewhere in this issue of the

Federal Register, effective November

13, 2020, § 1.163(j)–1 is amended by:

■1. Revising paragraph (b)(1)(iv)(B).

■2. Adding paragraphs (b)(1)(iv)(E),

(b)(22)(iii)(F), and (b)(35)

■3. In paragraph (c)(1), removing

‘‘paragraphs (c)(2) and (3)’’ from the first

sentence and adding ‘‘paragraphs (c)(2),

(3), and (4)’’ in its place.

■4. Adding paragraph (c)(4).

The revisions and additions read as

follows:

§ 1.163(j)–1 Definitions.

* * * * *

(b) * * *

(1) * * *

(iv) * * *

(B) Deductions by members of a

consolidated group—(1) In general. If

paragraph (b)(1)(ii)(C), (D), or (E) of this

section applies to adjust the tentative

taxable income of a taxpayer, and if the

taxpayer does not use the computation

method in paragraph (b)(1)(iv)(E) of this

section, the amount of the adjustment

under paragraph (b)(1)(ii)(C) of this

section equals the greater of the allowed

or allowable depreciation, amortization,

or depletion of the property, as provided

under section 1016(a)(2), for any

member of the consolidated group for

the taxable years beginning after

December 31, 2017, and before January

1, 2022, with respect to such property.

(2) Application of the alternative

computation method. If paragraph

(b)(1)(ii)(C), (D), or (E) of this section

applies to adjust the tentative taxable

income of a taxpayer, and if the

taxpayer uses the computation method

in paragraph (b)(1)(iv)(E) of this section,

the amount of the adjustment under

paragraph (b)(1)(ii)(C) of this section

equals the lesser of:

(i) Any gain recognized on the sale or

other disposition of such property by

the taxpayer (or, if the taxpayer is a

member of a consolidated group, the

consolidated group); and

(ii) The greater of the allowed or

allowable depreciation, amortization, or

depletion of the property, as provided

under section 1016(a)(2), for the

taxpayer (or, if the taxpayer is a member

of a consolidated group, the

consolidated group) for the taxable years

beginning after December 31, 2017, and

before January 1, 2022, with respect to

such property.

* * * * *

(E) Alternative computation method.

If paragraph (b)(1)(ii)(C), (D), or (E) of

this section applies to adjust the

tentative taxable income of a taxpayer,

the taxpayer may compute the amount

of the adjustments required by such

paragraph using the formulas in

paragraph (b)(1)(iv)(E)(1), (2), and (3) of

this section, respectively, provided that

the taxpayer applies such formulas to all

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dispositions for which an adjustment is

required under paragraph (b)(1)(ii)(C),

(D), or (E) of this section.

(1) Alternative computation method

for property dispositions. With respect

to the sale or other disposition of

property, the lesser of:

(i) Any gain recognized on the sale or

other disposition of such property by

the taxpayer (or, if the taxpayer is a

member of a consolidated group, the

consolidated group); and

(ii) The greater of the allowed or

allowable depreciation, amortization, or

depletion of the property, as provided

under section 1016(a)(2), for the

taxpayer (or, if the taxpayer is a member

of a consolidated group, the

consolidated group) for the taxable years

beginning after December 31, 2017, and

before January 1, 2022, with respect to

such property.

(2) Alternative computation method

for dispositions of member stock. With

respect to the sale or other disposition

of stock of a member of a consolidated

group by another member, the lesser of:

(i) Any gain recognized on the sale or

other disposition of such stock; and

(ii) The investment adjustments under

§ 1.1502–32 with respect to such stock

that are attributable to deductions

described in paragraph (b)(1)(ii)(C) of

this section.

(3) Alternative computation method

for dispositions of partnership interests.

With respect to the sale or other

disposition of an interest in a

partnership, the lesser of (i) any gain

recognized on the sale or other

disposition of such interest, and (ii) the

taxpayer’s (or, if the taxpayer is a

consolidated group, the consolidated

group’s) distributive share of deductions

described in paragraph (b)(1)(ii)(C) of

this section with respect to property

held by the partnership at the time of

such sale or other disposition to the

extent such deductions were allowable

under section 704(d).

* * * * *

(22) * * *

(iii) * * *

(F) Section 163(j) interest dividends—

(1) In general. Except as otherwise

provided in this paragraph

(b)(22)(iii)(F), a section 163(j) interest

dividend is treated as interest income.

(2) Limitation on amount treated as

interest income. A shareholder may not

treat any part of a section 163(j) interest

dividend as interest income to the

extent the amount of the section 163(j)

interest dividend exceeds the excess of

the amount of the entire dividend that

includes the section 163(j) interest

dividend over the sum of the conduit

amounts other than interest-related

dividends under section 871(k)(1)(C)

and section 163(j) interest dividends

that affect the shareholder’s treatment of

that dividend.

(3) Conduit amounts. For purposes of

paragraph (b)(22)(iii)(F)(2) of this

section, the term conduit amounts

means, with respect to any category of

income (including tax-exempt interest)

earned by a RIC for a taxable year, the

amounts identified by the RIC (generally

in a designation or written report) in

connection with dividends paid by the

RIC for that taxable year that are subject

to a limit determined by reference to

that category of income. For example, a

RIC’s conduit amount with respect to its

net capital gain is the amount of capital

gain dividends that the RIC pays under

section 852(b)(3)(C).

(4) Holding period. Except as

provided in paragraph (b)(22)(iii)(F)(5)

of this section, no dividend is treated as

interest income under paragraph

(b)(22)(iii)(F)(1) of this section if the

dividend is received with respect to a

share of RIC stock—

(i) That is held by the shareholder for

180 days or less (taking into account the

principles of section 246(c)(3) and (4))

during the 361-day period beginning on

the date which is 180 days before the

date on which the share becomes ex-

dividend with respect to such dividend;

or

(ii) To the extent that the shareholder

is under an obligation (whether

pursuant to a short sale or otherwise) to

make related payments with respect to

positions in substantially similar or

related property.

(5) Exception to holding period

requirement for money market funds

and certain regularly declared

dividends. Paragraph (b)(22)(iii)(F)(4)(i)

of this section does not apply to

dividends distributed by any RIC

regulated as a money market fund under

17 CFR 270.2a–7 (Rule 2a–7 under the

1940 Act) or to regular dividends paid

by a RIC that declares section 163(j)

interest dividends on a daily basis in an

amount equal to at least 90 percent of

its excess section 163(j) interest income,

as defined in paragraph (b)(35)(iv)(E) of

this section, and distributes such

dividends on a monthly or more

frequent basis.

* * * * *

(35) Section 163(j) interest dividend.

The term section 163(j) interest dividend

means a dividend paid by a RIC for a

taxable year for which section 852(b)

applies to the RIC, to the extent

described in paragraph (b)(35)(i) or (ii)

of this section, as applicable.

(i) In general. Except as provided in

paragraph (b)(35)(ii) of this section, a

section 163(j) interest dividend is any

dividend, or part of a dividend, that is

reported by the RIC as a section 163(j)

interest dividend in written statements

furnished to its shareholders.

(ii) Reduction in the case of excess

reported amounts. If the aggregate

reported amount with respect to the RIC

for the taxable year exceeds the excess

section 163(j) interest income of the RIC

for such taxable year, the section 163(j)

interest dividend is—

(A) The reported section 163(j)

interest dividend amount; reduced by

(B) The excess reported amount that

is allocable to that reported section

163(j) interest dividend amount.

(iii) Allocation of excess reported

amount—(A) In general. Except as

provided in paragraph (b)(35)(iii)(B) of

this section, the excess reported

amount, if any, that is allocable to the

reported section 163(j) interest dividend

amount is that portion of the excess

reported amount that bears the same

ratio to the excess reported amount as

the reported section 163(j) interest

dividend amount bears to the aggregate

reported amount.

(B) Special rule for noncalendar year

RICs. In the case of any taxable year that

does not begin and end in the same

calendar year, if the post-December

reported amount equals or exceeds the

excess reported amount for that taxable

year, paragraph (b)(35)(iii)(A) of this

section is applied by substituting ‘‘post-

December reported amount’’ for

‘‘aggregate reported amount,’’ and no

excess reported amount is allocated to

any dividend paid on or before

December 31 of such taxable year.

(iv) Definitions. The following

definitions apply for purposes of this

paragraph (b)(35):

(A) Reported section 163(j) interest

dividend amount. The term reported

section 163(j) interest dividend amount

means the amount of a dividend

distribution reported to the RIC’s

shareholders under paragraph (b)(35)(i)

of this section as a section 163(j) interest

dividend.

(B) Excess reported amount. The term

excess reported amount means the

excess of the aggregate reported amount

over the RIC’s excess section 163(j)

interest income for the taxable year.

(C) Aggregate reported amount. The

term aggregate reported amount means

the aggregate amount of dividends

reported by the RIC under paragraph

(b)(35)(i) of this section as section 163(j)

interest dividends for the taxable year

(including section 163(j) interest

dividends paid after the close of the

taxable year described in section 855).

(D) Post-December reported amount.

The term post-December reported

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amount means the aggregate reported

amount determined by taking into

account only dividends paid after

December 31 of the taxable year.

(E) Excess section 163(j) interest

income. The term excess section 163(j)

interest income means, with respect to

a taxable year of a RIC, the excess of the

RIC’s business interest income for the

taxable year over the sum of the RIC’s

business interest expense for the taxable

year and the RIC’s other deductions for

the taxable year that are properly

allocable to the RIC’s business interest

income.

(v) Example—(A) Facts. X is a domestic C

corporation that has elected to be a RIC. For

its taxable year ending December 31, 2021, X

has $100x of business interest income (all of

which is qualified interest income for

purposes of section 871(k)(1)(E)) and $10x of

dividend income (all of which is qualified

dividend income within the meaning of

section 1(h)(11) and would be eligible for the

dividends received deduction under section

243, determined as described in section

854(b)(3)). X has $10x of business interest

expense and $20x of other deductions. X has

no other items for the taxable year. On

December 31, 2021, X pays a dividend of

$80x to its shareholders, and reports, in

written statements to its shareholders,

$71.82x as a section 163(j) interest dividend;

$10x as dividends that may be treated as

qualified dividend income or as dividends

eligible for the dividends received deduction;

and $72.73x as interest-related dividends

under section 871(k)(1)(C). Shareholder A, a

domestic C corporation, meets the holding

period requirements in paragraph

(b)(22)(iii)(F)(4) of this section with respect to

the stock of X, and receives a dividend of $8x

from X on December 31, 2021.

(B) Analysis. X determines that $18.18x of

other deductions are properly allocable to X’s

business interest income. X’s excess section

163(j) interest income under paragraph

(b)(35)(iv)(E) of this section is $71.82x ($100x

business interest income¥($10x business

interest expense + $18.18x other deductions

allocated) = $71.82x). Thus, X may report up

to $71.82x of its dividends paid on December

31, 2021, as section 163(j) interest dividends

to its shareholders. X may also report up to

$10x of its dividends paid on December 31,

2021, as dividends that may be treated as

qualified dividend income or as dividends

that are eligible for the dividends received

deduction. X determines that $9.09x of

interest expense and $18.18x of other

deductions are properly allocable to X’s

qualified interest income. Therefore, X may

report up to $72.73x of its dividends paid on

December 31, 2021, as interest-related

dividends under section 871(k)(1)(C) ($100x

qualified interest income¥$27.27x

deductions allocated = $72.73x). A treats $1x

of its $8x dividend as a dividend eligible for

the dividends received deduction and no part

of the dividend as an interest-related

dividend under section 871(k)(1)(C).

Therefore, under paragraph (b)(22)(iii)(F)(2)

of this section, A may treat $7x of the section

163(j) interest dividend as interest income for

purposes of section 163(j) ($8x

dividend¥$1x conduit amount = $7x

limitation).

* * * * *

(c) * * *

(4) Alternative computation for

certain adjustments to tentative taxable

income, and section 163(j) interest

dividends—(i) Alternative computation

for certain adjustments to tentative

taxable income. Paragraphs (b)(1)(iv)(B)

and (E) of this section apply to taxable

years beginning on or after [DATE 60

DAYS AFTER DATE OF PUBLICATION

OF THE FINAL RULE IN THE Federal

Register]. Taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules in paragraphs

(b)(1)(iv)(B) and (E) of this section to a

taxable year beginning after December

31, 2017, and before [DATE 60 DAYS

AFTER DATE OF PUBLICATION OF

THE FINAL RULE IN THE Federal

Register], so long as the taxpayers and

their related parties consistently apply

the rules of the section 163(j)

regulations, and, if applicable,

§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,

1.382–1, 1.382–2, 1.382–5, 1.382–6,

1.382–7, 1.383–0, 1.383–1, 1.469–9,

1.469–11, 1.704–1, 1.882–5, 1.1362–3,

1.1368–1, 1.1377–1, 1.1502–13, 1.1502–

21, 1.1502–36, 1.1502–79, 1.1502–91

through 1.1502–99 (to the extent they

effectuate the rules of §§ 1.382–2, 1.382–

5, 1.382–6, and 1.383–1), and 1.1504–4,

to that taxable year and each subsequent

taxable year.

(ii) Section 163(j) interest dividends.

Paragraphs (b)(22)(iii)(F) and (b)(35) of

this section apply to taxable years

beginning on or after [DATE 60 DAYS

AFTER DATE OF PUBLICATION OF

THE FINAL RULE IN THE Federal

Register]. Taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules in paragraphs

(b)(22)(iii)(F) and (b)(35) of this section

for a taxable year beginning after

December 31, 2017, and before [DATE

60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE Federal Register], so long as the

taxpayers and their related parties

consistently apply the rules of the

section 163(j) regulations.

■Par. 6. As added in a final rule

published elsewhere in this issue of the

Federal Register, effective November

13, 2020, § 1.163(j)–2 is amended by:

■1. Adding paragraphs (b)(3)(iii) and

(iv) and (d)(3).

■2. Redesignating paragraph (k) as

paragraph (k)(1).

■3. Adding a new subject heading for

paragraph (k).

■4. Revising the subject heading of

redesignated paragraph (k)(1).

■5. Adding paragraph (k)(2).

The additions and revision read as

follows:

§ 1.163(j)–2 Deduction for business

interest expense limited.

* * * * *

(b) * * *

(3) * * *

(iii) Transactions to which section 381

applies. For purposes of the election

described in paragraph (b)(3)(i) of this

section, and subject to the limitation in

paragraph (b)(3)(ii) of this section, the

2019 ATI of the acquiring corporation in

a transaction to which section 381

applies equals the amount of the

acquiring corporation’s ATI for its last

taxable year beginning in 2019.

(iv) Consolidated groups. For

purposes of the election described in

paragraph (b)(3)(i) of this section, and

subject to the limitation in paragraph

(b)(3)(ii) of this section, the 2019 ATI of

a consolidated group equals the amount

of the consolidated group’s ATI for its

last taxable year beginning in 2019.

* * * * *

(d) * * *

(3) Determining a syndicate’s loss

amount. For purposes of section 163(j),

losses allocated under section

1256(e)(3)(B) and § 1.448–1T(b)(3) are

determined without regard to section

163(j). See also § 1.1256(e)–2(b).

* * * * *

(k) Applicability dates.

(1) In general. ***

(2) Paragraphs (b)(3)(iii), (b)(3)(iv),

and (d)(3). Paragraphs (b)(3)(iii) and (iv)

and (d)(3) of this section apply to

taxable years beginning on or after

[DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules of paragraphs (b)(3)(iii)

and (iv) of this section to a taxable year

beginning after December 31, 2017, and

before [DATE 60 DAYS AFTER DATE

OF PUBLICATION OF THE FINAL

RULE IN THE FEDERAL REGISTER],

provided that they consistently apply

the rules of paragraphs (b)(3)(iii) and

(iv) of this section and the rules in the

section 163(j) regulations for that

taxable year and for each subsequent

taxable year. Taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b), may choose to apply

the rules of paragraph (d)(3) of this

section to a taxable year beginning after

December 31, 2017, and before [DATE

60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

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IN THE FEDERAL REGISTER],

provided that they consistently apply

the rules of paragraph (d)(3) of this

section for that taxable year and for each

subsequent taxable year.

■Par. 7.As added in a final rule

published elsewhere in this issue of the

Federal Register, effective November

13, 2020, § 1.163(j)–6 is amended by:

■1. Adding paragraphs (c)(1) and (2),

(d)(3) through (5), (e)(5) and (6),

(f)(1)(iii), (g)(4), (h)(4) and (5), (j),

(l)(4)(iv), (n), and (o)(24) through (29).

■2. Redesignating paragraph (p) as

paragraph (p)(1).

■3. Adding a new subject heading for

paragraph (p).

■4. Revising the subject heading of

newly redesignated paragraph (p)(1).

■5. Adding paragraph (p)(2).

The additions and revision read as

follows:

§ 1.163(j)–6 Application of the business

interest deduction limitation to partnerships

and subchapter S corporations.

* * * * *

(c) * * *

(1) Modification of business interest

income for partnerships. The business

interest income of a partnership

generally is determined in accordance

with § 1.163(j)–1(b)(3). To the extent

that interest income of a partnership

that is properly allocable to trades or

businesses that are per se non-passive

activities and is allocated to partners

that do not materially participate

(within the meaning of section 469), as

described in section 163(d)(5)(A)(ii),

such interest income shall not be

considered business interest income for

purposes of determining the section

163(j) limitation of a partnership

pursuant to § 1.163(j)–2(b). A per se

non-passive activity is an activity that is

not treated as a passive activity for

purposes of section 469 regardless of

whether the owners of the activity

materially participate in the activity.

(2) Modification of business interest

expense for partnerships. The business

interest expense of a partnership

generally is determined in accordance

with § 1.163(j)–1(b)(2). To the extent

that interest expense of a partnership

that is properly allocable to trades or

businesses that are per se non-passive

activities is allocated to partners that do

not materially participate within the

meaning of section 469, as described in

section 163(d)(5)(A)(ii), such interest

expense shall not be considered

business interest expense for purposes

of determining the section 163(j)

limitation of a partnership pursuant to

§ 1.163(j)–2(b).

* * * * *

(d) * * *

(3) Section 743(b) adjustments and

publicly traded partnerships. Solely for

purposes of § 1.163(j)–6, a publicly

traded partnership, as defined in

§ 1.7704–1, shall treat the amount of any

section 743(b) adjustment of a purchaser

of a partnership unit that relates to a

remedial item that the purchaser

inherits from the seller as an offset to

the related section 704(c) remedial item.

For this purpose, § 1.163(j)–6(e)(2)(ii)

applies. See Example 25 in paragraph

(o)(25) of this section.

(4) Modification of adjusted taxable

income for partnerships. The adjusted

taxable income of a partnership

generally is determined in accordance

with § 1.163(j)–1(b)(1). To the extent

that the items comprising the adjusted

taxable income of a partnership are

properly allocable to trades or

businesses that are per se non-passive

activities and are allocated to partners

that do not materially participate

(within the meaning of section 469), as

described in section 163(d)(5)(A)(ii),

such partnership items shall not be

considered adjusted taxable income for

purposes of determining the section

163(j) limitation of a partnership

pursuant to § 1.163(j)–2(b).

(5) Election to use 2019 adjusted

taxable income for taxable years

beginning in 2020. In the case of any

taxable year beginning in 2020, a

partnership may elect to apply this

section by substituting its adjusted

taxable income for the last taxable year

beginning in 2019 for the adjusted

taxable income for such taxable year.

See § 1.163(j)–2(b)(4) for the time and

manner of making or revoking this

election. An electing partnership

determines each partner’s allocable ATI

(as defined in paragraph (f)(2)(ii) of this

section) pursuant to paragraph (j)(9) of

this section in the same manner as an

upper-tier partnership. See Example 34

in paragraph (o)(34) of this section.

* * * * *

(e) * * *

(5) Partner basis items, remedial

items, and publicly traded partnerships.

Solely for purposes of § 1.163(j)–6, a

publicly traded partnership, as defined

in § 1.7704–1, shall either allocate gain

that would otherwise be allocated under

section 704(c) based on a partner’s

section 704(b) sharing ratios, or, for

purposes of allocating cost recovery

deductions under section 704(c),

determine a partner’s remedial items, as

defined in § 1.163(j)–6(b)(3), based on

an allocation of the partnership’s asset

basis (inside basis) items among its

partners in proportion to their share of

corresponding section 704(b) items

(rather than applying the traditional

method, described in § 1.704–3(b)). See

Example 24 in paragraph (o)(24) of this

section.

(6) Partnership deductions capitalized

by a partner. The ATI of a partner is

increased by the portion of such

partner’s allocable share of qualified

expenditures (as defined in section

59(e)(2)) to which an election under

section 59(e) applies.

* * * * *

(f) * * *

(1) * * *

(iii) Exception applicable to publicly

traded partnerships. Publicly traded

partnerships, as defined in § 1.7704–1,

do not apply the rules in paragraph

(f)(2) of this section to determine a

partner’s share of section 163(j) excess

items. Rather, publicly traded

partnerships determine a partner’s share

of section 163(j) excess items by

applying the same percentage used to

determine the partner’s share of the

corresponding section 704(b) items that

comprise ATI.

* * * * *

(g) * * *

(4) Special rule for taxable years

beginning in 2019 and 2020. In the case

of any excess business interest expense

of a partnership for any taxable year

beginning in 2019 that is allocated to a

partner under paragraph (f)(2) of this

section, 50 percent of such excess

business interest expense (§ 1.163(j)–

6(g)(4) business interest expense) is

treated as business interest expense that,

notwithstanding paragraph (g)(2) of this

section, is paid or accrued by the

partner in the partner’s first taxable year

beginning in 2020. Additionally,

§ 1.163(j)–6(g)(4) business interest

expense is not subject to the section

163(j) limitation at the level of the

partner. For purposes of paragraph

(h)(1) of this section, any § 1.163(j)–

6(g)(4) business interest expense is,

similar to deductible business interest

expense, taken into account before any

excess business interest expense. This

paragraph applies after paragraph (n) of

this section. If a partner disposes of a

partnership interest in the partnership’s

2019 or 2020 taxable year, § 1.163(j)–

6(g)(4) business interest expense is

deductible by the partner and thus does

not result in a basis increase under

paragraph (h)(3) of this section. See

Example 35 and Example 36 in

paragraphs (o)(35) and (o)(36),

respectively, of this section. A taxpayer

may elect to not have this provision

apply. The rules and procedures

regarding the time and manner of

making, or revoking, such an election

are provided in Revenue Procedure

2020–22, 2020–18 I.R.B. 745, and may

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be further modified through other

guidance (see §§ 601.601(d) and 601.602

of this chapter).

* * * * *

(h) * * *

(4) Partner basis adjustments upon

liquidating distribution. For purposes of

paragraph (h)(3) of this section, a

disposition includes a distribution of

money or other property by the

partnership to a partner in complete

liquidation of the partner’s interest in

the partnership. However, a current

distribution of money or other property

by the partnership to a continuing

partner is not a disposition for purposes

of paragraph (h)(3) of this section.

(5) Partnership basis adjustments

upon partner dispositions. If a partner

(transferor) disposes of its partnership

interest, the partnership shall increase

the adjusted basis of partnership

property by an amount equal to the

amount of the increase required under

paragraph (h)(3) (or, if the transferor is

a partnership, (j)(5)(ii)) of this section (if

any) to the adjusted basis of the

partnership interest being disposed of

by the transferor. Such increase in the

adjusted basis of partnership property

(§ 1.163(j)–6(h)(5) basis adjustment)

shall be allocated among capital gain

property of the partnership in the same

manner as a positive section 734(b)

adjustment. However, the increase in

the adjusted basis of any partnership

property resulting from a § 1.163(j)–

6(h)(5) basis adjustment is not

depreciable or amortizable under any

section of the Code, regardless of

whether the partnership property

allocated such § 1.163(j)–6(h)(5) basis

adjustment is otherwise generally

depreciable or amortizable. In general, a

partnership allocates its § 1.163(j)–

6(h)(5) basis adjustment immediately

before the disposition (simultaneous

with the transferor’s basis increase

required under paragraph (h)(3) or

(j)(5)(ii) of this section). However, if the

disposition was the result of a

distribution by the partnership of

money or other property to the

transferor in complete liquidation of the

transferor’s interest in the partnership,

the partnership allocates its § 1.163(j)–

6(h)(5) basis adjustment among its

properties only after it has allocated its

section 734(b) adjustment (if any)

among its properties. See Example 31 in

paragraph (o)(31) of this section.

* * * * *

(j) Tiered partnerships—(1) Purpose.

The purpose of this section is to provide

guidance regarding the treatment of

business interest expense of a

partnership (lower-tier partnership) that

is allocated to a partner that is a

partnership (upper-tier partnership).

Specifically, this section clarifies that

disparities are not created between an

upper-tier partner’s basis in its upper-

tier partnership interest and such

partner’s share of the adjusted basis of

upper-tier partnership’s property

following the allocation of excess

business interest expense from lower-

tier partnership to upper-tier

partnership. Further, these rules

disallow any deduction for business

interest expense that was formerly

excess business interest expense to any

person that is not the specified partner

of such business interest expense. See

Example 27 through Example 30 in

paragraphs (o)(27) through (30),

respectively.

(2) Section 704(b) capital account

adjustments. If lower-tier partnership

pays or accrues business interest

expense and allocates such business

interest expense to upper-tier

partnership, then both upper-tier

partnership and any direct or indirect

partners of upper-tier partnership shall,

solely for purposes of section 704(b) and

the regulations thereunder, treat such

business interest expense as a section

705(a)(2)(B) expenditure. Any section

704(b) capital account reduction

resulting from such treatment occurs

regardless of whether such business

interest expense is characterized under

this section as excess business interest

expense or deductible business interest

expense by lower-tier partnership. If

upper-tier partnership subsequently

treats any excess business interest

expense allocated from lower-tier

partnership as business interest expense

paid or accrued pursuant to paragraph

(g) of this section, the section 704(b)

capital accounts of any direct or indirect

partners of upper-tier partnership are

not further reduced.

(3) Basis adjustments of upper-tier

partnership. If lower-tier partnership

allocates excess business interest

expense to upper-tier partnership, then

upper-tier partnership reduces its basis

in lower-tier partnership pursuant to

paragraph (h)(2) of this section. Upper-

tier partnership partners do not,

however, reduce the bases of their

upper-tier partnership interests

pursuant to paragraph (h)(2) of this

section until upper-tier partnership

treats such excess business interest

expense as business interest expense

paid or accrued pursuant to paragraph

(g) of this section.

(4) Treatment of excess business

interest expense allocated by lower-tier

partnership to upper-tier partnership.

Except as provided in paragraph (j)(7) of

this section, if lower-tier partnership

allocates excess business interest

expense to upper-tier partnership and

such excess business interest expense is

not suspended under section 704(d),

then upper-tier partnership shall treat

such excess business interest expense

(UTP EBIE) as a nondepreciable capital

asset, with a fair market value of zero

and basis equal to the amount by which

upper-tier partnership reduced its basis

in lower-tier partnership pursuant to

paragraph (h)(2) of this section due to

the allocation of such excess business

interest expense. The fair market value

of UTP EBIE, described in the preceding

sentence, is not adjusted by any

revaluations occurring under § 1.704–

1(b)(2)(iv)(f). In addition to generally

treating UTP EBIE as having a basis

component in excess of fair market

value and, thus, built-in loss property,

upper-tier partnership shall also treat

UTP EBIE as having a carryforward

component associated with it. The

carryforward component of UTP EBIE

shall equal the amount of excess

business interest expense allocated from

lower-tier partnership to upper-tier

partnership under paragraph (f)(2) of

this section that is treated as such under

paragraph (h)(2) of this section by

upper-tier partnership. If an allocation

of excess business interest expense from

lower-tier partnership is treated as UTP

EBIE of upper-tier partnership, upper-

tier partnership shall treat such

allocation of excess business interest

expense from lower-tier partnership as

UTP EBIE until the occurrence of an

event described in paragraph (j)(5) of

this section.

(5) UTP EBIE conversion events—(i)

Allocation to upper-tier partnership by

lower-tier partnership of excess taxable

income (or excess business interest

income). To the extent upper-tier

partnership is allocated excess taxable

income (or excess business interest

income) from lower-tier partnership, or

paragraph (m)(3) of this section applies,

upper-tier partnership shall—

(A) First, apply the rules in paragraph

(g) of this section to its UTP EBIE, using

any reasonable method (including, for

example, FIFO and LIFO) to determine

which UTP EBIE is treated as business

interest expense paid or accrued

pursuant paragraph (g) of this section. If

paragraph (m)(3) of this section applies,

upper-tier partnership shall treat all of

its UTP EBIE from lower-tier

partnership as business interest expense

paid or accrued.

(B) Second, with respect to any UTP

EBIE treated as business interest

expense paid or accrued in paragraph

(j)(5)(i)(A) of this section, allocate any

business interest expense that was

formerly such UTP EBIE to its specified

partner. For purposes of this section, the

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term specified partner refers to the

partner of upper-tier partnership that,

due to the initial allocation of excess

business interest expense from lower-

tier partnership to upper-tier

partnership, was required to reduce its

section 704(b) capital account pursuant

to paragraph (j)(2) of this section.

Similar principles apply if the specified

partner of such business interest

expense is itself a partnership. See

paragraph (j)(6) of this section for rules

that apply if a specified partner disposes

of its partnership interest.

(C) Third, in the manner provided in

paragraph (j)(7)(ii) (or (iii), as the case

may be) of this section, take into

account any negative basis adjustments

under section 734(b) previously made to

the UTP EBIE treated as business

interest expense paid or accrued in

paragraph (j)(5)(i)(A) of this section.

Additionally, persons treated as

specified partners with respect to the

UTP EBIE treated as business interest

expense paid or accrued in paragraph

(j)(5)(i)(A) shall take any negative basis

adjustments under section 743(b) into

account in the manner provided in

paragraph (j)(7)(ii) (or (iii), as the case

may be) of this section.

(ii) Upper-tier partnership disposition

of lower-tier partnership interest. If

upper-tier partnership disposes of a

lower-tier partnership interest

(transferred interest), upper-tier

partnership shall—

(A) First, apply the rules in paragraph

(h)(3) of this section (except as provided

in paragraphs (j)(5)(ii)(B) and (C) of this

section), using any reasonable method

(including, for example, FIFO and LIFO)

to determine which UTP EBIE is

reduced pursuant paragraph (h)(3) of

this section.

(B) Second, increase the adjusted

basis of the transferred interest

immediately before the disposition by

the total amount of the UTP EBIE that

was reduced in paragraph (j)(5)(ii)(A) of

this section (the amount of UTP EBIE

proportionate to the transferred

interest).

(C) Third, in the manner provided in

paragraph (j)(7)(iv) of this section, take

into account any negative basis

adjustments under sections 734(b) and

743(b) previously made to the UTP EBIE

that was reduced in (A) earlier.

(6) Disposition of a specified partner’s

partnership interest—(i) General rule. If

a specified partner (transferor) disposes

of an upper-tier partnership interest (or

an interest in a partnership that itself is

a specified partner), the portion of any

UTP EBIE to which the transferor’s

status as specified partner relates is not

reduced pursuant to paragraph (j)(5)(ii)

of this section. Rather, such UTP EBIE

attributable to the interest disposed of is

retained by upper-tier partnership and

the transferee is treated as the specified

partner for purposes of this section with

respect to such UTP EBIE. Thus, upper-

tier partnership must allocate any

business interest expense that was

formerly such UTP EBIE to the

transferee. However, see paragraph (j)(8)

of this section for rules regarding the

deductibility of such transferee’s

business interest expense that was

formerly UTP EBIE.

(ii) Special rules—(A) Distribution in

liquidation of a specified partner’s

partnership interest. If a specified

partner receives a distribution of

property in complete liquidation of an

upper-tier partnership interest, the

portion of UTP EBIE of upper-tier

partnership attributable to the

liquidated interest shall not have a

specified partner. If a specified partner

(transferee) receives a distribution of an

interest in upper-tier partnership in

complete liquidation of a partnership

interest, the transferee is the specified

partner with respect to UTP EBIE of

upper-tier partnership only to the same

extent it was prior to the distribution.

Similar principles apply where an

interest in a partnership that is a

specified partner is distributed in

complete liquidation of a transferee’s

partnership interest. See paragraph (j)(8)

of this section for rules regarding the

treatment of UTP EBIE that does not

have a specified partner.

(B) Contribution of a specified

partner’s partnership interest. If a

specified partner (transferor) contributes

an upper-tier partnership interest to a

partnership (transferee), the transferee is

treated as the specified partner with

respect to the portion of the UTP EBIE

attributable to the contributed interest.

Following the transaction, the transferor

continues to be the specified partner

with respect to the UTP EBIE

attributable to the contributed interest.

Similar principles apply where an

interest in a partnership that is a

specified partner is contributed to a

partnership.

(7) Effect of basis adjustments

allocated to UTP EBIE—(i) In general.

Negative basis adjustments under

sections 734(b) and 743(b) allocated to

UTP EBIE do not affect the carryforward

component (described in paragraph

(j)(4) of this section) of such UTP EBIE.

Rather, negative basis adjustments

under sections 734(b) and 743(b) affect

only the basis component of such UTP

EBIE. For purposes of §§ 1.743–1(d),

1.755–1(b), and 1.755–1(c), the amount

of tax loss that would be allocated to a

transferee from a hypothetical

disposition by upper-tier partnership of

its UTP EBIE equals the adjusted basis

of the UTP EBIE to which the

transferee’s status as specified partner

relates. Additionally, solely for

purposes of § 1.755–1(b), upper-tier

partnership shall treat UTP EBIE as an

ordinary asset of upper-tier partnership.

(ii) UTP EBIE treated as deductible

business interest expense. If UTP EBIE

that was allocated a negative section

734(b) adjustment is subsequently

treated as deductible business interest

expense, then such deductible business

interest expense does not result in a

deduction to the upper-tier partnership

or the specified partner of such

deductible business interest expense. If

UTP EBIE that was allocated a negative

section 743(b) adjustment is

subsequently treated as deductible

business interest expense, the specified

partner of such deductible business

interest expense recovers any negative

section 743(b) adjustment attributable to

such deductible business interest

expense (effectively eliminating any

deduction for such deductible business

interest expense).

(iii) UTP EBIE treated as excess

business interest expense. If UTP EBIE

that was allocated a negative section

734(b) or 743(b) adjustment is

subsequently treated as excess business

interest expense, the specified partner’s

basis decrease in its upper-tier

partnership interest required under

paragraph (h)(2) of this section is

reduced by the amount of the negative

section 734(b) or 743(b) adjustment

previously made to such excess

business interest expense. If such excess

business interest expense is

subsequently treated as business interest

expense paid or accrued by the

specified partner, no deduction shall be

allowed for any of such business

interest expense. If the specified partner

of such excess business interest expense

is a partnership, such excess business

interest expense is considered UTP EBIE

that was previously allocated a negative

section 734(b) adjustment for purposes

of this section.

(iv) UTP EBIE reduced due to a

disposition. If UTP EBIE that was

allocated a negative section 734(b) or

743(b) adjustment is reduced pursuant

to paragraph (j)(5)(ii)(A) of this section,

the amount of upper-tier partnership’s

basis increase under paragraph

(j)(5)(ii)(B) of this section to the

disposed of lower-tier partnership

interest is reduced by the amount of the

negative section 734(b) or 743(b)

adjustment previously made to such

UTP EBIE.

(8) Anti-loss trafficking—(i)

Transferee specified partner. No

deduction shall be allowed to any

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transferee specified partner for any

business interest expense derived from

a transferor’s share of UTP EBIE. For

purposes of this section, the term

transferee specified partner refers to any

specified partner that did not reduce its

section 704(b) capital account due to the

initial allocation of excess business

interest expense from lower-tier

partnership to upper-tier partnership

pursuant to paragraph (j)(2) of this

section. However, the transferee

described in paragraph (j)(6)(ii)(B) of

this section is not a transferee specified

partner for purposes of this section. If

pursuant to paragraph (j)(5)(i)(B) of this

section a transferee specified partner is

allocated business interest expense

derived from a transferor’s share of UTP

EBIE (business interest expense to

which the partner’s status as transferee

specified partner relates), the transferee

specified partner is deemed to recover a

negative section 743(b) adjustment with

respect to, and in the amount of, such

business interest expense and takes

such negative section 743(b) adjustment

into account in the manner provided in

paragraph (j)(7)(ii) (or (iii), as the case

may be) of this section, regardless of

whether a section 754 election was in

effect or a substantial built-in loss

existed at the time of the transfer by

which the transferee specified partner

acquired the transferred interest.

However, to the extent a negative

section 734(b) or 743(b) adjustment was

previously made to such business

interest expense, the transferee specified

partner does not recover an additional

negative section 743(b) adjustment

pursuant to this paragraph.

(ii) UTP EBIE without a specified

partner. If UTP EBIE does not have a

specified partner (as the result of a

transaction described in paragraph

(j)(6)(ii)(A) of this section), upper-tier

partnership shall not allocate any

business interest expense that was

formerly such UTP EBIE to its partners.

Rather, for purposes of applying

paragraph (f)(2) of this section, upper-

tier partnership shall treat such business

interest expense as the allocable

business interest expense (as defined in

paragraph (f)(2)(ii) of this section) of a

§ 1.163(j)–6(j)(8)(ii) account.

Additionally, if UTP EBIE that does not

have a specified partner (as the result of

a transaction described in paragraph

(j)(6)(ii)(A) of this section) is treated as

paid or accrued pursuant to paragraph

(g) of this section, upper-tier partnership

shall make a § 1.163(j)–6(h)(5) basis

adjustment to its property in the amount

of the adjusted basis (if any) of such

UTP EBIE at the time such UTP EBIE is

treated as business interest expense paid

or accrued pursuant to paragraph (g) of

this section.

(iii) Disallowance of addback. No

basis increase under paragraph (j)(5)(ii)

of this section shall be allowed to

upper-tier partnership for any

disallowed UTP EBIE. For purposes of

this section, the term disallowed UTP

EBIE refers to any UTP EBIE that has a

specified partner that is a transferee

specified partner (as defined in

paragraph (j)(8)(i) of this section) and

any UTP EBIE that does not have a

specified partner (as the result of a

transaction described in paragraph

(j)(6)(ii)(A) of this section). For purposes

of applying paragraph (j)(5)(ii) of this

section, upper-tier partnership shall

treat any disallowed UTP EBIE in the

same manner as UTP EBIE that has

previously been allocated a negative

section 734(b) adjustment and take such

negative section 734(b) adjustment into

account in the manner provided in

paragraph (j)(7)(iv) of this section.

However, upper-tier partnership does

not treat disallowed UTP EBIE as

though it were allocated a negative

section 734(b) adjustment pursuant to

this paragraph to the extent a negative

section 734(b) or 743(b) adjustment was

previously made to such disallowed

UTP EBIE.

(9) Determining allocable ATI and

allocable business interest income of

upper-tier partnership partners—(i) In

general. When applying paragraph

(f)(2)(ii) of this section, an upper-tier

partnership determines the allocable

ATI and allocable business interest

income of each of its partners in the

manner provided in this paragraph.

Specifically, if an upper-tier

partnership’s net amount of tax items

that comprise (or have ever comprised)

ATI is greater than or equal to its ATI,

upper-tier partnership applies the rules

in paragraph (j)(9)(ii)(A) of this section

to determine each partner’s allocable

ATI. See Example 32 in paragraph

(o)(32) of this section. However, if an

upper-tier partnership’s net amount of

tax items that comprise (or have ever

comprised) ATI is less than its ATI,

upper-tier partnership applies the rules

in paragraph (j)(9)(ii)(B) of this section

to determine each partner’s allocable

ATI. See Example 33 in paragraph

(o)(33) of this section. To determine

each partner’s allocable business

interest income, an upper-tier

partnership applies the rules in

paragraph (j)(9)(iii) of this section.

(ii) Upper-tier partner’s allocable

ATI—(A) If an upper-tier partnership’s

net amount of tax items that comprise

(or have ever comprised) ATI is greater

than or equal to its ATI (as determined

under § 1.163(j)–1(b)(1)), then an upper-

tier partner’s allocable ATI (for purposes

of paragraph (f)(2)(ii) of this section) is

equal to the product of—

(1) Such partner’s distributive share of

gross income and gain items that

comprise (or have ever comprised) ATI,

minus such partner’s distributive share

of gross loss and deduction items that

comprise (or have ever comprised) ATI;

multiplied by

(2) A fraction, the numerator of which

is upper-tier partnership’s ATI (as

determined under § 163(j)–1(b)(1)), and

the denominator of which is upper-tier

partnership’s net amount of tax items

that comprise (or have ever comprised)

ATI.

(B) If an upper-tier partnership’s net

amount of tax items that comprise (or

have ever comprised) ATI is less than its

ATI (as determined under § 1.163(j)–

1(b)(1)), then an upper-tier partner’s

allocable ATI (for purposes of paragraph

(f)(2)(ii) of this section) is equal to—

(1) The excess (if any) of such

partner’s distributive share of gross

income and gain items that comprise (or

have ever comprised) ATI, over such

partner’s distributive share of gross loss

and deduction items that comprise (or

have ever comprised) ATI; increased by

(2) The product of—

(i) Such partner’s share of residual

profits expressed as a fraction;

multiplied by

(ii) Upper-tier partnership’s ATI (as

determined under § 1.163(j)–1(b)(1)),

minus the aggregate of all the partners’

amounts determined under paragraph

(j)(9)(ii)(B)(1) of this section.

(iii) Upper-tier partner’s allocable

business interest income. An upper-tier

partner’s allocable business interest

income (for purposes of paragraph

(f)(2)(ii) of this section) is equal to the

product of—

(A) Such partner’s distributive share

of items that comprise (or have ever

comprised) business interest income;

multiplied by

(B) A fraction, the numerator of which

is upper-tier partnership’s business

interest income (as determined under

§ 1.163(j)–1(b)(4)), and the denominator

of which is the upper-tier partnership’s

amount of items that comprise (or have

ever comprised) business interest

income.

* * * * *

(l) * * *

(4) * * *

(iv) S corporation deductions

capitalized by an S corporation

shareholder. The ATI of an S

corporation shareholder is increased by

the portion of such S corporation

shareholder’s allocable share of

qualified expenditures (as defined in

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section 59(e)(2)) to which an election

under section 59(e) applies.

* * * * *

(n) Treatment of self-charged lending

transactions between partnerships and

partners. In the case of a lending

transaction between a partner (lending

partner) and partnership (borrowing

partnership) in which the lending

partner owns a direct interest (self-

charged lending transaction), any

business interest expense of the

borrowing partnership attributable to

the self-charged lending transaction is

business interest expense of the

borrowing partnership for purposes of

this section. If in a given taxable year

the lending partner is allocated excess

business interest expense from the

borrowing partnership and has interest

income attributable to the self-charged

lending transaction (interest income),

the lending partner is deemed to receive

an allocation of excess business interest

income from the borrowing partnership

in such taxable year. The amount of the

lending partner’s deemed allocation of

excess business interest income is the

lesser of such lending partner’s

allocation of excess business interest

expense from the borrowing partnership

in such taxable year or the interest

income attributable to the self-charged

lending transaction in such taxable year.

To prevent the double counting of

business interest income, the lending

partner includes interest income that

was treated as excess business interest

income pursuant to this paragraph (n)

only once when calculating its own

section 163(j) limitation. In cases where

the lending partner is not a C

corporation, to the extent that any

interest income exceeds the lending

partner’s allocation of excess business

interest expense from the borrowing

partnership for the taxable year, and

such interest income otherwise would

be properly treated as investment

income of the lending partner for

purposes of section 163(d) for that year,

such excess amount of interest income

will continue to be treated as

investment income of the lending

partner for that year for purposes of

section 163(d).

See Example 26 in paragraph (o)(26)

of this section.

(o) * * *

(24) Example 24—(i) Facts. On January 1,

2020, L and M form LM, a publicly traded

partnership (as defined in § 1.7704–1), and

agree that each will be allocated a 50 percent

share of all LM items. The partnership

agreement provides that LM will make

allocations under section 704(c) using the

remedial allocation method under § 1.704–

3(d). L contributes depreciable property with

an adjusted tax basis of $4,000 and a fair

market value of $10,000. The property is

depreciated using the straight-line method

with a 10-year recovery period and has 4

years remaining on its recovery period. M

contributes $10,000 in cash, which LM uses

to purchase land. Except for the depreciation

deductions, LM’s expenses equal its income

in each year of the 10 years commencing

with the year LM is formed. LM has a valid

section 754 election in effect.

(ii) Section 163(j) remedial items and

partner basis items. LM sells the asset

contributed by L in a fully taxable transaction

at a time when the adjusted basis of the

property is $4,000. Under § 1.163(j)–

6(e)(2)(ii), solely for purposes of § 1.163(j)–6,

the tax gain of $6,000 is allocated equally

between L and M ($3,000 each). To avoid

shifting built-in gain to the non-contributing

partner (M) in a manner consistent with the

rule in section 704(c), a remedial deduction

of $3,000 is allocated to M (leaving M with

no net tax gain), and remedial income of

$3,000 is allocated to L (leaving L with total

tax gain of $6,000).

(25) Example 25—(i) Facts. The facts are

the same as Example 24 in paragraph (o)(24)

of this section except the property

contributed by L had an adjusted tax basis of

zero. For each of the 10 years following the

contribution, there would be $500 of section

704(c) remedial income allocated to L and

$500 of remedial deductions allocated to M

with respect to the contributed asset. A buyer

of M’s units would step into M’s shoes with

respect to the $500 of annual remedial

deductions. A buyer of L’s units would step

into L’s shoes with respect to the $500 of

annual remedial income and would have an

annual section 743(b) deduction of $1,000

(net $500 of deductions).

(ii) Analysis. Pursuant to § 1.163(j)–

6(d)(2)(ii), solely for purposes of § 1.163(j)–6,

a buyer of L’s units immediately after

formation of LM would offset its $500 annual

section 704(c) remedial income allocation

with $500 of annual section 743(b)

adjustment (leaving the buyer with net $500

of section 743(b) deduction). As a result,

such buyer would be in the same position as

a buyer of M’s units. Each buyer would have

net deductions of $500 per year, which

would not affect ATI before 2022.

(26) Example 26—(i) Facts. X and Y are

partners in partnership PRS. In Year 1, PRS

had $200 of excess business interest expense.

Pursuant to § 1.163(j)–6(f)(2), PRS allocated

$100 of such excess business interest expense

to each of its partners. In Year 2, X lends

$10,000 to PRS and receives $1,000 of

interest income for the taxable year (self-

charged lending transaction). X is not in the

trade or business of lending money. The

$1,000 of interest expense resulting from this

loan is allocable to PRS’s trade or business

assets. As a result, such $1,000 of interest

expense is business interest expense of PRS.

X and Y are each allocated $500 of such

business interest expense as their distributive

share of PRS’s business interest expense for

the taxable year. Additionally, in Year 2, PRS

has $3,000 of ATI. PRS allocates the items

comprising its $3,000 of ATI $0 to X and

$3,000 to Y.

(ii) Partnership-level. In Year 2, PRS’s

section 163(j) limit is 30 percent of its ATI

plus its business interest income, or $900

($3,000 × 30 percent). Thus, PRS has $900 of

deductible business interest expense, $100 of

excess business interest expense, $0 of excess

taxable income, and $0 of excess business

interest income. Pursuant to § 1.163(j)–6(f)(2),

$400 of X’s allocation of business interest

expense is treated as deductible business

interest expense, $100 of X’s allocation of

business interest expense is treated as excess

business interest expense, and $500 of Y’s

allocation of business interest expense is

treated as deductible business interest

expense.

(iii) Lending partner. Pursuant to

§ 1.163(j)–6(n), X treats $100 of its $1,000 of

interest income as excess business interest

income allocated from PRS in Year 2.

Because X is deemed to have been allocated

$100 of excess business interest income from

PRS, and excess business interest expense

from a partnership is treated as paid or

accrued by a partner to the extent excess

business interest income is allocated from

such partnership to a partner, X treats its

$100 allocation of excess business interest

expense from PRS in Year 2 as business

interest expense paid or accrued in Year 2.

X, in computing its limit under section

163(j), has $100 of business interest income

($100 deemed allocation of excess business

interest income from PRS in Year 2) and $100

of business interest expense ($100 allocation

of excess business interest expense treated as

paid or accrued in Year 2). Thus, X’s $100

of business interest expense is deductible

business interest expense. At the end of Year

2, X has $100 of excess business interest

expense from PRS ($100 from Year 1). X

treats $900 of its $1,000 of interest income as

investment income for purposes of section

163(d).

(27) Example 27—(i) Formation. A, B, and

C formed partnership UTP in Year 1, each

contributing $1,000 cash in exchange for a

one third interest. Also in Year 1, UTP, D,

and E formed partnership LTP, each

contributing $1,200 cash in exchange for a

one third interest. LTP borrowed $9,000,

resulting in each of its partners increasing its

basis in LTP by $3,000. Further, the partners

of UTP each increased their bases in UTP by

$1,000 each as a result of the LTP borrowing.

(ii) Application of section 163(j) to LTP. In

Year 1, LTP’s only item of income, gain, loss,

or deduction was $900 of BIE. As a result,

LTP had $900 of excess business interest

expense. Pursuant to § 1.163(j)–6(f)(2), LTP

allocated $300 of excess business interest

expense to each of its partners.

(iii) Section 704(b) capital account

adjustments. Solely for purposes of section

704(b) and the regulations thereunder, each

direct and indirect partner of LTP treats its

allocation of excess business interest expense

from LTP as a section 705(a)(2)(B)

expenditure pursuant to § 1.163(j)–6(j)(2).

Further, each indirect partner of LTP that

reduced its section 704(b) capital account as

a result of the $300 allocation of excess

business interest expense to UTP is the

specified partner of such UTP EBIE, as

defined in § 1.163(j)–6(j)(5)(i)(B). Each

partner of UTP reduced its capital account by

$100 as a result of the $300 allocation of

excess business interest expense from LTP to

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UTP. As a result, A, B, and C are each a

specified partner with respect to $100 of UTP

EBIE.

(iv) Basis adjustments. Pursuant to

§ 1.163(j)–6(h)(2), D, E, and UTP each reduce

its basis in LTP by the amount of its

allocation of excess business interest expense

from LTP. As a result, each partner’s basis in

its LTP interest is $3,900. Pursuant to

§ 1.163(j)–6(j)(3), the direct partners of UTP

(A, B, and C) do not reduce the bases of their

interests in UTP as a result of the allocation

of excess business interest expense from LTP

to UTP. UTP treats its $300 allocation of

excess business interest expense from LTP as

UTP EBIE, as defined in § 1.163(j)–6(j)(4). At

the end of Year 1, the section 704(b) and tax

basis balance sheets of LTP and UTP are as

follows:

BILLING CODE 4830–01–P

(28) Example 28—(i) Facts. The facts are

the same as Example 27 in paragraph (o)(27)

of this section. In Year 2, while a section 754

election was in effect, C sold its UTP interest

to D for $900. In Year 3, LTP’s only item of

income, gain, loss, or deduction was $240 of

income, which it allocated to UTP. Such

$240 of income resulted in $240 of excess

taxable income, which LTP allocated to UTP

pursuant to § 1.163(j)–f(2). Further, in Year 3,

UTP’s only item of income, gain, loss, or

deduction was its $240 allocation of income

from LTP. UTP allocated such $240 of

income equally among its partners. In Year

4, UTP sold its interest in LTP to X for

$1,140.

(ii) Sale of specified partner’s UTP interest.

C’s section 741 loss recognized on the sale of

its partnership interest to D in Year 2 is $100

(amount realized of $900 cash, plus $1,000

relief of liabilities, less $2,000 basis in UTP).

D’s initial adjusted basis in the UTP interest

acquired from C in Year 2 is $1,900 (the cash

paid for C’s interest, $900, plus $1,000, D’s

share of UTP liabilities). D’s interest in UTP’s

previously taxed capital is $1,000 ($900, the

amount of cash D would receive if PRS

liquidated immediately after the hypothetical

transaction, decreased by $0, the amount of

tax gain allocated to D from the hypothetical

transaction, and increased by $100, the

amount of tax loss that would be allocated to

D from the hypothetical transaction). D’s

share of the adjusted basis to the partnership

of the partnership’s property is $2,000

($1,000 share of previously taxed capital,

plus $1,000 share of the partnership’s

liabilities). Therefore, the amount of the basis

adjustment under section 743(b) to

partnership property is negative $100 (the

difference between $1,900 and $2,000). D’s

negative $100 section 743(b) adjustment is

allocated among UTP’s assets under section

755. Under § 1.755–1(b)(2), the amount of D’s

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section 743(b) adjustment allocated to

ordinary income property is equal to the total

amount of income or loss that would be

allocated to D from the sale of all ordinary

income property in a hypothetical

transaction. Solely for purposes of § 1.755–

1(b), any UTP EBIE is treated as ordinary

income property. Thus, D’s negative $100

section 743(b) basis adjustment is allocated

to UTP EBIE.

(iii) Application of section 163(j) to UTP.

In Year 3, UTP was allocated excess taxable

income from LTP. Thus, UTP applies the

rules in § 1.163(j)–6(j)(5)(i). First, pursuant to

§ 1.163(j)–6(j)(5)(i)(A), UTP applies the rules

in § 1.163(j)–6(g) to its UTP EBIE. Because

UTP was allocated $240 of excess taxable

income from LTP in Year 3, UTP treats $240

of its UTP EBIE as business interest expense

paid or accrued in Year 3. Specifically, UTP

treats $80 of each partner’s share of UTP

EBIE as business interest expense paid or

accrued. Under these circumstances, UTP’s

method for determining which UTP EBIE is

treated as business interest expense paid or

accrued is reasonable. Second, pursuant to

§ 1.163(j)–6(j)(5)(i)(B), UTP allocates such

business interest expense that was formerly

UTP EBIE to its specified partner.

Accordingly, A and B are each allocated $80

of business interest expense. Pursuant to

§ 1.163(j)–6(j)(6)(i), D is treated as the

specified partner with respect to $100 of UTP

EBIE (C’s share of UTP EBIE prior to the

sale). Further, pursuant to § 1.163(j)–

6(j)(5)(i)(A), $80 of the UTP EBIE to which D

is the specified partner was treated as

business interest expense paid or accrued.

Accordingly, D is allocated such $80 of

business interest expense. After determining

each partner’s allocable share of section

163(j) items used in its own section 163(j)

calculation, UTP determines each partner’s

allocable share of excess items pursuant to

§ 1.163(j)–6(f)(2).

T

ABLE

62

TO

P

ARAGRAPH

(o)(28)(iii)—UTP’

S

A

PPLICATION OF

§ 1.163(j)–6(f)(2)(

II

)

IN

Y

EAR

3

A B D Total

Allocable ATI .................................................................................................... $80 $80 $80 $240

Allocable BII ..................................................................................................... 0 0 0 0

Allocable BIE ................................................................................................... 80 80 80 240

T

ABLE

63

TO

P

ARAGRAPH

(o)(28)(iii)—UTP’

S

A

PPLICATION OF

§ 1.163(j)–6(f)(2)(xi)

IN

Y

EAR

3

A B D Total

Deductible BIE ................................................................................................. $24 $24 $24 $72

EBIE allocated ................................................................................................. 56 56 56 168

ETI allocated .................................................................................................... 0 0 0 0

EBII allocated ................................................................................................... 0 0 0 0

(iv) Treatment of business interest expense

that was formerly UTP EBIE. After

determining each partner’s share of

deductible business interest expense and

section 163(j) excess items, UTP takes into

account any basis adjustments under section

734(b) and the partners take into account any

basis adjustments under section 743(b) to

business interest expense that was formerly

UTP EBIE pursuant to § 1.163(j)–6(j)(5)(i)(C).

None of the UTP EBIE treated as business

interest expense paid or accrued in Year 3

was allocated a section 734(b) adjustment.

Additionally, neither A’s nor B’s share of

business interest expense that was formerly

UTP EBIE was allocated a section 743(b)

basis adjustment. Further, neither A nor B is

a transferee specified partner, as defined in

§ 1.163(j)–6(j)(8)(i). Therefore, no special

adjustments are required to A’s or B’s $24 of

deductible business interest expense and $56

of excess business interest expense. At the

end of Year 3, A and B each has an adjusted

basis in UTP of $2,000 and each is the

specified partner with respect to $20 of UTP

EBIE. D’s share of business interest expense

that was formerly UTP EBIE was allocated a

negative $80 section 743(b) adjustment.

Pursuant to § 1.163(j)–6(j)(7)(ii), D recovers

$24 of the negative section 743(b)

adjustment, effectively eliminating the $24

deduction resulting from its $24 allocation of

deductible business interest expense.

Additionally, pursuant to § 1.163(j)–

6(j)(7)(iii), the $56 basis decrease required

under § 1.163(j)–6(h)(2) for D’s allocation of

excess business interest expense is reduced

by the negative section 743(b) adjustment

attributable to such excess business interest

expense ($56). Consequently, D does not

reduce the basis of its interest in UTP

pursuant § 1.163(j)–6(h)(2) upon being

allocated such excess business interest

expense. As a result, D has $56 of excess

business interest expense with a basis of $0.

At the end of Year 3, D has an adjusted basis

in UTP of $1,980 and is the specified partner

with respect to $20 of UTP EBIE.

(v) Application of anti-loss trafficking

rules. Although D is a transferee

specified partner, as defined in

§ 1.163(j)–6(j)(8)(i), with respect to its

$80 allocation of business interest

expense from UTP, no special basis

adjustments under § 1.163(j)–6(j)(8)(i)

are required because all $80 of such

business interest expense was already

fully offset by negative section 743(b)

adjustment. However, if such $80 of

business interest expense was not fully

offset by a negative section 743(b)

adjustment, D’s status as transferee

specified partner would cause such

business interest expense to be fully

offset by a negative section 743(b)

adjustment pursuant to § 1.163(j)–

6(j)(8)(i), regardless of whether a section

754 election was not in effect with

respect to the sale of UTP from C to D.

Such negative section 743(b) adjustment

would be taken into account in the

manner described in § 1.163(j)–6(j)(7).

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BILLING CODE 4830–01–C

(vi) Sale of LTP interest. In Year 4, UTP

disposed of its interest in LTP. Thus, UTP

applies the rules in § 1.163(j)–6(j)(5)(ii). First,

pursuant to § 1.163(j)–6(j)(5)(ii)(A), UTP

applies the rules in § 1.163(j)–6(h)(3) to its

UTP EBIE. Because UTP disposed of all of its

LTP interest, UTP reduces its UTP EBIE by

$60. Second, pursuant to § 1.163(j)–

6(j)(5)(ii)(B), UTP increases the adjusted basis

of its LTP interest by $60 (the total amount

of UTP EBIE that was reduced pursuant to

§ 1.163(j)–6(j)(5)(ii)(A)). Third, pursuant to

§ 1.163(j)–6(j)(5)(ii)(C), this $60 increase is

reduced by $20 to take into account the

negative $20 section 743(b) adjustment

allocated in Year 2 to the $20 of UTP EBIE

reduced pursuant to § 1.163(j)–6(j)(5)(ii)(A).

As a result, UTP’s adjusted basis in its LTP

interest immediately prior to the sale to X is

$4,180 ($3,900 at the end of Year 1, plus $240

allocation of income from LTP in Year 3, plus

$40 increase immediately prior to the sale

attributable to the basis of UTP EBIE). UTP’s

section 741 loss recognized on the sale is $40

(amount realized of $1,140 cash, plus $3,000

relief of liabilities, less $4,180 adjusted basis

in LTP). No deduction under section 163(j)

is allowed to the UTP or X under chapter 1

of subtitle A of the Code for any of such UTP

EBIE reduced under § 1.163(j)–6(h)(3).

Pursuant to § 1.163(j)–6(h)(5), LTP has a

§ 1.163(j)–6(h)(5) basis adjustment of $40.

LTP does not own property of the character

required to be adjusted. Thus, under § 1.755–

1(c)(4), the adjustment is made when LTP

subsequently acquires capital gain property

to which an adjustment can be made.

Regardless of whether a $20 negative section

743(b) adjustment was allocated to the $20 of

UTP EBIE reduced pursuant to § 1.163(j)–

6(j)(5)(ii)(A), UTP would only increase its

basis in LTP pursuant to § 1.163(j)–6(j)(5)(ii)

by $40. The specified partner of such $20 of

UTP EBIE is a transferee specified partner.

Therefore, it is treated as disallowed UTP

EBIE under § 1.163(j)–6(j)(8)(iii) of this

section. As a result, UTP would treat such

$20 of UTP EBIE for purposes of § 1.163(j)–

6(j)(5)(ii) as though it were allocated a

negative section 734(b) adjustment of $20.

(29) Example 29—(i) Facts. The facts are

the same as Example 27 in paragraph (o)(27)

of this section. In Year 2, while a section 754

election was in effect, UTP distributed $900

to C in complete liquidation of C’s

partnership interest. In Year 3, LTP’s only

item of income, gain, loss, or deduction was

$240 of income, which it allocated to UTP.

Such $240 of income resulted in $240 of

excess taxable income, which LTP allocated

to UTP pursuant to § 1.163(j)–f(2). Further, in

Year 3, UTP’s only item of income, gain, loss,

or deduction was its $240 allocation of

income from LTP. UTP allocated such $240

of income equally among its partners. In Year

4, UTP sold its interest in LTP to X for

$1,140.

(ii) Liquidating distribution to specified

partner. C’s section 731(a)(2) loss recognized

on the disposition of its partnership interest

is $100 ($2,000 basis in UTP, less amount

realized of $900 cash, plus $1,000 relief of

liabilities). Because the election under

section 754 is in effect, UTP has a section

734(b) decrease to the basis of its assets of

$100 (the amount of section 731(a)(2) loss

recognized by C). Under section 755, the

entire negative $100 section 734(b)

adjustment is allocated to UTP EBIE.

Following the liquidation of C, UTP’s basis

in its assets ($900 of cash, plus $3,900

interest in LTP, plus $200 basis of UTP EBIE)

equals the aggregate outside basis of partners

A and B ($5,000).

(iii) Application of section 163(j) to UTP.

In Year 3, UTP was allocated excess taxable

income from LTP. Thus, UTP applies the

rules in § 1.163(j)–6(j)(5)(i). First, pursuant to

§ 1.163(j)–6(j)(5)(i)(A), UTP applies the rules

in § 1.163(j)–6(g) to its UTP EBIE. Because

UTP was allocated $240 of excess taxable

income from LTP in Year 3, UTP treats $240

of its UTP EBIE as business interest expense

paid or accrued in Year 3. Specifically, UTP

treats $100 of A’s share, $100 of B’s share,

and $40 of the UTP EBIE that does not have

a specified partner as business interest

expense paid or accrued. Under these

circumstances, UTP’s method for

determining which UTP EBIE is treated as

business interest expense paid or accrued is

reasonable. Second, pursuant to § 1.163(j)–

6(j)(5)(i)(B), UTP allocates such business

interest expense that was formerly UTP EBIE

to its specified partner. Accordingly, each of

A and B is allocated $100 of business interest

expense.

(iv) Application of anti–loss trafficking

rules. Following the liquidating distribution

to C in Year 2 (a transaction described in

§ 1.163(j)–6(j)(6)(ii)(A)), the $100 of UTP

EBIE to which C was formerly the specified

partner does not have a specified partner.

Thus, UTP does not allocate any deductible

business interest expense or excess business

interest expense that was formerly C’s share

of UTP EBIE to A or B. Rather, pursuant to

§ 1.163(j)–6(j)(8)(ii), UTP treats such business

interest expense as the allocable business

interest expense, as defined in § 1.163(j)–

6(f)(2)(ii), of a § 1.163(j)–6(j)(8)(ii) account for

purposes of applying § 1.163(j)–6(f)(2). After

determining each partner’s allocable share of

section 163(j) items used in its own section

163(j) calculation, UTP determines each

partner’s allocable share of excess items

pursuant to § 1.163(j)–6(f)(2).

T

ABLE

65

TO

P

ARAGRAPH

(o)(29)(iv)—UTP’

S

A

PPLICATION OF

§ 1.163(j)–6(f)(2)(ii)

IN

Y

EAR

3

A B

§ 1.163(j)–

6(j)(8)(ii)

account Total

Allocable ATI .................................................................................................... $120 $120 $0 $240

Allocable BII ..................................................................................................... 0 0 0 0

Allocable BIE ................................................................................................... 100 100 40 240

T

ABLE

65

TO

P

ARAGRAPH

(o)(29)(iv)—UTP’

S

A

PPLICATION OF

§ 1.163(j)–6(f)(2)(xi)

IN

Y

EAR

3

A B

§ 1.163(j)–

6(j)(8)(ii)

account Total

Deductible BIE ................................................................................................. $36 $36 $0 $72

EBIE allocated ................................................................................................. 64 64 40 168

ETI allocated .................................................................................................... 0 0 0 0

EBII allocated ................................................................................................... 0 0 0 0

(v) Treatment of business interest expense

that was formerly UTP EBIE. After

determining each partner’s share of

deductible business interest expense and

section 163(j) excess items, UTP takes into

account any basis adjustments under section

734(b) and the partners take into account any

basis under section 743(b) to business

interest expense that was formerly UTP EBIE

pursuant to § 1.163(j)–6(j)(5)(i)(C). None of

the UTP EBIE treated as business interest

expense paid or accrued in Year 3 was

allocated a section 743(b) adjustment.

Further, neither A nor B is a transferee

specified partner, as defined in § 1.163(j)–

6(j)(8)(i). Therefore, no special basis

adjustments are required under § 1.163(j)–

6(j)(8)(i). The $40 of excess business interest

expense allocated to the § 1.163(j)–6(j)(8)(ii)

account is not allocated to A or B and is not

carried over by UTP. Additionally, UTP does

not have a § 1.163(j)–6(h)(5) basis adjustment

because such $40 of business interest

expense does not have any basis. Thus, A

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and B each has $36 of deductible business

interest expense and $64 of excess business

interest expense. At the end of Year 3, A and

B each has an adjusted basis in UTP of

$2,520 ($2,500 outside basis, plus $120

allocation of income, less $36 of deductible

business interest expense, less $64 of excess

business interest expense), and neither A nor

B is a specified partner with respect to any

of UTP’s $60 of UTP EBIE.

T

ABLE

66

TO

P

ARAGRAPH

(o)(29)(v)—UTP EBIE—E

ND OF

Y

EAR

3

Specified partner Partnership

Basis Carryforward Basis Carryforward

A ....................................................... $0 $0 UTP .................................................. $0 $60

B ....................................................... 0 0 ........................ ........................

§ 1.163(j)–6(j)(8)(ii) account ............. 0 60 ........................ ........................

Total .......................................... 0 60 Total .......................................... 0 60

(vi) Sale of LTP interest. In Year 4, UTP

disposed of its interest in LTP. Thus, UTP

applies the rules in § 1.163(j)–6(j)(5)(ii). First,

pursuant to § 1.163(j)–6(j)(5)(ii)(A), UTP

applies the rules in § 1.163(j)–6(h)(3) to its

UTP EBIE. Because UTP disposed of all of its

LTP interest, UTP reduces its UTP EBIE by

$60. Second, pursuant to § 1.163(j)–

6(j)(5)(ii)(B), UTP increases the adjusted basis

of its LTP interest by $60 (the total amount

of UTP EBIE that was reduced pursuant to

§ 1.163(j)–6(j)(5)(ii)(A)). Third, pursuant to

§ 1.163(j)–6(j)(5)(ii)(C), this $60 increase is

reduced by $60 to take into account the

negative $60 section 734(b) adjustment

allocated in Year 2 to the $60 of UTP EBIE

reduced pursuant to § 1.163(j)–6(j)(5)(ii)(A).

As a result, UTP’s adjusted basis in its LTP

interest immediately prior to the sale to X is

$4,140 ($3,900 at the end of Year 1, plus $240

allocation of income from LTP in Year 3).

UTP has no section 741 gain or loss

recognized on the sale (amount realized of

$1,140 cash, plus $3,000 relief of liabilities,

equals $4,140 adjusted basis in LTP). No

deduction under section 163(j) is allowed to

the UTP or X under chapter 1 of subtitle A

of the Code for any of such UTP EBIE

reduced under § 1.163(j)–6(h)(3). Regardless

of whether the $60 of UTP EBIE’s basis was

reduced by a $60 negative section 734(b)

adjustment, UTP would not increase its basis

in LTP pursuant to § 1.163(j)–6(j)(5)(ii) of this

section as a result of the sale to X. The $60

of UTP EBIE does not have a specified

partner. Therefore, it is treated as disallowed

UTP EBIE under § 1.163(j)–6(j)(8)(iii) of this

section. As a result, UTP would treat such

$60 of UTP EBIE for purposes of § 1.163(j)–

6(j)(5)(ii) as though it were allocated a

negative section 734(b) adjustment of $60.

(30) Example 30—(i) X, Y and Z are

partners in partnership PRS, PRS and A are

partners in UTP, and UTP is a partner in

LTP. LTP allocates $15 of excess business

interest expense to UTP. Pursuant to

§ 1.163(j)–6(j)(2), UTP reduces its section

704(b) capital account (capital account) in

LTP by $15, A reduces its capital account in

UTP by $5, PRS reduces its capital account

in UTP by $10, X reduces its capital account

in PRS by $4, and Y reduces its capital

account in PRS by $6. Thus, A, PRS, X, and

Y are the specified partner with respect to $5,

$10, $4, and $6 of UTP EBIE, respectively.

(ii) Assume the same facts in (i) except that

PRS distributed cash to Y in complete

liquidation of Y’s interest in PRS. As a result,

pursuant to § 1.163(j)–6(j)(6)(ii)(A), Y’s share

of UTP EBIE would not have a specified

partner. In a subsequent year, if LTP

allocated UTP $15 of excess business interest

income, UTP would apply the rules in

§ 1.163(j)–6(j)(5)(i) and allocate $5 of

deductible business interest expense to A

and $10 of deductible business interest

expense to PRS (the specified partners of

such deductible business interest expense).

Because the $10 of deductible business

interest expense allocated to PRS was

formerly UTP EBIE, PRS must also apply the

rules in § 1.163(j)–6(j)(5)(i). PRS would

allocate $4 of such deductible business

interest expense to X (the specified partner

of such $4). However, as a result of the

liquidating distribution to Y, the remaining

$6 of deductible business interest expense

does not have a specified partner. Thus,

pursuant to § 1.163(j)–6(j)(8)(ii), PRS would

make a § 1.163(j)–6(h)(5) basis adjustment to

its property in the amount of the adjusted

basis (if any) of such $6 of deductible

business interest expense.

(iii) Assume the same facts as in (i) except

that PRS distributed its interest in UTP to Y

in complete liquidation of Y’s interest in

PRS. Pursuant to § 1.163(j)–6(j)(6)(ii)(A), Y is

the specified partner with respect to UTP

EBIE of UTP only to the same extent it was

prior to the distribution ($6). As a result, the

UTP EBIE of UTP in excess of the UTP EBIE

for which Y is the specified partner (X’s $4)

does not have a specified partner. If in a

subsequent year LTP allocated UTP $15 of

excess business interest income, UTP would

apply the rules in § 1.163(j)–6(j)(5)(i) and

allocate $5 of deductible business interest

expense to A and $6 of deductible business

interest expense to Y. Regarding the $4 of

DBIE without a specified partner, UTP would

apply the rules in § 1.163(j)–6(j)(8)(ii) and

make a § 1.163(j)–6(h)(5) basis adjustment to

its property in the amount of the adjusted

basis (if any) of such $4 of deductible

business interest expense.

(iv) Assume the same facts as in (i) except

that A contributes its UTP interest to a new

partnership, PRS2. Following the

contribution, PRS2 is treated as the specified

partner with respect to the portion of the

UTP EBIE attributable to the contributed

interest ($5). Further, A continues to be the

specified partner with respect to the UTP

EBIE attributable to the contributed interest

($5). If in a subsequent year LTP allocated

UTP $15 of excess business interest income,

UTP would apply the rules in § 1.163(j)–

6(j)(5)(i) and allocate $5 of deductible

business interest expense to PRS2, and PRS2

would allocate such $5 of deductible

business interest expense to A.

(31) Example 31—(i) Facts. In Year 1, A,

B, and C formed partnership PRS by each

contributing $1,000 cash. PRS borrowed

$900, causing each partner’s basis in PRS to

increase by $300 under section 752. Also in

Year 1, PRS purchased Capital Asset X for

$200. In Year 2, PRS pays $300 of business

interest expense, all of which is disallowed

and treated as excess business interest

expense. PRS allocated the $300 of excess

business interest expense to its partners,

$100 each. Pursuant to § 1.163(j)–6(h)(2),

each partner reduced its adjusted basis in its

PRS interest by its $100 allocation of excess

business interest expense to $1,200. In Year

3, when the fair market value of Capital Asset

X is $3,200 and no partner’s basis in PRS has

changed, PRS distributed $1,900 to C in

complete liquidation of C’s partnership

interest in a distribution to which section 737

does not apply. PRS had a section 754

election in effect in Year 3.

(ii) Consequences to selling partner.

Pursuant to § 1.163(j)–6(h)(3), C increases the

adjusted basis of its interest in PRS by $100

immediately before the disposition. Thus, C’s

section 731(a)(1) gain recognized on the

disposition of its interest in PRS is $900

(($1,900 cash + $300 relief of liabilities) ¥

($1,200 outside basis + $100 excess business

interest expense add-back)).

(iii) Partnership basis. Pursuant to

§ 1.163(j)–6(h)(5), PRS has a $100 increase to

the basis of its assets attributable to a

§ 1.163(j)–6(h)(5) basis increase immediately

before C’s disposition. Under section 755, the

entire $100 adjustment is allocated to Capital

Asset X. Pursuant to § 1.163(j)–6(h)(5),

regardless of whether Capital Asset X is a

depreciable or amortizable asset, none of the

$100 of § 1.163(j)–6(h)(5) basis increase

allocated to Capital Asset X is depreciable or

amortizable. Additionally, PRS has a section

734(b) increase to the basis of its assets of

$900 (the amount of section 731(a)(1) gain

recognized by C). Under section 755, the

entire $900 adjustment is allocated to Capital

Asset X. As a result, PRS’s basis in Capital

Asset X is $1,200 ($200 + $100 § 1.163(j)–

6(h)(5) basis increase + $900 section 734(b)

adjustment). Following the liquidation of C,

PRS’s basis in its assets ($600 cash + $1,200

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Capital Asset X) equals the aggregate adjusted

basis of partners A and B in PRS ($1,800).

(32) Example 32—(i) Facts. X and Y are

equal partners in partnership UTP, which is

a partner in partnership LTP. In Year 1, LTP

allocated $100 of income to UTP. LTP, in

computing its limit under section 163(j),

treated such $100 of income as ATI.

Accordingly, in LTP’s § 1.163(j)–6(f)(2)(ii)

calculation, UTP’s allocable ATI was $100.

Additionally, pursuant to § 1.163(j)–6(f)(2),

LTP allocated $50 of excess taxable income

to UTP. UTP’s only items of income, gain,

loss or deduction in Year 1, other than the

$100 allocation from LTP, were $100 of trade

or business income and $30 of business

interest expense. UTP allocated its $200 of

income and gain items $100 to X and $100

to Y, and all $30 of its business interest

expense to X.

(ii) Partnership-level. Pursuant to

§ 1.163(j)–6(e)(1), UTP, in computing its limit

under section 163(j), does not increase or

decrease any of its section 163(j) items by any

of LTP’s section 163(j) items. Pursuant to

§ 1.163(j)–1(b)(1), UTP determines it has $150

of ATI in Year 1 ($100 of ATI resulting from

its $100 of trade or business income, plus $50

of excess taxable income from LTP). UTP’s

section 163(j) limit is 30 percent of its ATI,

or $45 ($150 × 30 percent). Thus, UTP has

$50 of excess taxable income and $30 of

deductible business interest expense.

(iii) Partner-level allocations. UTP

allocates its $50 of excess taxable income and

$30 of deductible business interest expense

to X and Y pursuant to § 1.163(j)–6(f)(2). To

determine each partner’s share of the $50 of

excess taxable income, UTP must determine

each partner’s allocable ATI and allocable

business interest expense (as defined in

§ 1.163(j)–6(f)(2)(ii)). X’s allocable business

interest expense is $30 and Y’s allocable

business interest expense is $0. Because UTP

is an upper-tier partnership, UTP determines

the allocable ATI of each of its partners in

the manner provided in § 1.163(j)–6(j)(9).

Specifically, because UTP’s net amount of tax

items that comprise (or have ever comprised)

ATI is $200 ($100 of trade or business

income that UTP treated as ATI, plus UTP’s

$100 allocation from LTP of items that

comprised ATI to LTP), which is greater than

its $150 of ATI, UTP must apply the rules in

§ 1.163(j)–6(j)(9)(ii)(A) to determine each of

its partner’s allocable ATI. UTP determines

X’s allocable ATI is $75 (X’s $100

distributive share of gross income and gain

items that comprise (or have ever comprised)

ATI, multiplied by ($150/$200), the ratio of

UTP’s ATI to its tax items that comprise (or

have ever comprised) ATI). In a similar

manner, UTP determines Y’s allocable ATI

also equals $75. Therefore, pursuant to

§ 1.163(j)–6(f)(2), X is allocated $30 of

deductible business interest expense and Y is

allocated $50 of excess taxable income.

(33) Example 33—(i) Facts. X and Y are

equal partners in partnership UTP, which is

a partner in partnership LTP. Further, X and

Y share the residual profits of UTP equally.

In Year 1, LTP allocated ($99) of income to

UTP. LTP, in computing its limit under

section 163(j), treated such ($99) of income

as ATI. Accordingly, in LTP’s § 1.163(j)–

6(f)(2)(ii) calculation, UTP’s allocable ATI

was ($99). UTP’s only items of income, gain,

loss or deduction in Year 1, other than the

($99) allocation from LTP, were $100 of trade

or business income and $15 of business

interest expense. UTP allocated $1 of income

to X and $0 to Y pursuant to section 704(c),

the ($99) of loss and remaining $99 of income

equally pursuant to section 704(b), and all

$15 of its business interest expense to X.

(ii) Partnership-level. Pursuant to

§ 1.163(j)–6(e)(1), UTP, in computing its limit

under section 163(j), does not increase or

decrease any of its section 163(j) items by any

of LTP’s section 163(j) items. Pursuant to

§ 1.163(j)–1(b)(1), UTP determines it has $100

of ATI in Year 1 ($100 of ATI resulting from

its $100 of trade or business income). UTP’s

section 163(j) limit is 30 percent of its ATI,

or $30 ($100 × 30 percent). Thus, UTP has

$50 of excess taxable income and $15 of

deductible business interest expense.

(iii) Partner-level allocations. UTP

allocates its $50 of excess taxable income and

$15 of deductible business interest expense

to X and Y pursuant to § 1.163(j)–6(f)(2). To

determine each partner’s share of the $50 of

excess taxable income, UTP must determine

each partner’s allocable ATI and allocable

business interest expense (as defined in

§ 1.163(j)–6(f)(2)(ii)). X’s allocable business

interest expense is $15 and Y’s allocable

business interest expense is $0. Because UTP

is an upper-tier partnership, UTP determines

the allocable ATI of each of its partners in

the manner provided in § 1.163(j)–6(j)(9).

Specifically, because UTP’s net amount of tax

items that comprise (or have ever comprised)

ATI is $1 ($100 of trade or business income

that UTP treated as ATI, plus UTP’s ($99)

allocation from LTP of items that comprised

ATI to LTP), which is less than its $100 of

ATI, UTP must apply the rules in § 1.163(j)–

6(j)(9)(ii)(B) to determine each of its partner’s

allocable ATI. UTP determines X’s allocable

ATI is $50.50 ($1, which is the excess of X’s

distributive share of gross income and gain

items that comprise (or have ever comprised)

ATI, $100, over X’s distributive share of gross

loss and deduction items that comprise (or

have ever comprised) ATI, $99; increased by

$49.50, which is the product of 50 percent,

X’s residual profit sharing percentage, and

$99, UTP’s $100 of ATI minus $1, which is

the aggregate of all the partners’ amounts

determined under § 1.163(j)–6(j)(9)(ii)(B)(1)).

In a similar manner, UTP determines Y’s

allocable ATI is $49.50. Therefore, pursuant

to § 1.163(j)–6(f)(2), X is allocated $15 of

deductible business interest expense and

$0.50 of excess taxable income, and Y is

allocated $49.50 of excess taxable income.

(34) Example 34—(i) Facts. X and Y are

equal partners in partnership PRS. Further, X

and Y share the profits of PRS equally. In

2019, PRS had ATI of $100. In 2020, PRS’s

only items of income, gain, loss or deduction

was $1 of trade or business income, which

it allocated to X pursuant to section 704(c).

(ii) Partnership-level. In 2020, PRS makes

the election described in § 1.163(j)–6(d)(5) to

use its 2019 ATI in 2020. As a result, PRS

has $100 of ATI in 2020. PRS does not have

any business interest expense. Therefore,

PRS has $100 of excess taxable income in

2020.

(iii) Partner-level allocations. PRS allocates

its $100 of excess taxable income to X and

Y pursuant to § 1.163(j)–6(f)(2). To determine

each partner’s share of the $100 of excess

taxable income, PRS must determine each

partner’s allocable ATI (as defined in

§ 1.163(j)–6(f)(2)(ii)). Because PRS made the

election described in § 1.163(j)–6(d)(5), PRS

must determine the allocable ATI of each of

its partners pursuant to paragraph (j)(9) of

this section in the same manner as an upper-

tier partnership. Specifically, because PRS’s

amount of tax items that comprise ATI before

the election is $1, which is less than its $100

of ATI following the election, PRS must

apply the rules in § 1.163(j)–6(j)(9)(ii)(B) to

determine each of its partner’s allocable ATI.

PRS determines X’s allocable ATI is $50.50

($1, which is the excess of X’s distributive

share of gross income and gain items that

would have comprised ATI had PRS not

made the election, $1, over X’s distributive

share of gross loss and deduction items that

would have comprised ATI had PRS not

made the election, $0; increased by $49.50,

which is the product of 50%, X’s residual

profit share, and $99, PRS’s $100 of ATI

minus $1, the aggregate of all the partners’

amounts determined under § 1.163(j)–

6(j)(9)(ii)(B)(1)). In a similar manner, PRS

determines Y’s allocable ATI is $49.50.

Therefore, pursuant to § 1.163(j)–6(f)(2), X is

allocated $50.50 of excess taxable income,

and Y is allocated $49.50 of excess taxable

income.

(35) Example 35—(i) Facts. X, a partner in

partnership PRS, was allocated $20 of excess

business interest expense from PRS in 2018

and $10 of excess business interest expense

from PRS in 2019. In 2020, PRS allocated $16

of excess taxable income to X.

(ii) Analysis. X treats 50 percent of its $10

of excess business interest expense allocated

from PRS in 2019 as § 1.163(j)–6(g)(4)

business interest expense. Thus, $5 of

§ 1.163(j)–6(g)(4) business interest expense is

treated as paid or accrued by X in 2020 and

is not subject to the section 163(j) limitation

at X’s level. Because X was allocated $16 of

excess taxable income from PRS in 2020, X

treats $16 of its $25 of excess business

interest expense as business interest expense

paid or accrued pursuant to § 1.163(j)–6(g)(2).

X, in computing its limit under section 163(j)

in 2020, has $16 of ATI (as a result of its

allocation of $16 of excess taxable income

from PRS), $0 of business interest income,

and $16 of business interest expense ($16 of

excess business interest expense treated as

paid or accrued in 2020). Pursuant to

§ 1.163(j)–2(b)(2)(i), X’s section 163(j) limit in

2020 is $8 ($16 × 50 percent). Thus, X has

$8 of business interest expense that is

deductible under section 163(j). The $8 of X’s

business interest expense not allowed as a

deduction ($16 business interest expense

subject to section 163(j), less $8 section 163(j)

limit) is treated as business interest expense

paid or accrued by X in 2021. At the end of

2020, X has $9 of excess business interest

expense from PRS ($20 from 2018, plus $10

from 2019, less $5 treated as paid or accrued

pursuant to § 1.163(j)–6(g)(4), less $16 treated

as paid or accrued pursuant to § 1.163(j)–

6(g)(2)).

(36) Example 36—(i) Facts. X is a partner

in partnership PRS. At the beginning of 2018,

X’s outside basis in PRS was $100. X was

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allocated $20 of excess business interest

expense from PRS in 2018 and $10 of excess

business interest expense from PRS in 2019.

X sold its PRS interest in 2019 for $70.

(ii) Analysis. X treats 50 percent of its $10

of excess business interest expense allocated

from PRS in 2019 as § 1.163(j)–6(g)(4)

business interest expense. Thus, $5 of

§ 1.163(j)–6(g)(4) business interest expense is

treated as paid or accrued by X in 2020 and

is not subject to the section 163(j) limitation

at X’s level. Pursuant to paragraph (h)(3) of

this section, immediately before the

disposition, X increases the basis of its PRS

interest to $95. Thus, X has a $25 section 741

loss recognized on the sale ($70–$95).

(p) Applicability dates—(1) In general.

***

(2) Paragraphs (c)(1) and (2), (d)(3)

through (5), (e)(5) and (6), (f)(1)(iii),

(g)(4), (h)(4) and (5), (j), (l)(4)(iv), (n),

and (o)(24) through (29). Paragraphs

(c)(1) and (2), (d)(3) through (5), (e)(5)

and (6), (f)(1)(iii), (g)(4), (h)(4) and (5),

(j), (l)(4)(iv), (n), and (o)(24) through (29)

of this section apply to taxable years

beginning on or after [DATE 60 DAYS

AFTER DATE OF PUBLICATION OF

THE FINAL RULE IN THE FEDERAL

REGISTER]. However, taxpayers and

their related parties, within the meaning

of sections 267(b) and 707(b)(1), may

choose to apply the rules of those

paragraphs to a taxable year beginning

after December 31, 2017, and before

[DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER],

provided that they also apply the

provisions of § 1.163(j)–6 in the section

163(j) regulations, and consistently

apply all of the rules of § 1.163(j)–6 in

the section 163(j) regulations to that

taxable year and to each subsequent

taxable year.

* * * * *

■Par. 8. As added in a final rule

elsewhere in this issue of the Federal

Register, effective November 13, 2020,

§ 1.163(j)–7 is amended by revising

paragraph (a), adding paragraphs (c)

through (f), (g)(3) and (4), (h), and (j)

through (l), and revising paragraph (m)

to read as follows:

§ 1.163(j)–7 Application of the section

163(j) limitation to foreign corporations and

United States shareholders.

(a) Overview. This section provides

rules for the application of section 163(j)

to relevant foreign corporations and

United States shareholders of relevant

foreign corporations. Paragraph (b) of

this section provides the general rule

regarding the application of section

163(j) to a relevant foreign corporation.

Paragraph (c) of this section provides

rules for applying section 163(j) to CFC

group members of a CFC group.

Paragraph (d) of this section provides

rules for determining a specified group

and specified group members.

Paragraph (e) of this section provides

rules and procedures for treating a

specified group member as a CFC group

member and for determining a CFC

group. Paragraph (f) of this section

provides rules regarding the treatment

of a CFC group member that has ECI.

Paragraph (g) of this section provides

rules concerning the computation of

ATI of an applicable CFC. Paragraph (h)

of this section provides a safe-harbor

that exempts certain stand-alone

applicable CFCs and CFC groups from

the application of section 163(j) for a

taxable year. Paragraph (i) of this section

is reserved. Paragraph (j) of this section

provides rules concerning the

computation of ATI of a United States

shareholder of an applicable CFC.

Paragraph (k) of this section provides

definitions that apply for purposes of

this section. Paragraph (l) of this section

provides examples illustrating the

application of this section.

* * * * *

(c) Application of section 163(j) to

CFC group members of a CFC group—

(1) Scope. This paragraph (c) provides

rules for applying section 163(j) to a

CFC group member. Paragraph (c)(2) of

this section provides rules for

computing a single section 163(j)

limitation for a specified period of a

CFC group. Paragraph (c)(3) of this

section provides rules for allocating a

CFC group’s section 163(j) limitation to

CFC group members for specified

taxable years. Paragraph (c)(4) of this

section provides currency translation

rules. Paragraph (c)(5) of this section

provides special rules for specified

periods beginning in 2019 or 2020.

(2) Calculation of section 163(j)

limitation for a CFC group for a

specified period—(i) In general. A single

section 163(j) limitation is computed for

a specified period of a CFC group. For

purposes of applying section 163(j) and

the section 163(j) regulations, the

current-year business interest expense,

disallowed business interest expense

carryforwards, business interest income,

floor plan financing interest expense,

and ATI of a CFC group for a specified

period equal the sums of each CFC

group member’s respective amounts for

its specified taxable year with respect to

the specified period. A CFC group

member’s current-year business interest

expense, business interest income, floor

plan financing interest expense, and

ATI for a specified taxable year are

generally determined on a separate-

company basis.

(ii) Certain transactions between CFC

group members disregarded. Any

transaction between CFC group

members of a CFC group that is entered

into with a principal purpose of

affecting a CFC group or a CFC group

member’s section 163(j) limitation by

increasing or decreasing a CFC group or

a CFC group member’s ATI for a

specified taxable year is disregarded for

purposes of applying section 163(j) and

the section 163(j) regulations.

(iii) CFC group treated as a single C

corporation for purposes of allocating

items to an excepted trade or business.

For purposes of allocating items to an

excepted trade or business under

§ 1.163(j)–10, all CFC group members of

a CFC group are treated as a single C

corporation.

(iv) CFC group treated as a single

taxpayer for purposes of determining

interest. For purposes of determining

whether amounts, other than amounts

in respect of transactions between CFC

group members of a CFC group, are

treated as interest within the meaning of

§ 1.163(j)–1(b)(22), all CFC group

members of a CFC group are treated as

a single taxpayer.

(3) Deduction of business interest

expense—(i) CFC group business

interest expense—(A) In general. The

extent to which a CFC group member’s

current-year business interest expense

and disallowed business interest

expense carryforwards for a specified

taxable year that ends with or within a

specified period may be deducted under

section 163(j) is determined under the

rules and principles of § 1.163(j)–5(a)(2)

and (b)(3)(ii), subject to the

modifications described in paragraph

(c)(3)(i)(B) of this section.

(B) Modifications to relevant terms.

For purposes of paragraph (c)(3)(i)(A) of

this section, the rules and principles of

§ 1.163(j)–5(b)(3)(ii) are applied by—

(1) Replacing ‘‘§ 1.163(j)–4(d)(2)’’ in

§ 1.163(j)–5(a)(2)(ii) with ‘‘§1.163(j)–

7(c)(2)(i)’’;

(2) Replacing the term ‘‘allocable

share of the consolidated group’s

remaining section 163(j) limitation’’

with ‘‘allocable share of the CFC group’s

remaining section 163(j) limitation’’;

(3) Replacing the terms ‘‘consolidated

group’’ and ‘‘group’’ with ‘‘CFC group’’;

(4) Replacing the term ‘‘consolidated

group’s remaining section 163(j)

limitation’’ with ‘‘CFC group’s

remaining section 163(j) limitation’’;

(5) Replacing the term ‘‘consolidated

return year’’ with ‘‘specified period’’;

(6) Replacing the term ‘‘current year’’

or ‘‘current-year’’ with ‘‘current

specified period’’ or ‘‘specified taxable

year with respect to the current

specified period,’’ as the context

requires;

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(7) Replacing the term ‘‘member’’ with

‘‘CFC group member’’; and

(8) Replacing the term ‘‘taxable year’’

with ‘‘specified taxable year with

respect to a specified period.’’

(ii) Carryforwards treated as

attributable to the same taxable year.

For purposes of applying the principles

of § 1.163(j)–5(b)(3)(ii), as required

under paragraph (c)(3)(i) of this section,

CFC group members’ disallowed

business interest expense carryforwards

that arose in specified taxable years

with respect to the same specified

period are treated as disallowed

business interest expense carryforwards

from taxable years ending on the same

date and are deducted on a pro rata

basis, under the principles of § 1.163(j)–

5(b)(3)(ii)(C)(3), pursuant to paragraph

(c)(3)(i) of this section.

(iii) Multiple specified taxable years

of a CFC group member with respect to

a specified period. If a CFC group

member has more than one specified

taxable year (each year, an applicable

specified taxable year) with respect to a

single specified period of a CFC group,

then all such applicable specified

taxable years are taken into account for

purposes of applying the principles of

§ 1.163(j)–5(b)(3)(ii), as required under

paragraph (c)(3)(i) of this section, with

respect to the specified period. The

portion of the section 163(j) limitation

allocable to disallowed business interest

expense carryforwards of the CFC group

member for its applicable specified

taxable years is prorated among the

applicable specified taxable years in

proportion to the number of days in

each applicable specified taxable year.

(iv) Limitation on pre-group

disallowed business interest expense

carryforward—(A) General rule—(1)

CFC group member pre-group

disallowed business interest expense

carryforward. This paragraph (c)(3)(iv)

applies to pre-group disallowed

business interest expense carryforwards

of a CFC group member. The amount of

the pre-group disallowed business

interest expense carryforwards

described in the preceding sentence that

are included in any CFC group

member’s business interest expense

deduction for any specified taxable year

under this paragraph (c)(3) may not

exceed the aggregate section 163(j)

limitation for all specified periods of the

CFC group, determined by reference

only to the CFC group member’s items

of income, gain, deduction, and loss,

and reduced (including below zero) by

the CFC group member’s business

interest expense (including disallowed

business interest expense carryforwards)

taken into account as a deduction by the

CFC group member in all specified

taxable years in which the CFC group

member has continuously been a CFC

group member of the CFC group

(cumulative section 163(j) pre-group

carryforward limitation).

(2) Subgrouping. In the case of a CFC

group member with a pre-group

disallowed business interest expense

carryforward (the loss member) that

joined the CFC group (the current

group) for a specified taxable year with

respect to a specified period (the

relevant period), if the loss member was

a CFC group member of a different CFC

group (the former group) immediately

prior to joining the current group, a pre-

group subgroup is composed of the loss

member and each other CFC group

member that became a CFC group

member of the current group for a

specified taxable year with respect to

the relevant period and was a member

of the former group immediately prior to

joining the current group. For purposes

of this paragraph (c), the rules and

principles of § 1.163(j)–5(d)(1)(B) apply

to a pre-group subgroup as if the pre-

group subgroup were a SRLY subgroup.

(B) Deduction of pre-group disallowed

business interest expense carryforwards.

Notwithstanding paragraph

(c)(3)(iv)(A)(1) of this section, pre-group

disallowed business interest expense

carryforwards are available for

deduction by a CFC group member in its

specified taxable year only to the extent

the CFC group has remaining section

163(j) limitation for the specified period

after the deduction of current-year

business interest expense and

disallowed business interest expense

carryforwards from earlier taxable years

that are permitted to be deducted in

specified taxable years of CFC group

members with respect to the specified

period. See paragraph (c)(3)(i) of this

section and § 1.163(j)–5(b)(3)(ii)(A). Pre-

group disallowed business interest

expense carryforwards are deducted on

a pro rata basis (under the principles of

paragraph (c)(3)(i) of this section and

§ 1.163(j)–5(b)(3)(ii)(C)(3)) with other

disallowed business interest expense

carryforwards from taxable years ending

on the same date.

(4) Currency translation. For purposes

of applying this paragraph (c), items of

a CFC group member are translated into

a single currency for the CFC group and

back to the functional currency of the

CFC group member using the average

rate for the CFC group member’s

specified taxable year, using any

reasonable method, consistently

applied. The single currency for the CFC

group may be the U.S. dollar or the

functional currency of a plurality of the

CFC group members.

(5) Special rule for specified periods

beginning in 2019 or 2020—(i) 50

percent ATI limitation applies to a

specified period of a CFC group. In the

case of a CFC group, § 1.163(j)–2(b)(2)

(including the election under § 1.163(j)–

2(b)(2)(ii)) applies to a specified period

of the CFC group beginning in 2019 or

2020, rather than to a specified taxable

year of a CFC group member. An

election under § 1.163(j)–2(b)(2)(ii) for a

specified period of a CFC group is not

effective unless made by each

designated U.S. person. Except as

otherwise provided in this paragraph

(c)(5)(i), the election is made in

accordance with Revenue Procedure

2020–22, 2020–18 I.R.B. 745. For

purposes of applying § 1.964–1(c), the

election is treated as if made for each

CFC group member.

(ii) Election to use 2019 ATI applies

to a specified period of a CFC group—

(A) In general. In the case of a CFC

group, for purposes of applying

paragraph (c)(2) of this section, an

election under § 1.163(j)–2(b)(3)(i) is

made for a specified period of a CFC

group beginning in 2020 and applies to

the specified taxable years of each CFC

group member with respect to such

specified period, taking into account the

application of paragraph (c)(5)(ii)(B) of

this section. The election under

§ 1.163(j)–2(b)(3)(i) does not apply to

any specified taxable year of a CFC

group member other than those

described in the preceding sentence. An

election under § 1.163(j)–2(b)(3)(i) for a

specified period of a CFC group is not

effective unless made by each

designated U.S. person. Except as

otherwise provided in this paragraph

(c)(5)(ii)(A), the election is made in

accordance with Revenue Procedure

2020–22, 2020–18 I.R.B. 745. For

purposes of applying § 1.964–1(c), the

election is treated as if made for each

CFC group member.

(B) Specified taxable years that do not

begin in 2020. If a specified taxable year

of a CFC group member with respect to

the specified period described in

paragraph (c)(5)(ii)(A) of this section

begins in 2019, then, for purposes of

applying paragraph (c)(2) of this section,

§ 1.163(j)–2(b)(3) is applied to such

specified taxable year by substituting

‘‘2018’’ for ‘‘2019’’ and ‘‘2019’’ for

‘‘2020.’’ If a specified taxable year of a

CFC group member with respect to the

specified period described in paragraph

(c)(5)(ii)(A) of this section begins in

2021, then, for purposes of applying

paragraph (c)(2) of this section,

§ 1.163(j)–2(b)(3) is applied to such

specified taxable year by substituting

‘‘2020’’ for ‘‘2019’’ and ‘‘2021’’ for

‘‘2020.’’

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(d) Determination of a specified group

and specified group members—(1)

Scope. This paragraph (d) provides rules

for determining a specified group and

specified group members. Paragraph

(d)(2) of this section provides rules for

determining a specified group.

Paragraph (d)(3) of this section provides

rules for determining specified group

members.

(2) Rules for determining a specified

group—(i) Definition of a specified

group. Subject to paragraph (d)(2)(ii) of

this section, the term specified group

means one or more chains of applicable

CFCs connected through stock

ownership with a specified group parent

(which is included in the specified

group only if it is an applicable CFC),

but only if—

(A) The specified group parent owns

directly or indirectly stock meeting the

requirements of section 1504(a)(2)(B) in

at least one applicable CFC; and

(B) Stock meeting the requirements of

section 1504(a)(2)(B) in each of the

applicable CFCs (except the specified

group parent) is owned directly or

indirectly by one or more of the other

applicable CFCs or the specified group

parent.

(ii) Indirect ownership. For purposes

of applying paragraph (d)(2)(i) of this

section, stock is owned indirectly only

if it is owned under section 318(a)(2)(A)

through a partnership or under section

318(a)(2)(A) or (B) through an estate or

trust not described in section

7701(a)(30).

(iii) Specified group parent. The term

specified group parent means a

qualified U.S. person or an applicable

CFC.

(iv) Qualified U.S. person. The term

qualified U.S. person means a United

States person described in section

7701(a)(30)(A) or (C). For purposes of

this paragraph (d), members of a

consolidated group that file (or that are

required to file) a consolidated U.S.

federal income tax return are treated as

a single qualified U.S person and

individuals described in section

7701(a)(30)(A) whose filing status is

married filing jointly are treated as a

single qualified U.S. person.

(v) Stock. For purposes of paragraph

(d)(3)(i) of this section, the term stock

has the same meaning as ‘‘stock’’ in

section 1504 (without regard to

§ 1.1504–4, except as provided in

paragraph (d)(2)(vi) of this section) and

all shares of stock within a single class

are considered to have the same value.

Thus, control premiums and minority

and blockage discounts within a single

class are not taken into account.

(vi) Options treated as exercised. For

purposes of this paragraph (d)(2),

options that are reasonably certain to be

exercised, as determined under

§ 1.1504–4(g), are treated as exercised.

For purposes of this paragraph (d)(2)(vi),

options include call options, warrants,

convertible obligations, put options, and

any other instrument treated as an

option under § 1.1504–4(d), determined

by replacing the term ‘‘a principal

purpose of avoiding the application of

section 1504 and this section’’ with ‘‘a

principal purpose of avoiding the

application of section 163(j).’’

(vii) When a specified group ceases to

exist. The principles of § 1.1502–

75(d)(1), (d)(2)(i) through (d)(2)(ii), and

(d)(3)(i) through (d)(3)(iv), apply for

purposes of determining when a

specified group ceases to exist. Solely

for purposes of applying these

principles, each applicable CFC that is

treated as a specified group member for

a taxable year with respect to a specified

period is treated as affiliated with the

specified group parent from the

beginning to the end of the specified

period, without regard to the beginning

or end of its taxable year.

(3) Rules for determining a specified

group member. If an applicable CFC is

included in a specified group on the last

day of a taxable year of the applicable

CFC that ends with or within a specified

period, the applicable CFC is a specified

group member with respect to the

specified period for its entire taxable

year ending with or within the specified

period. If an applicable CFC has

multiple taxable years that end with or

within a specified period, this

paragraph (d)(3) is applied separately to

each taxable year to determine if the

applicable CFC is a specified group

member for such taxable year.

(e) Rules and procedures for treating

a specified group as a CFC group—(1)

Scope. This paragraph (e) provides rules

and procedures for treating a specified

group member as a CFC group member

and for determining a CFC group for

purposes of applying section 163(j) and

the section 163(j) regulations.

(2) CFC group and CFC group

member—(i) CFC group. The term CFC

group means, with respect to a specified

period, all CFC group members for their

specified taxable years.

(ii) CFC group member. The term CFC

group member means, with respect to a

specified taxable year and a specified

period, a specified group member of a

specified group for which a CFC group

election is in effect.

(3) Duration of a CFC group. A CFC

group continues until the CFC group

election is revoked, or there is no longer

a specified period with respect to the

specified group.

(4) Joining or leaving a CFC group. If

an applicable CFC becomes a specified

group member for a specified taxable

year with respect to a specified period

of a specified group for which a CFC

group election is in effect, the CFC

group election applies to the applicable

CFC and the applicable CFC becomes a

CFC group member. If an applicable

CFC ceases to be a specified group

member for a specified taxable year with

respect to a specified period of a

specified group for which a CFC group

election is in effect, the CFC group

election terminates solely with respect

to the applicable CFC.

(5) Manner of making or revoking a

CFC group election—(i) In general. An

election is made or revoked under this

paragraph (e)(5) (a CFC group election)

with respect to a specified period of a

specified group. A CFC group election

remains in effect for each specified

period of the specified group until

revoked. A CFC group election that is in

effect with respect to a specified period

of a specified group applies to each

specified group member for its specified

taxable year that ends with or within the

specified period. The making or

revoking of a CFC group election is not

effective unless made or revoked by

each designated U.S. person.

(ii) Revocation by election. A CFC

group election cannot be revoked with

respect to any specified period

beginning prior to 60 months following

the last day of the specified period for

which the election was made. Once a

CFC group election has been revoked, a

new CFC group election cannot be made

with respect to any specified period

beginning prior to 60 months following

the last day of the specified period for

which the election was revoked.

(iii) Timing. A CFC group election

must be made or revoked with respect

to a specified period of a specified

group no later than the due date (taking

into account extensions, if any) of the

original Federal income tax return for

the taxable year of each designated U.S.

person in which or with which the

specified period ends.

(iv) Election statement. Except as

otherwise provided in publications,

forms, instructions, or other guidance,

to make or revoke a CFC group election

for a specified period of a specified

group, each designated U.S. person

must attach a statement to its relevant

Federal tax or information return. The

statement must include the name and

taxpayer identification number of all

designated U.S. persons, a statement

that the CFC group election is being

made or revoked, as applicable, the

specified period for which the CFC

group election is being made or revoked,

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and the name of each CFC group

member and its specified taxable year

with respect to the specified period. The

statement must be filed in the manner

prescribed in publications, forms,

instructions, or other guidance.

(v) Effect of prior CFC group election.

A CFC group election is made solely

pursuant to the provisions of this

paragraph (e)(5), without regard to

whether the election described in

proposed § 1.163(j)–7(f)(7) that was

included in a notice of proposed

rulemaking (REG–106089–18) that was

published on December 28, 2018, in the

Federal Register (83 FR 67490) was in

effect.

(f) Treatment of a CFC group member

that has ECI—(1) In general. If a CFC

group member has ECI in its specified

taxable year, then for purposes of

section 163(j) and the section 163(j)

regulations—

(i) The items, disallowed business

interest expense carryforwards, and

other attributes of the CFC group

member that are ECI are treated as

items, disallowed business interest

expense carryforwards, and attributes of

a separate applicable CFC (such deemed

corporation, an ECI deemed

corporation), subject to § 1.163(j)–8(d),

that has same taxable year and

shareholders as the applicable CFC; and

(ii) The ECI deemed corporation is not

treated as a specified group member for

the specified taxable year.

(2) Ordering rule. Paragraph (f)(1) of

this section applies before application of

§ 1.163(j)–8(d).

(g) * * *

(3) Treatment of certain taxes. For

purposes of computing the ATI of a

relevant foreign corporation for a

taxable year, tentative taxable income

takes into account any deduction for

foreign taxes. See section 164(a).

(4) Anti-abuse rule—(i) In general. If

a specified group member of a specified

group or an applicable partnership

(specified lender) includes an amount

(the payment amount) in income and

such amount is attributable to business

interest expense incurred by another

specified group member or an

applicable partnership of the specified

group (a specified borrower) during its

taxable year, then the ATI of the

specified borrower for the taxable year

is increased by the ATI adjustment

amount if—

(A) The business interest expense is

incurred with a principal purpose of

reducing the Federal income tax

liability of any United States

shareholder of a specified group

member (including over multiple

taxable years);

(B) Absent the application of this

paragraph (g)(4), the effect of the

specified borrower treating all or part of

the payment amount as disallowed

business interest expense would be to

reduce the Federal income tax liability

of any United States shareholder of a

specified group member; and

(C) Either no CFC group election is in

effect with respect to the specified

group or the specified borrower is an

applicable partnership.

(ii) ATI adjustment amount—(A) In

general. For purposes of this paragraph

(g)(4), the term ATI adjustment amount

means, with respect to a specified

borrower and a taxable year, the product

of 3

1

⁄

3

and the lesser of the payment

amount or the disallowed business

interest expense, computed without

regard to this paragraph (g)(4).

(B) Special rule for taxable years or

specified periods beginning in 2019 or

2020. For any taxable year of an

applicable CFC or specified taxable year

of a CFC group member with respect to

a specified period for which the section

163(j) limitation is determined based, in

part, on 50 percent of ATI, in

accordance with § 1.163(j)–2(b)(2),

paragraph (g)(4)(ii)(A) of this section is

applied by substituting ‘‘2’’ for ‘‘3

1

⁄

3

.’’

(iii) Applicable partnership. For

purposes of this paragraph (g)(4), the

term applicable partnership means,

with respect to a specified group, a

partnership in which at least 80 percent

of the interests in capital or profits is

owned, directly or indirectly through

one or more other partnerships, by

specified group members of the

specified group.

(h) Election to apply safe-harbor—(1)

In general. If an election to apply this

paragraph (h)(1) (safe-harbor election) is

in effect with respect to a taxable year

of a stand-alone applicable CFC or a

specified taxable year of a CFC group

member, as applicable, then, for such

year, no portion of the applicable CFC’s

business interest expense is disallowed

under the section 163(j) limitation. This

paragraph (h) does not apply to excess

business interest expense, as described

in § 1.163(j)–6(f)(2), until the taxable

year in which it is treated as paid or

accrued by an applicable CFC under

§ 1.163(j)–6(g)(2)(i). Furthermore, excess

business interest expense is not taken

into account for purposes of

determining whether the safe-harbor

election is available for a stand-alone

applicable CFC or a CFC group until the

taxable year in which it is treated as

paid or accrued by an applicable CFC

under § 1.163(j)–6(g)(2)(i).

(2) Eligibility for safe-harbor

election—(i) Stand-alone applicable

CFC. The safe-harbor election may be

made for the taxable year of a stand-

alone applicable CFC only if business

interest expense of the applicable CFC

is less than or equal to 30 percent of the

lesser of qualified tentative taxable

income or the eligible amount of the

applicable CFC for its taxable year.

(ii) CFC group—(A) In general. The

safe-harbor election may be made for the

specified period of a CFC group only if

the business interest expense of the CFC

group for the specified period is less

than or equal to 30 percent of the lesser

of the sum of qualified tentative taxable

income or the sum of the eligible

amounts of each CFC group member for

its specified taxable year with respect to

the specified period, and no CFC group

member has pre-group disallowed

business interest expense carryforward.

(B) Currency translation. For purposes

of applying paragraph (h)(2)(ii) of this

section, qualified tentative taxable

income and eligible amounts of each

CFC group member are translated into

the currency in which the business

interest expense of the CFC group is

denominated using the method used

under paragraph (c)(4) of this section.

See paragraph (c)(2)(i) of this section for

rules for determining the business

interest expense of a CFC group.

(3) Eligible amount—(i) In general.

Subject to paragraph (h)(3)(ii) of this

section, the term eligible amount means,

with respect to the taxable year of an

applicable CFC, the sum of the

following amounts, computed without

regard to the application of section

163(j) and the section 163(j) regulations

(including without regard to any

disallowed business interest expense

carryforwards)—

(A) Subpart F income (within the

meaning of section 952);

(B) The product of—

(1) The excess of 100 percent over the

percentage described in section

250(a)(1)(B), taking into account section

250(a)(3)(B), and

(2) The excess, if any, of tested

income (within the meaning of section

951A(c)(2)(A) and § 1.951A–2(b)(1)),

over the CFC-level net deemed tangible

income return.

(ii) Amounts properly allocable to a

non-excepted trade or business. For

purposes of computing an eligible

amount, subpart F income and tested

income are determined by only taking

into account items properly allocable to

a non-excepted trade or business.

(4) Qualified tentative taxable income.

The term qualified tentative taxable

income means, with respect to a taxable

year of an applicable CFC, the

applicable CFC’s tentative taxable

income, determined by only taking into

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account items properly allocable to a

non-excepted trade or business.

(5) Manner of making a safe-harbor

election—(i) In general. A safe-harbor

election is an annual election made

under this paragraph (h)(5) with respect

to a taxable year of a stand-alone

applicable CFC or with respect to a

specified period of a CFC group. A safe-

harbor election that is made with

respect to a specified period of a CFC

group is effective with respect to each

CFC group member for its specified

taxable year. A safe-harbor election is

only effective if made by each

designated U.S. person with respect to

a stand-alone applicable CFC or a CFC

group. A safe-harbor election is made

with respect to a taxable year of a stand-

alone applicable CFC, or a specified

period of a CFC group, no later than the

due date (taking into account

extensions, if any) of the original

Federal income tax return for the

taxable year of each designated U.S.

person, respectively, in which or with

which the taxable year of the stand-

alone applicable CFC ends or the

specified period of the CFC group ends.

(ii) Election statement. Unless

otherwise provided in publications,

forms, instructions, or other guidance,

to make a safe-harbor election, each

designated U.S. person must attach to

its relevant Federal income tax return or

information return a statement that

includes the name and taxpayer

identification number of all designated

U.S. persons, a statement that a safe-

harbor election is being made pursuant

to § 1.163(j)–7(h) and that the

requirements for making the election are

satisfied, and the taxable year of the

stand-alone applicable CFC or the

specified period of the CFC group, as

applicable, for which the safe-harbor

election is being made. In the case of a

CFC group, the statement must also

include the name of each CFC group

member and its specified taxable year

that ends with or within the specified

period for which the safe-harbor

election is being made. The statement

must be filed in the manner prescribed

in publications, forms, instructions, or

other guidance.

(6) Special rule for taxable years or

specified periods beginning in 2019 or

2020. In the case of a stand-alone

applicable CFC, for any taxable year

beginning in 2019 or 2020, paragraph

(h)(2)(i) of this section is applied by

substituting ‘‘50 percent’’ for ‘‘30

percent.’’ In the case of a CFC group, for

any specified period beginning in 2019

or 2020, paragraph (h)(2)(ii)(A) of this

section is applied by substituting ‘‘50

percent’’ for ‘‘30 percent.’’

* * * * *

(j) Rules regarding the computation of

ATI of certain United States

shareholders of applicable CFCs—(1) In

general. For purposes of computing ATI

of a United States shareholder of an

applicable CFC, for the taxable year of

the United States shareholder in which

or with which the taxable year of the

applicable CFC ends, there is added to

the United States shareholder’s tentative

taxable income the product of—

(i) The portion of the adjustment, if

any, made to the United States

shareholder’s tentative taxable income

under § 1.163(j)–1(b)(1)(ii)(G) (regarding

specified deemed inclusions) that is

attributable to the applicable CFC, but

for this purpose excluding the portion of

the adjustment that is attributable to an

inclusion under section 78 with respect

to the applicable CFC; and

(ii) A fraction, expressed as a

percentage, but not greater than 100

percent, the numerator of which is CFC

excess taxable income and the

denominator of which is the ATI of the

applicable CFC for the taxable year.

(2) Rules for determining CFC excess

taxable income—(i) In general. The term

CFC excess taxable income means, with

respect to a taxable year of an applicable

CFC, the amount described in paragraph

(j)(2)(ii) or (j)(2)(iii) of this section, as

applicable.

(ii) Applicable CFC is a stand-alone

applicable CFC. If an applicable CFC is

a stand-alone applicable CFC for a

taxable year, its CFC excess taxable

income for the taxable year is the

amount that bears the same ratio to the

applicable CFC’s ATI as—

(A) The excess (if any) of—

(1) 30 percent of the applicable CFC’s

ATI; over

(2) The amount (if any) by which the

applicable CFC’s business interest

expense exceeds its business interest

income and floor plan financing interest

expense; bears to

(B) 30 percent of the applicable CFC’s

ATI.

(iii) Applicable CFC is a CFC group

member. If an applicable CFC is a CFC

group member for a specified taxable

year, its CFC excess taxable income is

equal to the product of the CFC group

member’s ATI percentage and the

amount that bears the same ratio to the

CFC group’s ATI for the specified period

as—

(A) The excess (if any) of—

(1) 30 percent of the CFC group’s ATI;

over

(2) The amount (if any) by which the

CFC group’s business interest expense

exceeds the CFC group’s business

interest income and floor plan financing

interest expense; bears to

(B) 30 percent of the CFC group’s ATI.

(iv) ATI percentage. For purposes of

this paragraph (j), the term ATI

percentage means, with respect to a

specified taxable year of a CFC group

member and a specified period of the

CFC group, a fraction (expressed as a

percentage), the numerator of which is

the ATI of the CFC group member for

the specified taxable year, and the

denominator of which is the ATI of the

CFC group for the specified period. If

either the numerator or denominator of

the fraction is less than or equal to zero,

the ATI percentage is zero.

(3) Cases in which an addition to

tentative taxable income is not allowed.

Paragraph (j)(1) of this section is not

applicable for a taxable year of a United

States shareholder if, with respect to the

taxable year of the applicable CFC

described in paragraph (j)(1) of this

section—

(i) A safe-harbor election (as described

in paragraph (h) of this section) is in

effect; or

(ii) The applicable CFC is neither a

stand-alone applicable CFC nor a CFC

group member.

(4) Special rule for taxable years or

specified periods beginning in 2019 or

2020. In the case of a stand-alone

applicable CFC, for any taxable year

beginning in 2019 or 2020 to which the

election described in § 1.163(j)–

2(b)(2)(ii) does not apply, paragraph

(j)(2)(ii) of this section is applied by

substituting ‘‘50 percent’’ for ‘‘30

percent’’ each place it appears. In the

case of a CFC group member, for any

specified taxable year with respect to a

specified period beginning in 2019 or

2020 to which the election described in

§ 1.163(j)–2(b)(2)(ii) does not apply,

paragraph (j)(2)(iii) of this section is

applied by substituting ‘‘50 percent’’ for

‘‘30 percent’’ each place it appears.

(k) Definitions. The following

definitions apply for purposes of this

section.

(1) Applicable partnership. The term

applicable partnership has the meaning

provided in paragraph (g)(4)(iii) of this

section.

(2) Applicable specified taxable year.

The term applicable specified taxable

year has the meaning provided in

paragraph (c)(3)(iii) of this section.

(3) ATI adjustment amount. The term

ATI adjustment amount has the

meaning provided in paragraph (g)(4)(ii)

of this section.

(4) ATI percentage. The term ATI

percentage has the meaning provided in

paragraph (j)(2)(iv) of this section.

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(5) CFC excess taxable income. The

term CFC excess taxable income has the

meaning provided in paragraph (j)(2)(i)

of this section.

(6) CFC group. The term CFC group

has the meaning provided in paragraph

(e)(2)(i) of this section.

(7) CFC group election. The term CFC

group election means the election

described in paragraph (e)(5) of this

section.

(8) CFC group member. The term CFC

group member has the meaning

provided in paragraph (e)(2)(ii) of this

section.

(9) CFC-level net deemed tangible

income return—(i) In general. The term

CFC-level net deemed tangible income

return means, with respect to a taxable

year of an applicable CFC, the excess (if

any) of—

(A) 10 percent of the qualified

business asset investment, as defined in

section 951A(d)(1) and § 1.951A–3(b), of

the applicable CFC, over

(B) The excess, if any, of—

(1) Tested interest expense, as defined

in § 1.951A–4(b)(1), of the applicable

CFC, over

(2) Tested interest income, as defined

in § 1.951A–4(b)(2), of the applicable

CFC.

(ii) Amounts properly allocable to a

non-excepted trade or business. For

purposes of computing CFC-level net

deemed tangible income return,

qualified business asset investment is

determined by only taking into account

assets properly allocable to a non-

excepted trade or business, as

determined in § 1.163(j)–10(c)(3), and

tested interest expense and tested

interest income are determined by only

taking into account items properly

allocable to a non-excepted trade or

business, as determined in § 1.163(j)–

10(c).

(10) Cumulative section 163(j) pre-

group carryforward limitation. The term

cumulative section 163(j) pre-group

carryforward limitation has the meaning

provided in paragraph (c)(3)(iv)(A)(1) of

this section.

(11) Current group. The term current

group has the meaning provided in

paragraph (c)(3)(iv)(A)(2) of this section.

(12) Designated U.S. person. The term

designated U.S. person means—

(i) With respect to a stand-alone

applicable CFC, each controlling

domestic shareholder, as defined in

§ 1.964–1(c)(5) of the applicable CFC; or

(ii) With respect to a specified group,

the specified group parent, if the

specified group parent is a qualified

U.S. person, or each controlling

domestic shareholder, as defined in

§ 1.964–1(c)(5), of the specified group

parent, if the specified group parent is

an applicable CFC.

(13) ECI deemed corporation. The

term ECI deemed corporation has the

meaning provided in paragraph (f)(1)(i)

of this section.

(14) Effectively connected income.

The term effectively connected income

(or ECI) means income or gain that is

ECI, as defined in § 1.884–1(d)(1)(iii),

and deduction or loss that is allocable

to, ECI, as defined in § 1.884–1(d)(1)(iii).

(15) Eligible amount. The term eligible

amount has the meaning provided in

paragraph (h)(3)(i) of this section.

(16) Former group. The term former

group has the meaning provided in

paragraph (c)(3)(iv)(A)(2) of this section.

(17) Loss member. The term loss

member has the meaning provided in

paragraph (c)(3)(iv)(A)(2) of this section.

(18) Payment amount. The term

payment amount has the meaning

provided in paragraph (g)(4)(i) of this

section.

(19) Pre-group disallowed business

interest expense carryforward. The term

pre-group disallowed business interest

expense carryforward means, with

respect to a CFC group member and a

specified taxable year, any disallowed

business interest expense carryforward

of the CFC group member that arose in

a taxable year during which the CFC

group member (or its predecessor) was

not a CFC group member of the CFC

group.

(20) Qualified tentative taxable

income. The term qualified tentative

taxable income has the meaning

provided in paragraph (h)(4) of this

section.

(21) Qualified U.S. person. The term

qualified U.S. person has the meaning

provided in paragraph (d)(2)(iv) of this

section.

(22) Relevant period. The term

relevant period has the meaning

provided in paragraph (c)(3)(iv)(A)(2) of

this section.

(23) Safe-harbor election. The term

safe-harbor election has the meaning

provided in paragraph (h)(1) of this

section.

(24) Specified borrower. The term

specified borrower has the meaning

provided in paragraph (g)(4)(i) of this

section.

(25) Specified group. The term

specified group has the meaning

provided in paragraph (d)(2)(i) of this

section.

(26) Specified group member. The

term specified group member has the

meaning provided in paragraph (d)(3) of

this section.

(27) Specified group parent. The term

specified group parent has the meaning

provided in paragraph (d)(2)(iii) of this

section.

(28) Specified lender. The term

specified lender has the meaning

provided in paragraph (g)(4)(i) of this

section

(29) Specified period—(i) In general.

Except as otherwise provided in

paragraph (k)(29)(ii) of this section, the

term specified period means, with

respect to a specified group—

(A) If the specified group parent is a

qualified U.S. person, the period ending

on the last day of the taxable year of the

specified group parent and beginning on

the first day after the last day of the

specified group’s immediately

preceding specified period; or

(B) If the specified group parent is an

applicable CFC, the period ending on

the last day of the specified group

parent’s required year described in

section 898(c)(1), without regard to

section 898(c)(2), and beginning on the

first day after the last day of the

specified group’s immediately

preceding specified period.

(ii) Short specified period. A specified

period begins no earlier than the first

date on which a specified group exists.

A specified period ends on the date a

specified group ceases to exist under

paragraph (d)(2)(vii) of this section. If

the last day of a specified period, as

determined under paragraph (k)(29)(i) of

this section, changes, and, but for this

paragraph (k)(29)(ii), the change in the

last day of the specified period would

result in the specified period being

longer than 12 months, the specified

period ends on the date on which the

specified period would have ended had

the change not occurred.

(30) Specified taxable year. The term

specified taxable year means, with

respect to an applicable CFC that is a

specified group member of a specified

group and a specified period, a taxable

year of the applicable CFC that ends

with or within the specified period.

(31) Stand-alone applicable CFC. The

term stand-alone applicable CFC means

any applicable CFC that is not a

specified group member.

(32) Stock. The term stock has the

meaning provided in paragraph (d)(2)(v)

of this section.

(l) Examples. The following examples

illustrate the application of this section.

For each example, unless otherwise

stated, no exemptions from the

application of section 163(j) are

available, no foreign corporation has

ECI, and all relevant taxable years and

specified periods begin after December

31, 2020.

(1) Example 1. Specified taxable years

included in specified period of a specified

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group—(i) Facts. As of June 30, Year 1, USP,

a domestic corporation, owns 60 percent of

the common stock of FP, which owns all of

the stock of FC1, FC2, and FC3. The

remaining 40 percent of the common stock of

FP is owned by an unrelated foreign

corporation. FP has a single class of stock. FP

acquired the stock of FC3 from an unrelated

person on March 22, Year 1. The acquisition

did not result in a change in FC3’s taxable

year or a close of its taxable year. USP’s

interest in FP and FP’s interest in FC1 and

FC2 has been the same for a number of years.

USP has a taxable year ending June 30, Year

1, which is not a short taxable year. Each of

FP, FC1, FC2, and FC3 are applicable CFCs.

Pursuant to section 898(c)(2), FP and FC1

have taxable years ending May 31, Year 1.

Pursuant to section 898(c)(1), FC2 and FC3

have taxable years ending June 30, Year 1.

(ii) Analysis—(A) Determining a specified

group and specified period of the specified

group. Pursuant to paragraph (d) of this

section, FP, FC1, FC2, and FC3 are members

of a specified group, and FP is the specified

group parent. Because the specified group

parent, FP, is an applicable CFC, the

specified period of the specified group is the

period ending on June 30, Year 1, which is

the last day of FP’s required year described

in section 898(c)(1), without regard to section

898(c)(2), and on beginning July 1, Year 0,

which is the first day following the last day

of the specified group’s immediately

preceding specified period (June 30, Year 0).

See paragraph (k)(29)(i)(B) of this section.

(B) Determining the specified taxable years

with respect to the specified period. Pursuant

to paragraph (d)(3) of this section, because

each of FP and FC1 are included in the

specified group on the last day of their

taxable years ending May 31, Year 1 and such

taxable years end with or within the

specified period ending June 30, Year 1, FP

and FC1 are specified group members with

respect to the specified period ending June

30, Year 1, for their entire taxable years

ending May 31, Year 1, and those taxable

years are specified taxable years. Similarly,

because each of FC2 and FC3 are included in

the specified group on the last day of their

taxable years ending June 30, Year 1, and

such taxable years end with or within the

specified period ending June 30, Year 1, FC2

and FC3 are specified group members with

respect to the specified period ending June

30, Year 1, for their entire taxable years

ending June 30, Year 1, and those taxable

years are specified taxable years. The fact

that FC3 was acquired on March 22, Year 1,

does not prevent FC3 from being a specified

group member with respect to the specified

period for the portion of its specified taxable

year prior to March 22, Year 1.

(2) Example 2. CFC groups—(i) Facts. The

facts are the same as in Example 1 in

paragraph (l)(1)(i) of this section. In addition,

a CFC group election is in place with respect

to the specified period ending June 30, Year

1. (ii) Analysis. Because a CFC group election

is in place for the specified period ending

June 30, Year 1, pursuant to paragraph

(e)(2)(ii) of this section, each specified group

member is a CFC group member with respect

to its specified taxable year ending with or

within the specified period. Accordingly, FP,

FC1, FC2, and FC3 are CFC group members

with respect to the specified period ending

June 30, Year 1, for their specified taxable

years ending May 31, Year 1, and June 30,

Year 1, respectively. Pursuant to paragraph

(e)(2)(i) of this section, the CFC group for the

specified period ending June 30, Year 1,

consists of FP, FC1, FC2, and FC3 for their

specified taxable years ending May 31, Year

1, and June 30, Year 1, respectively. Pursuant

to paragraph (c)(2) of this section, a single

section 163(j) limitation is computed for the

specified period ending June 30, Year 1. That

section 163(j) calculation will include FP and

FC1’s specified taxable years ending May 31,

Year 1, and FC2 and FC3’s specified taxable

years ending June 30, Year 1.

(3) Example 3. Application of anti-abuse

rule—(i) Facts. USP, a domestic corporation,

is the specified group parent of a specified

group. The specified group members include

CFC1 and CFC2. USP owns (within the

meaning of section 958(a)) all of the stock of

all specified group members. USP has a

calendar year taxable year. All specified

group members also have a calendar year

taxable year and a functional currency of the

U.S. dollar. CFC1 is organized in, and a tax

resident of, a jurisdiction that imposes no tax

on certain types of income, including interest

income. With respect to Year 1, USP expects

to pay no residual U.S. tax on its income

inclusion under section 951A(a) (GILTI

inclusion) and expects to have unused

foreign tax credits in the category described

in section 904(d)(1)(A). A CFC group election

is not in effect for Year 1. With a principal

purpose of reducing USP’s Federal income

tax liability, on January 1, Year 1, CFC1 loans

$100x to CFC2. On December 31, Year 1,

CFC2 pays interest of $10x to CFC1 and

repays the principal of $100x. Absent

application of paragraph (g)(4)(i) of this

section, CFC2 would treat all $10x of interest

expense as disallowed business interest

expense and therefore would have $10x of

disallowed business interest expense

carryforward to Year 2. In Year 2, CFC2

disposes of one of its businesses at a

substantial gain that gives rise to tested

income (within the meaning of section

951A(c)(2)(A) and § 1.951A–2(b)(1)). Assume

that as a result of the gain being included in

the ATI of CFC2, absent application of

paragraph (g)(3)(i) of this section, CFC2

would be allowed to deduct the entire $10x

of disallowed business interest expense

carryforward and therefore reduce the

amount of CFC2’s tested income. Also,

assume that USP would have residual U.S.

tax on its GILTI inclusion in Year 2, without

regard to the application of paragraph (g)(4)(i)

of this section.

(ii) Analysis. The $10x of interest expense

paid in Year 1 is a payment amount

described in paragraph (g)(4)(i) of this section

because it is between specified group

members, CFC1 and CFC2. Furthermore the

requirements of paragraph (g)(4)(i)(A), (B),

and (C) of this section are satisfied because

the business interest expense is incurred

with a principal purpose of reducing USP’s

Federal income tax liability; absent the

application of paragraph (g)(4)(i) of this

section, the effect of CFC2 treating the $10x

of business interest expense as disallowed

business interest expense in Year 1 would be

to reduce USP’s Federal income tax liability

in Year 2; and no CFC group election is in

effect with respect to the specified group in

Year 1. Because the requirements of

paragraph (g)(4)(i)(A), (B), and (C) of this

section are satisfied, CFC2’s ATI for Year 1

is increased by $33.33x, which is the amount

equal to 3

1

⁄

3

multiplied by $10x (the lesser

of the payment amount of $10x and the

disallowed business interest expense of

$10x). As a result, the $10x of business

interest expense is not treated by CFC2 as

disallowed business interest expense in Year

1, and therefore does not give rise to a

disallowed business interest expense

carryforward to Year 2.

(m) Applicability dates—(1) General

applicability date. Except as provided in

paragraph (m)(2) of this section, this

section applies to taxable years of a

foreign corporation beginning on or after

November 13, 2020 However, except as

provided in paragraph (m)(2) of this

section, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules of this section to a

taxable year beginning after December

31, 2017, so long as the taxpayers and

their related parties consistently apply

the rules of this section to each

subsequent taxable year and the section

163(j) regulations, and if applicable,

§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,

1.382–1, 1.382–2, 1.382–5, 1.382–6,

1.382–7, 1.383–0, 1.383–1, 1.469–9,

1.469–11, 1.704–1, 1.882–5, 1.1362–3,

1.1368–1, 1.1377–1, 1.1502–13, 1.1502–

21, 1.1502–36, 1.1502–79, 1.1502–91

through 1.1502–99 (to the extent they

effectuate the rules of §§ 1.382–2, 1.382–

5, 1.382–6, and 1.383–1), and 1.1504–4

to that taxable year and each subsequent

taxable year.

(2) Exception. Paragraphs (a), (c)

through (f), (g)(3) and (4), and (h)

through (k) of this section apply to

taxable years beginning on or after

[DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply paragraphs (a), (c) through (f),

(g)(3) and (4), and (h) through (k) of this

section in their entirety for a taxable

year beginning after December 31, 2017,

so long as the taxpayers and their

related parties also apply § 1.163(j)–8 for

the taxable year. For taxable years

beginning before November 13, 2020,

taxpayers and their related parties may

not choose to apply paragraphs (a), (c)

through (f), (g)(3) and (4), and (h)

through (k) of this section unless they

also apply paragraphs (b) and (g)(1) and

(2) of this section in accordance with

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the second sentence of paragraph (m)(1)

of this section. Notwithstanding

paragraph (e)(5)(iii) or (h)(5)(i) of this

section, in the case of a specified period

of a specified group or a taxable year of

a stand-alone applicable CFC that ends

with or within a taxable year of a

designated U.S. person ending before

November 13, 2020, a CFC group

election or a safe-harbor election may be

made on an amended Federal income

tax return filed on or before the due date

(taking into account extensions, if any)

of the original Federal income tax return

for the first taxable year of each

designated U.S. person ending after

November 13, 2020.

■Par. 9. As reserved in a final rule

elsewhere in this issue of the Federal

Register, effective November 13, 2020,

§ 1.163(j)–8 is added to read as follows:

§ 1.163(j)–8 Application of the section

163(j) limitation to foreign persons with

effectively connected income.

(a) Overview. This section provides

rules concerning the application of

section 163(j) to foreign persons with

ECI. Paragraph (b) of this section

modifies the application of section

163(j) for a specified foreign person with

ECI. Paragraph (c) of this section sets

forth rules for a specified foreign partner

in a partnership with ECI. Paragraph (d)

of this section allocates disallowed

business interest expense for relevant

foreign corporations with ECI.

Paragraph (e) of this section provides

rules concerning disallowed business

interest expense. Paragraph (f) of this

section coordinates the application of

section 163(j) with § 1.882–5 and the

branch profits tax under section 884.

Paragraph (g) of this section provides

definitions that apply for purposes of

this section. Paragraph (h) of this

section illustrates the application of this

section through examples.

(b) Application to a specified foreign

person with ECI—(1) In general. If a

taxpayer is a specified foreign person,

then the taxpayer applies the

modifications described in this

paragraph (b), taking into account the

application of paragraph (c) of this

section.

(2) Modification of adjusted taxable

income. Adjusted taxable income for a

specified foreign person for a taxable

year means the specified foreign

person’s adjusted taxable income, as

determined under § 1.163(j)–1(b)(1),

taking into account only items that are

ECI.

(3) Modification of business interest

expense. Business interest expense for a

specified foreign person means business

interest expense described in § 1.163(j)–

1(b)(3) that is ECI, taking into account

the application of paragraph (f)(1)(iii) of

this section.

(4) Modification of business interest

income. The business interest income of

a specified foreign person means

business interest income described in

§ 1.163(j)–1(b)(4) that is ECI.

(5) Modification of floor plan

financing interest expense. The floor

plan financing interest expense of a

specified foreign person means floor

plan financing interest expense

described § 1.163(j)–1(b)(19) that is ECI.

(6) Modification of allocation of

interest expense and interest income

that is allocable to a trade or business.

For purposes of applying § 1.163(j)–

10(c) to a specified foreign person, only

interest income and interest expense

that are ECI and only assets that are U.S.

assets, as defined in § 1.884–1(d), are

taken into account. If the specified

foreign person is also a specified foreign

partner, this paragraph (b)(6) does not

apply to any trade or business of the

partnership.

(c) Rules for a specified foreign

partner—(1) Characterization of excess

taxable income—(i) In general. The

portion of excess taxable income

allocated to a specified foreign partner

from a partnership pursuant to

§ 1.163(j)–6(f)(2) that is ECI is equal to

the specified foreign partner’s allocation

of excess taxable income from the

partnership multiplied by its specified

ATI ratio with respect to the

partnership, and the remainder is not

ECI.

(ii) Specified ATI ratio. The term

specified ATI ratio means the fraction

described in this paragraph (c)(1)(ii). If

the specified foreign partner’s

distributive share of ECI and

distributive share of non-ECI are both

positive, the numerator of this fraction

is the specified foreign partner’s

distributive share of ECI and the

denominator is the specified foreign

partner’s distributive share of

partnership items of income, gain,

deduction, and loss. If the specified

foreign partner’s distributive share of

ECI is negative or zero and its

distributive share of non-ECI is positive,

this fraction is treated as zero. If the

specified foreign partner’s distributive

share of non-ECI is negative or zero and

its distributive share of ECI is positive,

this fraction is treated as one. If the

specified foreign partner’s distributive

share of ECI and distributive share of

non-ECI are both negative, the

numerator of this fraction is its

distributive share of non-ECI and the

denominator is its distributive share of

partnership items of income, gain,

deduction, and loss.

(iii) Distributive share of ECI. The

term distributive share of ECI means the

net amount of the specified foreign

partner’s distributive share of

partnership items of income, gain,

deduction, and loss that are ECI.

(iv) Distributive share of non-ECI. The

term distributive share of non-ECI

means the net amount of the specified

foreign partner’s distributive share of

partnership items of income, gain,

deduction, and loss that are not ECI.

(2) Characterization of excess

business interest expense—(i) Allocable

ECI excess BIE. The portion of excess

business interest expense allocated to a

specified foreign partner from a

partnership pursuant to § 1.163(j)–6(f)(2)

or paragraph (e)(2) of this section that is

ECI (allocable ECI excess BIE) is equal

to the excess, if any, of allocable ECI BIE

over allocable ECI deductible BIE.

(ii) Allocable non-ECI excess BIE. The

portion of excess business interest

expense allocated to a specified foreign

partner from a partnership pursuant to

§ 1.163(j)–6(f)(2) or paragraph (e)(2) of

this section that is not ECI (allocable

non-ECI excess BIE) is equal to the

excess, if any, of allocable non-ECI BIE

over allocable non-ECI deductible BIE.

(3) Characterization of deductible

business interest expense—(i) In

general. The portion of deductible

business interest expense, if any, that is

allocated to a specified foreign partner

from a partnership pursuant to

§ 1.163(j)–6(f)(2) that is ECI (allocable

ECI deductible BIE) is equal to the sum

of the amounts described in paragraphs

(c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of

this section. The portion of deductible

business interest expense, if any, that is

allocated to a specified foreign partner

from a partnership pursuant to

§1.163(j)–6(f)(2) that is not ECI

(allocable non-ECI deductible BIE) is

equal to the sum of the amounts

described in paragraphs

(c)(3)(ii)(A)(1)(ii) and (c)(3)(ii)(B)(2) of

this section.

(ii) Allocation between allocable ECI

deductible BIE and allocable non-ECI

deductible BIE. For purposes of

paragraph (c)(3)(i) of this section—

(A) Allocation to hypothetical

deductible amounts—(1) In general.

Subject to paragraph (c)(3)(ii)(A)(2) of

this section, deductible business interest

expense that is allocated to the specified

foreign partner from the partnership

pursuant to § 1.163(j)–6(f)(2) is allocated

pro rata to—

(i) Hypothetical partnership ECI

deductible BIE; and

(ii) Hypothetical partnership non-ECI

deductible BIE.

(2) Limitation. The amount allocated

to hypothetical partnership ECI

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deductible BIE in paragraph

(c)(3)(ii)(A)(1)(i) of this section cannot

exceed the lesser of hypothetical

partnership ECI deductible BIE or

allocable ECI BIE, and the amount

allocated to hypothetical partnership

non-ECI deductible BIE in paragraph

(c)(3)(ii)(A)(1)(ii) of this section cannot

exceed the lesser of hypothetical

partnership non-ECI deductible BIE or

allocable non-ECI BIE.

(B) Allocation of remaining deductible

amounts. Deductible business interest

expense that is allocated to the specified

foreign partner from the partnership

pursuant to § 1.163(j)–6(f)(2) in excess of

the amount allocated in paragraph

(c)(3)(ii)(A) of this section, if any, is

allocated pro rata to—

(1) Allocable ECI BIE, reduced by the

amount described in paragraph

(c)(3)(ii)(A)(1)(i) of this section; and

(2) Allocable non-ECI BIE, reduced by

the amount described in paragraph

(c)(3)(ii)(A)(1)(ii) of this section.

(iii) Hypothetical partnership

deductible business interest expense—

(A) Hypothetical partnership ECI

deductible BIE. The term hypothetical

partnership ECI deductible BIE means

the deductible business interest expense

of the partnership, as defined in

§ 1.163(j)–6(b)(5), determined by only

taking into account the specified foreign

partner’s allocable share of items that

are ECI (including by reason of

paragraph (f)(1)(iii) of this section).

(B) Hypothetical partnership non-ECI

deductible BIE. The term hypothetical

partnership non-ECI deductible BIE

means the deductible business interest

expense of the partnership, as defined

in § 1.163(j)–6(b)(5), determined by only

taking into account the specified foreign

partner’s allocable share of items that

are not ECI (including by reason of

paragraph (f)(1)(iii) of this section).

(4) Characterization of excess

business interest income—(i) In general.

The portion of excess business interest

income allocated to a specified foreign

partner from a partnership pursuant to

§ 1.163(j)–6(f)(2) that is ECI is equal to

the specified foreign partner’s allocation

of excess business interest income from

the partnership multiplied by its

specified BII ratio with respect to the

partnership, and the remainder is not

ECI.

(ii) Specified BII ratio. The term

specified BII ratio means the ratio of the

specified foreign partner’s allocable ECI

BII to allocable business interest income

(determined under § 1.163(j)–6(f)(2)(ii)).

(iii) Allocable ECI BII. The term

allocable ECI BII means the specified

foreign partner’s allocable BII, as

determined under § 1.163(j)–6(f)(2)(ii),

computed by only taking into account

income that is ECI.

(5) Rules for determining ECI. Except

as described in paragraph (f)(1) of this

section, if the determination as to

whether partnership items are ECI is

made by a direct or indirect partner,

rather than the partnership itself, then

for purposes of this paragraph (c), the

partnership must use a reasonable

method to characterize such items as

ECI or as not ECI.

(d) Characterization of disallowed

business interest expense by a relevant

foreign corporation with ECI—(1) Scope.

A relevant foreign corporation that has

ECI and disallowed business interest

expense for a taxable year determines

the portion of its disallowed business

interest expense and deductible

business interest expense that is

characterized as ECI or as not ECI under

this paragraph (d). A relevant foreign

corporation that is a specified foreign

partner also applies the rules in

paragraph (c) of this section. See also

§ 1.163(j)–7(f) for rules regarding CFC

group members with ECI.

(2) Characterization of disallowed

business interest expense—(i) FC ECI

disallowed BIE. For purposes of this

section, the portion of disallowed

business interest expense of a relevant

foreign corporation that is ECI (FC ECI

disallowed BIE) is equal to the excess,

if any, of FC ECI BIE over FC ECI

deductible BIE.

(ii) FC non-ECI disallowed BIE. For

purposes of this section, the portion of

disallowed business interest expense of

a relevant foreign corporation that is not

ECI (FC non-ECI disallowed BIE) is

equal to the excess, if any, of FC non-

ECI BIE over FC non-ECI deductible BIE.

(3) Characterization of deductible

business interest expense—(i) In

general. The portion of deductible

business interest expense, if any, that is

ECI (FC ECI deductible BIE) is equal to

the sum of the amounts described in

paragraphs (d)(3)(ii)(A)(1)(i) and

(d)(3)(ii)(B)(1) of this section. The

portion of deductible business interest

expense, if any, that is allocable to

income that is not ECI (FC non-ECI

deductible BIE) is equal to the sum of

the amounts described in paragraphs

(d)(3)(ii)(A)(1)(ii) and (d)(3)(ii)(B)(2) of

this section.

(ii) Allocation between FC ECI

deductible BIE and FC non-ECI

deductible BIE. For purposes of

paragraph (d)(3)(i) of this section—

(A) Allocation to hypothetical

deductible amounts—(1) In general.

Subject to paragraph (d)(3)(ii)(A)(2) of

this section, deductible business interest

expense is allocated pro rata to—

(i) Hypothetical FC ECI deductible

BIE; and

(ii) Hypothetical FC non-ECI

deductible BIE.

(2) Limitation. The amount allocated

to hypothetical FC ECI deductible BIE in

paragraph (d)(3)(ii)(A)(1)(i) of this

section cannot exceed the lesser of

hypothetical FC ECI deductible BIE or

FC ECI BIE, and the amount allocated to

hypothetical FC non-ECI deductible BIE

in paragraph (d)(3)(ii)(A)(1)(ii) of this

section cannot exceed the lesser of

hypothetical FC non-ECI deductible BIE

or FC non-ECI BIE.

(B) Allocation of remaining deductible

amounts. Deductible business interest

expense in excess of the amount

allocated in paragraph (d)(3)(ii)(A) of

this section, if any, is allocated pro rata

to—

(1) FC ECI BIE, reduced by the

amount described in paragraph

(d)(3)(ii)(A)(1)(i) of this section; and

(2) FC non-ECI BIE, reduced by the

amount described in paragraph

(d)(3)(ii)(A)(1)(ii) of this section.

(iii) Hypothetical FC deductible

business interest expense—(A)

Hypothetical FC ECI deductible BIE. The

term hypothetical FC ECI deductible BIE

means the deductible business interest

expense of the relevant foreign

corporation determined by only taking

into account its items that are ECI.

(B) Hypothetical FC non-ECI

deductible BIE. The term hypothetical

FC non-ECI deductible BIE means the

deductible business interest expense of

the relevant foreign corporation

determined by only taking into account

its items that are not ECI.

(e) Rules regarding disallowed

business interest expense—(1) Retention

of character in a succeeding taxable

year. Disallowed business interest

expense of a specified foreign person or

a relevant foreign corporation for a

taxable year (including excess business

interest expense allocated to a specified

foreign partner under § 1.163(j)–6(f)(2)

or paragraph (e)(2) of this section) that

is ECI or is not ECI retains its character

as ECI or as not ECI in a succeeding

taxable year.

(2) Deemed allocation of excess

business interest expense of a

partnership to a specified foreign

partner. For purposes of this paragraph

(e) and paragraphs (c)(2), (g)(3), and

(g)(7) of this section, a specified foreign

partner’s allocable share of business

interest expense is deemed to include

its allocable share of excess business

interest expense of a partnership in

which it is a direct or indirect partner.

For purposes of this paragraph (e)(2), a

specified foreign partner’s allocable

share of excess business interest

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expense of a partnership in which it is

a direct or indirect partner is

determined as if the excess business

interest expense of the partnership were

deductible in the taxable year in which

the interest expense is first paid or

accrued.

(3) Ordering rule for conversion of

excess business interest expense to

business interest expense paid or

accrued by a partner. A specified

foreign partner’s allocable share of

excess business interest expense

(determined under § 1.163(j)–6(f)(2) or

paragraph (e)(2) of this section) is

treated as business interest expense paid

or accrued under § 1.163(j)–6(g)(2)(i) in

the order of the taxable years in which

the excess business interest expense

arose, and pro rata between allocable

ECI excess BIE and allocable non-ECI

excess BIE that arose in the same taxable

year. This paragraph (e)(3) applies

before application of paragraph (b)(3) of

this section.

(4) Allocable ECI excess BIE and

allocable non-ECI excess BIE retains its

character when treated as business

interest expense paid or accrued in a

succeeding taxable year. If excess

business interest expense of a

partnership in which a specified foreign

partner is a direct or indirect partner is

treated as business interest expense paid

or accrued by the specified foreign

partner or a partnership in which it is

a direct or indirect partner under

§ 1.163(j)–6(g)(2)(i), then allocable ECI

excess BIE is treated as business interest

expense allocable to ECI and allocable

non-ECI excess BIE is treated as

business interest expense allocable to

income that is not ECI.

(f) Coordination of the application of

section 163(j) with § 1.882–5 and similar

provisions and with the branch profits

tax—(1) Coordination of section 163(j)

with § 1.882–5 and similar provisions—

(i) Ordering rule. A foreign corporation

first determines its business interest

expense allocable to ECI under § 1.882–

5 or any other relevant provision

(§ 1.882–5 and similar provisions) before

applying section 163(j) to the foreign

corporation. If a foreign corporation has

a disallowed business interest expense

carryforward from a taxable year, then

none of that business interest expense is

taken into account for purposes of

determining business interest expense

under § 1.882–5 and similar provisions

in a succeeding taxable year.

(ii) Treatment of excess business

interest expense. For purposes of

applying § 1.882–5 and similar

provisions, the business interest

expense of a specified foreign partner

that is a direct or indirect partner in a

partnership is determined without

regard to the application of section

163(j) to the partnership. As a result, for

purposes of applying § 1.882–5 and

similar provisions, the specified foreign

partner’s share of business interest

expense on liabilities of a partnership in

which it is a direct or indirect partner

is determined as if any excess business

interest expense of the partnership

(determined under § 1.163(j)–6(f)(2) or

paragraph (e)(2) of this section) were

deductible in the taxable year in which

the business interest expense is first

paid or accrued and not in a succeeding

taxable year.

(iii) Attribution of certain § 1.882–5

interest expense among the foreign

corporation and its partnership

interests—(A) In general. If a foreign

corporation is a specified foreign

partner in one or more partnerships,

then, for purposes of section 163(j) and

the section 163(j) regulations, interest

expense determined under § 1.882–5(b)

through (d) or § 1.882–5(e) (§1.882–5

three-step interest expense) is treated as

attributable to liabilities of the foreign

corporation or the foreign corporation’s

share of liabilities of each partnership in

accordance with paragraphs (f)(1)(iii)(B)

and (f)(1)(iii)(C) of this section.

Accordingly, the portion of the § 1.882–

5 three-step interest expense attributable

to liabilities of the foreign corporation

described in this paragraph (f)(1)(iii) is

subject to section 163(j) and the section

163(j) regulations at the level of the

foreign corporation. The portion of the

§ 1.882–5 three-step interest expense

interest attributable to liabilities of a

partnership described in this paragraph

(f)(1)(iii) is subject to section 163(j) and

the section 163(j) regulations at the

partnership-level. See § 1.163(j)–6. This

paragraph (f)(1)(iii) merely characterizes

interest expense of the foreign

corporation and its partnership interests

as ECI or not ECI. It does not change the

amount of interest expense of the

foreign corporation or its partnership

interests.

(B) Attribution of interest expense on

U.S. booked liabilities. The § 1.882–5

three-step interest expense is treated as

attributable, pro rata, to interest expense

on U.S. booked liabilities of a foreign

corporation, determined under § 1.882–

5(d)(2)(ii)–(iii) or its interest expense on

its share of U.S. booked liabilities of a

partnership, determined under § 1.882–

5(d)(2)(vii), as applicable, to the extent

thereof (without regard to whether the

foreign corporation uses the method

described in § 1.882–5(b) through (d) or

the method described in § 1.882–5(e) for

purposes of determining § 1.882–5

interest expense).

(C) Attribution of excess § 1.882–5

three-step interest expense—(1) In

general. The § 1.882–5 three-step

interest expense in excess of interest

expense attributable to U.S. booked

liabilities described in § 1.882–5(d)(2), if

any (excess § 1.882–5 three-step interest

expense), is treated as attributable to

liabilities of the foreign corporation or

the foreign corporation’s allocable share

of liabilities of one or more

partnerships, in accordance with

paragraphs (f)(1)(iii)(C)(2) and

(f)(1)(iii)(C)(3) of this section, subject to

the limitation in paragraph

(f)(1)(iii)(C)(4) of this section. For

purposes of this paragraph (f)(1)(iii)(C),

the term ‘‘U.S. assets’’ means U.S. assets

described in § 1.882–5(b).

(2) Attribution of excess § 1.882–5

three-step interest expense to the foreign

corporation. Excess § 1.882–5 three-step

interest expense is treated as

attributable to interest expense on

liabilities of the foreign corporation (and

not its partnership interests) in

proportion to its U.S. assets other than

its partnership interests over all of its

U.S. assets.

(3) Attribution of excess § 1.882–5

three-step interest expense to

partnerships—(i) In general. Excess

§ 1.882–5 three-step interest expense is

treated as attributable to interest

expense on the foreign corporation’s

direct or indirect allocable share of

liabilities of a partnership in proportion

to the portion of the partnership interest

that is treated as a U.S. asset under

paragraph (f)(1)(iii)(C)(3)(ii) of this

section over all of the foreign

corporation’s U.S. assets.

(ii) Direct and indirect partnership

interests. If a foreign corporation owns

an interest in a partnership that does not

own an interest in any other

partnerships, the portion of the

partnership interest that is a U.S. asset

is determined under § 1.882–5(b). If a

foreign corporation owns an interest in

a partnership (the top-tier partnership)

that owns an interest in one or more

other partnerships, directly or indirectly

(the lower-tier partnerships), the portion

of the foreign corporation’s direct or

indirect interest in the top-tier

partnership and lower-tier partnerships

that is a U.S. asset is determined by re-

attributing the portion of the top-tier

partnership interest that is a U.S. asset,

as determined under § 1.882–5(b),

among the foreign corporation’s direct

interest in the top-tier partnership and

indirect interests in each lower-tier

partnership in proportion to their

contribution to the portion of the foreign

corporation’s interest in the upper-tier

partnership that is a U.S. asset. Each

partnership interest’s contribution is

determined based on a reasonable

method consistent with the method

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used to determine the portion of the top-

tier partnership interest that is a U.S.

asset under § 1.882–5(b).

(4) Limitation on attribution of excess

§ 1.882–5 three-step interest expense.

The portion of excess § 1.882–5 three-

step interest expense attributable to a

foreign corporation under paragraph

(f)(1)(iii)(C)(2) of this section or to a

partnership under paragraph

(f)(1)(iii)(C)(2) or (f)(1)(iii)(C)(3) of this

section, as applicable, is limited to

interest on liabilities of the foreign

corporation or the foreign corporation’s

allocable share of liabilities of the

partnership, reduced by the sum of the

amounts of interest expense on its U.S.

booked liabilities described in § 1.882–

5(d)(2) and interest expense on

liabilities described in § 1.882–

5(a)(1)(ii)(A) or (B) (regarding direct

allocations of interest expense). The

portion of any excess § 1.882–5 three-

step interest expense that would be

treated as attributable to the foreign

corporation or a partnership interest, as

applicable, but for this paragraph

(f)(1)(iii)(C)(4) is re-attributable in

accordance with the rules and

principles of this paragraph (f)(1)(iii)(C).

The portion of any excess § 1.882–5

three-step interest expense that cannot

be re-attributed under the rules of

(f)(1)(iii)(C)(1) through (3) of this section

because of the application of the first

sentence of this paragraph

(f)(1)(iii)(C)(4) is attributable, first to

interest on liabilities of the foreign

corporation, and then, pro rata, to the

foreign corporation’s allocable share of

interest on liabilities of its direct or

indirect partnership interests, to the

extent such attribution is not in excess

of the limitation described in this

paragraph (f)(1)(iii)(C)(4), and without

regard to whether the foreign

corporation or its partnership interests

have U.S. assets.

(2) Coordination with the branch

profits tax. The disallowance and

carryforward of business interest

expense under § 1.163(j)–2(b) and (c)

will not affect the computation of the

U.S. net equity of a foreign corporation,

as defined in § 1.884–1(c).

(g) Definitions. The following

definitions apply for purposes of this

section.

(1) § 1.882–5 and similar provisions.

The term § 1.882–5 and similar

provisions has the meaning provided in

paragraph (f)(1)(i) of this section.

(2) § 1.882–5 three-step interest

expense. The term § 1.882–5 three-step

interest expense has the meaning

provided in paragraph (f)(1)(iii)(A) of

this section.

(3) Allocable ECI BIE. The term

allocable ECI BIE means, with respect to

a partnership, the specified foreign

partner’s allocable share of the

partnership’s business interest expense

that is ECI, taking into account the

application of paragraph (e)(2) of this

section.

(4) Allocable ECI BII. The term

allocable ECI BII has the meaning

provided in paragraph (c)(4)(ii) of this

section.

(5) Allocable ECI deductible BIE. The

term allocable ECI deductible BIE has

the meaning provided in paragraph

(c)(3)(i) of this section.

(6) Allocable ECI excess BIE. The term

allocable ECI excess BIE has the

meaning provided in paragraph (c)(2)(i)

of this section.

(7) Allocable non-ECI BIE. The term

allocable non-ECI BIE means, with

respect a partnership, the specified

foreign partner’s allocable share of the

partnership’s business interest expense

that is not ECI, taking into account the

application of paragraph (e)(2) of this

section.

(8) Allocable non-ECI deductible BIE.

The term allocable non-ECI deductible

BIE has the meaning provided in

paragraph (c)(3)(i) of this section.

(9) Allocable non-ECI excess BIE. The

term allocable non-ECI excess BIE has

the meaning provided in paragraph

(c)(2)(ii) of this section.

(10) Distributive share of ECI. The

term distributive share of ECI has the

meaning provided in paragraph

(c)(1)(iii) of this section.

(11) Distributive share of non-ECI. The

term distributive share of non-ECI has

the meaning provided in paragraph

(c)(1)(iv) of this section.

(12) Effectively connected income.

The term effectively connected income

(or ECI) means income or gain that is

ECI, as defined in § 1.884–1(d)(1)(iii),

and deduction or loss that is allocable

to, ECI, as defined in § 1.884–1(d)(1)(iii).

(13) Excess § 1.882–5 three-step

interest expense. The term excess

§ 1.882–5 three-step interest expense has

the meaning provided in paragraph

(f)(1)(iii)(C)(1) of this section.

(14) FC ECI BIE. The term FC ECI BIE

means, with respect to a relevant foreign

corporation and a taxable year, business

interest expense that is ECI, determined

without regard to the application of

section 163(j) and the section 163(j)

regulations except for the application of

paragraph (f)(1)(iii) of this section.

(15) FC ECI deductible BIE. The term

FC ECI deductible BIE has the meaning

provided in paragraph (d)(3)(i) of this

section.

(16) FC ECI disallowed BIE. The term

FC ECI disallowed BIE has the meaning

provided in paragraph (d)(2)(i) of this

section.

(17) FC non-ECI BIE. The term FC

non-ECI BIE means, with respect to a

relevant foreign corporation and a

taxable year, business interest expense

that is not ECI, determined without

regard to the application of section

163(j) and the section 163(j) regulations

except for the application of paragraph

(f)(1)(iii) of this section.

(18) FC non-ECI deductible BIE. The

term FC non-ECI deductible BIE has the

meaning provided in paragraph (d)(3)(i)

of this section.

(19) FC non-ECI disallowed BIE. The

term FC non-ECI disallowed BIE has the

meaning provided in paragraph (d)(2)(ii)

of this section.

(20) Hypothetical partnership ECI

deductible BIE. The term hypothetical

partnership ECI deductible BIE has the

meaning provided in paragraph

(c)(3)(iii)(A) of this section.

(21) Hypothetical partnership non-ECI

deductible BIE. The term hypothetical

partnership non-ECI deductible BIE has

the meaning provided in paragraph

(c)(3)(iii)(B) of this section.

(22) Hypothetical FC ECI deductible

BIE. The term hypothetical FC ECI

deductible BIE has the meaning

provided in paragraph (d)(3)(iii)(A) of

this section.

(23) Hypothetical FC non-ECI

deductible BIE. The term hypothetical

FC non-ECI deductible BIE has the

meaning provided in paragraph

(d)(3)(iii)(B) of this section.

(24) Specified ATI ratio. The term

specified ATI ratio has the meaning

provided in paragraph (c)(1)(ii) of this

section.

(25) Specified BII ratio. The term

specified BII ratio has the meaning

provided in paragraph (c)(4)(ii) of this

section.

(26) Specified foreign partner. The

term specified foreign partner means,

with respect to a partnership that has

ECI, a direct or indirect partner that is

a specified foreign person or a relevant

foreign corporation.

(27) Specified foreign person. The

term specified foreign person means a

nonresident alien individual, as defined

in section 7701(b) and the regulations

under section 7701(b), or a foreign

corporation other than a relevant foreign

corporation.

(28) Successor. The term successor

includes, with respect to a foreign

corporation, the acquiring corporation

in a transaction described in section

381(a) in which the foreign corporation

is the distributor or transferor

corporation.

(h) Examples. The following examples

illustrate the application of this section.

For all examples, assume that all

referenced interest expense is

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deductible but for the application of

section 163(j), the small business

exemption under § 1.163(j)–2(d) is not

available, no entity is engaged in an

excepted trade or business, no business

interest expense is floor plan financing

interest expense, all entities have the

same taxable year, all entities use the

U.S. dollar as their functional currency,

no foreign corporation is a relevant

foreign corporation, all relevant taxable

years begin after December 31, 2020,

and, for purposes of computing ATI,

none of the adjustments described in

§ 1.163(j)–1(b) are relevant other than

the adjustment for business interest

expense.

(1) Example 1. Limitation on business

interest deduction of a foreign corporation—

(i) Facts. FC, a foreign corporation, has $100x

of gross income that is ECI. FC has $60x of

other income which is not ECI. FC has total

expenses of $100x, of which $50x is business

interest expense. Assume that FC has $30x of

§ 1.882–5 three-step interest expense. Under

section 882(c) and the regulations, FC has

$40x of other expenses that are ECI, none of

which are business interest expense. FC does

not have any business interest income. All

amounts described in this paragraph (h)(1)(i)

are with respect to a single taxable year of

FC.

(ii) Analysis. FC is a specified foreign

person under paragraph (g)(27) of this

section. The amount of FC’s business interest

expense that is disallowed for the taxable

year is determined under § 1.163(j)–2(b) with

respect to business interest expense

described in paragraph (b)(3) of this section.

Under paragraph (b)(3) of this section, FC has

business interest expense of $30x. Under

paragraph (b)(2) of this section, FC has ATI

of $60x ($100x¥$40x). Accordingly, FC’s

section 163(j) limitation is $18x ($60x × 30

percent). Because FC’s business interest

expense ($30x) that is ECI exceeds the

section 163(j) limitation ($18x), FC may only

deduct $18x of business interest expense.

Under § 1.163(j)–2(c), the remaining $12x is

disallowed business interest expense

carryforward, and under paragraph (f)(1)(i) of

this section, the $12x is not taken into

account for purposes of applying § 1.882–5 in

the succeeding taxable year.

(2) Example 2. Use of a disallowed

business interest expense carryforward—(i)

Facts. The facts are the same as in Example

1 in paragraph (h)(1)(i) of this section except

that for the taxable year FC has $300x of

gross income that is all ECI. Furthermore,

assume that for the taxable year FC has a

disallowed business interest expense

carryforward of $25x with respect to business

interest expense described in paragraph (b)(3)

of this section.

(ii) Analysis. Under paragraph (f)(1)(i) of

this section, FC’s $25x of disallowed

business interest expense carryforward is not

taken into account for purposes of

determining FC’s interest expense under

§ 1.882–5 for the taxable year. Therefore, FC

has $30x of § 1.882–5 three-step interest

expense. Under paragraph (b)(2) of this

section, FC has ATI of $260x ($300x of gross

income reduced by $40 of expenses other

than business interest expense). Accordingly,

FC’s section 163(j) limitation is $78x ($260x

× 30 percent). Because FC’s business interest

expense ($55x) does not exceed the section

163(j) limitation ($78x), FC may deduct all

$55x of business interest expense.

(3) Example 3. Foreign corporation is

engaged in a U.S. trade or business and is

also a specified foreign partner—(i) Facts.

FC, a foreign corporation, owns a 50-percent

interest in ABC, a partnership that has ECI.

In addition to owning a 50-percent interest in

ABC, FC conducts a separate business that is

engaged in a trade or business in the United

States, Business Y. Business Y produces $65x

of taxable income before taking into account

business interest expense and has U.S. assets

with an adjusted basis of $300x, business

interest expense of $15x on $160x of

liabilities, and no business interest income.

All of the liabilities of Business Y are U.S.

booked liabilities for purposes of § 1.882–

5(d). FC also has various foreign operations,

some of which have U.S. dollar denominated

debt. ABC has two lines of business, Business

S and Business T. FC is allocated 50 percent

of all items of income and expense of

Business S and Business T. Business S

produces $140x of taxable income before

taking into account business interest

expense, and Business T produces $80x of

taxable income before taking into account

business interest expense. Business S has

business interest expense of $20x on $400x

of liabilities and no business interest income.

Business T has business interest expense of

$10x on $150x of liabilities and no business

interest income. With respect to FC, only

Business S produces ECI. FC has an outside

basis of $600x in the portion of its ABC

partnership interest that is a U.S. asset for

purposes of § 1.882–5(b), step 1. All of the

liabilities of Business S are U.S. booked

liabilities for purposes of § 1.882–5(d). FC

computes its interest expense under the

three-step method described in § 1.882–5(b)

through (d) and for purposes of § 1.882–5(c),

step 2, FC uses the fixed ratio of 50 percent

described in § 1.882–5(c)(4) for taxpayers that

are neither a bank nor an insurance company.

Under § 1.882–5(d)(5)(ii), FC’s interest rate

on excess U.S. connected liabilities is 5

percent. For the taxable year, assume FC has

total interest expense of $100x for purposes

of § 1.882–5(a)(3). All amounts described in

this paragraph (h)(3)(i) are with respect to a

single taxable year of FC or ABC, as

applicable.

(ii) Analysis—(A) Application of § 1.882–5

to FC. FC is a specified foreign person under

paragraph (g)(27) of this section and a

specified foreign partner under paragraph

(g)(26) of this section. Under paragraph (f)(1)

of this section, FC first determines its

§ 1.882–5 three-step interest expense and

then applies section 163(j). Under § 1.882–

5(b), step 1, FC has U.S. assets of $900x

($600x of basis in the portion of its ABC

partnership interest that is a U.S. asset

determined using the asset method described

in § 1.884–1(d)(3)(ii) + $300x basis in U.S.

assets of Business Y). Under § 1.882–5(c),

step 2, applying the 50-percent fixed ratio

described in § 1.882–5(c)(4), FC has U.S.

connected liabilities of $450x ($900x × 50

percent). Under § 1.882–5(d), step 3, FC has

U.S. booked liabilities of $360x ($200x

attributable to its 50-percent share of

Business S liabilities of ABC + $160x of

Business Y liabilities) and interest on U.S.

booked liabilities of $25x ($10x attributable

to its 50-percent share of $20x interest

expense of Business S + $15x of Business Y

interest expense). FC has excess U.S.

connected liabilities of $90x ($450x¥$360x)

and under § 1.882–5(d)(5) has interest

expense on excess U.S. connected liabilities

of $4.50x ($90x × 5 percent), which is excess

§ 1.882–5 three-step interest expense. FC’s

§ 1.882–5 three-step interest expense is

$29.50x ($25x + $4.50x).

(B) Attribution of § 1.882–5 business

interest expense between FC and ABC. Under

paragraph (f)(1)(iii) of this section, FC’s

§ 1.882–5 three-step interest expense is

attributable to interest on its liabilities or on

its share of ABC liabilities. Under paragraph

(f)(1)(iii)(B), FC’s § 1.882–5 three-step interest

expense of $29.50x is first attributable to $15

of interest expense on FC’s (Business Y) U.S.

booked liabilities and $10x of interest

expense on FC’s share of U.S. booked

liabilities of ABC. Under paragraph

(f)(1)(iii)(C)(2) of this section, of the excess

§ 1.882–5 three-step interest expense of

$4.50x ($29.50x¥$15x¥$10x), 66.67 percent

($600x of basis in the portion of the ABC

partnership interest that is a U.S. asset/$900x

of total U.S. assets), or $3.00x, is attributable

to interest expense on FC’s share of liabilities

of ABC and 33.33 percent ($300x U.S. assets

other than partnership interests/$900x of

total U.S. assets), or $1.50x, is attributable to

interest expense on liabilities of FC. As a

result, $16.50x of business interest expense

($15x + $1.50x) is attributed to FC and $13x

of business interest expense ($10x + $3x) is

attributed to ABC. The limitation under

paragraph (f)(1)(iii)(C)(4) of this section does

not change the result described in the

preceding sentence. Specifically, under

paragraph (f)(1)(iii)(C)(4) of this section, the

amount attributed to ABC (tentatively,

$3.00x) is limited to $5x (FC’s 50-percent

share of the $30x of business interest expense

of ABC or $15x, reduced by FC’s 50-percent

share of the $20x of business interest expense

on U.S. booked liabilities of Business S), and

the amount attributed to FC (tentatively,

$1.50x) is limited to $70x (FC’s business

interest expense of $100x, reduced by $15x

of business interest expense on U.S. booked

liabilities of Business Y and its $15x

allocable share of ABC’s business interest

expense).

(C) Application of the section 163(j)

limitation to ABC. Under § 1.163(j)–6(a), ABC

computes a section 163(j) limitation at the

partnership level. ABC has business interest

expense of $30x ($20x from Business S and

$10x from Business T). Under § 1.163(j)–6(d),

ABC has ATI of $220x ($140 + $80). Under

§ 1.163(j)–2(b), ABC’s section 163(j)

limitation is $66x ($220x × 30 percent).

Because ABC’s business interest expense

($30x) does not exceed the section 163(j)

limitation ($66x), all of ABC’s business

interest expense is deductible for the taxable

year.

(D) Excess taxable income of ABC. Under

§ 1.163(j)–1(b)(15), ABC has excess taxable

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income of $120x ($220x × ($36x/$66x)).

Under § 1.163(j)–6(f)(2), FC is allocated 50

percent of the $120x of ABC’s excess taxable

income or $60x of allocable excess taxable

income. Under paragraph (c)(1) of this

section, the amount of the allocable excess

taxable income of $60x that is ECI is equal

to FC’s allocable excess taxable income

multiplied by the specified ATI ratio. Under

paragraph (c)(1)(iii) of this section, FC’s

distributive share of ECI of ABC is $57x (FC’s

50-percent share of $140x (Business S

income computed without regard to business

interest expense) or $70x–$13x of business

interest expense that is ECI). Under

paragraph (c)(1)(iv) of this section, FC’s

distributive share of non-ECI of ABC is $38x

(FC’s 50-percent share of $80x (Business T

income computed without regard to business

interest expense) or $40x–$2x of business

interest expense that is not ECI). FC’s

distributive share of partnership items of

income, gain, deduction, and loss of ABC is

$95x ($57x distributive share of ECI and $38x

distributive share of non-ECI). Because both

FC’s distributive share of ECI and distributive

share of non-ECI are positive, under

paragraph (c)(1)(ii) of this section, the

specified ATI ratio is 60 percent ($57x

distributive share of ECI/$95x distributive

share of partnership items of income, gain,

deduction, and loss of ABC). As a result, the

amount of FC’s allocable excess taxable

income from ABC that is ECI is $36x ($60 of

allocable excess taxable income × 60 percent

specified ATI ratio).

(E) Application of section 163(j) to FC.

Under paragraph (b)(3) of this section, FC’s

business interest expense is $16.50x. Under

§ 1.163(j)–6(e)(1), FC’s ATI is determined

under § 1.163(j)–1(b)(1) without regard to

FC’s distributive share of any items of

income, gain, deduction, or loss of ABC.

Under paragraph (b)(2) of this section, FC’s

ATI is $101x ($65x of ECI from Business Y

+ $36x of allocable excess taxable income

from ABC that is ECI). FC’s section 163(j)

limitation is $30.30x ($101x × 30 percent).

Because FC’s business interest expense

($16.50x) is less than FC’s section 163(j)

limitation ($30.30x) and all of its share of

ABC’s business interest expense that is

allocable to ECI ($13x) is deductible, FC may

deduct all $29.50x of § 1.882–5 three-step

interest expense determined under paragraph

(h)(3)(ii)(A) of this section.

(4) Example 4. Specified foreign partner

with excess business interest expense from a

partnership—(i) Facts—(A) In general. FC, a

foreign corporation, owns a 50-percent

interest in ABC, a partnership that has ECI.

In addition to owning a 50-percent interest in

ABC, FC conducts a separate business that is

engaged in a trade or business in the United

States, Business Y. Business Y produces $56x

of taxable income before taking into account

business interest expense and has U.S. assets

with an adjusted basis of $800x, business

interest expense of $16x on $200x of

liabilities, and no business interest income.

All of the liabilities of Business Y are U.S.

booked liabilities for purposes of § 1.882–

5(d). FC also has various foreign operations,

some of which have U.S. dollar denominated

debt.

(B) ABC Partnership. ABC has two lines of

business, Business S and Business T, and

owns a 50-percent interest in DEF, a

partnership. FC is allocated 50 percent of all

items of income and expenses of Business S

and Business T and ABC’s allocable share of

items from partnership DEF. Business S

produces $80x of taxable income before

taking into account business interest

expense, and Business T produces $90x of

taxable income before taking into account

business interest expense. Business S has

business interest expense of $30x on $500x

of liabilities and no business interest income.

Business T has business interest expense of

$50x on $500x of liabilities and no business

interest income. With respect to FC, only

Business S produces ECI. All of the liabilities

of Business S are U.S. booked liabilities for

purposes of § 1.882–5(d).

(C) DEF Partnership. DEF has two lines of

business, Business U and Business V. ABC is

allocated 50 percent of all items of income

and expenses of Business U and Business V.

Business U produces $100x of taxable

income before taking into account business

interest expense and Business V produces

$140x of taxable income before taking into

account business interest expense. Business

U has business interest expense of $40x on

$600x of liabilities and no business interest

income. Business V has business interest

expense of $60x on $600x of liabilities and

no business interest income. With respect to

FC, only Business U produces ECI. All of the

liabilities of Business U are U.S. booked

liabilities for purposes of § 1.882–5(d).

(D) Section 1.882–5. FC has an outside

basis of $600x in the portion of its ABC

partnership interest that is a U.S. asset for

purposes of § 1.882–5(b), step 1, determined

using the asset method described in § 1.884–

1(d)(3)(ii). For purposes of § 1.884–1(d)(3)(ii),

ABC has a total basis of $500 in assets that

would be treated as U.S. assets if ABC were

a foreign corporation, including a basis of

$250x in the portion of its interest in DEF

partnership interest that would be treated as

a U.S. asset if ABC were a foreign

corporation. FC computes its interest expense

under the three-step method described in

§ 1.882–5(b) through (d), and for purposes of

§ 1.882–5(c), step 2, FC uses the fixed ratio

of 50 percent described in § 1.882–5(c)(4) for

taxpayers that are neither a bank nor an

insurance company. FC has total interest

expense of $100x for purposes of § 1.882–

5(a)(3). Under § 1.882–5(d)(5)(ii), FC’s

interest rate on excess U.S. connected

liabilities is 6 percent. All amounts described

in this paragraph (h)(4)(i) are with respect to

a single taxable year of FC, ABC, or DEF, as

applicable.

(ii) Analysis—(A) Application of § 1.882–5

to FC. FC is a specified foreign person under

paragraph (g)(27) of this section and a

specified foreign partner under paragraph

(g)(26) of this section. Under paragraph (f)(1)

of this section, FC first determines its

§ 1.882–5 three-step interest expense and

then applies section 163(j). Under § 1.882–

5(b), step 1, FC has U.S. assets of $1400x

($600x of basis in the portion of its ABC

partnership interest that is a U.S. asset +

$800x basis in U.S. assets of Business Y).

Under § 1.882–5(c), step 2, applying the 50-

percent fixed ratio described in § 1.882–

5(c)(4), FC has U.S. connected liabilities of

$700x ($1400x × 50 percent). Under § 1.882–

5(d), step 3, FC has U.S. booked liabilities of

$600x ($250x attributable to its 50-percent

share of Business S liabilities of ABC + $150x

attributable to its indirect 25-percent share of

Business U liabilities of DEF + $200x of

Business Y liabilities), and interest on U.S.

booked liabilities of $41x ($15x attributable

to its 50-percent share of $30x interest

expense of Business S + $10x attributable to

its 25-percent share of $40 interest expense

of Business U + $16x of Business Y interest

expense). FC has excess U.S. connected

liabilities of $100x ($700x¥$600x) and

under § 1.882–5(d)(5), interest expense on

excess U.S. connected liabilities of $6x

($100x × 6 percent), which is excess § 1.882–

5 three-step interest expense. FC’s § 1.882–5

three-step interest expense is $47x ($41x +

$6x).

(B) Attribution of certain § 1.882–5

business interest expense among FC, ABC,

and DEF. Under paragraph (f)(1)(iii) of this

section, FC’s § 1.882–5 three-step interest

expense is attributable to interest on its

liabilities or on its share of ABC and DEF’s

liabilities. Under paragraph (f)(1)(iii)(B) of

this section, FC’s § 1.882–5 three-step interest

expense of $47x is first attributable to $16 of

interest expense on FC’s U.S. booked

liabilities, $15x of interest expense on FC’s

share of U.S. booked liabilities of ABC, and

$10x of interest expense on FC’s share of U.S.

booked liabilities of DEF. Under paragraph

(f)(1)(iii)(C)(2) of this section, of the excess

§ 1.882–5 three-step interest expense of $6x

($47x¥$16x¥$15x¥$10x), 42.86 percent

($600x of basis in the portion of the ABC

partnership interest that is a U.S. asset/

$1400x of total U.S. assets) or $2.57x is

attributable to interest expense on FC’s share

of liabilities of ABC (and its partnership

interests), and 57.14 percent ($800x U.S.

assets other than partnership interests/

$1400x of total U.S. assets) or $3.43x is

attributable to interest expense on liabilities

of FC. Under paragraph (f)(1)(iii)(C)(3) of this

section, of the $2.57x of business interest

expense that is ECI and that is attributable to

interest expense on FC’s share of liabilities of

ABC (and its partnership interests), 50

percent ($250x of basis in the portion of the

DEF partnership interest that would be a U.S.

asset if ABC were a foreign corporation/

$500x total basis in assets that would be U.S.

assets if ABC were a foreign corporation), or

$1.29x, is attributable to interest expense on

FC’s share of liabilities of ABC and 50

percent ($250x of basis in assets other than

partnership interests that would be U.S.

assets if ABC were a foreign corporation/

$500x of total basis in assets that would be

U.S. assets if ABC were a foreign

corporation), or $1.29x is attributable to

interest expense on FC’s share of liabilities of

DEF. As a result, $19.43x ($16x + $3.43x) of

business interest expense is attributed to FC,

$16.29x ($15x + $1.29x) of business interest

expense is attributed to ABC, and $11.29x

($10x + $1.29x) of business interest expense

is attributed to DEF. The limitation under

paragraph (f)(1)(iii)(C)(4) of this section does

not change the result described in the

preceding sentence. Specifically, under

paragraph (f)(1)(iii)(C)(4) of this section, the

amount attributed to FC (tentatively, $3.43x)

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is limited to $19x (FC’s business interest

expense of $100x, reduced by $16x of

business interest expense on U.S. booked

liabilities of Business Y, its $40x allocable

share of ABC’s business interest expense, and

its $25 allocable share of DEF’s business

interest expense); the amount attributed to

ABC (tentatively, $1.29x) is limited to $25x

(FC’s 50-percent share of the $80x of business

interest expense of ABC, or $40x, reduced by

FC’s 50-percent share of the $30x of business

interest expense on U.S. booked liabilities of

Business S, or $15x); and the amount

attributed to DEF (tentatively, $1.29x) is

limited to $15x (FC’s 25-percent share of the

$100x of business interest expense of DEF, or

$25x, reduced by FC’s 25-percent share of the

$40x of business interest expense on U.S.

booked liabilities of Business U, or $10x).

(C) Application of section 163(j) to DEF—

(1) In general. Under § 1.163(j)–6(a), DEF

computes a section 163(j) limitation at the

partnership-level. DEF has business interest

expense of $100x ($40x from Business U +

$60x from Business V). Under § 1.163(j)–6(d),

DEF has ATI of $240x ($100x + $140x).

Under § 1.163(j)–2(b), DEF’s section 163(j)

limitation is $72x ($240x × 30 percent).

Because DEF’s business interest expense

($100x) exceeds the section 163(j) limitation

($72x), only $72x of DEF’s business interest

expense is deductible and $28x is disallowed

under section 163(j). Pursuant to paragraph

(e)(2) of this section, FC is allocated $7x of

excess business interest expense (25 percent

× $28x) and $18x of deductible business

interest expense (25 percent × $72x).

(2) Deductible business interest expense.

Under paragraph (c)(3) of this section, in

order to determine the portion of FC’s

allocable deductible business interest

expense ($18x) that is allocable ECI

deductible BIE and the portion that is

allocable non-ECI deductible BIE, the

hypothetical partnership ECI deductible BIE

and hypothetical partnership non-ECI

deductible BIE must be determined. Under

paragraph (c)(3)(iii)(A) of this section, FC’s

hypothetical partnership ECI deductible BIE

with respect to DEF is $7.50x ($25x of FC’s

allocable share of ECI before taking into

account interest expense × 30 percent).

Under paragraph (c)(3)(iii)(B) of this section,

FC’s hypothetical partnership non-ECI

deductible BIE with respect to DEF is

$10.50x ($35x of FC’s allocable share of

income that is not ECI before taking into

account interest expense × 30 percent).

Under paragraph (c)(3)(i) of this section,

allocable ECI deductible BIE is equal to the

amounts described in paragraphs

(c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of this

section and allocable non-ECI deductible BIE

is equal to the amounts described in

paragraphs (c)(3)(ii)(A)(1)(ii) and

(c)(3)(ii)(B)(2) of this section. Under

paragraph (c)(3)(ii)(A)(1) of this section, FC’s

allocable deductible business interest

expense ($18x) is allocated pro rata between

hypothetical partnership ECI deductible BIE

($7.50x) and hypothetical partnership non-

ECI deductible BIE ($10.50x). However, the

amount allocated to hypothetical partnership

ECI deductible BIE cannot exceed the lesser

of hypothetical partnership ECI deductible

BIE ($7.50x) or allocable ECI BIE ($11.29x),

and the amount allocated to hypothetical

partnership non-ECI deductible BIE cannot

exceed the lesser of hypothetical partnership

non-ECI deductible BIE ($10.50x) or allocable

non-ECI BIE (total allocable business interest

expense of $25x reduced by allocable ECI BIE

of $11.29x, or $13.71x). The portion of FC’s

allocable deductible business interest

expense ($18x) from DEF that is allocable ECI

deductible BIE is 41.67 percent ($7.50x of

hypothetical partnership ECI deductible BIE/

$18x of total hypothetical partnership

deductible BIE), or $7.5x. The portion of FC’s

allocable deductible business interest

expense from DEF ($18x) that is allocable

non-ECI deductible BIE is 58.33 percent

($10.50x of hypothetical partnership ECI

deductible BIE/$18x of total hypothetical

partnership deductible BIE), or $10.50x.

Because the full amount of FC’s allocable

deductible business interest expense ($18x)

is allocable under paragraph (c)(3)(ii)(A)(1) of

this section, no portion is allocated under

paragraph (c)(3)(ii)(B) of this section.

(3) Excess business interest expense. Under

paragraph (c)(2)(i) of this section, the portion

of excess business interest expense allocated

to FC from DEF pursuant to paragraph (e)(2)

of this section ($7x) that is allocable ECI

excess BIE is $3.79x ($11.29x of allocable ECI

BIE¥$7.50x allocable ECI deductible BIE).

Under paragraph (c)(2)(ii) of this section, the

portion of excess business interest expense

allocated to FC from DEF pursuant to

paragraph (e)(2) of this section ($7x) that is

allocable non-ECI excess BIE is $3.21x

($13.71x of allocable non-ECI BIE¥$10.50x

allocable non-ECI deductible BIE).

(D) Application of section 163(j) to ABC—

(1) In general. Under § 1.163(j)–6(a), ABC

computes a section 163(j) limitation at the

partnership-level. ABC has business interest

expense of $80x ($30x from Business S +

$50x from Business T). Under § 1.163(j)–6(d),

ABC has ATI of $170x ($80x + $90x). Under

§ 1.163(j)–2(b), ABC’s section 163(j)

limitation is $51x ($170x × 30 percent).

Because ABC’s business interest expense

($80x) exceeds the section 163(j) limitation

($51x), ABC may only deduct $51x of

business interest expense, and $29x is

disallowed under section 163(j). Pursuant to

§ 1.163(j)–6(f)(2), FC is allocated $14.50x of

excess business interest expense (50 percent

× $29x) and $25.50x of deductible business

interest expense (50 percent × $51x).

(2) Deductible business interest expense.

Under paragraph (c)(3) of this section, in

order to determine the portion of FC’s

allocable deductible business interest

expense ($25.50x) that is allocable ECI

deductible BIE and the portion that is

allocable non-ECI deductible BIE, the

hypothetical partnership ECI deductible BIE

and hypothetical partnership non-ECI

deductible BIE must be determined. Under

paragraph (c)(3)(iii)(A) of this section, FC’s

hypothetical partnership ECI deductible BIE

with respect to ABC is $12x ($40x of FC’s

allocable share of ECI before taking into

account interest expense × 30 percent).

Under paragraph (c)(3)(iii)(B) of this section,

FC’s hypothetical partnership non-ECI

deductible BIE with respect to ABC is

$13.50x ($45x of FC’s allocable share of

income that is not ECI before taking into

account interest expense × 30 percent).

Under paragraph (c)(3)(i) of this section,

allocable ECI deductible BIE is equal to the

amounts described in paragraphs

(c)(3)(ii)(A)(1)(i) and (c)(3)(ii)(B)(1) of this

section and allocable non-ECI deductible BIE

is equal to the amounts described in

paragraphs (c)(3)(ii)(A)(1)(ii) and

(c)(3)(ii)(B)(2) of this section. Under

paragraph (c)(3)(ii)(A)(1) of this section, FC’s

allocable deductible business interest

expense ($25.50x) is allocated pro rata

between hypothetical partnership ECI

deductible BIE ($12x) and hypothetical

partnership non-ECI deductible BIE

($13.50x). However, the amount allocated to

hypothetical partnership ECI deductible BIE

cannot exceed the lesser of hypothetical

partnership ECI deductible BIE ($12x) or

allocable ECI BIE ($16.29x), and the amount

allocated to hypothetical partnership non-ECI

deductible BIE cannot exceed the lesser of

hypothetical partnership non-ECI deductible

BIE ($13.50x) or allocable non-ECI BIE (total

allocable business interest expense of $40x

reduced by allocable ECI BIE of $16.29x, or

$23.71x). The portion of FC’s allocable

deductible business interest expense from

ABC ($25.50x) that is allocable ECI

deductible BIE is 47.06 percent ($12x of

hypothetical partnership ECI deductible BIE/

$25.50x of total hypothetical partnership

deductible BIE), or $12x. The portion of FC’s

allocable deductible business interest

expense from ABC that is allocable non-ECI

deductible BIE is 52.94 percent ($13.50x of

hypothetical partnership ECI deductible BIE/

$25.50x of total hypothetical partnership

deductible BIE), or $13.50x. Because the full

amount of FC’s allocable deductible business

interest expense ($25.50x) is allocable under

paragraph (c)(3)(ii)(A)(1) of this section, no

portion is allocated under paragraph

(c)(3)(ii)(B) of this section.

(3) Excess business interest expense. Under

paragraph (c)(2)(i) of this section, the portion

of excess business interest expense allocated

to FC from ABC pursuant to § 1.163(j)–

6(f)(2)($14.50x) that is allocable ECI excess

BIE is $4.29x ($16.29x of allocable ECI

BIE¥$12x allocable ECI deductible BIE).

Under paragraph (c)(2)(ii) of this section, the

portion of excess business interest expense

allocated to FC from ABC pursuant to

§ 1.163(j)–6(f)(2) ($14.50x) that is allocable

non-ECI excess BIE is $10.21x ($23.71x of

allocable non-ECI BIE¥$13.50x allocable

non-ECI deductible BIE).

(E) Application of section 163(j) to FC.

Under paragraph (b)(3) of this section, FC’s

business interest expense is $19.43x. Under

§ 1.163(j)–6(e)(1), FC’s ATI is determined

under § 1.163(j)–1(b)(1) without regard to

FC’s distributive share of any items of

income, gain, deduction, or loss of ABC or

DEF. Under paragraph (b)(2) of this section,

FC’s ATI is $56x ($56x of ECI of Business Y

before taking into account interest expense).

FC’s section 163(j) limitation is $16.80x

($56x × 30 percent). Because the portion of

FC’s business interest expense determined

under § 1.882–5 that is attributed to FC

($19.43x) exceeds the section 163(j)

limitation ($16.80x), FC may only deduction

$16.80x of business interest expense, and

$2.63x is disallowed business interest

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expense carryforward. After taking into

account FC’s allocable share of deductible

business interest expense, FC may deduct

$36.30x ($16.80x from FC + $12x allocable

ECI deductible BIE from ABC + $7.50x

allocable ECI deductible BIE from DEF). FC

also has $2.63x disallowed business interest

expense carryforward characterized as ECI,

$4.29x allocable ECI excess BIE from ABC,

$10.21x allocable non-ECI excess BIE from

ABC, and, under paragraph (e)(2) of this

section, is deemed to have $3.79x allocable

ECI excess BIE from DEF and $3.21x

allocable non-ECI excess BIE from DEF.

(i) [Reserved]

(j) Applicability date. This section

applies to taxable years beginning on or

after [DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply this section in its entirety for a

taxable year beginning after December

31, 2017, so long as the taxpayers and

their related parties also apply

§ 1.163(j)–7(a), (c) through (f), (g)(3) and

(4), and (h) through (k) for the taxable

year. For a taxable year beginning before

November 13, 2020, taxpayers and their

related parties may not choose to apply

this section unless they also apply

§ 1.163(j)–7(b) and (g)(1) and (2) in

accordance with the second sentence of

§ 1.163(j)–7(m)(1).

■Par. 10. As added in a final rule

elsewhere in this issue of the Federal

Register, effective November 13, 2020,

§ 1.163(j)–10 is amended by:

■1. Designating paragraph (c)(5)(ii)(D)

as paragraph (c)(5)(ii)(D)(1).

■2. Adding a subject heading for

paragraph (c)(5)(ii)(D).

■3. Adding paragraph (c)(5)(ii)(D)(2).

■4. Designating paragraph (f) as

paragraph (f)(1).

■5. Adding a subject heading for

paragraph (f).

■6. Revising the subject heading of

newly redesignated paragraph (f)(1).

■7. Adding paragraph (f)(2).

The additions and revision read as

follows:

1.163(j)–10 Allocation of interest expense,

interest income, and other items of expense

and gross income to an excepted trade or

business.

* * * * *

(c) * * *

(5) * * *

(ii) * * *

(D) Limitations on application of look-

through rules. ***

(2) Limitation on application of look-

through rule to C corporations. Except

as provided in § 1.163(j)–9(h)(4)(iii) and

(iv) (for a REIT or a partnership making

the election under § 1.163(j)–9(h)(1) or

(7), respectively), for purposes of

applying the look-through rules in

paragraph (c)(5)(ii)(B) and (C) of this

section to a non-consolidated C

corporation (upper-tier entity), that

upper-tier entity may not apply these

look-through rules to a lower-tier non-

consolidated C corporation. For

example, assume that P wholly and

directly owns S1 (the upper-tier entity),

which wholly and directly owns S2.

Further assume that each of these

entities is a non-consolidated C

corporation to which the small business

exemption does not apply. S1 may not

look through the stock of S2 (and may

not apply the asset basis look-through

rule described in paragraph

(c)(5)(ii)(B)(2)(iv) of this section) for

purposes of P’s allocation of its basis in

its S1 stock between excepted and non-

excepted trades or businesses; instead,

S1 must treat its stock in S2 as an asset

used in a non-excepted trade or

business for that purpose. However, S1

may look through the stock of S2 for

purposes of S1’s allocation of its basis

in its S2 stock between excepted and

non-excepted trades or businesses.

* * * * *

(f) Applicability dates.

(1) In general. ***

(2) Paragraph (c)(5)(ii)(D)(2). The

rules contained in paragraph

(c)(5)(ii)(D)(2) of this section apply for

taxable years beginning on or after

[DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers may choose to

apply the rules of paragraph

(c)(5)(ii)(D)(2) of this section to a taxable

year beginning after December 31, 2017,

and before [DATE 60 DAYS AFTER

DATE OF PUBLICATION OF THE

FINAL RULE IN THE FEDERAL

REGISTER], so long as they consistently

apply the rules in the section 163(j)

regulations, and, if applicable,

§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,

1.382–1, 1.382–2, 1.382–5, 1.382–6,

1.383–0, 1.383–1, 1.469–9, 1.704–1,

1.882–5, 1.1362–3, 1.1368–1, 1.1377–1,

1.1502–13, 1.1502–21, 1.1502–79,

1.1502–91 through 1.1502–99 (to the

extent they effectuate the rules of

§§ 1.382–2, 1.382–5, 1.382–6, and

1.383–1), and 1.1504–4 to that taxable

year and each subsequent taxable year.

■Par. 11. Section 1.469–4 is amended

by adding paragraph (d)(6) to read as

follows:

§ 1.469–4 Definition of activity.

* * * * *

(d) * * *

(6) Activities described in section

163(d)(5)(A)(ii). An activity described in

section 163(d)(5)(A)(ii) that involves the

conduct of a trade or business which is

not a passive activity of the taxpayer

and with respect to which the taxpayer

does not materially participate may not

be grouped with any other activity or

activities of the taxpayer, including any

other activity described in section

163(d)(5)(A)(ii).

* * * * *

■Par. 12. As amended in a final rule

elsewhere in this issue of the Federal

Register, effective November 13, 2020,

§ 1.469–9 is further amended by revising

paragraphs (b)(2)(ii)(A) and (B) to read

as follows:

§ 1.469–9 Rules for certain rental real

estate activities.

* * * * *

(b) * * *

(2) * * *

(ii) * * *

(A) Real property development. The

term real property development means

the maintenance and improvement of

raw land to make the land suitable for

subdivision, further development, or

construction of residential or

commercial buildings, or to establish,

cultivate, maintain or improve

timberlands (that is, land covered by

timber-producing forest). Improvement

of land may include any clearing (such

as through the mechanical separation

and removal of boulders, rocks, brush,

brushwood, and underbrush from the

land); excavation and gradation work;

diversion or redirection of creeks,

streams, rivers, or other sources or

bodies of water; and the installation of

roads (including highways, streets,

roads, public sidewalks, and bridges),

utility lines, sewer and drainage

systems, and any other infrastructure

that may be necessary for subdivision,

further development, or construction of

residential or commercial buildings, or

for the establishment, cultivation,

maintenance or improvement of

timberlands.

(B) Real property redevelopment. The

term real property redevelopment means

the demolition, deconstruction,

separation, and removal of existing

buildings, landscaping, and

infrastructure on a parcel of land to

return the land to a raw condition or

otherwise prepare the land for new

development or construction, or for the

establishment and cultivation of new

timberlands.

* * * * *

■Par. 13. Section 1.469–11 is amended

by revising paragraphs (a)(1) and (4) to

read as follows:

§ 1.469–11 Applicability date and

transition rules.

(a) * * *

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(1) The rules contained in §§ 1.469–1,

1.469–1T, 1.469–2, 1.469–2T, 1.469–3,

1.469–3T, 1.469–4, but not § 1.469–

4(d)(6), 1.469–5 and 1.469–5T apply for

taxable years ending after May 10, 1992.

The rules contained in § 1.469–4(d)(6)

apply for taxable years beginning on or

after [DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b), may choose to apply

the rules of § 1.469–4(d)(6) to a taxable

year beginning after December 31, 2017,

and before [DATE 60 DAYS AFTER

DATE OF PUBLICATION OF THE

FINAL RULE IN THE FEDERAL

REGISTER], so long as they consistently

apply the rules in the section 163(j)

regulations, and, if applicable,

§§ 1.263A–9, 1.263A–15, 1.381(c)(20)–1,

1.382–1, 1.382–2, 1.382–5, 1.382–6,

1.383–0, 1.383–1, 1.469–9, 1.704–1,

1.882–5, 1.1362–3, 1.1368–1, 1.1377–1,

1.1502–13, 1.1502–21, 1.1502–79,

1.1502–91 through 1.1502–99 (to the

extent they effectuate the rules of

§§ 1.382–2, 1.382–5, 1.382–6, and

1.383–1), and 1.1504–4 to that taxable

year and each subsequent taxable year.

* * * * *

(4) The rules contained in § 1.469–

9(b)(2), other than paragraphs

(b)(2)(ii)(A) and (B), apply to taxable

years beginning on or after [INSERT

DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER]. Section

1.469–9(b)(2)(ii)(A) and (B) applies to

taxable years beginning on or after

[DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, within the meaning of sections

267(b) and 707(b)(1), may choose to

apply the rules of § 1.469–9(b)(2), other

than paragraphs (b)(2)(ii)(A) and (B), to

a taxable year beginning after December

31, 2017, and before [INSERT DATE 60

DAYS AFTER DATE OF PUBLICATION

OF THE FINAL RULE IN THE

FEDERAL REGISTER] and may choose

to apply the rules contained in 1.469–

9(b)(2)(ii)(A) and (B) to taxable years

beginning after December 31, 2017, and

before [DATE 60 DAYS AFTER DATE

OF PUBLICATION OF THE FINAL

RULE IN THE FEDERAL REGISTER], so

long as they consistently apply the rules

of the section 163(j) regulations, and, if

applicable, §§ 1.263A–9, 1.263A–15,

1.381(c)(20)–1, 1.382–1, 1.382–2, 1.382–

5, 1.382–6, 1.383–0, 1.383–1, 1.469–9,

1.704–1, 1.882–5, 1.1362–3, 1.1368–1,

1.1377–1, 1.1502–13, 1.1502–21,

1.1502–79, 1.1502–91 through 1.1502–

99 (to the extent they effectuate the

rules of §§ 1.382–2, 1.382–5, 1.382–6,

and 1.383–1), and 1.1504–4 to that

taxable year and each subsequent

taxable year.

* * * * *

■Par. 14. Section 1.1256(e)–2 is added

to read as follows:

§ 1.1256 (e)–2 Special rules for syndicates.

(a) Allocation of losses. For purposes

of section 1256(e)(3), syndicate means

any partnership or other entity (other

than a corporation that is not an S

corporation) if more than 35 percent of

the losses of such entity during the

taxable year are allocated to limited

partners or limited entrepreneurs

(within the meaning of section

461(k)(4)).

(b) Determination of loss amount. For

purposes of section 1256(e)(3), the

amount of losses to be allocated under

paragraph (a) of this section is

calculated without regard to section

163(j).

(c) Example. The following example

illustrates the rules in this section:

(1) Facts. Entity is an S corporation that is

equally owned by individuals A and B. A

provides all of the goods and services

provided by Entity. B provided all of the

capital for Entity but does not participate in

Entity’s business. For the current taxable

year, Entity has gross receipts of $5,000,000,

non-interest expenses of $4,500,000, and

interest expense of $600,000.

(2) Analysis. Under paragraph (b) of this

section, Entity has a net loss of $100,000

($5,000,000 minus $5,100,000) for the current

taxable year. One half (50 percent) of this loss

is allocated to B, a limited owner. Therefore,

for the current taxable year, Entity is a

syndicate within the meaning of section

1256(e)(3)(B).

(d) Applicability date. This section

applies to taxable years beginning on or

after [DATE 60 DAYS AFTER DATE OF

PUBLICATION OF THE FINAL RULE

IN THE FEDERAL REGISTER].

However, taxpayers and their related

parties, under sections 267(b) and

707(b)(1), may choose to apply the rules

of this section for a taxable year

beginning after December 31, 2017, and

before [DATE 60 DAYS AFTER DATE

OF PUBLICATION OF THE FINAL

RULE IN THE FEDERAL REGISTER],

provided that they consistently apply

the rules of this section to that taxable

year and each subsequent taxable year.

Sunita Lough,

Deputy Commissioner for Services and

Enforcement.

[FR Doc. 2020–16532 Filed 9–3–20; 4:15 pm]

BILLING CODE 4830–01–P

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