Anti-abuse rules of sec. 444.

• Author: Pigga, Joseph F.

Temporary regulations under Sec. 444 provide rules for partnerships, S corporations and personal service corporations (PSCs) that attempt to avoid the limitations of Sec. 444. The regulations provide two anti-abuse provisions. The first deals with predecessor entities. Temp. Regs. Sec. 1.444-1T(b)(5)(iii) must be considered when a partnership, S corporation or PSC transfers assets to a related party; it will apply when the principal purpose of the transfer is to create a deferral period greater than the deferral period of the predecessor, or to make a Sec. 444 election following the termination of the predecessor entity's Sec. 444 election. The deferral period is defined as the months between the end of an entity's year and December 31. If a partnership, S corporation or PSC makes a predecessor transfer for one of these two reasons, the new entity will not be able to make a valid Sec. 444 election.

The regulations apply to entities changing their tax year by making a Sec. 444 election. Sec. 444 limits changes in tax years to the shorter of three months or the deferral period of the tax year being changed.

Example 1: Partnership AB has historically used the calendar year. AB's required tax year is the calendar year. Under Sec. 444, AB has no deferral period since it uses a calendar year. AB would therefore be precluded from changing to a different tax year since a change is limited to three months or the entity's deferral period (in this case, zero).

Temp. Regs. Sec. 1.444-1T(b)(5) is designed to prevent partnerships, S corporations and PSCs from avoiding the deferral period limitation. In addition, the regulation prevents entities that terminated a prior Sec. 444 election from making a new election.

Example 2: Assume that P1 is a partnership that has used the calendar year. P1 wishes to make a Sec. 444 election to change to an October year-end for the tax year beginning Jan. 1, 1994. P1 cannot make a Sec. 444 election, however, since P1 current deferral period is limited to zero. Further, P1 transfers its assets to newly formed partnership P2. If not for Temp. Regs. Sec. 1.444-1T(b)(5)(iii), P2 could make a Sec. 444 election to use a tax year with a deferral period of three months or less (i.e., September 30, October 31 or November 30). However, the regulation grants the IRS authority to void such election, since P2 f or all intents and purposes is a contribution of P1.

Temp. Regs. Sec. 1.444-1T(b)(5)(iii) can apply not only to transfers by...