Abusive S Corporation Income Shifting
Arrangements (SC2)
IRS Notice 2004-30

 

According to the IRS, the transaction described above is designed to artificially shift the incidence of taxation on S corporation income away from taxable shareholders to an exempt party (i.e., tax indifferent party). Over a period of time, the original shareholders attempt to use the SC2 arrangement to avoid paying income tax on most of the S corporation’s income over a period of time. The IRS pointed out that the transaction is structured for the original shareholders to exercise their warrants and dilute the shares on nonvoting stock held by the exempt party, or alternatively, to allow for the S corporation to purchase the nonvoting stock from the exempt party at a value that is substantially reduced by reason of the existence of the warrants. The exempt party is viewed as having received a share of the total economic benefit of stock ownership that is substantially lower than the share of the S corporation income allocated to the exempt party.

If you believe that you may have engaged in a transaction that is the same or substantially similar to the transaction described above, Federal law may require you to disclose your and other parties’ participation in any such “listed transaction” on IRS Form 8886. For more information about Federal law requirements, please contact us.