31 Years Later, Treasury Notices Typo Fix Did Not Make It Into Code of Federal Regulations

Although it took 30 years, the IRS has issued a correction to a regulation dealing with attribution rules for purposes of determining a “brother-sister group” under IRC §52.  In TD 8179 the IRS changes a reference from “Reg. §1.414(c)-4(b)(1)” to “Reg. §1.414-4.”  And it’s the sort of quirky flaw that only tax geeks can love—and potentially exploit for the (temporary) benefit of eligible clients.

Since IRC §52 is titled “Special rules” and is found the IRC provisions dealing with the Work Opportunity Credit you may figure this issue has limited impact. But that’s actually not the case—the attribution rules for IRC §52 are cross-referenced in other provisions, most importantly in IRC §448(c) that provide the $25 million test that, after the TCJA, allows businesses with gross receipts below that level to:

  • Elect to use the overall cash basis of accounting;

  • Escape the requirement to apply the uniform capitalization rules of IRC §263A;

  • Elect out of following the inventory provisions of §471 and either treat items held for sale as nonincidental supplies or use inventory methods other than those allowed under §471;

  • Apply the small contractor rules when dealing with long-term contracts (no requirement to use the percentage of completion method); and

  • Not have to apply the limitations on the deduction of business interest under §163(j).

The cross reference is used to determine which businesses must be aggregated in order to determine if gross receipts exceed $25 million.  That is, if businesses are related via defined types of common control, the receipts of those businesses are combined to calculate the $25 million limit.  If that combined total ends up with average revenue of over $25 million, all businesses in the group are ineligible for any of the benefits.

Reg. §1.414(c)-4 contains “Rules for determining common ownership” and, as the use of the plural in “rules” would suggest, the regulation defines multiple cases where such ownership must be combined.  Conversely Reg. §1.414(c)-4(b)(1) only relates to one specific situation where the entities would be considered related.

So all that trivia is wonderful, but what real impact does this have?  It turns out quite a bit.  The problem was noted in a March 8, 2019 article posted on Forbes website by Tony Nitti, CPA.[1]  Tony noted a discrepancy between a 2012 printed copy of Reg. §1.52-1(c) he initially consulted and the version found in the online service from the same publisher (Wolters Kluwer/CCH in this case). The issue is found in the area dealing with brother-sister groups under common control found at Reg. §1.52-1(d)(1)(i). 

The online version of the regulation (and the one shown on the Cornell University Legal Information Institute at the time this was written) showed the following:

(d)Brother-sister group under common control -

(1) In general. The term “brother-sister group under common control” means two or more organizations conducting trades or businesses if -

(i) The same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of § 1.414(c)-4(b)(1) (emphasis added)), a controlling interest of each organization;[2]

However, the printed 2012 copy of the regulation that Mr. Nitti consulted has the cross-referenced provision as “Reg. §1.414(c)-4,” no longer restricting it to just (b)(1).

Tony’s article describes his attempts to resolve this issue, eventually leading to contacting Mark Friedlich at Wolters Kluwer/CCH who uncovered a portion of the issue. CCH originally had the reference to Reg. §1.414(c)-4 but changed it to §1.414(c)-4(b)(1) when a customer pointed out that the federal government’s online Code of Federal Regulations had the longer reference.

But that begged the question—how did that different reference get into the CFR?  And was it correct?

The IRS, in issuing the new “correction” tells us exactly what transpired.  TD 8179 notes:

The final regulations (TD 8179) that are the subject of this correction are under section 52 of the Internal Revenue Code. Treasury Decision 8179 was corrected at 53 FR 16408, May 9, 1988; however, the Office of the Federal Register did not properly incorporate the correction into the Code of Federal Regulations at that time.[3]

Basically—there was a typo in the version of the regulations originally issued in March of 1988, so a correction to the regulations was published on May 9, 1988. However, that correction never did make its way into the Code of Federal Regulations, so the IRS has essentially “republished” the typo correction 31 years later.

So which set of rules apply before this typo correction (hopefully) gets incorporated into the Code of Federal Regulations on (again, hopefully) July 11, 2019?  Treasury decided to not force the issue on that question.  Continuing on in the preamble, Treasury provides the following titled “Applicability of Correction:”

Generally, the amendments to the regulations under section 52 of the Code (relating to tax credits for employees) apply to taxable years beginning after December 31, 1976. However, because the May 9, 1988 correction was not properly incorporated into the Code of Federal Regulations at the time of publication, with respect to taxable years that began prior to the Effective date, the Internal Revenue Service will not challenge the application of either published version of the regulation.[4]

The effective date of this correction is July 11, 2019.[5]

So what does any of this really impact?

Tony Nitti provides an example in his article that illustrates, step-by-step, what the impact is.  We’ll condense that down a bit here to show you a situation where, under the regulations we’ve had in the Federal Register for 31 years (without the correction), where two entities would not be related and this could avoid the §163(j) rules, as well as have access to the special accounting rules.


No Aggregation for $25 Million Test With the Typo Left in Reg. §1.52-1 – (Based on Example in Tony Nitti’s Article)[6]

Castle, Inc. is a corporation with $18 million of revenue each of the last 3 years.  It is owned 50% by Albert and 50% by Greg.

Phoenix Real Estate, LLC operates as a partnership for tax purposes, with revenues of $10 million in each of the prior three years.  It is owned 10% by Albert, 60% by Greg and 30% by Mary, Albert’s wife.

Under the aggregation rules of §52(b), a pair of organizations have to meet two tests to be considered brother-sister organizations subject to aggregation. First, five or fewer owners have to own at least 80% of each business (only counting owners that hold an interest in each business.  Second, taking into account the lowest ownership percentage of each owner in each business, they own more than 50% of the businesses.

Under the regulation with the typo intact, we can ignore the ownership held by Mary in Phoenix Real Estate, LLC, even though Mary is Albert’s wife.  While Reg. §1.414(c)-4(b)(5) would attribute ownership between spouses, the typo limited the types attribution found in Reg. §1.414(c)-4 to only those with an option to acquire an interest in an entity found at Reg. §1.414(c)-4(b)(1).

While Albert and Greg own 100% of Castle, Inc., they only own 70% of Phoenix Real Estate, LLC.  Since Mary has no ownership interest in Castle, Inc., we ignore her ownership interest in Phoenix Real Estate, LLC.

Thus, no aggregation is necessary and both entities have average revenue of less than $25 million in the prior years.  Thus, neither is subject to the limitation on business interest found at IRC §163(j).

However, when we change the reference back to Reg. §1.414(c)-4 instead of Reg. §1.414(c)-4(b)(1), the attribution of stock owned by a spouse now comes into play—and now the entities must combine their revenues for this test.


Aggregation for $25 Million Test With the Typo Corrected in Reg. §1.52-1 – (Based on Example in Tony Nitti’s Article)[7]

Under Reg. §1.52-1(d), which now references Reg. §1.414(c)-4 in total, stock owned by Mary is considered owned by her spouse, Albert.  With that change, Albert and Greg own 100% of each enterprise, meeting the first test.

Albert owns 50% of Castle, Inc. and 40% of Phoenix Real Estate, LLC.  For the second test we use the lower percentage (40%) for Albert’s interest.  Greg owns 50% of Castle, Inc. and 60% of Phoenix Real Estate, Inc.  Like Albert, we will only consider the lower of the two interests (50%) for Greg for the second test.  Adding those two percentages together (40% + 50%) we get 90% for common ownership—more than the 50% minimum required.

Since Castle, Inc. and Phoenix Real Estate, Inc. meet both tests, they are considered brother-sister organizations and their revenues are combined ($18 million + $10 million).  As the total ($28 million) exceeds $25 million, both organizations must limit business interest deductions to no more than is allowed under IRC §163(j)

What is interesting about this issue is that it took over 30 years before anyone appears to have noticed that the correction of the typographical error had never been moved into the Code of Federal Regulations.  This sort of correction for typographical errors in recently published regulations is a regular occurrence—in fact, it’s rare for there not to be such a correction published for regulations of any significant length.

As well, we all tend to assume that our research service’s documents we read or bring up on our screen are ones that can be relied upon.  In this case, though, it wasn’t clear which version of the regulation was correct (in fact, Treasury doesn’t address this issue, effectively allowing either treatment for years beginning before the July 11, 2019 correction date)—but at least one publisher did quietly change the version in their materials and database. 

But for now there is one key takeaway—certain related organizations will be able to escape the application of IRC §163(j) for two years.  In theory they could also make the small business accounting method changes, but they would face a need to change back in 2020—so that relief would be fleeting.

Note, as well, that if all entities involved are corporations this issue doesn’t impact them—they are governed by the controlled group of corporations test at IRC §52(a), and that section isn’t affected by this issue.

[1] Tony Nitti, “Is There A Mistake In The Tax Law That Changes The Way We Apply The New Interest Limitation Rules?” Forbes website, March 8, 2019, https://www.forbes.com/sites/anthonynitti/2019/03/08/is-there-a-mistake-in-the-tax-law-that-changes-the-way-we-apply-the-new-interest-limitation-rules/#34eefb4b7ca8, retrieved July 11, 2019

[2] https://www.law.cornell.edu/cfr/text/26/1.52-1, retrieved July 11, 2019 (note that this site should be eventually updated to remove the specific reference discussed here)

[3] Federal Register, Vol. 84, No. 133, July 11, 2019, 33002

[4] Ibid

[5] Ibid

[6] Tony Nitti, “Is There A Mistake In The Tax Law That Changes The Way We Apply The New Interest Limitation Rules?” Forbes website, March 8, 2019, https://www.forbes.com/sites/anthonynitti/2019/03/08/is-there-a-mistake-in-the-tax-law-that-changes-the-way-we-apply-the-new-interest-limitation-rules/#34eefb4b7ca8, retrieved July 11, 2019

[7] Ibid