Tax Department

Related Party Transactions and how they are treated under the Tax Code.


A corporation that uses an accrual method of accounting cannot deduct business expenses and interest owed to a related person who uses the cash method of accounting until the corporation makes the payment and the corresponding amount is includible in the related person's gross income.

This information is provided as a public service, and should not be construed as individual accounting or tax advice. For information on how these general principles apply to your situation, please consult your Cook & Co. Agent.

Determine the relationship, for this rule, as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied under this rule, the rule will continue to apply even if the corporation's relationship with the person ends before the expense or interest is includible in the gross income of that person. These rules also deny the deduction of losses on the sale or exchange of property between related persons.

Related persons
For purposes of this rule, the following persons are related to a corporation. Another corporation that is a member of the same controlled group as defined in section 267(f) of the Internal Revenue Code.
An individual who owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation.
A trust fiduciary when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.
 
An S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation.

A partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership.
 
Any employee-owner if the corporation is a personal service corporation (defined later), regardless of the amount of stock owned by the employee-owner.
 
Ownership of stock
To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.

Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust is treated as being owned proportionately by or for its shareholders, partners, or beneficiaries.

An individual is treated as owning the stock owned, directly or indirectly, by or for his or her family. Family includes only brothers and sisters (including half brothers and half sisters), a spouse, ancestors, and lineal descendants.
Any individual owning (other than by applying rule (2)) any stock in a corporation is treated as owning the stock owned directly or indirectly by that individual's partner.
 
To apply rule (1), (2), or (3), stock constructively owned by a person under rule (1) is treated as actually owned by that person. But stock constructively owned by an individual under rule (2) or (3) is not treated as actually owned by the individual for applying either rule (2) or (3) to make another person the constructive owner of that stock.

Personal service corporation
For this purpose, a corporation is a personal service corporation if it meets all of the following requirements.

It is not an S corporation.
 
Its principal activity is performing personal services. Personal services are those performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and performing arts.
Its employee-owners substantially perform the services in (2).
Its employee-owners own more than 10% of the fair market value of its outstanding stock.

Reallocation of income and deductions. Where it is necessary to clearly show income or prevent tax evasion, the IRS can reallocate gross income, deductions, credits, or allowances between two or more organizations, trades, or businesses owned or controlled directly, or indirectly, by the same interests.

Complete liquidations. The disallowance of losses from the sale or exchange of property between related persons does not apply to liquidating distributions.


Have you ever received a tax document that has bold print that reads "CONSULT YOUR TAX ADVISOR"?

Bring it to us! The reason for those disclaimers is because of the potential liability associated with providing tax advice. Providing tax advice is what we do. But please remember that when you are with your agent working on the current tax returns, if you have tax questions about the future, try to hold those until the end of the interview. Once your agent has gathered all of your information and keyed it into our computer system, he will have an updated snapshot picture of your tax and financial situation on his computer screen and will be better equipped to answer questions about the future.

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Cook and Co., Enrolled Agents are licensed by the U.S. Treasury Department to represent taxpayers before the Internal Revenue Service (IRS). Greg Cook is also an Accredited Tax Advisor and a Certified Public Accountant (CPA) licensed by the states of Alabama and Tennessee.

The related party rules are very important ... if you have questions about these rules, contact us.