Section 871(a) of the Code imposes a tax of 30 percent on U.S. source fixed or determinable annual or periodic (FDAP) income, including interest, received by a nonresident alien individual to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States. Section 881(a) imposes a similar tax with respect to FDAP income, including interest, received by a foreign corporation. Both sections 871(h)(3)(A) and 881(c)(3)(B) provide, among other limitations, that portfolio interest does not include interest received by a 10-percent shareholder, as defined in section 871(h)(3)(B).

The IRS and the Treasury Department issued proposed regulations (REG-118775-06, 2006-28 I.R.B. 73) under sections 871(h) and 881(c) in the Federal Register (71 FR 34047) on June 13, 2006. The proposed regulations address the application of the 10-percent shareholder test when U.S. source interest is paid to a partnership that has a nonresident alien individual or foreign corporation as a partner. The proposed regulations provide that, for interest paid on obligations issued on or after the date that final regulations are published, the 10-percent shareholder test is to be applied only at the partner level and at the time that the withholding agent would otherwise be required to withhold.

No public hearing was requested or held. However, a few comments were received. After consideration of the comments, the proposed regulations are adopted in these final regulations, with two modifications. In addition, these final regulations implement section 5 of Notice 2006-99, 2006-46 I.R.B. 907 (See §601.601(d)(2) of this chapter), modifying §1.1441-1(b)(7)(iii), as discussed below.

1. Time for Applying the 10-Percent Shareholder Test.

The proposed regulations provide that the 10-percent shareholder test applies at the time the withholding agent would otherwise be required to withhold. The regulations then provide an example in which the test is stated to apply on the “earliest” of when the interest is distributed, the date the statement under section 6031(b) is mailed, or the due date for furnishing the statement. In order to make clear that the test may be applied on multiple dates (and not only on the date of a first partial distribution of such interest), the example has been rephrased. The example now states that the 10-percent shareholder test is applied when any distributions that include the interest are made to a foreign partner and, to the extent that a foreign partner’s distributive share of the interest has not actually been distributed, on the earlier of the date that the statement required under section 6031(b) is mailed or otherwise provided to such partner, or the due date for furnishing such statement. This change conforms more closely to the language of §1.1441-5(c)(2).

2. Effective Date of the Regulation.

The new provisions set forth in the proposed regulations were proposed to apply to interest paid on obligations issued after the date that final regulations are published. One commentator stated that, in order to provide for consistency and to eliminate uncertainty and avoid possible disputes with respect to interest paid to partnerships prior to the date that the final regulations are published, the final regulations should apply to interest paid after July 18, 1984, with respect to obligations issued after July 18, 1984, the effective date of the portfolio interest provisions. Another commentator stated that the final regulations should apply to interest paid after the date the final regulations are issued.

The IRS and the Treasury Department agree that taxpayers should be able to apply the regulations to interest paid in certain prior taxable years. Accordingly, while the final regulations generally provide that the provisions relating to the 10-percent shareholder test for interest paid to partnerships are to apply to interest paid after the date the regulations are published as final regulations, the regulations also permit taxpayers to choose to apply the provisions to interest paid in any taxable year that is not closed by the period of limitations, provided that the taxpayer consistently applies the provisions to all relevant partnerships during such years.

3. Interest Imposed When No Tax Due.

Treasury Regulation §1.1441-1(b)(7)(iii) provides that a withholding agent that has failed to withhold tax other than based on reliance on the appropriate presumptions is not relieved from liability for interest under section 6601. It further provides that such liability exists even when there is no underlying tax that is ultimately shown to be due. That is, the regulation imposes an interest charge under section 6601 on a withholding agent for an amount of tax that has not in fact been imposed. Treasury Regulation §1.1441-1(b)(7)(v) sets forth two examples that illustrate the operation of this rule.

In Notice 2006-99, 2006-46 I.R.B. 907, the IRS and the Treasury Department announced their intention to remove the rule in Treasury Regulation §1.1441-1(b)(7)(iii), and the accompanying examples illustrating the rule in Treasury Regulation §1.1441-1(b)(7)(v), that impose interest under section 6601 when no underlying tax liability is imposed. Further, the notice announced that the IRS and the Treasury Department intend to clarify that, like interest, penalties that are computed based on underpayments of tax will not be imposed when no tax has in fact been imposed.

These final regulations retroactively remove, in accordance with Notice 2006-99, the rule in §1.1441-1(b)(7)(iii) that would impose interest and penalties based on hypothetical underpayments of tax when in fact no tax has been imposed. The examples illustrating this rule in Treasury Regulation §1.1441-1(b)(7) are also removed.

It has been determined that these regulations are not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

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

Par. 2. Section 1.871-14 is amended as follows:

1. Paragraphs (g) and (h) are redesignated as paragraphs (h) and (i), respectively.

2. New paragraph (g) is added.

3. Paragraph (1) of newly-designated paragraph (i) is amended by adding two sentences at the end of the paragraph.

The additions read as follows:

The aggregate amount of the monetary penalty (or penalties) imposed by the Secretary for any prohibited conduct may not exceed the collective gross income derived by the practitioner and the employer, firm, or other entity in connection with such prohibited conduct. If a single act of prohibited conduct giving rise to a monetary penalty is an integral part of a larger engagement, the amount of the penalty will be limited by the “gross income derived (or to be derived)” from the larger engagement. In the event that the larger engagement began on or before October 22, 2004, the “gross income derived (or to be derived)” will be calculated, on a pro rata basis, to exclude amounts attributable to conduct occurring on or before October 22, 2004. In determining the amount of the monetary penalty (or penalties), the Secretary will consider amounts that the practitioner, employer, firm, or other entity could reasonably expect to realize, irrespective of whether the amounts have actually been received.

The Secretary has discretion to impose a monetary penalty in an amount less than the amount allowed by statute. In determining the amount of the penalty (or penalties), the Service will consider the level of culpability of the practitioner, firm, or other entity; whether the practitioner, firm, or other entity violated a duty owed to a client or prospective client; the actual or potential injury caused by the prohibited conduct; and the existence of aggravating or mitigating factors. Mitigating factors may include whether the practitioner, employer, firm, or other entity took prompt action to correct the noncompliance after the prohibited conduct was discovered; promptly ceased engaging in the prohibited conduct; attempted to rectify any harm caused by the prohibited conduct; or undertook measures to ensure that the prohibited conduct would not occur again in the future. In general, the Service will not impose monetary penalties in cases of minor technical violations, when there is little or no injury to a client, the public, or tax administration, and there is little likelihood of repeated similar misconduct.

The Secretary may impose separate penalties against the practitioner and against the employer, firm, or other entity for any prohibited conduct. Each separate penalty may not exceed the gross income derived by the practitioner and the employer, firm, or other entity, respectively.

If a practitioner acted on behalf of an employer, firm, or other entity in connection with prohibited conduct, the Secretary may impose a separate monetary penalty on the employer, firm, or other entity if the employer, firm, or other entity knew, or reasonably should have known, of the prohibited conduct.

A practitioner is considered to have acted on behalf of an employer, firm, or other entity if -

(1) An agency relationship existed between the practitioner and the employer, firm, or other entity;

(2) The purpose of the agency relationship was to provide services in connection with practice before the Internal Revenue Service (as defined in section 10.2(d) of Circular 230); and

(3) The prohibited conduct giving rise to the penalty arose in connection with the agency relationship.

An employer, firm, or other entity knows or reasonably should know of the prohibited conduct if -

(1) One or more members of the principal management (or officers) of the employer, firm, or other entity, or one or more members of the principal management (or officers) of a branch office knows, or has information from which a person with similar experience and background would reasonably know, of the prohibited conduct; or

(2) The employer, firm, or other entity through willfulness, recklessness, or gross indifference (including ignoring facts that would lead a person of reasonable prudence and competence to investigate or ascertain) did not take reasonable steps to ensure compliance with Circular 230; and one or more individuals associated with the employer, firm, or other entity, in connection with their agency relationship with the employer, firm, or other entity, engages in prohibited conduct within the meaning of section 10.52 of Circular 230 that harms a client, the public, or tax administration, or a pattern or practice of failing to comply with Circular 230.

The following examples illustrate the above provisions:

Example 1: Attorney A specializes in tax planning and works out of a national accounting firm’s headquarters. Attorney A is involved in the development of off-the-shelf tax planning strategies, including Strategy X. Attorney A has wide discretion over his day-to-day work product and rarely supervises other professionals at the firm. Attorney A rarely deals directly with clients as this work is handled by other firm partners or employees. Attorney A works directly with the firm’s other attorneys, accountants and support staff across the country to market and fine-tune Strategy X. Clients of the firm are examined by the Service with respect to Strategy X, but Attorney A is not identified on any Form 2848 as a representative.

Attorney A reports to the director of the firm’s tax practice. The director of the firm’s tax practice provides general oversight as to Attorney A. The director of the firm’s tax practice was aware of the strategies that Attorney A developed, including Strategy X, although he was not necessarily familiar with the technical tax details of each strategy. The director of the firm’s tax practice also knew that Strategy X generated measurable revenue for the firm.

OPR determines that Attorney A engaged in prohibited conduct in violation of Circular 230 in the creation, promotion and marketing of Strategy X. Attorney A acted on behalf of the firm because an agency relationship existed between Attorney A and the firm, and the misconduct arose in connection with that agency relationship as Attorney A worked on behalf of the firm to promote Strategy X. The firm knew or had reason to know of the prohibited conduct in this situation. The director of the firm’s tax practice, who is a member of principal management of the firm, had general knowledge that Attorney A developed the tax-advantaged strategies. Alternatively, in the absence of general knowledge, the director of the firm’s tax practice would need to inquire into Strategy X because it added measurably to the firm’s revenue. Both Attorney A and the firm are subject to a monetary penalty.

Example 2: Unenrolled Return Preparer B owns and operates her own firm that provides return preparation services to the public and also specializes in preparing Forms 656, Offers In Compromise. B’s firm employs 10 attorneys, CPAs and enrolled agents (all practitioners) and 15 unenrolled return preparers. B supervises and directs all of her employees. B’s firm is structured in such a manner so that the first and predominant contact for clients coming in from the public is with the unenrolled return preparers. The unenrolled return preparers assist clients with preparing Forms 656 that are later submitted directly to the Service. B does not review individual Forms 656 but has provided specific instructions to her staff regarding how to complete false and misleading Forms 656 in violation of Circular 230. In order to facilitate the submission to the Service of the false or misleading Forms 656, B’s procedure is to authorize one of her 10 practitioners to submit a Form 2848 on behalf of a client much later in the process, well after submission of the Forms 656 in violation of Circular 230.

Although B is not a practitioner, the practitioner’s actions in submitting the Forms 2848 are done on behalf of the firm pursuant to an agency relationship and occur in connection with prohibited conduct. B’s firm is considered to know or have reason to know of the prohibited conduct because B, a member of principal management, instructed her staff regarding completion of the forms in violation of Circular 230. The practitioner’s actions subject B’s firm to a monetary penalty.

When determining if a monetary penalty should be imposed on an employer, firm, or other entity, the Secretary will consider factors in addition to whether the employer, firm, or other entity knew, or reasonably should have known, of the prohibited conduct (or whether the employer, firm or other entity did not use reasonable efforts to ensure compliance with Circular 230). For example, the Secretary will consider the gravity of the misconduct, any history of noncompliance by the employer, firm, or other entity, preventative measures in effect prior to the misconduct, and any corrective measures taken by the employer, firm, or other entity after the prohibited conduct was discovered, including measures to ensure that future prohibited conduct does not occur.

The Service may issue additional guidance regarding the application of monetary penalties, including, but not limited to, the factors that the Service should consider when evaluating all the facts and circumstances of a particular case. The Service requests comments with respect to the appropriate factors to be considered when determining whether a monetary penalty is appropriate. Comments also are requested as to factors that the Service should consider in declining to impose a monetary penalty on an employer, firm, or other entity, including the weight given to adequate procedures in place for purposes of complying with Circular 230.

Additionally, in order to develop a penalty system that best encourages compliance with Circular 230, the Service requests comments regarding mitigating circumstances to consider when determining the amount of a monetary penalty. Mitigating circumstances could be considered, for example, in varying the amount of the penalty to correspond to the seriousness of the misconduct or pattern of misconduct. Mitigating circumstances could include, but not be limited to, the immediacy of the misconduct, history of misconduct, the existence of firm procedures, and corrective measures taken after discovery of the misconduct.

Interested parties are invited to submit comments by August 13, 2007. Comments should be submitted to: Internal Revenue Service, CC:PA:LPD:PR (Notice 2007-39), Room 5203, P.O. Box 7604, Ben Franklin Station, Washington, DC 20224. Alternatively, comments may be hand delivered Monday through Friday between the hours of 8:00 a.m. to 4:00 p.m. to: CC:PA:LPD:PR (Notice 2007-39), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC. Comments may also be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov. Please include “Notice 2007-39” in the subject line of any electronic submissions.

The collections of information contained in this notice of proposed rulemaking have 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). Comments on the collections of information should be sent to the Office of Management and Budget, Attention: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attention: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224.

The recordkeeping requirement in these proposed regulations is in §1.1367-2(a)(2)(i). This information must be maintained by the shareholder to ensure that the indebtedness of the S corporation to the shareholder continues to meet the definition of open account debt found in §1.1367-2(a)(2)(i). The recordkeepers will be S corporation shareholders who have open account debt.

The following estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on the information that is available to the Internal Revenue Service. Individual recordkeepers may require greater or less time, depending on their particular circumstances.

Estimated total annual recordkeeping burden: 250 hours.

Estimated average annual burden: hours per recordkeeper varies from .75 to 1.25 hours, depending on individual circumstances, with an estimated average of 1 hour.

Estimated number of recordkeepers: 250.

Estimated annual frequency of recordkeeping: On occasion.

This document proposes to amend §1.1367-2 of the Income Tax Regulations (26 CFR part 1) regarding the definition of open account debt and adjustments in basis of indebtedness for shareholder advances and repayments on advances of open account debt.

Section 1367(a)(1) provides that the basis of each shareholder’s stock in an S corporation is increased by the shareholder’s pro rata share of the S corporation’s income (separately and nonseparately computed items of income) and the excess of the deductions for depletion over the basis of the property subject to depletion. Section 1367(a)(2) provides that the basis of each shareholder’s stock in the S corporation is decreased by the shareholder’s pro rata share of distributions not includible in income of the shareholder by reason of section 1368 (nontaxable distributions), losses and deductions (separately and non-separately computed losses), any expense of the corporation that is not deductible and not properly chargeable to capital account, and certain deductions for depletion for any oil and gas property held by the S corporation. Under section 1367(b)(2)(A), if for any taxable year the amounts specified in section 1367(a)(2) (other than distributions) exceed the amount which reduces the shareholder’s basis to zero, such excess losses and deductions shall be applied to reduce (but not below zero) the shareholder’s basis in any indebtedness of the S corporation to the shareholder. Section 1367(b)(2)(B) provides that if a shareholder’s basis in indebtedness is reduced for any taxable year, any net increase (the amount by which the items described in section 1367(a)(1) exceed the items described in section 1367(a)(2)) for any subsequent taxable year is applied to restore the reduction in basis in indebtedness before any of the excess is used to increase basis in stock.

On January 3, 1994, the Treasury Department and the IRS published final regulations under section 1367 of the Code (T.D. 8508, 1994-1 C.B. 219 [59 FR 12], amended on December 22, 1999 (T.D. 8852, 2000-1 C.B. 253 [64 FR 71641])). Those final regulations relate, in part, to adjustments to basis in both stock of shareholders and indebtedness of an S corporation to its shareholders. Section 1.1367-2 of the Income Tax Regulations provides specific rules for required adjustments (reductions and restorations) to basis in any indebtedness of an S corporation to a shareholder. Section 1.1367-2(a) also provides that for purposes of adjustments to basis of indebtedness to shareholders, shareholder advances not evidenced by separate written instruments and repayments on the advances (open account debt) are treated as a single indebtedness. Further, §1.1367-2(a) provides that the basis of indebtedness of the S corporation to a shareholder is reduced as provided in §1.1367-2(b) and restored as provided in §1.1367-2(c). Thus, the basis adjustment rules under the final regulations apply to all indebtedness of an S corporation to a shareholder, whether the indebtedness is evidenced by a written instrument or is open account debt.

Section 1.1367-2(b) provides the rules for the reduction of basis of indebtedness of an S corporation to a shareholder. Generally, under §1.1367-2(b)(1), if the basis of a shareholder’s stock in the S corporation has been reduced to zero under section 1367(a)(2), the excess of certain losses and deductions specified in section 1367(a)(2) is applied to reduce (but not below zero) the basis of any indebtedness of the S corporation to the shareholder held by the shareholder at the close of the S corporation’s taxable year. Any indebtedness of the S corporation to the shareholder that has been satisfied by the S corporation, or disposed of or forgiven by the shareholder during the taxable year, is not held by the shareholder at the close of that year and is not subject to basis reduction. Further, §1.1367-2(b)(2) provides that if the interest of the shareholder in the S corporation is terminated during the taxable year, the rules in §1.1367-2(b) are applied to any indebtedness of the S corporation to the shareholder held by the shareholder immediately before the termination of the shareholder’s interest in the S corporation. If a shareholder holds more than one indebtedness at the close of the taxable year (or, if applicable, immediately prior to the termination of the shareholder’s interest in the corporation), the basis of each indebtedness is reduced under §1.1367-2(b)(3) in the same proportion that the basis of each indebtedness bears to the aggregate bases of the indebtedness of the S corporation to the shareholder.

Section 1.1367-2(c) provides the rules for restoring basis of indebtedness of an S corporation to a shareholder. Generally, under §1.1367-2(c)(1), if, for any taxable year of the S corporation, there has been a reduction in the basis of an indebtedness of the S corporation to a shareholder, any net increase in any subsequent taxable year of the S corporation is applied to restore that reduction. For purposes of §1.1367-2, a net increase is the amount by which the shareholder’s pro rata share of S corporation items described in section 1367(a)(1) exceed the items described in section 1367(a)(2) for the taxable year. The restoration rules apply only to indebtedness held by the shareholder as of the beginning of the taxable year in which the net increase arises. Further, the reduction in basis of indebtedness must be restored before a net increase is used to restore the shareholder’s basis in stock. The shareholder’s basis in indebtedness may not be restored above the adjusted basis of the indebtedness under section 1016(a) (excluding any prior year’s adjustments under section 1367), determined as of the beginning of the taxable year in which the net increase arises.

Under §1.1367-2(c)(2), if a shareholder holds more than one indebtedness as of the beginning of an S corporation’s taxable year, any net increase is applied first to restore the reduction of basis in any indebtedness repaid (in whole or in part) in that taxable year to the extent necessary to offset any gain that would otherwise be realized on the repayment. Any remaining net increase is applied to restore each outstanding indebtedness in proportion to the amount that the basis of each outstanding indebtedness has been reduced and not restored.

Section 1.1367-2(d) provides rules for the time at which adjustments to basis of indebtedness under section 1367(b)(2) are effective. Generally, under §1.1367-2(d)(1) the amount of the adjustments to basis of indebtedness are determined and effective as of the close of an S corporation’s taxable year. However, if the shareholder is not a shareholder in the S corporation at that time, the adjustments are effective immediately before the shareholder’s interest in the S corporation is terminated. Moreover, if a debt is disposed of or repaid, in whole or in part, before the close of the taxable year, the basis of that debt is restored effective immediately before the disposition or the first repayment on the debt during the taxable year.

On August 25, 2005, the Tax Court issued its decision in Brooks v. Commissioner, TC Memo. 2005-204. In Brooks, the taxpayer borrowed money from a bank and advanced that money as open account debt to his S corporation in one taxable year and reduced basis in that open account debt for losses passed through to the taxpayer at the end of that same year. In the first few weeks of the subsequent taxable year, the S corporation repaid the open account debt (the taxpayer then repaid his debt for the borrowed money). Late in that subsequent year, the taxpayer advanced additional money (again, amounts borrowed from a bank) in an amount that offset the repayment of advances to avoid the recognition of gain from repayment of the indebtedness. Also, the taxpayer’s advances increased the shareholder’s basis in the indebtedness and allowed losses for that year to pass through to the taxpayer shareholder. Taxpayer and the S corporation made these repayments and advances for several taxable years and deferred indefinitely the recognition of income on any repayment of his open account debt.

The court in Brooks held “that the basis of the open account indebtedness is properly computed by netting at the close of the year advances of open account debt during the year and repayments of open account debt during the year.”

The Treasury Department and the IRS believe that the concept of “open account debt” as defined in §1.1367-2(a) was intended to provide administrative simplicity for S corporations but was not intended to permit the deferral allowed in Brooks. The IRS and Treasury Department are proposing these amendments to narrow the definition of open account debt and to modify the rules for adjustments of basis in indebtedness for the more narrowly defined open account debt.

In these proposed regulations, open account debt is defined as shareholder advances not evidenced by separate written instruments for which the principal amount of the aggregate advances (net of repayments on the advances) does not exceed $10,000 at the close of any day during the S corporation’s taxable year. Included within that definition are separate advances under a line of credit agreement if the advances are not evidenced by a separate written instrument. Open account debt is treated as a single indebtedness. This $10,000 limitation on open account debt for the purposes of the §1.1367-2 regulations is modeled after section 7872(c)(3) and the §1.7872-9 proposed regulations, which provide a $10,000 de minimis exception to the treatment of loans with below-market interest rates for compensation-related or corporation-shareholder loans.

Under these proposed regulations, to determine whether shareholder advances and repayments on the advances exceed the $10,000 aggregate principal threshold on any day during the S corporation’s taxable year for open account debt, the shareholder will have to maintain a “running balance” of those advances and repayments, and the outstanding principal amount of the open account debt. If the resulting aggregate principal of the running balance does not exceed $10,000 at the close of any day during the S corporation’s taxable year, the advances and repayments on advances would constitute open account debt, would be treated as a single indebtedness, and would be accounted for at the close of the taxable year (as explained in this preamble). However, if the resulting aggregate principal of the running balance exceeds $10,000 at the close of any day during the S corporation’s taxable year, the entire principal amount of that indebtedness would no longer constitute open account debt effective at the close of the day on the date the amount of the running balance exceeds $10,000. This principal amount would be treated as indebtedness evidenced by a written instrument for that taxable year, and would be accounted for according to the timing rules in §1.1367-2(d) for that taxable year and subsequent taxable years. Any new shareholder advances not evidenced by a written instrument and repayments on those advances within the $10,000 aggregate principal threshold amount during the taxable year would constitute a new open account debt.

The proposed regulations also modify the manner in which repayments on open account debt are accounted for under the existing final §1.1367-2 regulations. These rules are separate from the maintenance of a running balance of the advances and repayments to determine if a shareholder has exceeded the $10,000 threshold amount. For purposes of accounting for open account debt, each shareholder, at the end of the S corporation’s taxable year, must determine if that shareholder has made a net advance or received a net repayment on open account debt for that taxable year. To determine if a net advance or a net repayment has occurred, each shareholder, at the end of the S corporation’s taxable year, must net all advances and repayments made during the year without regard to the outstanding principal amount of the open account debt. If, at the end of the taxable year, a net repayment exists, the net repayment must be taken into account effective at the close of the S corporation’s taxable year under the general basis adjustment rules in the existing final §1.1367-2 regulations. If, at the end of the taxable year, a net advance exists, the net advance is combined with the outstanding aggregate principal balance of the existing open account debt and that amount is carried forward to the beginning of the subsequent taxable year as the outstanding aggregate principal amount of the open account debt. If at any time during the taxable year the resulting aggregate principal of the running balance exceeds the $10,000 threshold amount so the entire principal amount of the indebtedness no longer constitutes open account debt, the running balance must be reconciled effective at the close of the day the balance exceeds $10,000 to determine the aggregate principal amount of the indebtedness, and for the remainder of the taxable year that principal amount is treated in the same manner as indebtedness evidenced by a written instrument for the purposes of this section.

The regulations, as proposed, apply to any shareholder advances to the S corporation made on or after the date of publication of a Treasury decision adopting these rules as final regulations in the Federal Register and repayments on those advances by the S corporation.

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Because these regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and the Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for July 31, 2007, beginning at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. In addition, all visitors must present photo identification to enter the building. Because of access restrictions, visitors will not be admitted beyond the immediate entrance area more than 30 minutes before the hearing starts. For information about having your name placed on the building access list to attend the hearing, see the “FOR FURTHER INFORMATION CONTACT” section of this preamble.

The rules of 26 CFR 606.601(a)(3) apply to the hearing. Persons who wish to present oral comments at the hearing must submit electronic or written comments and an outline of the topics to be discussed and time to be devoted to each topic (a signed original and eight (8) copies) by July 10, 2007. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the scheduling of the speakers will be prepared after the deadline for receiving outlines has passed. Copies of the agenda will be available free of charge at the hearing.

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

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

The temporary regulations that are the subject of this correction are under section 368 of the Internal Revenue Code.

As published, temporary regulations (T.D. 9313) contain an error that may prove to be misleading and is in need of clarification.

* * * * *

Accordingly, 26 CFR part 1 is corrected by making the following amendment:

* * * * *

(l) * * *

(2) * * *

(iv) Exception. This paragraph (l)(2) does not apply to a transaction otherwise described in section 1.358-6(b)(2) or section 368(a)(1)(G) by reason of section 368(a)(2)(D).

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