IRS & Treasury Propose Removal of Section 385 Documentation Regulations

On Friday, September 21, 2018, the Internal Revenue Service (IRS) and Treasury filed a proposal to remove the regulations under Section 1.385-2, which set forth minimum documentation requirements to be satisfied in order for certain instruments to be treated as indebtedness for federal tax purposes. 

As a result, taxpayers are relieved from these specific documentation requirements, which were set to go into effect next year. The regulations applied to certain related party debt transactions involving U.S. borrowers on or after January 1, 2019. 

This proposal is the latest in a series of recent governmental actions taken to temper the 385 regulations since their introduction in April 2016. As expected, the proposal suggests that the passage of the Tax Cut and Jobs Act (TCJA), specifically the revised 163(j) provision which caps interest expense deductibility for federal tax purposes, limits the benefits of minimum documentation requirements, which influenced the decision to remove the regulations. The IRS and Treasury also suggest that their decision was informed by careful consideration of public commentary received on these documentation regulations in connection with Executive Order 13789. 

Despite their proposal to remove these documentation regulations, the IRS and Treasury indicated that they will continue to study the issues addressed by these rules and maintain the possibility of proposing a “substantially simplified and streamlined” version of the regulations at a later date. If proposed, the IRS and Treasury committed to an effective date allowing sufficient time for taxpayers to comply.

The proposal was published in the Federal Register on September 24, 2018. To access a full copy of the proposal, click here.