[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1362-8]

[Page 734-735]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1362-8  Dividends received from affiliated subsidiaries.

    (a) In general. For purposes of section 1362(d)(3), if an S 
corporation holds stock in a C corporation meeting the requirements of 
section 1504(a)(2), the term passive investment income does not include 
dividends from the C corporation to the extent those dividends are 
attributable to the earnings and profits of the C corporation derived 
from the active conduct of a trade or business (active earnings and 
profits). For purposes of applying section 1362(d)(3), earnings and 
profits of a C corporation are active earnings and profits to the extent 
that the earnings and profits are derived from activities that would not 
produce passive investment income (as defined in section 1362(d)(3)) if 
the C corporation were an S corporation.
    (b) Determination of active or passive earnings and profits--(1) In 
general. An S corporation may use any reasonable method to determine the 
amount of dividends that are not treated as passive investment income 
under section 1362(d)(3)(E). Paragraph (b)(5) of this section describes 
a method of determining the amount of dividends that are not treated as 
passive investment income under section 1362(d)(3)(E) that is deemed to 
be reasonable under all circumstances.
    (2) Lower tier subsidiaries. If a C corporation subsidiary (upper 
tier corporation) holds stock in another C corporation (lower tier 
subsidiary) meeting the requirements of section 1504(a)(2), the upper 
tier corporation's gross receipts attributable to a dividend from the 
lower tier subsidiary are considered to be derived from the active 
conduct of a trade or business to the extent the lower tier subsidiary's 
earnings and profits are attributable to the active conduct of a trade 
or business by the subsidiary under paragraph (b) (1), (3), (4), or (5) 
of this section. For purposes of this section, distributions by the 
lower tier subsidiary will be considered attributable to active earnings 
and profits according to the rule in paragraph (c) of this section. This 
paragraph (b)(2) does not apply to any member of a consolidated group 
(as defined in Sec. 1.1502-1(h)).
    (3) De minimis exception. If less than 10 percent of a C 
corporation's earnings and profits for a taxable year are derived from 
activities that would produce passive investment income if the C 
corporation were an S corporation, all earnings and profits produced by 
the corporation during that taxable year are considered active earnings 
and profits.
    (4) Special rules for earnings and profits accumulated by a C 
corporation prior to 80 percent acquisition. A C corporation may treat 
all earnings and profits accumulated by the corporation in all taxable 
years ending before the S corporation held stock meeting the 
requirements of section 1504(a)(2) as active earnings and profits in the 
same proportion as the C corporation's active earnings and profits for 
the three taxable years ending prior to the time when the S corporation 
acquired 80 percent of the C corporation bears to the C corporation's 
total earnings and profits for those three taxable years.
    (5) Gross receipts safe harbor. A corporation may treat its earnings 
and profits for a year as active earnings and profits in the same 
proportion as the corporation's gross receipts (as defined in Sec. 
1.1362-2(c)(4)) derived from activities that would not produce passive 
investment income (if the C corporation were an S corporation), 
including those that do not produce passive investment income under 
paragraphs (b)(2) through (b)(4) of this section, bear to the 
corporation's total gross receipts for the year in which the earnings 
and profits are produced.
    (c) Allocating distributions to active or passive earnings and 
profits--(1) Distributions from current earnings and profits.

[[Page 735]]

Dividends distributed by a C corporation from current earnings and 
profits are attributable to active earnings and profits in the same 
proportion as current active earnings and profits bear to total current 
earnings and profits of the C corporation.
    (2) Distributions from accumulated earnings and profits. Dividends 
distributed by a C corporation out of accumulated earnings and profits 
for a taxable year are attributable to active earnings and profits in 
the same proportion as accumulated active earnings and profits for that 
taxable year bear to total accumulated earnings and profits for that 
taxable year immediately prior to the distribution.
    (3) Adjustments to active earnings and profits. For purposes of 
applying paragraph (c) (1) or (2) of this section to a distribution, the 
active earnings and profits of a corporation shall be reduced by the 
amount of any prior distribution properly treated as attributable to 
active earnings and profits from the same taxable year.
    (4) Special rules for consolidated groups. For purposes of applying 
section 1362(d)(3) and this section to dividends received by an S 
corporation from the common parent of a consolidated group (as defined 
in Sec. 1.1502-1(h)), the following rules apply--
    (i) The current earnings and profits, accumulated earnings and 
profits, and active earnings and profits of the common parent shall be 
determined under the principles of Sec. 1.1502-33 (relating to earnings 
and profits of any member of a consolidated group owning stock of 
another member); and
    (ii) The gross receipts of the common parent shall be the sum of the 
gross receipts of each member of the consolidated group (including the 
common parent), adjusted to eliminate gross receipts from intercompany 
transactions (as defined in Sec. 1.1502-13(b)(1)(i)).
    (d) Examples. The following examples illustrate the principles of 
this section:

    Example 1. (i) X, an S corporation, owns 85 percent of the one class 
of stock of Y. On December 31, 2002, Y declares a dividend of $100 ($85 
to X), which is equal to Y's current earnings and profits. In 2002, Y 
has total gross receipts of $1,000, $200 of which would be passive 
investment income if Y were an S corporation.
    (ii) One-fifth ($200/$1,000) of Y's gross receipts for 2002 is 
attributable to activities that would produce passive investment income. 
Accordingly, one-fifth of the $100 of earnings and profits is passive, 
and $17 (\1/5\ of $85) of the dividend from Y to X is passive investment 
income.
    Example 2. (i) The facts are the same as in Example 1, except that Y 
owns 90 percent of the stock of Z. Y and Z do not join in the filing of 
a consolidated return. In 2002, Z has gross receipts of $15,000, $12,000 
of which are derived from activities that would produce passive 
investment income. On December 31, 2002, Z declares a dividend of $1,000 
($900 to Y) from current earnings and profits.
    (ii) Four-fifths ($12,000/$15,000) of the dividend from Z to Y are 
attributable to passive earnings and profits. Accordingly, $720 (\4/5\ 
of $900) of the dividend from Z to Y is considered gross receipts from 
an activity that would produce passive investment income. The $900 
dividend to Y gives Y a total of $1,900 ($1,000 + $900) in gross 
receipts, $920 ($200 + $720) of which is attributable to passive 
investment income-producing activities. Under these facts, $41 ($920/
$1,900 of $85) of Y's distribution to X is passive investment income to 
X.

    (e) Effective date. This section applies to dividends received in 
taxable years beginning on or after January 20, 2000; however, taxpayers 
may elect to apply the regulations in whole, but not in part, for 
taxable years beginning on or after January 1, 2000, provided all 
affected taxpayers apply the regulations in a consistent manner. To make 
this election, the corporation and all affected taxpayers must file a 
return or an amended return that is consistent with these rules for the 
taxable year for which the election is made. For purposes of this 
section, affected taxpayers means all taxpayers whose returns are 
affected by the election to apply the regulations.

[T.D. 8869, 65 FR 3854, Jan. 25, 2000; 65 FR 16318, Mar. 28, 2000]