[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: 26CFR1.1366-3]

[Page 743]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.1366-3  Treatment of family groups.

    (a) In general. Under section 1366(e), if an individual, who is a 
member of the family of one or more shareholders of an S corporation, 
renders services for, or furnishes capital to, the corporation without 
receiving reasonable compensation, the Commissioner shall prescribe 
adjustments to those items taken into account by the individual and the 
shareholders as may be necessary to reflect the value of the services 
rendered or capital furnished. For these purposes, in determining the 
reasonable value for services rendered, or capital furnished, to the 
corporation, consideration will be given to all the facts and 
circumstances, including the amount that ordinarily would be paid in 
order to obtain comparable services or capital from a person (other than 
a member of the family) who is not a shareholder in the corporation. In 
addition, for purposes of section 1366(e), if a member of the family of 
one or more shareholders of the S corporation holds an interest in a 
passthrough entity (e.g., a partnership, S corporation, trust, or 
estate), that performs services for, or furnishes capital to, the S 
corporation without receiving reasonable compensation, the Commissioner 
shall prescribe adjustments to the passthrough entity and the 
corporation as may be necessary to reflect the value of the services 
rendered or capital furnished. For purposes of section 1366(e), the term 
family of any shareholder includes only the shareholder's spouse, 
ancestors, lineal descendants, and any trust for the primary benefit of 
any of these persons.
    (b) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. The stock of an S corporation is owned 50 percent by F 
and 50 percent by T, the minor son of F. For the taxable year, the 
corporation has items of taxable income equal to $70,000. Compensation 
of $10,000 is paid by the corporation to F for services rendered during 
the taxable year, and no compensation is paid to T, who rendered no 
services. Based on all the relevant facts and circumstances, reasonable 
compensation for the services rendered by F would be $30,000. In the 
discretion of the Internal Revenue Service, up to an additional $20,000 
of the $70,000 of the corporation's taxable income, for tax purposes, 
may be allocated to F as compensation for services rendered. If the 
Internal Revenue Service allocates $20,000 of the corporation's taxable 
income to F as compensation for services, taxable income of the 
corporation would be reduced by $20,000 to $50,000, of which F and T 
each would be allocated $25,000. F would have $30,000 of total 
compensation paid by the corporation for services rendered.
    Example 2. The stock of an S corporation is owned by A and B. For 
the taxable year, the corporation has paid compensation to a partnership 
that rendered services to the corporation during the taxable year. The 
spouse of A is a partner in that partnership. Consequently, if based on 
all the relevant facts and circumstances the partnership did not receive 
reasonable compensation for the services rendered to the corporation, 
the Internal Revenue Service, in its discretion, may make adjustments to 
those items taken into account by the partnership and the corporation as 
may be necessary to reflect the value of the services rendered.

[T.D. 8852, 64 FR 71648, Dec. 22, 1999]