Section 267: Understanding Related Party Transaction Rules in Tax Law

One of the most overlooked areas of the tax code—yet frequently scrutinized during audits—is IRC §267, which governs related party transactions. These rules are designed to prevent taxpayers from taking advantage of timing differences or artificial losses through dealings with related parties.

Whether you're an individual taxpayer, a corporation, or a partner in a business, Section 267 can impact how and when deductions are allowed, and whether certain losses are disallowed entirely.

In this blog post, we'll cover:

• What Section 267 is

• Who qualifies as a related party

• How the rule impacts deductions and losses

• Common scenarios

• Practical tax planning considerations

  
  

What Is Section 267?

IRC §267 disallows or defers certain deductions and losses for transactions between related parties. The provision is in place to stop taxpayers from creating tax benefits without real economic loss—for example, by deducting expenses that haven’t been paid, or claiming losses from sales that don’t result in a true change in ownership.

Who Is Considered a Related Party Under §267?

The IRS has specific definitions for related parties under Section 267(b) and 267(e), which include:

Individuals and Family Members:

• Spouse

• Parents

• Children and grandchildren

• Siblings

• In-laws are not included

Entity Relationships:

• A shareholder and their >50% owned corporation

• Two corporations if more than 50% of the stock is owned by the same individuals or entities

• Partnerships and their partners with >50% ownership

• Trusts and beneficiaries

• Corporations and partnerships with overlapping ownership

The key threshold is typically more than 50% direct or indirect ownership.

How Section 267 Affects Tax Deductions and Losses

There are two primary ways §267 limits tax benefits:

1. Deferral of Accrued Expenses to Related Cash-Basis Taxpayers

If an accrual-basis taxpayer (like a C corp or partnership) accrues an expense to a related party who is on the cash basis, the deduction is not allowed until the related party includes the amount in income.

Example: Accrued Compensation

• A C corporation accrues a $15,000 year-end bonus to its sole shareholder (who is cash basis) on December 31, 2024, but doesn’t pay it until February 2025.

• Under Section 267(a)(2), the corporation cannot deduct the expense in 2024.

• It must wait until 2025, the year the related party reports the income.

This prevents mismatched timing: a deduction in one year and income in a later year.

2. Disallowance of Losses on Sales to Related Parties

Section 267(a)(1) disallows losses on sales or exchanges of property between related parties.

Example: Asset Sale to a Related Party

• Jane sells stock to her brother at a $10,000 loss.

• The loss is disallowed under Section 267.

• If her brother later sells the stock at a gain, part of the gain may be offset by the disallowed loss, but only if a gain is actually realized.

This rule prevents taxpayers from generating capital losses by simply selling property to a relative or controlled entity while still retaining effective control.

Special Rules for Partnerships and S Corporations

Partnerships:

• A partner cannot deduct a loss from a sale to their own partnership (if they own >50%).

• The partnership cannot deduct expenses owed to a partner who is a related cash-basis party until paid.

S Corporations:

• Shareholders and their S corps are related if the shareholder owns more than 50%.

• Same deferral rules apply for accrued but unpaid compensation, rent, and other items.

Planning Considerations and Best Practices

1. Time Payments to Match Deductions

• If you're an accrual-basis business with related cash-basis owners or employees, try to make payments by year-end if you want the deduction in that year.

2. Avoid Artificial Loss Transactions

• Don’t sell assets to family members or related entities to recognize tax losses unless there's substance to the transaction and ownership is clearly changing.

3. Document Ownership and Relationships

• Especially in closely held businesses, maintain clear records of ownership percentages to determine when §267 applies.

4. Consider S Corp vs. Partnership Structuring

• Because of how related party rules interact with entity types, choice of entity may affect the timing of deductions and loss recognition.

Final Thoughts

Section 267 exists to preserve the integrity of the tax system by ensuring that related parties can't use accounting mismatches or artificial losses to reduce tax liabilities. While it can be complex, being aware of these rules is essential—especially for closely held businesses, family-run operations, and tax-savvy investors.

Understanding when and how §267 applies can help avoid disallowed deductions, timing mismatches, and audit issues. If you're working with related entities or family-owned businesses, a proactive approach to tax planning is key.