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neither party argued that the statutory text and the
recharacterization rule suffice to answer the question in issue.
Instead, the parties’ arguments were based on their respective
analyses of the applicable provisions of the several successive
sets of regulations the Commissioner has issued under section
469, interpreting the terms “participation” or “activity”.
More particularly, the parties have agreed that the 1994
final regulations, and the 1992 proposed regulations, are the
governing law. As discussed in more detail below, the 1994 final
activity regulation clearly provides that shareholders
participate in the activities of their C corporations; that
regulation generally applies to 1994. See sec. 1.469-11(a)(1),
Income Tax Regs. (sec. 1.469-4, Income Tax Regs., applies for
taxable years ending after May 10, 1992). However, the 1994
final regulations also contain a transitional rule applicable to
the year in issue. Section 1.469-11(b)(1), Income Tax Regs.,
provides that taxpayers may apply the 1992 proposed regulations
to 1994 if they so choose, instead of the 1994 final activity
regulation otherwise applicable. In other words, the 1994 final
regulations make the 1992 proposed regulations applicable to the
year in issue.
For this reason, the parties believed that the crucial issue
was whether shareholders participate in C corporation activities
under the 1992 proposed regulations, and they made their
arguments accordingly.
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