It’s that time of year when the President releases his annual wish list of tax revenue proposals, also known as the “Green Book”. The 2017 Green Book includes many familiar items such as taxing Carried Interests as ordinary income, capping certain itemized deductions by individuals at a 28% tax rate benefit, and broad-based international tax reform. The proposals include other interesting items such as eliminating the tax basis step up at death over $100,000 per person, raising the top tax rate on capital gains and qualified dividends from 20 percent to 24.2 percent, broadening the scope of the 3.8% net investment income tax (NIIT) so that all active business income would be subject to either the NIIT or Medicare payroll tax, and limiting the amount of capital gain deferred under section 1031 to $1 million (indexed for inflation) per taxpayer per taxable year. The Treasury press release provides more background and proposed effective dates.
The IRS published temporary and proposed regulations on allocations of creditable foreign tax expenditures (CFTEs). The regulations make various technical changes to the existing regulatory safe harbor for allocating CFTEs. The regulations are effective on February 4, 2016.
The existing regulations provide special rules for foreign tax expense allocations when those expenses are eligible for a credit under section 901(a) or an applicable U.S. income tax treaty, stating that allocations of such items do not have substantial economic effect and must be allocated in accordance with the partners’ interests in the partnership. The regulations provide a safe harbor for CFTE allocations to be deemed in accordance with the partners’ interests in the partnership if: (1) the CFTE is allocated and reported on the partnership return in proportion to the distributive shares of income to which the CFTE relates; and (2) allocations of all other partnership items that, in the aggregate, have a material effect on the amount of CFTEs allocated to a partner are valid. In general, the purpose of the safe harbor is to match allocations of CFTEs with the income to which the CFTEs relate. The new regulations make a series of highly-technical tweaks to this safe harbor.
The IRS favorably ruled that an internal partnership restructuring was essentially a “nothing” for tax purposes even though the transaction moved the tax-regarded partnership to a different state-law entity. Specifically, in PLR 201605004, the IRS privately ruled that an upper-tier disregarded entity succeeded to the partnership status of a lower-tier tax partnership when the second partner in the lower-tier partnership contributed its partnership interest to the upper-tier entity. The ruling concluded that effectively the lower-tier partnership was converted into the upper-tier partnership and the upper-tier partnership will be considered a continuation of the lower-tier partnership.
The guidance is consistent with prior IRS guidance on conversions between state-law entities taxed as partnerships under Rev. Rul. 84-52 and Rev. Rul. 95-37. Specifically the IRS concluded that (1) the conversion of the lower-tier tax-partnership into the upper-tier partnership did not cause the partners in the partnerships to recognize gain or loss under §§ 741 or 1001 (except for the possible results of debt shifting under § 752); (2) the conversion resulted in the holding period of the partners’ interests in the upper-tier partnership to include the period of time during which those interests were held as partners in the lower-tier partnership; (3) the conversion did not cause the taxable year of the partnership to close under § 706; (4) the continuing upper-tier partnership does not need to obtain a new taxpayer identification number; (5) the basis of the assets held by the upper-tier partnership is the same as the basis of the assets in the hands of the lower-tier partnership prior to the conversion; and (6) the conversion did not result in the assets of the partnership being contributed or distributed to the partners of the partnership.
Today the Senate voted 65-33 to pass the Extenders bill (H.R. 2029) and the President quickly signed it into law with the official Date of Enactment being December 18. As discussed in more detail in yesterday’s blog, the legislation makes permanent or creates an extended life for many take breaks that have been annually renewed, or “extended” for many years. From R&D credits, to bonus depreciations, to FIRPTA reform and REIT spin-off limitations, the legislation has wide ranging impact and will require detailed scrutiny. Particularly for real estate there are significant REIT provisions and a significant FIRPTA exception for qualifying foreign pension plans (see pension exception text and summary).
Today the House passed the much talked about “Extenders” legislation and it now moves to the Senate with momentum. The bill makes many of the annual extenders permanent (or for a period of multiple years) and covers a wide range of topics. Below is a list of some of the provisions affecting the real estate industry, with more detail on these and other provisions found in the full text, in the section-by-section summary, and in the JCT summary. The legislation is roughly estimated to cost $622 billion over a 10-year period after revenue offsets. For the current status of the Extenders legislation (called the “Protecting Americans from Tax Hikes Act of 2015” or “PATH”), see H.R. 2029, Amendment 2.
Real Estate Related Provisions (non-REIT)
- Special rule for qualified conservation contributions made permanent
- Extension of 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
- Extension and modification of increased expensing limitations and treatment of certain real property as section 179 property
- Extension of reduction in S corporation recognition period for built-in gains tax
- Extension of RIC qualified investment entity treatment under FIRPTA
- Extension of new markets tax credit
- Extension and modification of bonus depreciation
REIT Related Provisions
- Restriction on tax-free spinoffs involving REITs
- Reduction in percentage limitation on assets of REIT which may be taxable REIT subsidiaries
- Prohibited transaction safe harbors
- Repeal of preferential dividend rule for publicly offered REITS; authority for alternative remedies to address certain REIT distribution failures
- Limitations on designation of dividends by REITs
- Debt instruments of publicly offered REITs and mortgages treated as real estate assets
- Asset and income test clarification regarding ancillary personal property
- Hedging provisions
- Modification of REIT earnings and profits calculation to avoid duplicate taxation
- Treatment of certain services provided by taxable REIT subsidiaries
- Exception from FIRPTA for certain stock of REITs; exception for interests held by foreign retirement and pension funds
- Increase in rate of withholding of tax on dispositions of United States real property interests
- Interests in RICs and REITs not excluded from definition of United States real property interests
- Dividends derived from RICs and REITs ineligible for deduction for United States source portion of dividends from certain foreign corporations
Alternative Energy Related Provisions
- Extension and modification of credit for nonbusiness energy property
- Extension of credit for alternative fuel vehicle refueling property
- Extension of Credit for Electric Motorcycles
- Extension of second generation biofuel producer credit
- Extension of biodiesel and renewable diesel incentives
- Extension of credit for the production of Indian coal facilities
- Extension of credits with respect to facilities producing energy from certain renewable resources
- Extension of credit for energy-efficient new homes
- Extension of special allowance for second generation biofuel plant property
- Extension of energy efficient commercial buildings deduction
- Extension of special rule for sales or dispositions to implement FERC or State electric restructuring policy for qualified electric utilities
- Extension of excise tax credits and payment provisions relating to alternative fuel
- Extension of credit for fuel cell vehicles
This week is a big week for the retail industry: its results can predict the overall success of an important shopping period. If stores perform well, this week can contribute significantly toward a successful quarterly earnings report. Given the potential of these few shopping days, retailers are understandably focused on what happens from the time the doors swing open in the dark early morning and tired shoppers race to claim their Black Friday bargains to the end of the night when the registers shut down. However, some industry-watchers are already planning for what happens beyond the 2015 holiday season and anticipating what improvements they can make for a strong showing in 2016.
The IRS recently introduced Revenue Procedure 2015-56, the much anticipated Industry Issue Resolution that provides a capitalization safe harbor percentage for retail and restaurant store remodels. The safe harbor provides qualifying taxpayers the opportunity to deduct 75% and capitalize 25% of qualifying remodel costs. Detailed here, the Revenue Procedure may be a boost to an industry that is often at the mercy of a fickle consumer base and under pressure to provide a continuously improving customer experience. The revenue procedure is effective for taxable years beginning on or after January 1, 2014.
As we’ve mentioned in previous posts on our sister blog, the Retail Law Advisor, consumers demand a lot from their retail experience. They want an omnichannel approach, technology on demand, and a personalized experience. In response, retailers continue to blend shopping and entertainment, including food and hospitality services, into the shopping experience.
This approach isn’t cheap: retailleader.com outlines the cost of several different types of capital improvements and which ones provide the most ROI. According to analysts, most remodels are fueled by competition and what will create most excitement in a community. A fresh look can increase foot traffic but even small changes, such as the installation of sustainability solutions to product displays, can make existing customers take notice.
Retailers need to approach the process with goals, timelines and a thorough plan. Embarking on a capital improvement project, no matter how large or small, has potential to affect daily operations and thus the overall customer experience. In addition, if a retail or restaurant establishment wants to use the new safe harbor, it will be treated as a change in method of accounting, implicating Form 3115, Application for Change in Accounting Method. And, as with any major adjustment, enhancement or expansion to a business, owners and operators should consult their team of advisors to ensure they are not just compliant with regulations but positioned to maximize their investment.
Following on its prior Notice 2014-52 anti-inversion guidance, the IRS has issued new Notice 2015-79 to further limit (i) inversion transactions that are contrary to the purposes of the Section 7874 anti-inversion rules and (ii) the benefits of post-inversion tax avoidance transactions. The Notice also describes corrections and clarifications to the prior Notice 2014-52. According to the Treasury Fact Sheet, the guidance both strengthens the scope of the existing anti-inversion rules and prevents inverted companies from transferring foreign operations “out from under” the U.S. tax net without paying current U.S. tax.
The Notice addresses transactions structured to avoid the Section 7874 anti-inversion rules by (i) requiring the foreign acquiring corporation to be subject to tax as a resident of the relevant foreign country in order to have substantial business activities in the relevant foreign country; (ii) disregarding certain stock of the foreign acquiring corporation in “third-country” transactions; and (iii) clarifying the definition of nonqualified property for purposes of disregarding certain stock of the foreign acquiring corporation.
The Notice also describes future regulations that will address certain post-inversion tax avoidance transactions by (i) defining inversion gain for purposes of Section 7874 to include certain income or gain recognized by an expatriated entity from an indirect transfer or license of property and providing for aggregate treatment of certain transfers or licenses of property by foreign partnerships for purposes of determining inversion gain; and (ii) requiring an exchanging shareholder to recognize all of the gain realized upon an exchange of stock of a controlled foreign corporation (as defined in section 957) (CFC), without regard to the amount of the CFC’s undistributed earnings and profits, if the transaction terminates the status of the foreign subsidiary as a CFC or substantially dilutes the interest of a United States shareholder (as defined in section 951(b)) (U.S. shareholder) in the CFC.
This morning the Senate passed H.R. 1314 (The Bipartisan Budget Act of 2015), which will completely change the way partnerships (and LLCs taxed as partnerships) are audited. The House passed the legislation on Wednesday and it is reported that President Obama will sign the legislation as soon as it reaches his desk. As discussed in Tuesday’s blog, this legislation will make it much easier for the IRS to audit partnerships and will also allow the IRS to assess and collect the proposed additional tax against the partnership itself as opposed to being required to assess the individual partners. Although the legislation implies it is only applicable to partnerships with over 100 partners, it can apply to even a two-partner partnership if one of those partners is itself a partnership. Although the legislation has a two-year delayed effective date, it is important to plan for this immediately in terms of drafting partnership agreements. For example, because the IRS will no longer notify the individual partners of an audit, the partners may insist in the partnership agreement that the partnership notify them of an audit and obtain partner consents relating to certain audit elections or IRS settlements. The legislation’s section-by-section summary provides a general overview of the new rules.
Note that the legislation also removes Section 704(e)(1) to eliminate the presumption that one is a partner for tax purposes merely because they have a capital interest in the partnership. This change was likely in response to the taxpayer arguments found in the 2012 Castle Harbour decision discussed in our 2012 blog where a debt-like partnership interest was argued to qualify as partnership equity based on this Section 704(e)(1) language. Now the Section 704(e) rules are more clearly limited to the context of gifted partnership interest.
As part of the current Bipartisan Budget Act of 2015, sweeping changes to the partnership audit rules could be imminent. The new rules would greatly simplify the IRS procedures for auditing partnerships and likely increase the audit rate of partnerships. The new rules would replace the current “TEFRA” and “Electing Large Partnership” rules with a new entity-level audit process that would allow the IRS to assess and collect the taxes against the partnership absent certain election out procedures. The new legislation is patterned after the recent H.R. 2821, but thankfully removes the onerous joint and several liability provision in the earlier bill and allows the IRS to reduce the potential tax rate assessed against the partnership to take into account factors such as tax-exempt partners and potential favorable capital gains tax rates. The new rules will simplify the current complex procedures on determining who is authorized to settle on behalf of the partnership and also avoid the IRS’s need to send various notices to all of the partners. Although partnerships with 100 or less partners can elect out of the new rules, such election is not available if there is another partnership as a partner. If passed, new rules are to apply to partnership taxable years beginning after December 31, 2017. Partnership agreements can be expected to need to take into account these changes.
In DJB Holding Corp. the 9th Circuit concluded that a purported related-party partnership was not a bona fide partnership for tax purposes and taxable income was redirected to the taxable C corporation performing the underlying profitable services. The ultimate taxable services were performed by the C corporation but a partnership agreement between that C corporation and an upper-tier pass-through entity directed 70% of the income to the upper-tier pass-through entity for the stated consideration that the pass-through entity (and its owners) provided a needed financial guarantee as shown in this simplified diagram. The 9th Circuit affirmed the Tax Court conclusion that this was not a bona fide partnership under the historical Culbertson and Luna authorities.
The underlying Tax Court decision essentially disregarded the upper-tier guarantor’s nominal ownership in the partnership, noting that the totality of the circumstances did not support partner status. First, as an factual matter, the partners did not respect their own documentation and the actual income sharing between the partners was substantially different than the documented sharing and the accountant did not file partnership tax returns. Second, the court did not find the guarantee to be of significant value and noted that the other related parties that joined in the guarantee did not also receive partnership interest. Third, the court noted that the unilateral control exercised by the taxable C corporation supported the lack of partnership status. The primary issue on appeal was whether the guarantee had any significant value. The 9th circuit court found that the record supported that there were no value to such guarantee, asserting that the 100% owned taxable C corporation would have been entitled to the guarantees of the ultimate individual owners through their existing obligations to the C corporation.