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Tax Law Roundup

current law developments in U.S. taxation

Final Regulations Provide Partnership Technical Terminations Have No Impact on Unamortized Organization and Start-Up Costs

Posted in General, Joint Venture, Partnership/LLC

The IRS issued final regulations confirming that a technical termination of a partnership does not accelerate unamortized start up or organizational costs under Sections 195 and 709.  The regulations are effective as of the date of the underlying proposed regulations and apply to a Section 708(b)(1)(B) partnership technical termination that occurs on or after December 9, 2013.  The only change in the final regulations was to clarify that there is no restart of the amortization period for these capitalized costs.

A sale or exchange of 50% or more of a partnership interest within 12 months creates a partnership technical termination, causing a short partnership taxable year, among other events.  Many of the consequences of technical terminations were reduced or eliminated in 1997 when regulations changed the mechanics of a technical termination, but questions still remain.  This latest regulation prevents taxpayers from receiving an accelerated tax deduction as a result of a technical termination.  However, until Congress acts on proposals to completely repeal technical terminations, taxpayers will continue to need to watch out for these events and their consequences, such as a restart of Section 168 depreciation lives.

Final S corporation Regulations Limit Basis To Bona Fide Shareholder Loans

Posted in Debt vs. Equity, S corporation

The IRS issued final regulations granting an S corporation shareholder outside basis only in “bona fide” loans directly from the shareholder to the S corporation. A shareholder does not obtain debt basis merely by guaranteeing a loan or acting as a surety, accommodation party, or in any similar capacity relating to a loan.  Further, a shareholder can receive basis from a so-called “back-to-back” loan (where the shareholder first borrows the money from another before making the loan to the S corporation), but only if the loan from the shareholder to the S corporation is respected as a bona fide loan.  The final regulations adopt the proposed regulations discussed in our 2012 blog without substantive change and officially remove the prior “economic outlay” concept for S corporation debt basis determinations.  The final regulations will be effective when published as final in the federal register (scheduled for July 23, 2014).


Internet Sales Tax Update: Senate Introduces Marketplace and Internet Tax Fairness Act

Posted in Real Estate, Sales Tax

Last night, Senators Enzi, Durbin, Alexander, Heitkamp, Collins and Pryor introduced the Marketplace and Internet Tax Fairness Act (MITFA).  Essentially, the legislation combines the previously introduced Marketplace Fairness Act (with several technical changes) and a 10-year extension of the Internet Tax Freedom Act, which provides a moratorium on state and local taxation on internet access.  The new bill would allow states to collect sales/use tax on internet retailers with gross sales over $1 million. This legislative vehicle follows on the 2013 Senate vote of 69-27 for Marketplace Fairness Act of 2013.

According to the ICSC shopping center trade association, the new legislation provides states the authority to enforce existing sales and use tax laws, if they choose to do so, by adopting one of the following options:

  • Streamlined Sales and Use Tax Agreement (SSUTA): Allows any state that is a member of SSUTA to require remote retailers to collect state and local sales and use taxes.
  • Alternative Minimum Simplification Requirements: States that are not SSUTA members may require remote retailers to collect state and local sales and use taxes if they adopt minimum simplification requirements as outlined in the bill.

 Small Seller Exception: The legislation would prohibit states from requiring remote sellers with less than $1 million in annual nationwide remote sales to collect sales and use taxes.

Cross-Border Interest Expense Apportionment Regulations Finalized

Posted in International, Partnership/LLC

The IRS issued cross-border interest apportionment final regulations.  These adopt the approach from the 2012 temporary regulations, requiring a 10% corporate partner to apportion its interest expense by reference to the value of the partnership’s assets.  Thus, regardless of special allocations in the partnership, a 20% corporate partner would be treated as owning a straight 20% of the partnership assets for purposes of determining how the corporate partner apportions its interest expense for Section 861 US vs. non-US sourcing calculations.  The regulations conform to the “asset method” dictated by the 2010 statutory changes to Section 864(e).

Specifically, a corporate partner shall apportion its interest expense, including the partner’s distributive share of partnership interest expense, by reference to the partner’s assets, including the partner’s pro rata share of partnership assets, if the corporate partner’s direct and indirect interest in the partnership (as determined under the attribution rules of section 318) is 10 percent or more.  Further, an individual partner is subject to the rules if either the individual is a general partner or the individual’s direct and indirect interest (as determined under the attribution rules of section 318) in the partnership is 10 percent or more.  The regulations are effective on July 16, 2014.

New FBAR Amnesty Program Changes Help Some, Hurt Some

Posted in International, Procedure

The IRS has significantly expanded the streamlined amnesty programs for persons who did not timely comply with Foreign Bank Account Reporting (FBAR) rules.  Although these changes broaden the base of taxpayers qualifying for the 0% or new 5% penalty, certain taxpayers will see their penalty go up to 50% where it becomes public that the government is investigating the bank at issue.  The penalties are based on of the foreign financial assets that gave rise to the tax compliance issue.

The Carrot – Expanding Qualification for Streamlined Procedures

Originally, the IRS’s streamlined filing compliance procedures (as announced in 2012) were available only to non-resident, non-filers.  The expanded streamlined procedures will be available to a wider group of U.S. taxpayers living abroad, as well as certain U.S. taxpayers living in the United States.  Key changes include the elimination of a requirement that the taxpayer have $1,500 or less of unpaid tax per year, the elimination of the required risk questionnaire, and a new requirement that the taxpayer certify that previous failures to comply were due to non-willful conduct.   All penalties will be waived for eligible U.S. taxpayers living abroad, while eligible U.S. taxpayers residing in the United States will only be subject to a miscellaneous offshore penalty equal to 5% of the foreign financial assets at issue. 

The Stick – Increased Penalties for Some

The modifications to the offshore voluntary disclosure program (OVDP) incorporate changes to the penalty calculation and payment provisions, and increase potential penalties in certain instances.  For example, the modified OVDP eliminates the reduced penalty percentage for certain non-willful taxpayers (presumably because non-willful taxpayers can take advantage of the streamlined procedures discussed above).  Also, while the existing 27.5% penalty continues to apply in many cases, certain voluntary disclosures (those filed on or after August 3, 2014) could face a 50% penalty on the maximum value of unreported assets, but only with respect to accounts held at a financial institution (or through a facilitator) and it becomes public that the institution (or facilitator) is under investigation by the IRS or the Department of Justice.  The new rules also require taxpayers to submit all account statements and pay the offshore penalty at the time of the OVDP application.

For more information on FBAR rules and the OVDP, see our prior FBAR blogs.

New Final Regulations on Written Tax Advice: The End of Circular 230 Disclaimers

Posted in General, Procedure

On Monday, June 9th the IRS issued final regulations (T.D. 9668) that eliminate the requirement to include Circular 230 disclaimers in documents and transmissions and provide other welcome changes to practice standards under Circular 230.

Since 2004, practitioners have been grappling with the strict (and complicated) “covered opinion” requirements for written tax advice imposed by the Circular 230 regulations.  Those rules led to the widespread use of carefully worded banners on documents and transmissions disclaiming reliance for penalty purposes.  The final regulations have replaced the prior detailed “covered opinion” with a more flexible approach, eliminating the need for banner disclaimers.

The new regulations adopt a single standard for all written tax advice.  Practitioners must base all written advice on reasonable factual and legal assumptions, exercise reasonable reliance, and consider all relevant facts the practitioner knows (or should know).  The regulations also provide a number of other changes, including a new competence standard for tax practitioners and new responsibilities for firm managers overseeing Circular 230 compliance.

The final regulations are effective as of June 12, 2014.

Tax Court Denies Residential Land Developer Use of Homebuilder Tax Deferral Rule

Posted in Real Estate

Under the Completed Contract method of accounting, homebuilders are allowed to defer taxable income until 95% of the costs of the home development are incurred.  On June 2, the Tax Court concluded in Howard Hughes that a residential land developer was not eligible for this generous tax rule because they did not actually build homes.  Petitioner developed parcels and lots, was responsible for constructing infrastructure necessary for homebuilding up to the edge of the parcels or lots, and retained some control over the style and materials used in the home construction.  However, the Tax Court concluded this did not make petitioner a homebuilder.  Distinguishing this case from their recent taxpayer-favorable case of Shea Homes, the Court said that though common improvement costs could be included in the cost of home construction, “at no point in Shea Homes did we say that a home construction contract could consist solely of common improvement costs.”  The court did allow the custom lot contracts and the bulk sale agreements to be treated as Section 460 long-term construction contracts, which may be eligible for the percentage of completion method.

The takeaway from the Howard Hughes case is the new clear test for what constitutes a homebuilder eligible for the Completed Contract method.  The Tax Court set forth this test as follows:

Our Opinion today draws a bright line. A taxpayer’s contract can qualify as a home construction contract only if the taxpayer builds, constructs, reconstructs, rehabilitates, or installs integral components to dwelling units or real property improvements directly related to and located on the site of such dwelling units. It is not enough for the taxpayer to merely pave the road leading to the home, though that may be necessary to the ultimate sale and use of a home.

Proposed Regulations Update Definition of Real Property for REITs

Posted in Real Estate, REITs

The IRS issued new proposed regulations for the definition of real property for REIT purposes, updating the original 1962 regulations.  The proposed regulations come in the wake of news reports criticizing the IRS for allowing too many taxpayers to convert to REIT status and a temporary moratorium (since lifted) on private letter rulings regarding the conversion of operating entities with substantial real estate assets to REITs. The regulations provide a framework to analyze the types of assets that qualify as real property for the REIT asset tests. The regulations are limited to asset testing and explicitly do not cover the types of income that qualify as good real estate income for REITs.

The proposed regulations define real property to include land, inherently permanent structures, and structural components.  For each major type of asset, the regulations provide lists of assets that qualify as real property.  If an asset is not identified in one of the lists, the regulations also provide a “facts and circumstances” test to determine whether the asset satisfies the REIT test. The proposed regulations also identify certain types of intangible assets that are real property or interests in real property for REIT purposes.

Facts & Circumstances Test:

For assets that are not specifically identified, the regulations list the following facts and circumstances that should be taken into account to determine whether the asset qualifies as real property:

(A) The manner, time, and expense of installing and removing the distinct asset;

(B) Whether the distinct asset is designed to be moved;

(C) The damage that removal of the distinct asset would cause to the item itself or to the inherently permanent structure to which it is affixed;

(D) Whether the distinct asset serves a utility-like function with respect to the inherently permanent structure;

(E) Whether the distinct asset serves the inherently permanent structure in its passive function;

(F) Whether the distinct asset produces income from consideration for the use or occupancy of space in or upon the inherently permanent structure;

(G) Whether the distinct asset is installed during construction of the inherently permanent structure;

(H) Whether the distinct asset will remain if the tenant vacates the premises; and

(I) Whether the owner of the real property is also the legal owner of the distinct asset.

The proposed regulations also provide several illustrative examples to show how the new definitions are intended to work in practice.

Effective Date: Because the IRS views the regulations as only a clarification of existing law and not a significant modification, they are proposed to be effective for the calendar quarters beginning after they are published as final.

IRS Issues Final Regulations on Deducting Fiduciary Expenses

Posted in Estate and Gift

The IRS has released final regulations regarding which expenses incurred by a trust are fully deductible for income tax purposes and which are subject to the 2% floor for miscellaneous itemized deductions.  In general, the regulations provide that expenses incurred by a trust are subject to the 2% floor if they commonly are, or customarily would be, incurred by an individual owning the property.  The final regulations retain the general principal set forth in Knight v. Commissioner, 552 U.S. 181 (2008), the case that first brought attention to this issue.

Following Knight, the IRS issued 2011 proposed regulations.  The proposed regulations provided that a single fiduciary fee bundling charges for a variety of services would need to be unbundled for purposes of applying the 2% floor to the portions of the bundled fee representing expenses commonly incurred by an individual.  However, in Notice 2011-37 the IRS delayed the implementation of the unbundling requirement for tax years beginning before the regulations became final.  Accordingly, now that the regulations are final, a bundled fiduciary fee will need to be unbundled for purposes of deductibility under section 67 for tax years beginning after May 9, 2014.

UPDATE (July 16, 2014):  The IRS has amended these final regulations to postpone their implementation until January 1, 2015.  Under the amended regulations, a bundled fiduciary fee will need to be unbundled for purposes of deductiblity under section 67 for tax years beginning on or after January 1, 2015.

More FATCA Transition Relief and Clarification

Posted in FATCA, International

New Notice 2014-33 sets forth calendar years 2014 and 2015 as a transition period for IRS FACTA implementation enforcement for withholding agents, foreign financial institutions and certain other withholding responsibilities.  However, an entity that has not made good faith efforts to comply with the new requirements will not be given any relief from IRS enforcement during the transition period.  The transition period and other guidance described in Notice 2014-33 is intended to facilitate an orderly transition for withholding agent and FFI compliance with FATCA’s requirements.

Notice 2014-33 also announces the intention of the government to further amend the regulations under sections 1441, 1442, 1471, and 1472, as applicable, to provide: (i) that a withholding agent or FFI may treat an obligation (which includes an account) held by an entity that is opened, executed, or issued on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of sections 1471 and 1472, subject to certain modifications described in section IV of the Notice; (ii) additional guidance under section 1471 concerning the requirements for an FFI (or a branch of an FFI, including a disregarded entity owned by an FFI) that is a member of an expanded affiliated group of FFIs to be treated as a limited FFI or limited branch, including the requirement for a limited FFI to register on the FATCA registration website; (iii) a modification to the standards of knowledge for withholding agents under §1.1441-7(b) for accounts documented before July 1, 2014; and (iv) a revision to the definition of a reasonable explanation of foreign status in §1.1471-3(e)(4)(viii).  Prior to the issuance of these amendments, taxpayers are allowed to rely on the provisions of this Notice 2014-33 regarding these proposed amendments to the regulations.