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Tax Law Roundup

current law developments in U.S. taxation

IRS Ruling Addresses LLC Eligibility for Cancellation of Debt Exception

Posted in Cancellation of Debt Income, Partnership/LLC, Real Estate, Workouts

government-contracts-usaIn new CCA 201525010, the IRS addressed the issue of whether a general “exculpatory” debt of an LLC is recourse or non-recourse for purposes of classifying debt-relief as potential cancellation of debt (COD) income. Recourse treatment means the debt forgiveness creates COD income. Non-recourse means the debt relief is treated as proceeds from the sale of the underlying property. In this case the taxpayer wanted COD treatment because they were eligible for a special COD income exclusion.

Ultimately the IRS said that there is authority both for and against treating exculpatory debt of a single purpose LLC as recourse debt for COD purposes. However, the IRS concluded that in making this determination, the Section 752 partnership regulations were not relevant and the answer turned on the more general test as to whether the debt was recourse or non-recourse to the LLC itself (as opposed to looking at whether the members were at risk through their member guarantees).

Details

In the ruling, the real estate LLC had a first and second mortgage, with the second mortgage lender also having guarantees and interest pledges by the LLC members. The loan documents required the LLC to be a single purpose entity (SPE). The loan documents did not specifically say the loan was recourse or non-recourse. But by being an SPE, the assets were necessarily limited, although technically all LLC assets were at risk for the second mortgage that was at issue.

After a non-judicial foreclosure by the first mortgage lender, the second mortgage lender forgave its debt. The LLC members reported the debt forgiveness as COD income, and excluded a portion of the income under the Section 108 insolvency exception. Both the taxpayers and the IRS acknowledged that if the loan was recourse, the loan forgiveness was COD income, but if it was non-recourse, the forgiveness was treated as disposition proceeds from the underlying real estate. In this case the taxpayer asserted recourse treatment, because it could exclude the income under the Section 108 insolvency exception.

The taxpayers argued that the debt must be recourse for COD purposes because it was recourse under the Section 752 partnership debt sharing rules because there were member guarantees. The taxpayer noted that this result was implied in the Great Plains Gasification Associates v. Commissioner Tax Court memorandum decision. In the CCA, the IRS concludes that the implication in that case is erroneous and the more general “Section 1001” rules apply to determine whether the loan is recourse or non-recourse. Having said that, the IRS said that there was legal support under the general Section 1001 rules for treating such SPE exculpatory debt as either recourse or non-recourse and further factual development of the specific case was needed.

Estate Tax Regulations Allow Taxpayers to Request Late Portability Relief

Posted in Estate and Gift

putting-coin-in-piggy-bankThe IRS released new final estate and gift tax regulations that include guidance on taxpayers seeking so-called “portability” elections to carry over the lifetime exclusion from the first spouse to die to the second spouse.  The new rules require a formal private letter ruling request under Section 9100 to request permission of the IRS to waive the missed election that would have been filed on the estate tax return of the first spouse to die. The relief is only applicable if no estate tax return was required on the death of the first spouse.  The new rules replace the simplified portability election relief found in Rev. Proc. 2014-18.

New Regulations Address Treatment of Corporate Partners with Appreciated Partnership Interest

Posted in Corporate, Partnership/LLC

List CheckingAfter much promise, the IRS issued two sets of regulations to address the potential avoidance of gain by corporate partners.  First, new § 337(d) temporary regulations, often referred to as the “May Company” regulations, define when and how a corporate partner is deemed to recognize taxable gain in its partnership interest if the partnership acquires stock in such corporate partner.  Second, new § 732(f) proposed regulations clarify when a corporate partner recognizes gain when a partnership distributes stock of a different corporation to such partner.

Section 337(d) May Company Regulations

The § 337(d) temporary regulations replace 1992 proposed regulations on when a corporate partner recognizes gain when the partnership acquires stock in such partner.  The regulations address the gain avoidance that occurred when May Company contributed appreciated property to a partnership and effectively sold that property by having the partnership use cash to purchase May Company stock.  When the partnership later distributed the acquired stock back to May Company, the gain effectively disappeared.  The original proposed regulations imposed arguably overlapping gain recognition rules both when the corporate partner obtained an indirect interest in the stock through its partnership interest (the deemed redemption rule) and when the partnership distributed the stock to the corporate partner.  The new regulations streamlined the rules by eliminating the distribution rule and incorporating certain concepts into a single deemed redemption rule that imposes taxable gain on the corporate partner when there is an expansion of the partner’s share of its stock held by the partnership.  The regulations make a number of additional nuanced mechanical changes to clarify administration of the rule and require that consistent concepts be applied in the tiered partnership context.

Section 732(f) Partnership Distributions of Stock to Corporate Partners

The second set of regulations propose to update rules under § 732(f), enacted in 1999, which prevents corporate partners from avoiding tax on their share of partnership appreciation by having the partnership redeem them with a controlling interest in stock of a new corporation (Newco), where Newco holds high-basis assets. The avoidance occurred because, although the corporate partner received a low-basis in the distributed Newco stock, the corporate partner simply liquidated Newco, and the high-basis assets inside Newco carried over to the corporate partner. In such context, § 732(f) generally requires that both the Newco stock and the Newco assets be stepped down. The new regulations further clarify the mechanics of these rules, including addressing tiered partnerships and adding a special rule to aggregate basis computations if the partnership distributes stock to multiple members of the same consolidated group.

New Option for Late FBARs – Just File It!

Posted in Compliance, FBAR, International

foreign-assets globeAn often overlooked filing obligation is the annual June 30 requirement to file the FBAR form for taxpayers with foreign bank accounts aggregating over $10,000. Late FBARs are a consistent problem and the IRS has a long history of complicated solutions. The latest (and greatest) is the “just file it!” approach, as long as the underlying taxes are all paid up and the government is not already investigating it.

Taxpayers who have reported and paid tax on all income, but haven’t filed required FBARs for prior years, have this relatively quick and easy compliance option (and one which generally avoids penalties altogether). Specifically, what such taxpayers need to do is file the delinquent FBARs with the IRS according to the form’s instructions and the Bank Secrecy Act’s E-Filing System along with a statement explaining why the reports are being filed late (the dog ate your homework is not a permitted excuse). The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and the taxpayer has not previously been contacted by the IRS regarding an income tax examination or a request for delinquent returns – to avoid penalties, taxpayers may want to file delinquent FBARs as soon as they are aware of the requirement, to minimize the chance that the IRS will begin an audit or independently request the FBARs.

What is an FBAR?

The FBAR filing requirement relates to foreing bank accounts and can come as an unwelcome surprise (often one or more years past the filing deadline). The filing requirement is broad, and applies to all “U.S. persons” (including U.S. citizens, U.S. residents, entities created or organized in the U.S. (or under the laws of the U.S.) and trusts or estates formed under the laws of the U.S.) who (1) have financial interests or signatory authority over at least one financial account located outside of the United States; and (2) the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year reported. It doesn’t take much for U.S. persons with assets overseas to be subject to the FBAR requirements, and as a result it’s possible for taxpayers to be delinquent before they have even realized they are subject to the FBAR filing requirements in the first place.

Alternative solutions for late FBARs

Note that not all taxpayers can bring themselves into compliance by simply filing delinquent FBARs.   Individual U.S. taxpayers who have failed to file required U.S. income returns and who want to resolve their tax and penalty obligations can take advantage of streamlined filing compliance procedures that were put in place in 2012, and substantially expanded in June 2014. These procedures are more time-consuming than simply filing delinquent FBARs, but they come with a significant benefit: the IRS will waive all penalties for taxpayers living outside the U.S. who participate in the streamlined filing compliance procedures, and taxpayers living within the U.S. will only be subject to a “miscellaneous” offshore penalty equal to 5% of the foreign financial assets that gave rise to the tax compliance issues.

The streamlined filing compliance procedures aren’t available to all taxpayers, and also don’t provide the added benefit of protecting taxpayers from criminal prosecution. Taxpayers with undisclosed foreign accounts and unreported income who cannot (or choose not to) take advantage of the streamlined procedures, and/or who are seeking protection from criminal prosecution as a result of their nondisclosure, can participate in the IRS’s offshore voluntary disclosure program (commonly referred to as “OVDP”).   Taxpayers participating in OVDP pay a lump offshore penalty instead of a number of other penalties that could otherwise be assessed, and the OVDP also offers protection from criminal prosecution.   This may be a good option for taxpayers who need it, but it is a more onerous process than simply filing delinquent FBAR forms. In order to participate in the OVDP, taxpayers must first request acceptance into the program. After acceptance, taxpayers must submit a significant amount of information to the IRS, including eight years of amended tax returns, FBARs, and information returns as well as information about their offshore accounts.  In addition, taxpayers must submit full payment of the tax and interest due, and whatever lump offshore penalty has been assessed (although taxpayers who disagree with the amount of the assessed offshore penalty may choose to opt out of the civil settlement structure of the program; in such circumstances, the IRS will separately determine whether any penalty mitigation is appropriate under the facts and circumstances).

Taxpayers who find themselves in violation of the IRS’s FBAR filing requirements should take a step back and evaluate their options (here presented in a handy IRS chart). Depending on the facts, it might be possible to simply file delinquent FBARs with very little added effort – or, at the other extreme, a taxpayer may want to participate in OVDP in order to mitigate penalties and avoid any threat of criminal prosecution.

BE-10 Filings For Foreign Subsidiaries: the Countdown is On

Posted in Compliance, International

money flagThe countdown is on: every five years, the U.S. Department of Commerce’s (DoC) Bureau of Economic Analysis (BEA) conducts a survey of U.S. corporate entities with foreign affiliates. The DoC conducts these surveys to produce statistics about U.S. direct investment abroad and ultimately to help formulate international financial and monetary policy. The deadline for this year’s survey is drawing near.

According to the U.S. Department of Commerce, all U.S. persons that owned, directly or indirectly, 10% or more of the voting stock of a foreign corporation, or an equivalent interest in an unincorporated foreign business enterprise (e.g., a partnership), at any time during the 2014 fiscal year, are required to file a BE-10 Report. These U.S. corporate entities are referred to in this process as “U.S. reporters”.

Individual forms are confidential, but the aggregated data is eventually made public for interested parties. According to analysts and government scholars, any information contained in the forms is confidential and is not used for the purpose of regulation, investigation or taxation and material contained within is exempt from legal proceedings.

That said, it is still compulsory for U.S. reporters to file the BE-10 according to the International Investment and Trade in Services Act. Failure to report may result in penalties of up to $25,000.00. The DoC offers a number of helpful resources on its site including video tutorials.

Companies filing more than 50 BE-forms of BE-10B, 10C and 10D are required to file by June 30. Companies filing less than 50 BE-forms of BE-10B, 10C and 10D were due May 29 however, the DoC will grant extensions on a case-by-case basis after reviewing the request of the U.S. reporter.  Note that the filing deadline for all new filers has been extended to June 30, 2015.

What should filers have ready to prepare the response? Companies will want to enlist the help of a few different functional areas in order to complete the filing. The filing requires financial data, including assets, liabilities, total sales and net income. In addition the filing requires operational data such as fiscal year end, ownership structure, products and services, and primary industry.

As noted above, the deadlines are short. If you have questions about your responsibility as a U.S. reporter, or whether you are considered a U.S. reporter, please contact us or visit BEA’s website.

Don’t forget other surveys – BE-13 Foreign Investment in U.S.

As described in our prior client alert, the US Department of Commerce also requires Form BE-13 reporting by U.S. entities receiving certain direct or indirect foreign investment in U.S. businesses, including commercial real estate held through U.S. entities. In general, this reporting is required by the US entity receiving investments of over $3 million from direct or indirect foreign investors who receive at least a 10% “voting interest” in the US entity. The is a general rebuttable presumption that the general partner is treated as having all of the vote of a limited partnership, and that voting in an LLC is shared equally among its members. Information is confidential and may be used only for statistical purposes.

Specifically, a BE-13A report must be filed by a U.S. business enterprise when a foreign entity acquires a voting interest (directly, or indirectly through an existing U.S. affiliate) in that U.S. enterprise, segment, or operating unit and

(1) the total cost of the acquisition is greater than $3 million,

(2) the U.S. business enterprise will operate as a separate legal entity, and

(3) by this acquisition, at least 10 percent of the voting interest in the acquired entity is now held (directly or indirectly) by the foreign entity.

How and when do I file BE-13?

Electronic filing is available through BEA’s eFile system at www.bea.gov/efile.  Copies of the report forms and instructions are available on BEA’s Web site at www.bea.gov/fdi. The due date for each report is no later than 45 days after the acquisition is completed, the new legal entity is established, or the expansion is begun.

Proposed Regulations on Publicly Traded Partnerships Affect Natural Resource Industry

Posted in Partnership/LLC

Magnifying glass-resized-600The IRS proposed regulations [REG-132634-14] to provide guidance on what is “qualified income” from a publicly traded partnership’s (PTP) activities regarding minerals or natural resources, such as oil and gas fracturing (“fracking”).

The proposed changes provide some clarity and reaffirm that activities such as fracking can provide qualifying income, but they could also raise the requirements for income to be considered qualifying income or in some cases reverse previous private letter rulings (PLRs).

In order for a PTP to receive favorable tax status, 90 percent of its gross income for each taxable year must meet requirements for “qualifying income” (which includes income and gains from certain natural resource-related activities such as exploration, development, mining or production, processing, refining, transportation, and marketing of minerals and natural resources).

In recent years, the IRS has issued a number of PLRs reaffirming that certain natural resource-related income was qualifying income. However, PLRs can technically only apply to the specific PTPs that receive the rulings. Due to an increase in requests for PLRs, the IRS is proposing the new regulations to provide broad guidance for all natural resource-related partnerships.

In addition to qualifying activities (mineral or natural resource activities that generate qualifying income), the IRS recognizes that there are intrinsic support activities that may also produce qualifying income. The proposed regulations present a three-part test to determine “intrinsic activity.” Intrinsic activities must be specialized, essential and significant.

  • Specialized: the personnel performing the activity must have received specialized training, unique to the mineral or natural resource industry, used only to support a qualifying activity.
  • Essential: necessary to complete the activity or to comply with federal, state or local law requirements. For example, income derived from the water delivery and recycling/treatment of fracking wastewater is qualifying income because these are necessary to complete the activity and water disposal must comply with federal, state and local laws.
  • Significant: services such as a partnership that requires personnel to have a frequent or constant presence at the activity site in order for the partnership to provide its services or to support the activity.

The regulations are proposed to apply to income earned by a partnership in a taxable year beginning on or after finalization, subject to a 10-year transition period in certain cases.

IRS Treats Rotating Digital Display Income As Good REIT Income

Posted in Real Estate, REITs

photoIn PLR 201522002, the IRS clarified that REITs can earn good rent income from outdoor advertising displays even if multiple tenants rent the same display area for rotating ads. In the ruling, the REIT owned outdoor advertising displays (i.e., billboards) and planned to build new displays with rotating digital displays. The taxpayer planned to make an election under §1033(g)(3) to treat all of its displays as real property for purposes of chapter 1 of the Code. The IRS relied on this §1033 election for the conclusion that the outdoor displays were real property and that income from tenants under the rental agreement qualified as good “rents from real property” for REIT purposes. This is consistent with the recent proposed REIT regulations that list as an inherently permanent structure such outdoor advertising displays subject to an election to be treated as real property under §1033(g)(3).

In reaching its conclusion the IRS noted that some of the displays share their advertising space with other advertisers so that any particular advertiser’s advertising copy is displayed for only certain intervals of time in a rotation with those of other advertisers. The IRS concluded that such rotating feature does not change the character of the income as rents from real property, because the sharing of the rented space has no bearing on the passive nature of the income from renting the space on the display and advertisers pay for the right to use the display for specified intervals of time.

IRS Issues Internal FBAR Penalty Guidance To Ensure Consistency

Posted in FBAR, International

washington-treasury-1431763-mShortly before the annual June 30 FBAR filing deadline, the IRS issued penalty guidance for those that miss the foreign bank account reporting deadline. The purpose of the new penalty guidance is to improve the IRS’s administration and application of FBAR penalties. The guidance is immediately effective for all open cases.

The IRS observes that statutory penalty guidance focuses on only the maximum penalties and the IRS is charged with discretion on when to apply a lower penalty. The guidance is intended to ensure consistency and effectiveness in the IRS’s application of these penalties and to help ensure FBAR penalty determinations are adequately supported and penalties are asserted in a fair and consistent manner. The guidance explains at what IRS level penalties are asserted and approved and includes a list of what information the IRS must include in its case file to support the penalties.

The House Joins the Senate Finance Committee in Proposing FIRPTA Reform

Posted in International, Legislative, Real Estate

IMG_3999FIRPTA real estate tax reform continues its momentum with the recent release of bill text for H.R. 2128, the latest House bill introduced by Kevin Brady (R-Texas) and J Crowley (D-NY). In connection with the filing of the bill, Brady stated that H.R. 2128 is similar to the changes approved by the Senate Finance Committee and that he has previously proposed, but will now include a provision (like that supported by the Senate Finance Committee and the President) to eliminate the FIRPTA tax on foreign pension plans investing in U.S. real estate. The hope is that this will unlock material off-shore capital that could help fund infrastructure investments. Given the significant, bi-partisan support for these FIRPTA revisions in both houses of Congress and the Administration, we are optimistic that this is moving forward and on a possible path to enactment.

The bill defines a foreign pension plan qualifying for the proposed exemption to include any foreign pension plan or any other entity wholly-owned by a foreign pension plan. For this purpose, a foreign pension plan must (a) be organized under the law of a country other than the U.S., (b) provide benefits to present or former employees or their designees, (c) not have any single 5% participant or beneficiary, (d) be subject to governmental regulation and tax reporting in the country where established or organized, and (e) either (i) provide the employee with a tax deduction, exemption or reduced rate of tax for contributions, or (ii) be itself taxable on a deferred basis or at a reduced rate of tax.

The bill would also increase from 5% to 10% the maximum percentage that foreign holders of interests in publicly-traded REITs may hold and still qualify for exemption of REIT distributions and gain on sale of REIT stock from U.S. FIRPTA taxation. Further, the draft bill also tightens the definition of “domestic control” for REITs. This is relevant because of the FIRPTA tax exemption for the sale of stock in a domestically controlled REIT.  The bill provides certain look through rules in determining whether an upper-tier REIT is consider domestic or foreign for purposes of testing domestic control over the lower-tier REIT.

Treasury Releases Select Draft Provisions for Next U.S. Model Income Tax Treaty

Posted in International, treaty

money flagThe Treasury Department announced draft changes for the U.S. Model Income Tax Treaty — the baseline text used by the Treasury Department when it negotiates tax treaties. The current U.S. Model was last updated in 2006. The proposed changes in the draft provisions are intended to combat so-called Base Erosion or Profit Shifting (BEPS), which has been the subject of substantial debate in recent years. Treasury notes that treaties are designed to eliminate double taxation, but not to create opportunities for BEPS.

One set of draft provisions combats “special tax regimes” which provide low tax rates in certain countries, particularly to mobile income like royalties and interest. The second set of draft provisions is to combat corporate inversions by imposing full withholding taxes on key payments such as dividends and base stripping payments, including interest and royalties, made by U.S. companies that are “expatriated entities”. A third set of draft provisions makes revisions intended to prevent residents of third-countries from inappropriately obtaining the benefits of a bilateral tax treaty. The announcement also stated that Treasury intends to include in the next U.S. Model a new article to resolve disputes between tax authorities through mandatory binding arbitration.