The IRS issued Notice 2015-54 stating that it plans to issue regulations under Section 721(c) to ensure that U.S. taxpayers do not use partnerships to shift built-in gains to non-U.S. affiliates. In 1997 Congress authorized the IRS to issue regulations to turn off the normal tax-free rules for partnership contributions if there could be a shifting of built-in gain to non-U.S. persons. In response to a concern of U.S. taxpayers using partnerships to shift gain to non-U.S. affiliates, Notice 2015-54 provides that new regulations will mandate using the “Remedial” method under Section 704(c), plus several other restrictions, if a U.S. person contributes built-in gain property to a domestic or foreign partnership when (i) a related foreign person is a direct or indirect partner, and (ii) the U.S. transferor (or a related person) owns more than 50% of the partnership. The new guidance will generally apply to transfers occurring on or after August 6, 2015 (or earlier deemed contributions from check-the-box elections made on or after this date).
In T.D. 9728 the IRS finalized the 2009 proposed § 706(d) regulations relating to how partnerships should allocate tax items to take into account a variance in a partner’s interest during a year. A typical example is when a partner makes a disproportionate contribution or received a disproportionate distribution during the year. The IRS also issued new proposed regulations to address the special interaction with tiered partnerships and so-called “allocable cash basis items” such as interest, taxes and service payments that are required to be prorated among the days to which they relate. In general these rules effect the legislative requirement that one cannot generally make a large capital contribution to a partnership at the very end of the year and receive a disproportionate loss allocation that relates to losses incurred earlier in the year.
The final regulations are quite lengthy and show the great attention to detail by the IRS as they tried to incorporate many practical taxpayer comments to make the process of allocating items among the partners more administrable. Helpful changes made in the final regulations include (1) expanding the exception for service partnerships to no longer be limited to specific types of services but instead include any partnership where capital is not a material income producing factor; (2) allowing a partnership to use different methods for different ownership changes, such as closing the books for one change and pro-rations for another change, provided that the overall combination of methods is reasonable based on the overall facts and circumstances; (3) permitting partnerships to perform regular monthly or semi-monthly interim closings, and to prorate items within each month or semi-month, as applicable, and (4) expanding the list of extraordinary items that may not be prorated to allow a partnership to add additional non-enumerated items for a taxable year if, for that taxable year, there is an agreement of the partners to consistently treat such items as extraordinary items and no substantial distortion of income results.
The Senate today voted 91-4 to extend the highway trust fund authorization through October 29th from its current expiration date of July 31st, 2015 and it is now headed to the President for signature. The bill – H.R. 3236 – contains numerous revenue raising provisions (intended to raise approximately $8 billion in revenue to offset the cost of continued highway spending). Among the other revenue-related provisions, the bill (approved by the House of Representatives on July 29th) would accelerate the deadline for filing partnership tax returns to March 15 for calendar year taxpayers (or two and a half months after the close of the tax year for fiscal year taxpayers). At present, partnerships have until April 15 (or three and a half months after the close of the tax year) to file returns. The proposed effective date is for returns for taxable years beginning after December 31, 2015. If passed, partnerships will need to accelerate when they prepare K-1s and file tax returns before the new, accelerated deadline, and ultimately may need to request extensions of time to file. The maximum extension for partnership Form 1065 is proposed to be a 6-month period ending on September 15 for calendar year taxpayers.
The IRS issued the much anticipated proposed regulations that severely curtail the practice of a fund manager waiving management fees in exchange for a share of future partnership profits. In essence the regulations tighten the necessary “entrepreneurial risk” required of the future profits interest plus list five other negative factors for recasting the profits interest back into a fee. The IRS also noted that Rev. Proc. 93-27, which treats a qualifying profits interest as having a zero value, will be amended to provide an additional exception for profits interests given in exchange for a partner forgoing a substantially fixed right to payment for services. This latter change would mean that even if the fee waiver has the requisite entrepreneurial risk, there would still be a material risk that the IRS will treat the present value of the profits interest as compensation income. This one-two punch has the distinct possibility of knocking out fee waivers altogether plus extending uncertainty beyond fee waivers to other targeted issuances of profits interests. The regulations are to be effective for all arrangements entered into or modified after the regulations are published as final.
The proposed regulations also address other related topics. First, the examples in the proposed regulations that find sufficient entrepreneurial risk involved partnerships that liquidated with positive capital accounts, despite the prevalence of partnerships liquidating instead with a cash waterfall and using “targeted” tax allocations. The Preamble specifically states that there is no inference whether such targeted capital accounts could satisfy the allocation safe harbors and requests comments if taxpayers want more guidance. Second, the proposed regulations modify an important “guaranteed payment” example that currently treats an allocation of profits over a fixed floor amount as always getting the benefit of profits interest treatment to the extent the profit share exceeds the floor amount. The example now always treats the fixed floor amount as a guaranteed payment even if the profits exceed the minimum floor amount. Finally, the Preamble appears to confirm the IRS position in Rev. Rul. 69-184, that a guaranteed payment to a partner cannot be treated as an employee payment (i.e., no W-2).
In an effort to improve e-filing, the IRS has proposed to eliminate the need to file a copy of a Section 83(b) election with the service provider’s annual tax return. Taxpayers receiving non-vested stock or partnership interest often file a Section 83(b) election within 30 days of receipt to treat the equity as vested for tax purposes. This election allows the taxpayers to avoid paying compensation income on the often higher value of the equity at the later vesting date. Under current law, taxpayers are required to file a copy of that same election with their annual tax return for the year they receive the equity interest. The proposed regulations note that often taxpayers are unable to e-file their annual tax returns with a Section 83(b) election, thus forcing them onto paper returns. The IRS is now able to internally associate the Section 83(b) election with a taxpayer’s annual return and thus has proposed to eliminate this second filing and help more people e-file. Although the new regulations officially apply to the receipt of unvested equity as of January 1, 2016, taxpayers may rely on the regulations for property received on or after January 1, 2015.
The newly-enacted Trade Preference Extension Act boosts the penalties for failing to provide accurate information returns to the IRS and payees – such as Forms W-2, 1098, and 1099, as well as Forms 1095-B and 1094-B. The penalty under Section 6721 (reports to the IRS) and Section 6722 (reports to payees) has more than doubled, from $100 to $250 per return, up to a maximum of $3 million per year. Although taxpayers can correct unintended mistakes within 30 days for a reduced penalty, even that reduced penalty increased from $30 to $50 per return. The penalty is further doubled ($500 per return) if the failure is intentional. The increased penalties apply to returns required to be filed after December 31, 2015. The legislation also increased the amount due for corporation estimated taxes such that the amount of any required installment of corporate estimated tax which is otherwise due in July, August, or September of 2020 shall be increased by 8 percent. This increase in estimated taxes applies to corporations with assets of at least $1 billion.
In 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).
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.
The 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.
After 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.
An 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.