New IRS Safe Harbor on When COD Is Qualifying Income for Publicly Traded Partnerships

The IRS issued Rev. Proc. 2012-28, providing a helpful safe harbor for publicly traded partnerships (PTPs) to avoid non-qualifying PTP income from debt cancellation.  Prior to this guidance, PTPs did not have clear guidance on whether Cancellation Of Debt (COD) income was qualifying income for PTP qualification purposes.  PTPs need minimum amounts of qualifying income to avoid being taxed as corporations.  Under the safe harbor, the IRS “will not challenge a PTP’s determination that COD income is qualifying income under section 7704(d) if COD income is attributable to debt incurred in direct connection with activities of the PTP that generate qualifying income.”  The procedure allows taxpayers to apply “any reasonable method” to make this determination, and provides that the Reg. §1.163-8T tracing approach is a reasonable method but a straight proration based on relative qualifying and non-qualifying gross income is generally not reasonable.

The guidance is effective for COD from discharged debt on or after June 15, 2012.  However, the guidance also allows taxpayers to apply the guidance to COD attributable to any taxable year in which the statute of limitations is open.  This subject of this guidance had been on the IRS Business Plan as a top priority guidance item.