A monthly roundup of recent important tax developments affecting practitioners.
IRS proposes rules on carried interests
The IRS issued proposed regulations (REG-107213-18) on the tax treatment of carried interests. Carried interests are ownership interests in a partnership that share in the partnership's net profits. They are often transferred in connection with the performance of substantial services by an individual. Proceeds from that individual's partnership interest are often taxed as capital gain rather than ordinary income. The law known as the Tax Cuts and Jobs Act, PL. 115-97, extended the holding period for certain carried interests, applicable partnership interests (APIs), to three years to be eligible for capital gain treatment. The proposed regulations include:
* Prop. Regs. Sec. 1.1061-1, which provides definitions of the terms used in the proposed regulations.
* Prop. Regs. Sec. 1.1061-2, which provides rules and examples regarding APIs and applicable trades or businesses (ATBs).
* Prop. Regs. Sec. 1.1061-3, which provides guidance on the exceptions to the definition of an API, including the capital interest exception.
* Prop. Regs. Sec. 1.1061-4, which explains how to compute the recharacterization amount and contains examples on how to compute it.
* Prop. Regs. Sec. 1.1061-5, which explains the related-party rules and how they apply to Sec. 1061(d).
* Prop. Regs. Sec. 1.1061-6, which provides reporting rules.
* Prop. Regs. Sec. 1.1223-3, which contains rules for determining a divided holding period when a partnership interest includes an API and/or a profits interest. These clarifying amendments are provided because Sec. 1061 requires a clear determination of the holding period of a partnership interest that is, in whole or in part, an API.
The proposed regulations also include related clarifying amendments to Regs. Sec. 1.702-1(a)(2) and Regs. Sec. 1.704-3(e).
In Notice 2018-18, the IRS had stopped taxpayers from using an S corporation to avoid the carried interest rules by saying that, for purposes of the carried interest rules, a "corporation" for purposes of Sec. 1061(c)(4)(A) does not include an S corporation. Under Sec. 1061(c)(4)(A), an API does not include any interest in a partnership that is directly or indirectly held by a corporation. The proposed regulations reiterate this provision, meaning that partnership interests held by S corporations are treated as APIs if the interest otherwise meets the API definition.
The proposed regulations also extend this treatment to encompass certain partnership interests held by a passive foreign investment company (PFIC) for which a taxpayer has a qualifying electing fund (QEF) election in effect, treating that interest as an API if the interest meets the API definition.
The proposed regulations contain a transition rule for partnership property that was held by the partnership for more than three years on Sec. 1061's effective date. A partnership that was in existence as of Jan. 1,2018, may irrevocably elect to treat all long-term capital gains and losses from the disposition of all assets, regardless of whether they would be API gains or losses in prior periods, that were held by the partnership for more than three years as of Jan. 1,2018, as partnership transition amounts. Partnership transition amounts that are allocated to the API holder are not taken into account for purposes of determining the recharacterization amount. Rather, they are treated as long-term capital gains and losses and are not subject to recharacterization.
IRS issues additional regs. on charitable organization payments in lieu of state and local taxes
The IRS issued final regulations (T.D. 9907) on the treatment of payments made to charitable organizations in return for consideration, including in return for state and local tax credits. The regulations finalize proposed regulations issued in December 2019 and also incorporate two earlier pieces of IRS guidance, Rev. Proc. 2019-12 and Notice 2019-12, as well as addressing other issues. The final regulations provide further guidance on the issue of states' and taxpayers' attempts to avoid the $10,000 cap on state and local tax deductions by making charitable contributions instead (see also earlier final regulations in T.D. 9864). The IRS says it received over 40 comments on the proposed regulations; the final regulations adopt the proposed regulations with some clarifications.
The new final regulations update the current Sec. 162 regulations to reflect statutory changes on how Sec. 162 applies when taxpayers make a payment to a Sec. 170(c) charitable organization for business purposes. They also provide safe harbors under Sec. 162 for payments made by businesses to Sec. 170(c) organizations and under Sec. 164 for payments made to a Sec. 170(c) organization by individual taxpayers who itemize and receive (or expect to receive) a state or local tax credit in return for the payment. Finally, they update the regulations to reflect past guidance and case law on the application of the quid pro quo principle under Sec. 170 to benefits received (or expected to be received) by a donor from a third party.
The preamble to the final regulations notes that it retains the proposed amendments to Regs. Sec. 1.162-15(a), which clarify that a taxpayer's payment or transfer to a Sec. 170(c) entity may constitute an allowable deduction as a trade or business expense under Sec. 162, rather than a charitable contribution. The final regulations also retain the examples demonstrating the application of this rule with minor clarifications.
The final regulations further retain the Sec. 162 safe harbors to provide certainty about the treatment of payments business entities make to an entity described in Sec. 170(c). The final regulations provide Sec. 162 safe harbors for payments a business entity that is a C corporation or specified passthrough entity makes to or for the use of an organization described in Sec. 170(c) if the business entity receives or expects to receive state or local tax credits in return. These safe harbors allow an eligible business entity to treat the portion of the payment that is equal to the amount of the credit received or expected to be received as meeting the requirements of a Sec. 162 ordinary and necessary business expense. The safe harbors apply only to payments of cash and cash equivalents, not if the credit received or expected to be received reduces a state or local income tax.
The final regulations in addition retain the Sec. 164 safe harbor under which an individual who itemizes deductions and who makes a payment to a Sec. 170(c) entity in exchange for a state or local tax credit is permitted to treat it as a payment of state or local tax under Sec. 164 the portion of the payment for which a charitable contribution deduction under Sec. 170 is or will be disallowed under Regs. Sec. 1.170A-1(h)(3). This treatment is allowed in the tax year in which the payment is made but only to the extent that the resulting credit is applied under state or local law to offset the individual's state or local tax liability for that tax year or the preceding tax year.
Any unused credit permitted to be carried forward may be treated as a payment of state or local tax under Sec. 164 in the tax year or years for which the carryover credit is applied in accordance with state or local law. The safe harbor for individuals applies only to payments of cash and cash equivalents.
The IRS explained that because the final regulations are not intended to permit a taxpayer to avoid the Sec. 164(b)(6) limitation, they provide that any payment treated as a state or local tax under the safe harbor in Regs. Sec. 1.164-3(j) is subject to the Sec. 164(b)(6) limitation. Additionally, under the final regulations, an individual who relies on the Regs. Sec. 1.164-3(j) safe harbor to deduct qualifying payments may not also deduct the same payments under any other Code section.
As discussed in the preamble, the final regulations also retain the amendments to the Sec. 170 regulations to reflect past guidance and case law regarding the application of the Sec. 170 quid pro quo principle to a donor who receives or expects to receive benefits from a third party. The final regulations clarify that the quid pro quo principle applies regardless of whether the party providing the quid pro quo is the donee or a third party. To reflect existing law, the final regulations amend the rules in Regs. Sec. 1.170A-1(h) that address a donor's payments in exchange for consideration.
Finally, the regulations make certain clarifying changes to the definitions in Regs. Sec. 1.170A-1(h).
The amendments under Regs. Sec. 1.162-15 apply to payments or transfers made on or after Dec. 17, 2019, but taxpayers may apply them to payments or transfers on or after Jan. 1, 2018. Regs. Sec. 1.164-3(j) applies to payments made to Sec. 170(c) entities on or after June 11,2019, but taxpayers may choose to apply it to payments made to Sec. 170(c) entities after Aug. 27,2018. The definitions provided in Regs. Sec. 1.170A-1(h)(4) apply to amounts paid or property transferred on or after Dec. 17,2019.
Final regs. and proposed regs. issued under Sees. 245A and 954
The IRS issued final regulations that limit the deduction under Sec. 245A for certain dividends U.S. persons receive from foreign corporations and the exception to Subpart F income under Sec. 954(c)(6) for certain dividends received by controlled foreign corporations (CFCs). The regulations also contain information reporting regulations under Sec. 6038 to administer these rules. The regulations (T.D. 9909) finalize proposed regulations (REG-106282-18) and withdraw temporary regulations (T.D. 9865) issued in June 2019. The IRS also issued additional proposed regulations (REG-103470-19) about the coordination between Sec. 245A and the global intangible low-taxed income (GILTI) rules in Sec. 951.
Sees. 245A and 954(c)(6) were added to the Code by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, which was enacted on Dec. 22, 2017. Sec. 245A provides a 100% deduction to domestic corporations for certain dividends received from foreign corporations after Dec. 31,2017. Sec. 954(c)(6) provides that a dividend received by a CFC from a related CFC is not included in the recipient CFC's income subject to current tax under Sees. 951(a) and 954(c) if certain requirements are satisfied.
The temporary regulations in T.D. 9865 and proposed regulations in REG-106282-18 limited the Sec. 245A deduction and the Sec. 954(c)(6) exception with respect to distributions supported by certain earnings and profits (E&P) not subject to the integrated international tax regime created by the TCJA.
The IRS received many comments on the temporary and proposed regulations, including a number of comments objecting to the IRS's regulatory authority to issue the rules and a claim that the regulations were an attempt to change the effective date of the Sec. 965 transition tax or the GILTI rules. The preamble to the final regulations contains a lengthy discussion regarding the IRS's authority for issuing the rules and its position regarding the effective dates.
The final regulations adopt the proposed regulations with a number of modifications in response to other comments. These include changes and additions regarding the rules for extraordinary disposition accounts and extraordinary reductions, and the addition of new illustrations to clarify the anti-abuse rule in Regs. Sec. 1.245A-5 and a modification of the rule to make it self-executing rather than applicable under the discretion of the IRS.
The final regulations are effective on Aug. 27, the date they were published as final in the Federal Register. They apply to tax years ending on or after June 14,2019, the date the temporary regulations were issued. If both the temporary and final regulations could apply, only the final regulations do. As an example, if a CFC has a tax period ending on Nov. 30, 2019, and it made a distribution during that period on Dec. 1, 2018, a portion of which would be an ineligible amount, the final regulations apply to the distribution.
Distributions made after Dec. 31, 2017, and before the final regulations apply, continue to be subject to the rules in the temporary regulations. However, a taxpayer may choose to apply the final regulations to distributions made during this period if the taxpayer and all related parties consistently apply the final rules in their entirety.
The IRS solicited comments in the preamble to the 2019 regulations on whether and how to coordinate the rules in Prop. Regs. Sees. 1.245A-5(c) and (d) (regarding extraordinary dispositions) with the rules in Regs. Sec. 1.951A-2(c)(5) (regarding the allocation of deduction or loss attributable to disqualified basis under the GILTI rules in Sec. 951A). In response to the comments received, the IRS issued proposed coordination rules in REG-103470-19.
Base-erosion and anti-abuse tax rules are finalized
On Sept. 1, the IRS finalized regulations that provide additional guidance on the base-erosion and anti-abuse tax (BEAT) (T.D. 9910).
The BEAT final regulations keep the basic approach and structure of the proposed regulations (REG-112607-19) that were issued in December 2019, with certain revisions. Like the proposed regulations, the final regulations permit an election to waive certain deductions to avoid a potential cliff effect that had worried some taxpayers.
The BEAT is designed to deter large multinational enterprises from reducing their tax liability through certain payments made to foreign related parties and certain tax credits. To be subject to the BEAT, which functions essentially as a minimum tax, businesses must have average annual gross receipts of at least $500 million as well as a so-called base-erosion percentage above a specified threshold.
A previous set of final regulations (T.D. 9885) was issued in December 2019 implementing BEAT, which was created in Sec. 59A by the law known as the Tax Cuts and Jobs Act, PL. 115-97.
The new final regulations address the following topics, among others:
* The determination of a taxpayer's aggregate group for purposes of determining gross receipts and the base-erosion percentage;
* The election to waive deductions for purposes of the BEAT;
* The application of the BEAT to partnerships; and
* The anti-abuse rule provided in Regs. Sec. 1.59A-9(b)(4) with respect to certain basis step-up transactions.
The final regulations' preamble states that the IRS is considering whether future guidance may be appropriate regarding the interaction of the qualified derivative payment (QDP) exception, the BEAT netting rule in Regs. Sec. 1.59A-2(e)(3)(iv) (with respect to positions for which a taxpayer applies a mark-to-market method of accounting for U.S. federal income tax purposes), and the QDP reporting requirements in Regs. Sec. 1.59A-6 and Regs. Sec. 1.6038A-2(b)(7)(ix).
These final regulations apply to tax years beginning on or after the day the regulations are published in the Federal Register (which as of this writing had not occurred), with certain exceptions. Taxpayers may apply the final regulations retroactively in their entirety for tax years beginning after Dec. 31,2017, provided that, once applied, taxpayers continue to apply these regulations in their entirety for all subsequent tax years.
From Dave Strausfeld, J.D.
How to make extended qualified plan rollovers
In REG-116475-19, the IRS addressed the amendments to Sec. 401(c) by Section 13613 of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, which provides an extended rollover period for a qualified plan loan offset.
Sec. 72(p)(1) provides that if, during any tax year, a participant or beneficiary receives (directly or indirectly) any amount as a loan from a qualified employer plan (defined under Sec. 72(p) (4)(A)), that amount will be treated as having been received by the individual as a distribution from the plan. For certain plan loans, Sec. 72(p)(2) provides an exception to the general treatment of loans as distributions. For this exception to apply, the loan generally must satisfy three requirements:
* The loan's terms must satisfy the limits on loan amounts, under Sec. 72(p)(2)(A) ($50,000);
* The loan must be repayable within five years; and
* The loan must require substantially level amortization over the loan term.
Section 13613 of the TCJA amended Sec. 402(c)(3) to provide an extended rollover deadline for qualified plan loan offset (QPLO) amounts. Any portion of a QPLO amount (up to the entire amount) may be rolled over into an eligible retirement plan by the individual's tax filing due date (including extensions) for the tax year in which the offset occurs.
Prop. Regs. Sec. 1.402(c)-3 takes into account changes to the QPLO rollover rules. They confirm that a QPLO is a type of plan loan offset; accordingly, most of the general rules relating to plan loan offset amounts apply to QPLO amounts. In addition, the rules in Regs. Sec. 1.401(a)(31)-1, Q&A-16 (which explains the offering of a direct rollover of a plan loan offset amount), and Regs. Sec. 31.3405(c)-1, Q&A-11 (which contains special withholding rules for plan loan offset amounts), that apply to plan loan offset amounts in general also apply to QPLO amounts. The proposed regulations provide examples to illustrate the interaction of the special rules for QPLOs with the general rules for plan loan offsets.
Consistent with Regs. Sec. 1.402(c)-2, Q&A-9, the proposed regulations provide that a distribution of a plan loan offset amount that is an eligible rollover distribution and not a QPLO amount may be rolled over by the employee (or spousal distributee) to an eligible retirement plan within the 60-day period set forth in Sec. 402(c) (3)(A).
Consistent with the Sec. 402(c) (3)(C) amendments, the proposed regulations provide that a distribution of a plan loan offset amount that is an eligible rollover distribution and a QPLO amount may be rolled over by the employee (or spousal distributee) to an eligible retirement plan through the period ending on the individual's tax filing due date (including extensions) for the tax year in which the offset is treated as distributed from a qualified employer plan.
Thus, a taxpayer with an eligible rollover distribution that is a QPLO amount may roll over any portion of the distribution to an eligible retirement plan, including another qualified retirement plan (if that plan permits rollovers) or an IRA, by the taxpayer's deadline for filing income taxes for the year of the distribution, including extensions.
If a taxpayer to whom a QPLO amount is distributed satisfies the conditions in Regs. Sec. 301.9100-2(b), the taxpayer will have an extended period past his or her tax filing due date in which to complete a rollover of the QPLO amount, even if the taxpayer does not request an extension to file his or her income tax return but instead files the return by the unextended filing due date.
The proposed regulations also contain definitions of plan loan offset amount, QPLO amount, and qualified employer plan, and special rules for QPLO determinations when a severance from employment has occurred.
The rules will be effective when they are final, but taxpayers may rely on them with respect to plan loan offset amounts, including QPLO amounts, treated as distributed on or after Aug. 20, 2020, until the final regulations are issued.
Sally P. Schreiber, J.D.