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Tax Insights, November 4, 2015
Tracking Tax News You Need to Know

November 04, 2015
Publications

Budget Deal Causes Sweeping Changes to Partnership Audit Rules
The White House and congressional leaders reached a two-year budget deal last week to lift mandatory spending caps and raise the federal debt ceiling (the “Bipartisan Budget Act of 2015” – see Title XI for the partnership provisions, and a section-by-section summary can be found here). President Obama signed the Bipartisan Budget Act of 2015 into law on Monday (Nov. 2). In addition to providing for a temporary extension of the public debt limit through March 15, 2017, the proposal includes dramatic changes to the rules on IRS examination of partnerships, eliminating the “TEFRA” unified partnership audit rules (so-called because they were introduced in the Tax Equity And Fiscal Responsibility Act of 1982) and the electing large partnership rules, and replacing them with a more streamlined set of partnership audit rules.

Under the proposed provisions in the budget agreement, the current TEFRA and electing large- partnership (ELP) rules would be repealed, and the partnership audit rules would be streamlined into a single set of rules for auditing partnerships and their partners at the partnership level. Similar to the current TEFRA rule excluding small partnerships, the provision would allow partnerships with 100 or fewer qualifying partners to opt out of the new rules, in which case the partnership and partners would be audited under the general rules applicable to individual taxpayers.

The proposal also would replace the tax matters partner rules with a simplified partnership representative provision that allows a partnership to designate either a partner or nonpartner to be the representative with the sole authority to act on behalf of the partnership for purposes of partnership audit and judicial proceedings. The proposed statute of limitations for assessments would look only at when the partnership's return was filed and extensions between the IRS and the partnership, rather than taking into account partners' individual statutes of limitations. The statute of limitations for filing partnership refund claims would be based solely on when the partnership return was filed but could not be extended by agreement.

These provisions would apply to returns filed for partnership tax years beginning after 2017. With limited exceptions, partnerships may elect to apply the new rules to any return of the partnership filed for partnership taxable years beginning after the date of the enactment of the new law and before Jan. 1, 2018.

Under the new audit approach, the IRS would examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership (the reviewed year), and any adjustments would be taken into account by the partnership (not the individual partners) in the year that the audit or any judicial review is completed (the adjustment year). Partners would not be subject to joint and several liability for any liability determined at the partnership level.

Partnerships would have the option of demonstrating that the adjustment would be lower if it were based on certain partner-level information from the reviewed year rather than imputed amounts determined solely by the partnership's information in such year. This information could include amended returns of partners opting to file, the tax rates applicable to specific types of partners (e.g., individuals, corporations, tax-exempt organizations) and the type of income subject to the adjustment (e.g., ordinary income, dividends, capital gains).

As an alternative to taking the adjustment into account at the partnership level, a partnership would be permitted to issue adjusted information returns (i.e., adjusted Forms K-1) to the reviewed-year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process. (As a result, partnerships generally would no longer issue amended Forms K-1 after the partnership return is filed, but instead would use the adjusted Form K-1 process.)

In addition, a partnership would have the option of initiating an adjustment for a reviewed year, such as when it believes additional payment is due or an overpayment was made, with the adjustment taken into account in the adjustment year. The partnership generally would be allowed to take the adjustment into account at the partnership level or issue adjusted information returns to each reviewed-year partner.

Final Regulations Issued On Definition of “Private Activity Bond”
In TD 9741, the IRS issued final regulations providing state and local governmental issuers of tax-exempt bonds with guidance for applying the private activity bond restrictions. The regulations clarify how proceeds of state and local bonds and other sources of funds are allocated for purposes of the rules that treat as “private activity bonds” state and local bonds that have too close a connection to private activities.

IRS Reviews Capitalization/Amortization of Internet Domain Names
The IRS issued Chief Counsel Advice 201543014 reviewing several fact patterns involving purchased Internet domain names and drawing conclusions regarding whether the costs of those domain names must be capitalized under Section 263 and whether they may be amortized under Section 197.

IRS Finds Payments to Exempt Organizations Deductible as Trade or Business Expenses
Some charitably inclined businesses advertise that they will give a certain percentage of their sales proceeds to organizations devoted to a particular cause. Chief Counsel Advice (CCA) 201543013 examines the deductibility of such payments made by a business to such organizations. The CCA states that a taxpayer's payments to exempt organizations described in Section 170 as part of its specified program were deductible under Section 162(a) as business expenses (to the extent not disallowed by other provisions of Section 162 and to the extent they were not charitable contributions) when the taxpayer reasonably expected to receive commensurate financial return for its payments. The CCA states that the taxpayer appears to have acted with the reasonable belief that in establishing the program it would enhance and increase its business.

IRS Rules on Status of Plan Established by College as Church Plan
In Private Letter Ruling 201543012, the IRS ruled that a defined contribution Section 403(b) plan, established by a college exempt from federal income tax as an organization described in Section 501(c)(3) that is an official institution of higher learning of a specified church, constituted a Section 414(e) church plan since the college was associated with the church under Section 414(e)(3)(D). The plan's eligible participants were deemed to be employees of the church, and the plan was administered by church members.

IRS Rules on Issuance of Forms 1099-C by Financial Institution
The IRS ruled in Private Letter Ruling 201543004 that a financial institution was required to file Forms 1099-C with respect to its waiving and extinguishing of class members' deficiency balances for less than full consideration pursuant to a settlement agreement and a preliminary order due to the occurrence of a Treasury Regulation Section 1.6050P-1(b)(2)(F) “identifiable event.”

Additional Competent Authority Arrangements Available
The U.S. competent authorities have signed arrangements with the following countries under the respective country’s intergovernmental agreements with the U.S. to implement the information reporting and withholding tax provisions of FATCA:

Malta
South Africa

JCT Summarizes Provisions of U.S.-Japan Income Tax Treaty
The Joint Committee on Taxation released an explanation of the proposed income tax treaty between the United States and Japan. The report states that among the proposed modification to the existing income tax treaty and protocol are modifications to foreign tax credit rules to reflect Japan's recently adopted participation exemption system, a reduction in the ownership threshold for the elimination of source country taxation of dividends for specified taxpayers and mandatory arbitration for cases in which competent authorities do not reach agreement.

New Jersey Superior Court Denies LLC Tax-Exempt Status
The New Jersey Superior Court, Appellate Division, in 1785 Swarthmore, LLC v. Township of Lakewood, N.J. Super. Ct., App. Div., Dkt. No. A-4701-13T4, 10/28/2015, affirmed the New Jersey Tax Court's oral ruling that an LLC property owner was not entitled to an exemption from local property taxes as a nonprofit organization. The LLC held record title to property that was leased to a religious school. As such, the LLC satisfied the second and third prongs of the three-prong test to obtain exempt status. However, the LLC did not satisfy the first prong, requiring “the property owner be organized exclusively for the tax-exempt purpose,” because the LLC had effectively been formed for any purpose under the LLC statutory scheme, and not specifically organized for a tax-exempt purpose.

Michigan Establishes ABLE Savings Program
Michigan enacted the Michigan Achieving a Better Life Experience (ABLE) Program (Act L. 2015, H4542 [P.A. 160], effective 10/28/2015). The act establishes the Michigan ABLE savings program in the Department of Treasury, which allows an individual to open an ABLE savings account to pay the qualified disability expenses of a designated beneficiary. Contributions to, and interest earned on, an ABLE savings account are exempt from taxation, and withdrawals made from ABLE savings accounts are taxable. Another Michigan act, L. 2015, H4543 (P.A. 161), effective Oct. 28, 2015, provides that for tax years beginning after Dec. 31, 2015, a taxpayer may deduct from taxable income, to the extent they are not deducted from adjusted gross income, contributions made by the taxpayer in the tax year less qualified withdrawals made in the tax year from an ABLE savings account, not to exceed a total deduction of $5,000 for a single return or $10,000 for a joint return per tax year. ABLE savings accounts may be established beginning Jan. 1, 2016.

D.C. Legislation Authorizes ABLE Accounts
Washington, D.C., mayor Muriel Bowser signed the ABLE Program Trust Establishment Temporary Act of 2015 (L. 2015, Act 21-175, effective after a 30-day period of congressional review and publication in the D.C. Register), which will be sent to Congress for review. The temporary legislation will establish, in accordance with the federal ABLE Act, a qualified ABLE program as a trust, which authorizes an eligible individual to create an ABLE account so that the eligible individual can benefit from the tax incentives provided under the federal ABLE Act.

Tennessee Department of Revenue Rules on Tax Status of Irish Private Limited Company
The Tennessee Department of Revenue ruled in Tennessee Letter Ruling 15-03, Sept. 23, 2015, that an Irish private limited company cannot be treated as a disregarded entity for Tennessee franchise and excise tax purposes even if it is a disregarded entity for federal income tax purposes. Tennessee law allows only single-member limited liability companies (LLCs) whose single member is a corporation to be disregarded for Tennessee franchise and excise tax purposes. The Tennessee Department of Revenue interprets the term corporation to include an entity formed as a corporation under state law; a noncorporate entity whose default classification for federal tax purposes is to be treated as a corporation; an entity formed under another country's laws whose default classification for federal tax purposes is to be treated as a corporation; and an entity that makes an election on Form 8832 (Entity Classification Election) to be classified as a corporation for federal tax purposes. Under Treasury Regulation Section 301.7701-2, Example 3, an Irish private limited company has a default classification as a C corporation for U.S. federal income tax purposes. Therefore, the ruling finds that the Irish private limited company does not qualify as a single-member LLC that may be disregarded, as it is more akin to and properly treated as a corporation as that term is interpreted for Tennessee franchise and excise tax purposes.

Texas Comptroller of Public Accounts Rules on Franchise Tax Combined Reporting
The Texas Comptroller of Public Accounts issued Texas Comptrollers Decision 109,672, 06/23/2015, ruling that a medical services provider and a management services company, who provided services for the medical services provider, could file a Texas franchise tax report on a single combined group basis because a controlling interest in both entities is held by the same set of common owners. In Texas, taxable entities that are part of an affiliated group engaged in a unitary business must file a combined group report in lieu of individual reports based on the combined group's business, and an “affiliated group” means a group of one or more entities in which a controlling interest is owned by a common owner or owners, either corporate or noncorporate, or by one or more of the member entities. Although the comptroller argued, without citing authority, that a single owner must hold the requisite controlling interest, the plain language of the definition of “affiliated group” permits more than one common owner.

Philadelphia School Income Tax Does Not Result In Double Taxation
The Philadelphia Tax Review Board (TRB) ruled in In re: Jonathan B. Freedman, Philadelphia Tax Review Board, Dkt. Nos. 36SIMERZZ9875; 36SIREFZZ9972, 10/27/2015 that a minority shareholder in a Philadelphia S corporation was not entitled to a refund of Philadelphia school district earned income tax paid on dividends issued by the S corporation. The taxpayer argued that the school income tax constituted double taxation because the S corporation had already paid Philadelphia business income and receipts tax (BIRT) on its income. However, the TRB found that the levying of different taxes on different classes of income does not constitute double taxation, nor does it violate the Uniformity Clause of the Pennsylvania Constitution. Further, it found that a tax is unconstitutional only when two similarly situated taxpayers are classified differently and the classification is unreasonable. BIRT is imposed on the privilege of doing business in Philadelphia and is paid by the person doing business (in this case the S corporation). The school income tax is imposed on the income received by the shareholder in the form of dividends issued by the S corporation.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2015 Stradley Ronon Stevens & Young, LLP. All rights reserved.
 

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