Insights & News

Tax Insights, May 25, 2016
Tracking Tax News You Need to Know

May 25, 2016
Management Fees Excluded From Gross Income for Purposes of REIT Gross Income Test
In Private Letter Ruling 201620001, the IRS ruled that to the extent a manager earns management fees from managing an operating partnership’s wholly owned investments, the taxpayer (a REIT) may exclude from its gross income (for purposes of Section 856(c)(2) and (c)(3)) the taxpayer’s allocable pro rata share of the operating partnership’s allocable pro rata share of management fees that the manager receives from the operating partnership (section references are to the Internal Revenue Code of 1986, as amended). The ruling describes a taxpayer which conducts substantially all of its investment activities through an operating partnership, which is treated as a partnership for federal income tax purposes. The taxpayer owns the sole general partnership interest in the operating partnership through its wholly owned subsidiary, which is disregarded for federal income tax purposes. The taxpayer also directly owns a limited partnership interest in the operating partnership. The operating partnership is the sole owner of a corporation that elected to be a taxable REIT subsidiary. The taxable REIT subsidiary owns an interest in the manager, which is treated as a partnership for federal income tax purposes. The manager also owns an interest in the taxpayer.

Pursuant to a management agreement between the taxpayer and the operating partnership, the manager implements the operating partnership’s business strategy and manages its business and investment activities and day-to-day operations. As part of a restructuring, the taxpayer’s wholly owned subsidiary will distribute its interest in the manager to the operating partnership. Thus, the operating partnership will directly own an interest in the manager. Because the operating partnership will be a partner in the manager and the taxpayer is a partner in the operating partnership, the taxpayer will be allocated a portion of the fees that the manager receives from the operating partnership. Therefore, the taxpayer, as a partner of the operating partnership and, through its partnership interest in the operating partnership, an interest holder in the manager, will include as income both its proportionate share of the investment income from its direct interest in the operating partnership and the management fee income from its indirect interest in the manager. The IRS reasoned that because the management fees are derived from the same investments that generate the investment income, including the management fees in the taxpayer’s gross income would cause the amounts to be counted twice for purposes of the gross income tests under Section 856(c), which is an incorrect result. Further, the IRS noted that excluding the management fees as described above from the taxpayer’s gross income for purposes of Section 856(c)(2) and (c)(3) does not interfere with Congressional policy objectives in enacting the income tests under those provisions.

JCT Analyzes Wyden Derivatives Proposal
The Joint Committee on Taxation released a technical explanation of the discussion draft released by Senate Finance Committee ranking minority member Ron Wyden to modernize the tax treatment of derivatives and their underlying investments, and for other purposes, the “Modernization of Derivatives Tax Act of 2016” (MODA) released May 18, 2016. The technical explanation notes that (1) MODA unifies and simplifies the treatment of derivatives, with one timing rule, one character rule and one sourcing rule for all derivative contracts; (2) MODA expands the scope of the mark-to-market timing rule to a broader class of taxpayers and contracts than has been subject to that rule in the past; (3) gain or loss from derivative contracts and certain related assets are treated as ordinary income or loss under MODA; and (4) the source of flows on derivatives under MODA is generally the country of residence of the taxpayer. A section-by-section analysis of the bill is also available.

JCT Considers Alternatives to Eliminate the Effects of Double Taxation of Corporate Income
The Joint Committee on Taxation has issued a report on ways of eliminating or lessening the effects of double taxation of corporate income. The report provides a discussion of present law and data relating to corporate integration, and of certain approaches to corporate integration, specifically complete integration and dividend relief.

Disregarded Entity Is Tax Matters Partner
In emailed advice, the IRS noted that a disregarded entity may be the tax matters partner because only a general partner (or member manager) may be a tax matters partner under state agency law, and the fact that the entity is disregarded under federal tax laws cannot change state agency law and convert the owner of a disregarded entity into a general partner with power under state law to bind other partners.

IRS Publishes Final Regulations on Disbursements From Roth Accounts
The IRS issued final regulations (T.D. 9769) eliminating the requirement that each disbursement from a designated Roth account that is directly rolled over to an eligible retirement plan be treated as a separate distribution from any amount paid directly to the employee and therefore separately subject to the rule in Section 72(e)(2) allocating pretax and after-tax amounts to each distribution. As a result of this change, if disbursements are made from a taxpayer’s designated Roth account to the taxpayer, and also to the taxpayer’s Roth IRA or designated Roth account in a direct rollover, then pretax amounts will be allocated first to the direct rollover, rather than being allocated pro rata to each destination. Also, a taxpayer will be able to direct the allocation of pretax and after-tax amounts that are included in disbursements from a designated Roth account that are directly rolled over to multiple destinations, applying the same allocation rules to distributions from designated Roth accounts that apply to distributions from other types of accounts. These regulations finalize the proposed regulations (REG-105739-11) issued in September 2014, with a one-year delay of the applicability date (from Jan. 1, 2015, to Jan. 1, 2016). They are substantively the same as the proposed regulations, but express the rule differently to reflect the ongoing rule and the transition rule.

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 © 2016 Stradley Ronon Stevens & Young, LLP. All rights reserved.

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