ch3 ppt 163j psps s corps - mntaxclass.commntaxclass.com/files/ch3_ppt_163j_psps_s_corps.pdf · tax...

Chapter 3

Interest Expense Limit, Partnerships, and

S corporations

TCJA:

New Interest Deduction Limit

Section 163(j)

© 2018. These materials are copyrighted and may not be reproduced or distributed in whole or in part without permission of the author/CALCPA Education Foundation.

3

Business interest expense for a tax year cannot exceed the sum of:

a) the business interest income;

b) 30% of the taxpayer’s adjusted taxable income (ATI);

c) the taxpayer's floor plan financing interest expense.

Carryforward. Disallowed business interest expense is treated as business interest expense paid or accrued in the succeeding taxable year.

4

Draft Form


Taxable Income without regard to:(i) Nonbusiness income, gain, deduction, loss, or

loss;(ii) Any business interest expense or business

interest income;(iii) Net operating loss deduction;(iv) Section 199A deduction; and,(v) TYBB January 1, 2022, any depreciation,

amortization, or depletion.

ATI

5

6


• Applies to all taxpayers, including C corporations.

• Major exception: §163(j)(1) [the interest deduction limit] does not apply if gross receipts, per §448(c), are < $25 million.

• Exception to exception: The gross receipts exception does not apply to tax shelters defined in §448(c)(3) (defined below).

Scope

7

“A corporation or partnership meets the gross receipts test of this subsection for any taxable year if the average annual gross receipts of such entity for the 3-

taxable-year period ending with the taxable year which precedes such

taxable year does not exceed $25,000,000.”

Gross Receipts Test of 448(c)(1)

8


“ln the case of any taxpayer (other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting under section §448(a)(3)) which meets the gross receipts test of section §448(c) for any taxable year, paragraph (1) [the interest deduction limit] shall not apply to such taxpayer for such taxable year. In the case of any taxpayer which is not a corporation or a partnership, the gross receipts test of section 448(c) shall be applied in the same manner as if such taxpayer were a corporation or partnership.” (163(j)(3))

Gross Receipts Exception if > 25 mil.

9

“All persons treated as a single employer under subsection (a) or (b) of section 52 or subsection (m) or (o) of section 414 shall be treated as one person for purposes of paragraph (1).”

§52(a). [same controlled group of corporations” substituting 50% for 80%].

52(b). Employees of T-Bs under common control, whether or not incorporated (Sch C, PSPs, S corps, C corp., Trust, Estate)

§414(m). Affiliated Service Group.

§414(o). Authority for anti-abuse regulations.

Aggregation rules -- §448(c)(2)

10


A-Org. Affiliated Service group consists of:• a First Service Organization (FSO), and• One or more A-organizations (all service organizations)

Grouped if:1) The A-Org (s) must have an ownership interest in the

FSO (no minimum ownership).o Attributed ownership counts.

2) The A-org (s) must regularly perform services for the FSO.

3) The A-org(s) must be regularly associated with each other in performing services to 3rd parties.

A-Org. Affiliated Service Group Example§414(m)

e11

12

LLCLaw Firm

(FSO)

25%

25% 25%

25%

An Affiliated Service Group

JackPSC

A-org.

JillPSC

A-org

VincePSC

A-orgSusanPSC

A-org


B-Org. Affiliated Service group consists of:• A First Service Organization (FSO), and• One or more B-organizations (not necessarily service

organizations) Grouped if:1) Highly compensated employees of the FSO must own at

least 10% of the B org. o Attributed ownership counts.

2) The B-org must receive a significant portion of its business from performing services for the FSO.

3) At least 10% of service receipts is significant.4) B org. must perform services for the FSO that are

traditionally done by employees.

B-Org. Affiliated Service Group Example§414(m)

e13

14

CentralBilling

25%

25% 25%

25%

Dr. JackPSCFSO

Dr. JillPSCFSO

Dr. VincePSCFSO

Dr/ SusanPSCFSO

Four different B-Org affiliated service groups with billing firm in all four.


One or more chains of organizations conducting trades or businesses that are connected through ownership of a controlling interest [>50%] with a common parent organization if—

(i) A controlling interest in each of the organizations, except the common parent organization, is owned … by one or more of the other organizations; and

(ii)The common parent organization owns … a controlling interest in at least one of the other organizations, excluding, in computing the controlling interest, any direct ownership interest by the other organizations.

Reg. 1.52-1(c) – Parent-Subsidiary Group§52(b)

e15

16

A Parent-Sub Controlled Group under 52(a)

C Corp. AT-B#1

49%

Z

51%

T-B #2Partnership

T-B #3Partnership51%

Y

49%


“The term ‘brother-sister group under common control’ means two or more organizations conducting trades or businesses if

(i) the same five or fewer persons who are individuals, estates, or trusts own (directly and with the application of §1.414(c)-4(b)(1) (options)), a controlling interest of each organization” (Control = 80% or more)

(ii) Taking into account identical ownership only, the five or fewer persons have “effective control” (= 50% or more ownership).

Family attribution: spouse, children (see §1563(e)(6))

Reg. 1.52-1(d) – Brother-Sister Group

e17

18

Brother-Sister Partnership?

A B C D

CateringBusiness

25% 25% 25% 25%

A DCB

RestaurantBusiness

25%25%25%25%

Five or fewer own 100% controlling interest (not merely 80%) and have effective control 100% (not merely 50%)


19

• No controlling interest (only 40%) and no “effective control (only 40%).

AManages

SMLLCRental Real

Estate

Ltd. PSPHolding Real

Estate For Sale

XLtd. Ptr.

20%

YLtd. Ptr.

20% ZLtd. Ptr.

If A, X,Y, and Z are all unrelated?

40%GeneralPartner 20%

20

• A has a Controlling interest (80%) so a brother-sister control group.

AManages

SMLLCRental Real

Estate

Ltd. PSPHolding Real

Estate For Sale

XLtd. Ptr.

20%

YLtd. Ptr.

20% ZLtd. Ptr.

If A, X, and Y are related

40%GeneralPartner 20%


A. “any enterprise (other than a C corporation) if … required to be registered with any Federal or State agency having the authority to regulate the offering of securities for sale, and

B. any syndicate (within the meaning of section 1256(e)(3)(B)), and

C. any tax shelter (as defined in section 6662(d)(2)(C)(ii)).”

21

“Tax Shelter” (sec. 461(c)(3))

Syndicate: “a partnership or any other entity [other than a C corporation] if more than 35 percent of the losses during any period are allocable to limited partners or limited entrepreneurs.” (Sec. 1256(e)(3)(B)

– No losses, not a syndicate (PLR 8753032)

22


Option to Elect Out

Of §163(j)

23

Election Out for RPTBs

24

• A “real property trade or business” (RPTB) can elect out.

• An RPTB is any real property:o development, o redevelopment, o construction, o reconstruction, o acquisition, o conversion, o rental, o operation, o management, o leasing, or o brokerage trade or business. (sec. 469(c)(7)(C))


25

• Price of Election Out: For qualified improvement property (QIP), residential rental property (RRP) , and nonresidential real property (NRP) (Section 168(g)(8)), the taxpayer must use ADS lives -- 20, 30 (residential RP post-TCJA), and 40-year (nonresidential) – instead of the 15, 27.5, and 39-year regular MACRS lives.

• Election precludes bonus depreciation on the QIP, RRP and NRP.• But §179 remains available for QIP…

• The election out is irrevocable.

• Consider loss limits of §461(l) -- $500K (MFJ)/ 250K

Election Out for a Farming Business

26

• Taxpayers engaged in a farming business can elect out.

• A farming business includes the traditional cultivation of land or the raising or harvesting of any agricultural or horticultural commodity.

• Price of Election Out: Must use ADS for any “property with a recovery period of 10 years or more which is held by an electing farming business” including land improvements, barns, and farm buildings. o The election is irrevocable.o Election precludes bonus depreciation (Section 168(g)(1)(G))


Tax years beginning after December 31,

2017.

Effective Date

27

28

• All interest paid on C corporation debt owed is business interest.

• All interest income on loans by a C corporation is business interest income.

• The above rules do not apply to S corporations.

• Future guidance will address C corp. partners.

• Future regs. will clarify that the limit in section 163(j)(1) applies at the level of the consolidated group.

Notice 2018-28 (April 2, 2018)


29

• Generally the same as C corporations

• First, compute the 163(j) limit on the deduction for business interest expense.

• The excess interest expense over the 163(j) limit in the current year is carried forward to the following year – at the entity level (same as a C corporation).

• Unlike C corporations, with S corps the entity reports its “Excess Taxable Income” to S shareholders to help the shareholder increase ATI at the shareholder level (same for partners).

Treatment of S Corporations

30

S Corporation Example • Jan. 1, 2015, the ABC calendar year S corporation is

highly leveraged and is a “syndicate”, thus a “tax shelter” in the years it generates losses.

• Individual A contributed $500K for 50% of the stock and individuals B and C each contributed $250K for 25% of the stock.

• B and C do not actively participate in the S corporation.

• The S corporation borrowed $9,000,000 and purchased real estate for $10 million ($5.5 mil. building cost; $4.5 mil. land). For simplicity, no principal is paid.


31

• Although an eligible real estate T-B, S corporation does not elect out of section 163(j) in 2018.

• Shareholder A has gross receipts of $25 million and has business interest expense that is limited by section 163(j) in 2018 and 2019.

• Shareholder A wants high ATI to free A’s business interest expense.

• Annual MACRS depreciation is $200,000

• ABC recognizes a net loss of <$100K> each year in 2015, 2016, 2017, and 2018.

32

Indiv.B

50% 25% Indiv.C

25%

Indiv.A

S Corporation


33

2018

34

ABC In 2018 Gross Rent 1,200,000

Interest Expense - 700,000Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 300,000

Net Loss (Before) =<100,000> (a “Tax Shelter”)


35



Net Loss (Before) =<100,000> (a “Tax Shelter”)+ Adjustments 900,000 (Int. + Dep.)

ATI =800,000

36




ATI =800,00030% x 800,000 -240,000 (Allowed Int.)


37




ATI =800,00030% x 800,000 -240,000 (Allowed Int.)

Interest Carried Forward = 460,000 Net Income (After) = 360,000 (<100K> + 460K)

Same for an S corporation or C corporation

38

A, B, and C’s 2018 K-1s:

Non-Separately Stated Inc.

A (50%) $180,000B (25%) $ 90,000C (25%) $ 90,000


39

2019(no longer a “Tax Shelter” due to net profit)

40

ABC in 2019Gross Rent 2,100,000

Interest Expense - 500,000* Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 300,000

Net Income = 1,000,000

* $40,000 (current year interest) + $460,000 (carried from 2018)


41

ABC 2019 Gross Rent 2,100,000


Net Income = 1,000,000 (not a Tax Shelter*)+ Adjustments 700,000 (Int. + Dep.)

ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))

42

S Shareholder ATI is:

1) determined without regard to such shareholder’s distributive share of any items of income, gain, deduction, or loss of the S corporation, and

2) is increased by partner’s share of Excess Taxable Income.

S shareholder Adjusted Taxable Income (ATI) – Same as Partners

This rule is intended to eliminate double counting of entity ATI


43

S Corp Draft K-1 for 2018Box 17 – Other Information

44

• Conceptually, it represents the income of the entity that was not needed to free-up interest expense at the entity level.

• A partner’s (and S shareholder’s) distributive share of ETI must match the partner's distributive share of bottom line income or loss. (section 163(j)(4)(A)(i)(II) flush language)

• Excess taxable income will need to be reported by S corporations and partnerships, each year, even if the entity’s business interest expense is NOT limited by section 163(j).

Excess Taxable Income (ETI)


45

Recall, S shareholder A wants adjusted taxable income (ATI) in order to

free-up interest expense at the shareholder level.

46



Net Income = 1,000,000 (not a Tax Shelter)+ Adjustments 700,000 (Int. + Dep.)

ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))

= 10,000 (510,000 – 500,000)Excess Taxable Inc. 33,333 (10,000 ÷ 510,000) x 1.7 Mil.)


47




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))

= 10,000 (510,000 – 500,000)Excess Taxable Inc. 33,333 (10,000 ÷ 510,000) x 1.7 Mil.)Proof $1,666,667 ($1,700,000 - $33,333) x

30% = $500,000

48

2019 K-1s:

Non-Sep.Stated Inc.

ExcessT.I.

A (50%) 500,000 16,667B (25%) 250,000 8,333C (25%) 250,000 8,333

Each shareholder’s share of Excess Taxable Income counts as ATI of the shareholder.


How do Partnership’s Differ?

The Special Rule For Carryforwards

49

50

Interest Not Limited by section 163(j)(1) is:

1) “taken into account in determining” partner bottom line income or loss (that is, non-separately stated income or loss).

2) allocated the same as bottom line income or loss.(Section 163(j)(4)(A))

Observation: so no special allocations are allowed.

Interest Allowed To Partnership(same as S corp.)


51

Special Rule for

Carryforwards

ROD SERLING

52

• The excess business interest expense is carried forward at the partner level where it can only be used with excess taxable income from that same partnership.

• An S corps. excess business interest expense carries forward at the entity level.

Partnerships Only


53

Partnership Draft K-1 for 2018Box 13 – Other Deductions

Partnerships But NotS Corps

54

• EBIE is pushed forward to the partner’s following tax year (at the partner level).

• EBIE must be allocated to partners the same as bottom line income or loss.

• The partner’s outside basis is reduced by the partner’s share of EBIE. (Section 163(j)(4)(B))


55

Partnership Example (1)• Jan. 1, 2015, the ABC calendar year residential rental

real estate limited partnership was formed.

• The rental is a trade or business

• C corp., A, contributed $500K for a 50% general partnership interest, and individuals B and C each contributed $250K for 25% limited partnership interests.

• The PSP borrowed $9,000,000 (recourse) and purchased real estate for $10 million ($5.5 mil. building cost; $4.5 mil. land). For simplicity, no principal is paid.

• The PSP is a “tax shelter in 2018: It is a “syndicate” due to the net loss.

56

• Although an eligible real estate T-B, the partnership does not elect out of section 163(j) in 2018.

• Partner A (the C corp. general partner) has gross receipts of $50 million and has business interest expense that is limited by section 163(j) in 2018 and 2019.

• Annual MACRS depreciation is $200,000

• All partnership items are allocated 50% to A, 25% to B, and 25% to C.

• Partnership recognizes a net loss of <$100K> each year in 2015, 2016, 2017, and 2018.


57

Ltd. PSP

Indiv.Ltd. Ptr.

B

C Corp. Gen. Ptr.

A

50% 25% Indiv.Ltd. Ptr.

C

25%

58

2018


59

ABC Partnership In 2018 Gross Rent 1,200,000


Net Loss (Before) =<100,000> (a “Tax Shelter”)

60




ATI =800,000


61




ATI =800,00030% x 800,000 -240,000 (Allowed Int.)

Excess Bus. Int. Exp. = 460,000 (Disallowed Int.)Net Income (After) = 360,000 (<100K> + 460K)

62

Partner’s A, B, and C’s 2018 K-1s:

Non-Separately Stated Inc.

Excess Business Interest Expense

Partner A (50%) $180,000 $230,000Partner B (25%) $ 90,000 $115,000Partner C (25%) $ 90,000 $115,000

Each partner’s share of Excess Business Interest Expense is pushed forward to 2019 (subsection (j)4)(B)), but reduces O.B. in full.


63

Draft Form 1065 K-1Box 13 – Other Deductions Codes

64

Excess Business Interest Expense is deductible by the partner only if and to

the extent of the partner’s share of the ABC

partnership’s Excess Taxable Income

(subsection (j)(4)(B)(ii)(I)).


65

Partner’s A, B, and C’s Outside Basis at the End of 2018 (debt shared 50%, 25%, 25%):

A B CBeg. O.B. 5,000,000 2,500,000 2,500,0002015 -50,000 -25,000 -25,0002016 -50,000 -25,000 -25,0002017 -50,000 -25,000 -25,0002018 -50,000 -25,000 -25,000Ending O.B. 4,800,000 2,400,000 2,400,000

66

2019(no longer a “Tax Shelter” due to net profit)


67

ABC Partnership in 2019Gross Rent 2,100,000

Interest Expense - 500,000 (none from 2018)Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 300,000


68

ABC Partnership 2019 Gross Rent 2,100,000

Interest Expense - 500,000 (none from 2018)Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 300,000

Net Income = 1,000,000 (not a Tax Shelter*)+ Adjustments 700,000 (Int. + Dep.)

ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))


69




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))


70




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))


30% = $500,000


71

Partnership Draft K-1 for 2018Box 20 – Other Information

72

2019 K-1s:

Non-Sep.Stated Inc.

ExcessT.I.

Remaining Excess Business Int. Exp.(carries to 2020)

A (50%) 500,000 16,667 213,333B (25%) 250,000 8,333 106,667C (25%) 250,000 8,333 106,607

Each partner’s share of Excess Taxable Income enables the partner to deduct that amount of Excess Business Interest Expense pushed forward from 2018.


73

Partner’s A, B, and C’s Outside Basis at the End of 2019 (debt shared 50%, 25%, 25%):

A B CBeg. O.B. 5,000,000 2,500,000 2,500,0002015 -50,000 -25,000 -25,0002016 -50,000 -25,000 -25,0002017 -50,000 -25,000 -25,0002018 -50,000 -25,000 -25,0002019 500,000 250,000 250,000

Ending O.B. 5,300,000 2,650,000 2,650,000

74

Only after all Excess Business Interest Expense for all prior tax years has been treated as paid or

accrued (via Excess Taxable Income) can any remaining Excess

Taxable Income be taken into account when computing the

partner's section 163(j)(1) limitation at the partner level.


75

2020Disposition

By Partner A

76

If a partner disposes of a partnership interest, the partner’s O.B. is increased immediately before the disposition by the amount of the excess (if any) of the amount of Excess Business Interest Expensenot previously deducted.

o Applies to transfers of a partnership interest (including by reason of death) in a transaction in which gain is not recognized in whole or in part.

o No deduction is allowed to the transferor or transferee for any Excess Business Interest Expense resulting in a basis increase.


77

• At the beginning of 2020, Partner A’s interest is redeemed by the partnership for $200,000 cash and A’s $4.5 million share of PSP debt is shifted from A to B and C.

• So A receives $4,700,000 (cash and deemed cash) in the redemption.

• A’s outside basis is increased, immediately before the redemption by A’s remaining excess business interest expense of $213,333; therefore, A’s outside basis is increased to from $5,300,000 to $5,513,333.

• A’s capital loss on the redemption is <$813,333> (section 731). (4,700,000 (cash) - $5,513,333 (O.B.))

78

Outcome:

1) A is allowed a capital loss for A’s $213,333 of remaining excess interest expense (total capital loss <$813,333>).

2) Because the loss exceeds $250,000, it triggers a substantial basis reduction which forces a mandatory downward section 734(b) adjustment of <$813,333> to the PSP’s basis in the real property.


79

Partnership Example (2)• Same facts as Example (1), but in 2018 ABC

Partnership generates 1,000,000 of net business income:

ABC Partnership in 2018

Gross Rent 2,100,000

Interest Expense - 500,000

Prop. Taxes - 100,000

Depreciation - 200,000

Operating Exp. - 300,000


80

• Partner A has gross receipts over $25 million and has business interest expense limited by section 163(j).

• Given that ABC partnership is not subject to the section 163(j) limit, can Partner A simply use its 50% share of the ABC business income ($500,000) as adjusted taxable income?


81

No.



Net Income = 1,000,000 (not a Tax Shelter)

82




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))

Only Excess Taxable Income can be used.


83

• No. A’s ATI is increased by $16,667; A’s 50% share of PSP ETI of $33,333:




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))


84

Partner ATI is:

1) determined without regard to such partner’s distributive share of any items of income, gain, deduction, or loss of such partnership, and

2) is increased by partner’s share of Excess Taxable Income.

Parter Adjusted Taxable Income (ATI)


85

ETI will need to be reported by S

corporations and partnerships, each

year, even if the entity escapes section 163(j).

86

Draft Form 1065 K-1Box 20 – Other Information Codes


87




ATI = 1,700,00030% x 1,700,000 = 510,000 (Sec. 163(j)(1)(B))


30% = $500,000

88

• If a partner is subject to section 163(j) the higher the ATI the better.

• If the ABC partnership generated a large net loss, that loss would not reduce the partner’s ATI.

Planning Point


89

Treasury intends to “issue regulations providing that, for purposes of calculating a partner's annual deduction for business interest [expense]…, a partner cannot include the partner's share of the partnership's business interest income for the taxable year except to the extent of the partner's share of the excess of:

(i) the partnership's business interest income over

(ii) the partnership's business interest expense (not including floor plan financing [interest expense]).”

Notice 2018-28 (April 2, 2018)

90

Draft Form 1065 K-1Box 20 – Other Information Codes


91

Partnership Example (3)• Same facts as Example (1) but assume that

the partnership is also in the business of loaning money (first and second mortgages) and earns $800,000 of business interest income in 2018.

• Assume that the partnership’s operating expenses are increased by $800,000.

92

ABC Partnership In 2018 Gross Rent 1,200,000Business Int. Inc. 800,000= Gross Income 2,000,000

Interest Expense - 700,000Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 1,100,000

Net Loss (Before) = <100,000>


93

ABC Partnership In 2018 Gross Rent 1,200,000Business Int. Inc. 800,000= Gross Income 2,000,000

Interest Expense - 700,000Prop. Taxes - 100,000 Depreciation - 200,000Operating Exp. - 1,100,000

Net Loss (Before) = <100,000> ATI: <100,000> Net Loss

+700,000 Int. Exp.- 800,000 Int. Inc.

+ 200,000 Depreciation= 0

94

• At the partnership level, the $700,000 of 2018 interest expense is allowed in full.

o The sec. 163(j) limit is: $800,000 (Bus. Int. Income) + $0 (ATI) = $800,000.

• Because partnership ATI is zero, no excess taxable income is available to allocate to Partner A.


95

Issue: Can Ptr. A use any of the partnership income to help free up its own business interest expense?

Yes, per Notice 2018-28, Ptr. A can use its share of the net business interest income of $50,000 (50% x $100,000 ($800,000 - $700,000).

REG-104397-18 (Aug. 8, 2018)

Impact of Proposed Bonus Depreciation

Regs. on Partnerships


97

1) Section 743(b) adjustments – Bonus Depreciation May be OK

• Regs. take aggregate view of PSPs. -- a purchase of used property from the selling partner.

• Not qualified if a sale to a related party.

• Buyer cannot have a prior depreciable interest in the PSP property.

o But OK if buyer is an existing partner.

• Buyer can elect bonus even if PSP elects out.

• Doesn’t work for inheritance of PSP interest.

98

2) Section 734 adjustments – No Bonus Deprec.• Because the 734 adjustment is an entity level

adjustment to the basis of PSP property, it fails to qualify due to prior use of the property by the partnership.

3) Section 704(c) adjustments – No Bonus Deprec.

3) The section 732 basis of distributed property –No Bonus Depreciation


99

Special Rule:

• If qualified property is transferred to in a step-in-the-shoes transaction (such as §§721/723), in the same tax year qualified property is placed in service by the transferor, then:

• Bonus depreciation is allocated between transferor and transfereeo Transferor counts the month property is placed in

service.

o Transferee counts the month in which the property is transferred.

754 Election Activates

Sec. 743

Sec. 734

Sales, Exchanges, Deaths

Distributions100


101

• Section 754 elections are more important than pre-TCJA to eliminate inside gain representing:• 1250 Capital Gain • 1245 and 1250 Recapture for Bonus

Depreciation and section 179;• Unrealized Trade Receivables of Cash Basis

Business;• Appreciated Inventory Items of Cash Basis

Business.• Unique importance for foreign persons to

minimize inside gain.

TCJACarried

Interests

New Section 1061© 2018. These materials are copyrighted and may not be reproduced or distributed in whole or in part without permission of the author/CALCPA Education Foundation.

Background on Profits

Only Interests

103

Rev Proc 93-27

IRS AdministrativeConcession For

Vested Profits Only Interest

104


Rev Proc 93-27Profits Interest not taxable if NOT:

1) A substantially certain and predictable stream of income.

2) Disposed of within two years of receipt.

3) A limited partnership interest in a publicly traded partnership.

105

Profits InterestDefinition

A partnership interest other than

a capital interest.

106


Capital Interest Definition

A “capital interest is “an interest that would give the holder a share of the proceeds if the partnership’s assets were sold at fair market value and then the proceeds were distributed in a complete liquidation of the partnership.”

107

IRS Concession for Forfeitable Profits Only Interest -- Rev. Proc. 2001-43

Grant and Vesting are tax free if:

1) Otherwise meet Rev. Proc. 93-27

2) Treat grantee as a a partner (K-1)

3) No compensation deduction upon either grant or vesting.

108


TCJANo Change in

Rev. Proc. 93-27Or

Rev. Proc. 2001-43

109

•Holding period for LTCG treatment is more than 3 years for certain profits-only PSP interests for services.

•Applies only to “applicable partnership interests”.

•Sales of capital assets held for 3 years or less are recharacterized as STCG.

•May apply to activities that are NOT a trade or business (investments) under other code sections. 110

TCJA General Rules


• Tax years beginning after December 31, 2017.

• The provision does not sunset.

• No relief for applicable partnership interests created before 2018.

111

Effective Date

•A PSP interest transferred to a partner for services in an “applicable trade or business”.

•Applicable trade or business is:a)Raising or returning capital andb)Either:

1)Investing in or disposing of specified assets, or

2)Developing specified assets.112

Applicable Partnership Interest


•Specified assets: o securities,o commodities, o real estate held for rental or investment, o cash or cash equivalents, o options or derivative contracts with respect to

any of the foregoing, and o an interest in a partnership to the extent of the

partnership's proportionate interest in any of the foregoing.

113

• “Developing specified assets takes place, for example, if it is represented to investors, lenders, regulators, or others that the value, price, or yield of a portfolio business may be enhanced or increased in connection with choices or actions of a service provider or of others acting in concert with or at the direction of a service provider.”

• “Merely voting shares owned does not amount to development; for example, a mutual fund that merely votes proxies received with respect to shares of stock it holds is not engaged in development.” 114

Developing (per Senate Report)


•Corporate Partners. Partnership interests held by a corporation are excluded from section 1016.

• IRS Notice 2018-18 (March 1, 2018). IRS says S Corporations are not eligible for the exclusion from section 1016.

•Capital Interests. Partnership interests received in exchange for capital escape section 1061.• Right to share in capital must be “commensurate with” capital contributed or value of PSP interest taxable under section 83.

115

Exceptions

“[I]f the partnership agreement provides that the partner's share of partnership capital is commensurate with the amount of capital he or she contributed (as of the time the partnership interest was received) compared to total partnership capital, the partnership interest is not an applicable partnership interest to that extent.”

116

PSP Agreement Language Suggested in House Report


• Hedge fund manager, M, and three investors (I-1, I-2, and I-3) form a partnership.

• Each investor contributes $800,000 and manager agrees to provide services for a fully vested 25% capital interest.

117

Example 1 -- Exception for Capital

118

Manager Gen. Ptr.

I-1Ltd. Ptr. I-2

Ltd. Ptr.

I-3Ltd. Ptr.Services

Each Investor Contributes$800K for a 25% Interest


119

Manager Gen. Ptr.

I-1Ltd. Ptr. I-2

Ltd. Ptr.

I-3Ltd. Ptr.

Services

O.B. $800K O.B. $800K

O.B. $800K$2,400,000

25%Capital Interest

in PSP ---not an API

25% 25%

25%

25%

120

Manager Gen. Ptr.

I-1Ltd. Ptr. I-2

Ltd. Ptr.

I-3Ltd. Ptr.

PSP Deducts$600,000

O.B. $600KO.B. $600K

O.B. $600K


Same facts as Example (1) but:

• M is entitled to a 20% profits interest, after all of the investors are returned their capital, plus a 10% return on their invested capital.

• No current taxable income to M per Rev. Proc. 93-27 (unchanged in TCJA).

• An API so the new 3 year holding period rules for carried interests apply.

121

Example 2 – Applicable PSP Interest (API)

122

Manager Gen. Ptr.

I-1Ltd. Ptr. I-2

Ltd. Ptr.

I-3Ltd. Ptr.

Services

O.B. $800K O.B. $800K

O.B. $800K$2,400,000

Profits Only –ApplicablePartnershipInterest


With respect to an applicable partnership interest, the new law

applies “notwithstanding section 83 or any election in effect under section

83(b).” (section 1061(a)(2) flush language).

123

Role of Section 83

For transfers to related parties, the taxpayer must recognize as STCG

the taxpayer’s share of gain on assets of the partnership not held for more than three years. Section

1061(d).

124

Look-Thru Rule for Transfers to Related Persons


125

Example 3 – PSP Sale of Capital AssetM was granted a 20% applicable

partnership interest (API) in December of 2014.

In 2018, the partnership sells a capital asset with a holding period of 30 months for a gain of $1,000,000.

By the sale date, she held her API more than 3 years.

126

PSP held stock 30 months

Manager Gen. Ptr.

Held Over 3 Years

I-1Ltd. Ptr.

I-2Ltd. Ptr.

Stock Buyer

PSP Gain on Stock Sale = $1,000,0000

20%ProfitsOnly

40% 40%


127

Sec. 1231 Assets Escape Sec. 1061

•Section 1061(a) only applies to assets referred to in section 1222 which address the “sale or exchange of a capital asset held for more than 1 year”.

•Section 1231 assets are NOT capital assets under section 1222.

TCJA: Outside Basis Loss Limit Applied to

Charitable Contributions And

Foreign Taxes(Sec. 704(d))

13


129

• Post-TCJA a partner with zero outside basis is not allowed to deduct (per sec. 704(d)) • charitable contributions, and • foreign taxes (described in sec. 901).

• Charitable contributions of property, the O.B. limit applies to the adjusted basis of the property.

130

Effective DateApplies to partnership tax years

beginning after December 31, 2017.


Look-Thru Rule for Disposition Gain of

Nonresident Partners

(Secs. 864(c)(8) and 1446(f))

132

New Effectively Connected Income • Applies to partners who are nonresident

alien individuals or foreign corporations.

• Outside gain of loss on any disposition is effectively connected gain (ECG) or loss (ECL) to the extent of the partner’s inside built-in ECG or ECL on partnership property.

• Inside ECG or ECL must allocated per distributive share of nonseparately stated taxable income.


133

U.S. or Foreign

Partnership

Other Partners

Foreign Seller

U.S. or Foreign Buyer

Sale

USTB

Transferee

Transferor

Cash

134

U.S. or Foreign

Partnership

Other Partners

Foreign Partner

USTB

Redemption

Transferee

Transferor

Cash


135

New Withholding Obligations• The transferee must withhold 10% of the

amount realized by the transferor.

• If the transferee fails to adequately withhold, the partnership is liable (“backstop” withholding).

• Forms and the withholding tax are due within 20 days of the disposition.• Forms 8288 and 8288A modified.• No penalties or interest if due on or before

May 31, 2018 (Notice 2018-29 §5)

136

Effective Dates 1) The provision making gain or loss

ECG or ECL is effective for sales, exchanges, or other dispositions occurring on or after November 27, 2017.

2) The new withholding rules are effective for sales, exchanges, or other dispositions after Dec. 31, 2017.


137

Publicly Traded PSP Interest Withholding Relief - IRS Notice 2018-8

• No withholding by transferee until IRS guidance is published.

• Foreign transferor must still recognize gain.

138

Withholding Relief for non-PTP PSPs IRS Notice 2018-29 (4/2/2018)

• If Transferor Certifies:o Non-Foreign Status -- affidavit or Form W-9.o No Realized Gain.o Had ECTI < 25% in 3 Prior Tax Years.

• PSP certifies that ECG < 25% of total inside gain.

• No withholding for now on nonrecognition transactions.


139

• PSP can rely on its books or a certificate from transferee to determine outside basis of distributee partner.

• No backstop withholding on PSP until further guidance.

Expanded Definition of Built-in Loss For Mandatory Section 743(b) Adjustment


141

• Backgroundo Basis adjustments are mandatory if the

partnership has a section 754 election in effect, or if there is a “substantial built-in loss.”

o A “substantial built-in loss” exists if the partnership’s adjusted basis in its property is $250,000 greater than the fair market value of partnership property.

• Per the TCJA: a “substantial built-in loss” also exists if the transferee would be allocated a net loss in excess of $250,000 in a hypothetical disposition immediately after the transfer. (section 743(b)(1)(B))

Elimination of Deemed

Terminations(Sec. 708(b)(1))


143

• The TCJA repeals the deemed termination rules for partnership tax years beginning after Dec. 31, 2017.

• No changes to the actual termination rules under section 708(b)(1)(A) (now (b)(1).

S Corporation TCJA Changes


145

Changes To Electing Small Business Trusts

• Allows nonresident alien individual to be a current beneficiary of an ESBT.

• The charitable contribution deduction of an ESBT is not determined by the rules for trusts but rather by the rules applicable to individuals.

So 60% limit and five year carryforward provisions applicable to individuals apply to the portion of an ESBT holding S corporation stock.

146


Effective Date:• The nonresident alien beneficiary

provision takes effect on January 1, 2018.

• The change to the charitable deduction applies to tax years beginning after December 31, 2017.

147

148

Modification of Treatment of S Corporation Conversions to C

Corporations


If S status is revoked within 2 years of TCJA enactment, and the S corp. is eligible then:

• Cash Distributions after the PTTP are characterized based upon the ratio of AAA/E&P.

149

Eligible if: (1) Is an S corporation on 12/21/2017 (the day

before TCJA enactment);

(2) During the two-year period beginning on 12/22/2017 revokes its S corporation election under Section 1362(a);

(3) All of the owners on the date the S corporation election is revoked are the same owners (and in identical proportions) as the owners on the date of such enactment.

150


• Section 481 adjustment for accounting method changes:

A “6 tax year period beginning in the year of change” whether positive or negative.

• Rev. Proc. 2018-44 (8/22/2018) allows “automatic permission for change” in method for eligible terminated S corp:

• For required change from cash to accrual.• For optional change from cash to accrual.• Rev Proc. does not apply to other changes.

151


ch3 ppt 163j psps s corps - mntaxclass.commntaxclass.com/files/ch3_ppt_163j_psps_s_corps.pdf · tax...

Documents