In an article published on Dec. 04, 2018, in Tax Analysts, shareholder Jerry August provides comments on planning strategies for U.S. companies engaging in real estate and licensing transactions overseas. Jerry says, “Real estate deals are often heavily leveraged, so it’s common to see a special purpose vehicle (SPV) formed to borrow money. That SPV is owned by a joint venture with the U.S. taxpayer, either as a general partner or a limited partner, as well as partners from other countries.” Subscribers to Tax Notes may view the full article here.
The growing use of the “Up-C” structure for business ventures which seek access to greater amounts of capital, such as through a public offering, has been discussed at various tax forums and discussed in several articles on the subject over the past five years or more. The Up-C umbrella partnership is being used by private equity funds as well as other venture funds with respect to current and future public offerings. It provides a private equity or VC fund organized as a partnership to continue to enjoy flow through income tax treatment while retaining a degree of control of the business operations and further provide a cash-out of investor fund option through a structured redemption or through a similar call right.
This post highlights a few of the “moving pieces” affecting the structure for engaging in a merger or acquisition of a privately owned company brought about by the Tax Cuts and Jobs Act of 2017, P.L. 115-97, 12/22/2017. The reduction in the corporate income tax rate to a flat 21% will encourage business entities to evaluate whether a conversion from a pass through entity to a C or regular corporation makes sense, taking relevant foreign, if any, and state income tax issues into account. Certain sources of foreign income will, for certain domestic corporations, be subject to a maximum federal income tax rate of 13.5% or 10.5% as will be highlighted below. On the other hand, net operating losses of both corporations and individual are subject to new limitations. In general, net operating losses generated in taxable year subject to the TCJA are subject to a 20% cutback. In other words, only 80% of a NOL can be used against taxable income in a subsequent year. Subject to limited exceptions, NOLs under the TCJA ca not be carried back 2 years as before. This means the overall value of a corporate NOL for example is reduced by 20% of the gross available amount with a discounted rate for the projected absorption of the NOLs against future income. There is also new section 461(l) which applies to non-corporate taxpayers and limits the use of current NOLs to $250,000 ($500,000) for a joint return.
The must-awaited guidance on new section 951A was recently issued on September 13, 2018 by the Treasury and the Internal Revenue Service in the form of proposed regulations (REG-104390-18). Section 951A, an important provision in the Tax Cuts and Jobs Act, P.L. 115-97, requires certain U.S. shareholders to include their share of global intangible-low taxed income (GILTI) derived by controlled foreign corporation to be included in their gross income. Under section 250(a)(1)(B)(i) a U.S. domestic corporation which is a U.S. shareholder in a controlled foreign corporation is entitled to a deduction equal to 50% of the amount of GILTI required to be included in gross income. This deduction drives down the corporate income tax rate from 21% to 10.5% reduced further by a certain percentage of otherwise allowable foreign tax credits (FTCs). The GILTI provision, section 951A, applies to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.
On August 6, final regulations under Section 6223 were issued in T.D. 8939 and are effective for partnership taxable years commencing after 2017. When the centralized partnership audit rules were Enacted into law on November 2, 2015 as part of the Bipartisan Budget Act of 2015 (BBA), the new law made profound changes to the partnership audit rules.
One of the more profound significant reforms was the removal of the “tax matters partner” provision under the prior version of the unified partnership audit rules,that were enacted in 1982 as part of the Tax Equity and Fiscal Responsibility Act (TEFRA) and its replacement by the BBA with the “partnership representative” rule. In section 6223(a), the law requires that each partnership designate, in the manner provided by the IRS in regulations or other guidance, “a partner (or other person)” having a “substantial presence in the United States” as the partnership representative. The statute further provides that the partnership representative has the “sole authority” to act on behalf of the partnership. That was clearly not the case under the Tax Equity And Fiscal Responsibility Act Of 1982 the TEFRA) entity level audit rules, where “notice partners”, in addition to the tax matters partner, enjoyed rights to receive audit information and participate in the audit, appeal or litigation involving proposed adjustments made by the IRS to informational returns previously filed and under audit. Section 6223(b) next tells us that “a partnership and all partners of such partnership shall be bound by actions under this subchapter (BBA) by the partnership, and by any final decision in a proceeding brought under this subchapter with respect to the partnership”.
Did they really mean that? Unfortunately, they did.Why? The former Commissioner of the IRS had testified before the tax-writing committees of Congress that the IRS lacked appropriate resources to effectively audit partnerships. In fact, the audit rate was quite low (i.e., .08 percent), and there frequently were off-setting adjustments which resulted in not producing much revenue to the government.. Congress listened in enacting the BBA and the fulcrum for opening and closing audits, or settling tax disputes over partnership items, was for the government to only have to deal with one person, the new rule requiring the annual designation of a “partnership representative”. Moreover, unlike the tax matters partner provision under TEFRA’s entity level audit rule, the partnership representative does not have to be a partner. It could be an accountant, lawyer, business advisor or other individual provided that such person had a “substantial presence” in the U.S.
The following post is taken in part from an article authored by Mr. August which article was recently published by the Practising Law Institute, New York, NY as part of its symposium on Tax Planning for Domestic & Foreign Partnerships, LLCs, Joint Ventures and Other Strategic Alliances (2017/2018)
The following items highlight several of the important revisions to the new partnership audit rules that have either been enacted into law by Congress in amending the BBA through the technical corrections legislation passed in March, 2018 or under the final regulations under the electing out provision. Special attention should be given to the new pull-in modification procedure as well as the special assessment and collection provisions contained in new Section 6232(f). Proposed regulations have also been issued on tax attributes and basis adjustments as well on the application of the BBA to the international withholding rules. Final regulations are promised to be issued in the near future on the partnership representative provision. It is anticipated that the regulations projects will be completed sometime in the Fall which would presumably include proposed and temporary regulations on the recent technical corrections made to the BBA.
The Internal Revenue Service’s offshore voluntary disclosure program (OVDP) , which has reportedly realized $11.1 billion in payments from taxpayers hiding assets and not reporting income from interests in foreign financial accounts, is due to wind down in September as a result of declining participation rates. In 2011, for example, approximately 18,000 taxpayers filed for OVDP relief. In contrast, the IRS has reported that only 600 filed OVDP relief applications in 2017. That is quite a drop off. Nevertheless, taxpayers with undeclared foreign financial assets can still avail themselves of the IRS’s streamlined filing compliance procedures although the streamlined program may also be phased out in the near future.
As published in the first post to this blog, Section 199A, added to the Code by the Tax Cuts and Jobs Act of 2017, P.L. 115-97, and effective for taxable years beginning in 2018, allows certain noncorporate taxpayers to deduct from taxable income an amount equal to 20% of their “qualified business income”. Specified business are precluded from using section 199A and taxpayers entitled to claim a deduction under section 199A are further subject to a ceiling rule in reducing the amount of allowable deduction to the extent of 50% of W-2 wages, or, if greater, the sum of 25% of the W-2 wages paid with respect to a qualified trade or business plus 2.5% of the unadjusted asset basis immediately after acquisition of the qualified property.
A profits interest issued by a partnership to a service provider has been the subject of a long-standing debate by the Internal Revenue Service and taxpayers receiving such profits interest. The Service has, in general, viewed such interests that are issued in exchange for services to be “property” that is subject to current taxation under section 61(a) to the extent of the fair market value of the interest received. The Service was challenged with respect to its position on the basis that the value of the profits interest on grant was indeterminable or on the basis that the interest was not “property” under a section 83 type of approach where the profits interest was forfeitable and non-transferable. The scorecard of the reported cases in this area reflects that there were more taxpayer victories than defeats but victory did not come by accident but through careful advance planning.