Tax implications, considerations, and new developments related to the use of partnerships by exempt organizations

Transcription

1 Tax implications, considerations, and new developments related to the use of partnerships by exempt organizations The 22nd Annual EY Exempt Health Care Tax Roundtable Portland, OR July 2018

2 Agenda Partnership audit rules Section 199A Section 168(k) Partnership transaction planning issues Special issues for exempt partners Page 2

3 Partnership audit rules Page 3

4 Background Enacted by the Bipartisan Budget Act of 2015 (BBA). Applies generally to partnership tax years beginning after December 31, BBA rules affect: Audit procedures Who pays tax How much tax is paid Several sets of proposed and final regulations have been issued. Technical corrections enacted on March 23, Page 4

5 Partnerships subject to BBA rules Mandatory when partnership: Has more than 100 partners, or Any partner is other than an individual, C corp (including a nonprofit organized as a corporation), S corp or estate A flow-through partner (other than S corps) is an ineligible partner under proposed regulations. For partnerships eligible to elect out: Default rule is that the BBA rules apply. Election out of BBA rules must be made each year. Thus a partnership could be subject to different audit regimes in different years. If the BBA rules do not apply, IRS would make adjustments for each partner in separate proceedings. Page 5

6 Menu of Options Options Omitted Income Overreported Income 1. Default Rule Partnership pays tax Partnership omits future income 2. Rate Reduction Partnership pays reduced amount 3. Partners Amend Historic partners amend (or enter into closing agreements) and pay tax Partnership omits future income Historic partners amend and receive refunds 4. Push Out Election Historic partners pay tax Remedy often available 5. Election Out Historic partners pay tax Refunds available Page 6

7 Partnership representative Sole person with authority to act on behalf of the partnership and its partners. Replaces the tax matters partner (TMP) under TEFRA More powerful than the administrative role held by the TMP under TEFRA Partners have no statutory right to participate in audit or litigation Does not matter whether partner has adopted an inconsistent position Has authority to bind all partners to audit adjustments Partners will not separately sign IRS audit settlement agreements Page 7

8 Partnership representative Need not be a partner Could be an entity, but must also appoint and identify an individual to act on the entity s behalf Difficult to change once designation is made. Eligible persons: any person with a substantial presence in the United States Substantial presence means: Be able to meet with the IRS in the US at a reasonable time and place Be reachable during normal business hours at a US street address and have a phone number with a US area code Have a US Taxpayer Identification Number (TIN) Designation of partnership representative is made on partnership return for partnership taxable year to which designation relates Page 8

9 Section 199A Page 9

10 Section 199A: overview Deduction for individuals of 20% of qualified business income (QBI): Effectively reduces the 37% highest marginal individual income tax rate to 29.6% where no limitations apply. QBI is defined as taxable income that would constitute effectively connected income (ECI) to a foreign taxpayer from a taxpayer s qualified trade or business (QTB), subject to certain exclusions. QBI does not include: Investment-type income such as dividends and short-term and long-term capital gains/losses; Reasonable compensation paid to the taxpayer by any QTB of the taxpayer. Section 707(c) guaranteed payment and, to extent provided in regulations, Section 707(a) payments. Certain items, such as qualified real estate investment trust (REIT) dividends, are excluded from the definition of QBI but are separately eligible for the 20% deduction under Section 199A. Page 10

11 Section 199A: qualified trade or business Qualified trade or business (QTB): Any business other than Specified service trades or businesses (SSTBs) Trade or business of performing services as an employee SSTB includes the following trades or businesses: Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services (but excludes engineering and architecture). PLR : Company generating diagnostic lab reports was not engaged in the field of health under 1202(e)(3)(A). PLR : Pharmaceutical research, testing, and manufacturing company not engaged in business described under 1202(e)(3)(A). Where the principal asset is the reputation or skill of one or more employee or owner. Investing and investment management, trading, or dealing in securities, partnership interests or commodities. Page 11

12 Section 199A: wage and basis limitations With respect to each qualified trade or business, the deduction is computed as the lesser of: 20% of QBI or The greater of: 50% of the W-2 wages properly allocable to the QTB or The sum of 25% of the W-2 wages properly allocable to the QTB plus 2.5% of the unadjusted basis of all qualified property used in the QTB. The wage and property limitation and the SSTB limitation are phased in (for married filing jointly, between $315,000 and $415,000 of taxable income). A net loss of a taxpayer from its QTBs for a taxable year is carried forward to the subsequent taxable year and treated as a loss from a QTB in that year. Page 12

13 Section 168(k) Page 13

14 Section 168(k): overview 100% bonus depreciation for eligible property. Eligible property is generally tangible property with a recovery period of under 20 years. Now includes used property. 100% bonus depreciation begins with property placed in service after September 18, % bonus depreciation continues until December 31, Phased out by 20% every year after until gone starting January 1, Property must be qualified property within the meaning of Section 168(k)(2)(A)(i) and either: The original use must begin with the taxpayer, or The acquisition of such property meets the acquisition requirements of Section 168(k)(2)(E)(ii). Page 14

15 Section 168(k): acquisition requirements The property was not used by the taxpayer at any time before the acquisition, The transferor and transferee do not have a relationship described in Sections 267 or 707(b), The transferor and transferee are not part of the same controlled group, Transferee s basis cannot be determined in whole or in part by reference to the basis of the property in the transferor s hands, and The cost of property does not include so much of the basis of such property as is determined by reference to the basis of other property held at any time by the person acquiring such property. Page 15

16 Section 168(k): partnership questions Are adjustments to partnership property basis under Section 743(b), 734(b), 732 or 751(b) eligible for Section 168(k)? Does Section 168(k) apply with respect to a Section 704(c) s remedial layer? Does Section 168(k) apply with respect to assets deemed purchased in a Rev. Rul springing partnership transaction? Does Section 168(k) apply with respect to assets deemed purchased in a Rev. Rul disappearing partnership transaction? Page 16

17 Partnership transaction planning issues Page 17

18 Section 704(c) A B 50% 50% Property FMV = $100 Basis = $60 PS $100 When does Section 704(c) apply? Contribution of property with a FMV different than tax basis Revaluation events Mechanics of Section 704(c) Allocate difference between FMV and tax basis to contributing partner Section 704(c) is generally tracked on an asset by asset basis Generally requires built-in-gain in a contributed asset to be allocated to the contributing partner Generally requires depreciation in contributed asset to be allocated away from the contributing partner Page 18

19 Disguised sales of property Transfer by partner to partnership and related transfer by partnership to partner may be reclassified as a sale of property between the partner and the partnership. A B Facts and circumstances two-part test 33% & $50 66% Part 1: One transfer would not have been made but for the other AND Property FMV = $100 Basis = $60 PS $100 Part 2: Non-simultaneous transfers are not dependent upon entrepreneurial risks of partnership operations. Presumptions: Transfers made within two years of each other presumed part of a sale. Transfers made more than two years apart presumed not to be part of a sale. Page 19

20 Disguised sales of property: exceptions Preformation expenditures Debt-financed distributions Guaranteed payments Preferred returns Operating cash flow distributions Page 20

21 Disguised sales of property: liabilities Shifts in liabilities are treated as cash distributions. Thus, shifts in liabilities in connection with a contribution of encumbered property may result in disguised sale. Qualified liabilities: If the partnership assumes a qualified liability, the shift of that liability away from the contributing partner generally is not considered disguised sale proceeds. More than two years old and encumber the property; Less than two years old (but not incurred in anticipation of the transfer) and encumber the property; Traceable to capital expenditures with respect to the property; Incurred in the ordinary course of the trade or business in which the property was used, but only if all the assets material to that trade or business are transferred to the partnership; OR Incurred in connection with the conduct of a trade or business (but not in anticipation of the transfer), but only if all of the assets material to that trade or business are transferred to the partnership Nonqualified liabilities are all liabilities other than qualified liabilities. Page 21

22 Disguised sales of partnership interests $75 A B $75 50% 50% Disguised sale of partnership interests? C $150 PS Section 743 adjustment for C? Respected according to its form? Section 734 common basis adjustment? A B C What if cash is distributed to B in complete redemption of its interest in PS? 25% 25% 50% PS Page 22

23 Special issues for exempt partners Page 23

24 JVs: potential impact on exempt status Participation in a JV may cause an exempt organization to lose its exempt status See Redlands Surgical Services v. Comm r; Rev. Rul Rev. Rul : Exempt organizations may participate in a JV without losing their exempt status provided: Participation furthers a charitable purpose; Arrangement permits the exempt organization to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of the for-profit partners or LLC members; and If a management contract is entered, the exempt organization retains ultimate authority over the assets and activities being managed and the terms and conditions of the contract are reasonable Page 24

25 JVs: unrelated business taxable income (UBTI) Section 512(c)(1): Allocable share of partnership income is UBTI to tax exempt partner if the trade or business of the partnership is not substantially related to the organization s exempt purpose. PLR : If JV carries on a trade or business that is related to partner s exempt purpose, partner s allocable share of partnership income is not UBTI to tax exempt partner if: Partner contributes to JV s gross income (e.g., by paying fees to JV itself) Partner s percentage interest in JV is less than its percentage contribution to JV s gross income e.g. Partner is 20% partner of JV and partner pays service fees to JV representing 25% of JV s gross income Page 25

26 Impacts on JV and other taxable partners Section 704(b) and substantial economic effect Section 704(c) anti-abuse rule Absent the anti-abuse rule, the traditional method may shift income to a tax exempt partner in certain instances Section 706 Recovery period and method of depreciable property See Section 168(h)(6) Page 26