Partnerships and the Tax Cuts and Jobs Act (TCJA) Overview of new Sections 163(j), 199A, 1061 and selected other provisions of the TCJA

Transcription

1 Partnerships and the Tax Cuts and Jobs Act (TCJA) Overview of new Sections 163(j), 199A, 1061 and selected other provisions of the TCJA

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is 2018 Ernst & Young LLP. All Rights Reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 1

3 Today s presenters Mark Opper Principal, National Tax (Partnership Transactions Planning & Economics Group), Ernst & Young LLP Morgan K. Anderson Senior Manager, National Tax (Partnership Transactions Planning & Economics Group), Ernst & Young LLP Max Pakaluk Senior Manager, National Tax (Partnership Transactions Planning & Economics Group), Ernst & Young LLP Page 3

4 Section 163(j) Page 4

5 Section 163(j): Basic rules For tax years beginning after December 31, 2017, the TCJA imposes a new limitation on deductibility of business interest expense: Business interest is interest paid or accrued on indebtedness properly allocable to a trade or business. Limited to 30% of adjusted taxable income (ATI) plus business interest income plus floor plan financing interest for the tax year: For tax years beginning after December 31, 2017, and before January 1, 2022, ATI is 30% of EBITDA Starting in 2022, ATI is 30% of EBIT. Electing real property trades/businesses and certain other businesses is excluded. Section 163(j) does not apply to investment interest expense, as defined under Section 163(d). Page 5

6 Section 163(j): Basic rules Section 163(j) limitation is applied at the partnership level: Interest expense that is not limited under Section 163(j) at the partnership level is not retested under Section 163(j) at the partner level. Notice provides that a partner cannot include the partner s share of the partnership s business interest income for the tax year except to the extent of the partner s share of the excess of: The partnership s business interest income over The partnership s business interest expense (not including floor plan financing) If 30% of the partnership s adjusted taxable income exceeds the partnership s net business interest expense, excess available to support deductions at the partner level Pass-through of nondeductible partnership interest expense to partners Limitation on partner s future recovery of suspended excess partnership interest expense: A partner s suspended interest expense may be freed up, but only if it is allocated ETI from that same partnership in a later year. Partner-level basis adjustments for excess partnership interest expense: Recovery of basis adjustment on transfer of partnership interest Page 6

7 Section 163(j): Example 1 (no disallowance) Facts: ATI = $100 ATI = $0 A and B are equal partners and agree to allocate items of AB pro rata. All of the interest expense and the ATI are attributable to a trade or business conducted by AB. A B Analysis: AB interest expense deduction is $10 (limit of $18 = $60 x 30%) Allowed interest expense becomes part of AB s nonseparately stated income or loss. AB s business interest should not be retested by A and B under Section163(j). AB $100 Bank Further, each of A and B is allocated $13.33 of the excess taxable income (ETI) from AB, where partnership excess taxable income is $60 x [($18 $10)/$18], or $ ATI = $60 Int. exp. = $10 Because A and B do not incur interest expense and have no excess business interest from prior years, the ETI cannot be used. ETI does not carry forward. Page 7

8 Section 163(j): Example 2 (disallowance) Facts: ATI = $100 ATI = $0 Same facts as in Example 1, except AB s ATI is $20 in year one. Analysis: A B AB disallowed interest expense is $4 (interest expense of $10 limit of $6 [$20 x 30%]). AB interest expense allowed is $6 (interest expense of $10 disallowed interest expense of $4). The allowed interest expense of $6 becomes part of AB s non-separately stated income or loss, which is allocated to A and B. Each of A and B is also allocated $2 of excess business interest ($4 AB disallowed interest expense/2), which may be carried forward indefinitely but may only be used to offset ETI from AB. Each of A and B should reduce its adjusted basis in AB by $2. AB ATI = $20 Int. exp. = $10 $100 Bank Note: Despite A having $100 of ATI, its excess business interest of $2 is suspended. Page 8

9 Section 163(j): Example 3 (partnership-level determination) Facts: Facts are same as in Example 1. Partner A Partner B Partner A also has a loss of $50 from its sole proprietorship. Analysis: AB s interest expense deduction is $10 (limit of $18 [$60 x 30%]) exceeds interest expense of $10). Each of A and B is allocated $13.33 of excess taxable income from AB (excess taxable income = [$60 x ($18 $10)/$18]). The deductibility of AB s interest expense is not retested under Section 163(j) at the partner level. A s share of the AB interest deduction is not limited by Section 163(j), notwithstanding that A has a net loss when taking account of its $50 loss from its sole proprietorship outside of AB. Loss = $50 Sole proprietorship AB $100 Bank ATI = $60 Int. exp. = $10 Page 9

10 Section 163(j): Example 4 (investment interest) Individual A B A B AB $100 Bank AB $100 Bank Int. exp. = $10 Int. Exp. = $10 Z Z As noted earlier, Section 163(j) applies only to business interest and not to investment interest. In each scenario above, AB owns only stock, which it holds for investment. How should Section 163(j) apply to the interest expense of AB where AB has one corporate partner and one individual partner? Should the answer change if AB has only corporate partners? Note: Similar questions arise in the context of a trader hedge fund. Page 10

11 Section 163(j): Example 5 (multiple trades or businesses) AB has two trades or businesses: an electing real property trade or business and a trucking business. A B How should AB determine how much of its interest expense is properly allocable to its electing real property trade or business vs. its trucking business? How should AB delineate the assets and liabilities associated with those businesses? Different answer if the two businesses are held in separate disregarded entities (DREs)? Int. exp. = $10 AB $100 Bank Electing RP T/B Trucking business Page 11

12 Section 199A Page 12

13 Section 199A 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 for certain investment and compensation type income. QTB: Excludes specified service trades or businesses (SSTBs) and the 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) 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 13

14 Section 199A With respect to each qualified trade or business, the deduction is computed as the lesser of 20% of: QBI The greater of: 50% of the W-2 wages properly allocable to the QTB 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, at $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 14

15 Section 199A QBI does not include: Investment-type income such as dividends; investment interest income (i.e., interest income not attributed to a trade or business); short-term and long-term capital gains; commodities gains; foreign currency gains; certain notional principal contract items (but excluding notional principal contract items from Section 1221(a)(7) hedging transactions); other similar items Any guaranteed payment described in Section 707(c) paid to a partner for services rendered with respect to the trade or business To extent provided in regulations, Section 707(a) payments for services rendered with respect to the trade or business The following items are excluded from the definition of QBI but are separately eligible for the 20% deduction under Section 199A: Qualified real estate investment trust (REIT) dividends Cooperative dividends Qualified publicly traded partnership (PTP) income Page 15

16 Section 199A: Example Facts: Partner A Partner B AB is a pro rata 50/50 partnership between individuals A and B. AB earns $1,000,000 of ordinary income from a qualified trade or business. AB pays W-2 wages of $60,000. AB originally acquired qualified property X for $800,000; the property s current adjusted tax basis is $150,000. Analysis: A and B each compute their Section 199A deduction as follows: QBI 500,000 Section 199A deduction 20% Tentative Section 199A deduction 100,000 [A] W-2 wages allocable to each partner 30,000 Limitation percentage 50% Limitation amount 15,000 [B] Unadjusted basis 400,000 Limitation percentage 2.5% Property limitation amount 10,000 AB $1,000,000 income from QTB W-2 wages of $60,000 Sum of property limitation plus 25% of W-2 wages 17,500 [C] Section 199A deduction 17,500 Lesser of (1) A, or (2) the greater of B or C Page 16

17 Section 1061 Page 17

18 Section 1061 Additional holding period requirement for long-term capital gain with respect to applicable partnership interests (APIs): API includes any interest in a partnership which, directly or indirectly, is transferred to (or held by) the taxpayer in connection with the performance of substantial services by the taxpayer (or any related person) in any applicable trade or business (ATB). Holding period test: Excess of: The taxpayer s net long-term capital gain with respect to such interests for such taxable year over The taxpayer s net long-term capital gain with respect to such interests for such taxable year computed by applying paragraphs (3) and (4) of Section 1222 by substituting three years for one year shall be treated as short-term capital gain Page 18

19 Section 1061 Applicable trade or business: Any activity conducted on a regular, continuous and substantial basis that, regardless of whether the activity is conducted in one or more entities, consists, in whole or in part, of: Raising or returning capital Either: Specified assets: Investing in (or disposing of) specified assets (or identifying specified assets for such investing or disposition) Developing specified assets Securities, commodities, real estate held for rental or investment, cash or cash equivalents, options or derivatives contracts with respect to any of the foregoing, an interest in a partnership to the extent of the partnership s proportionate interest in any of the foregoing Page 19

20 Section 1061 Individual A GP GP s interest in Fund is an API, acquired by the GP in year one. Individual A s interest in GP is an API, acquired by Individual A in year three. Fund acquired Asset X in year one. Fund sells Asset X in year five. A portion of the gain is allocated to the GP, and a portion of that gain is allocated to Individual A. Does Section 1061 apply to recharacterize Individual A s allocable share of the gain from the sale of Asset X as shortterm capital gain? Fund Asset X Page 20

21 Miscellaneous items Page 21

22 Miscellaneous: Section 864(c) Grecian Magnesite Mining v. Comm r, 149 T.C. 3 (July 13, 2017): Tax Court declined to follow Rev. Rul , holding that the gain recognized by a foreign person on its redemption from a partnership engaged in a US trade or business did not result in ECI. TCJA effectively codified Rev. Rul in Section 864(c)(8). Withholding requirement under Section 1446(f): IRS Notice suspends Section 1446(f) withholding for PTP interests pending release of regulations under Section 1446(f). IRS Notice provides additional guidance and describes additional regulations intended to be issued, regarding the application of Section 1446(f), including: A transferee may generally rely on a transferor s most recent K-1 to determine the transferor s share of liabilities included in the amount realized. Where amount realized is unknown or gain exceeds cash or property transferred, the withholding amount is limited to the total amount of cash or property transferred. No withholding is required where the partnership s effectively connected gain would be less than 25% of the total gain recognized on the deemed sale of all of the partnership s assets. Page 22

23 Miscellaneous: Sections 461(l) and 168(k) Section 461(l): excess business loss not allowed: Disallowed net operating loss treated as a loss carryforward under Section 172: Such loss carryforwards are subject to the new limits on NOL deductions imposed under the TCJA (NOLs are limited for tax years beginning in 2018 to 80% of taxable income, no ability to carry back such NOLs, and indefinite carryforwards). Excess business loss means the excess of: The aggregate deductions of the taxpayer for the taxable year attributable to trades or businesses of such taxpayer over The sum of: The aggregate gross income or gain of such taxpayer for the taxable year attributable to such trades or businesses $250,000 (or 200% of such amount for married filing jointly taxpayers) Page 23

24 Miscellaneous: Sections 461(l) and 168(k) Section 168(k): full expensing of certain tangible asset purchases: Prior use by taxpayer prohibited Restrictions on related-party acquisitions Application to partnership transactions: Is full expensing available for Section 743(b) adjustments to partnership property? Other issues (e.g., RR 99-5 partnership formations) Page 24

25 Miscellaneous: Subchapter K provisions Section 708(b)(1)(B): No more technical terminations Effective for partnership tax years beginning after December 31, 2017 Section 743(d): Mandatory Section 743(b) adjustment if transferee partner would be allocated loss >$250,000 upon a hypothetical sale of partnership assets for fair market value (FMV) immediately after the transfer, regardless of whether partnership s assets have built-in loss (effective for transfers of interests occurring after December 31, 2017) Section 704(d): Taking into account charitable contributions and taxes, described in Section 901, paid or accrued to foreign countries and to possessions of the US, in determining outside basis loss limitation of Section 704(d) Page 25

26 Q&A Page 26

27 Thank you! #EYDTC Page 27

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