The Intersection of Subchapter K and Consolidated Returns

The Intersection of Subchapter K and Consolidated Returns Affiliated & Related Corporations Committee American Bar Association Tax Section Greg Fairbanks Grant Thornton LLP Washington, DC E.J. Forlini Deloitte Tax LLP Washington, DC Krishna Vallabhaneni Acting Deputy Tax Legislative Counsel U.S. Treasury Department Washington, DC Holly Porter Chief, Branch 3 Craig Gerson PwC Washington, DC Internal Revenue Service (PSI) Chicago, IL September 18, 2015

Agenda I. Partnership Formation Issues Within Consolidation II. Mid-Stream Life Cycle Issues III. Partnership Termination Issues 2

I. Partnership Formation Issues Within Consolidation A. Breaking Affiliation B. Incorporating a Partnership 3

Breaking Affiliation Affiliated Group Section 1504(a) Requirements One or more chains of includible corporations connected through stock ownership with a common parent but only if: Common parent owns directly at least 80% of the vote and value of at least one of the other includible corporations, and At least 80% of the vote and value of the stock of each of the includible corporations owned directly by one or more other includible corporations Affiliated Group Includible Corporations (Section 1504(b)) Any corporation except: Subchapter S corporations (section 1361) Exempt corporations (section 501) Foreign corporations Life Insurance companies (section 801) Possession Tax Credit corporations (section 936) RICs and REITs DISCs 4

Breaking Affiliation Under 1502 PLR 8135075 (June 5, 1981) PLR 8449019 (Aug. 30, 1984) P Unrelated 95% 5% Partnership 5

Breaking Affiliation Under 1502 PLR 9626031 (Mar. 29, 1996) SH SH 21% Z 92.5% X S-Corp LLC Individuals 7.5% Z 92.5% X S-Corp LLC Individuals 7.5% Y C-Corp 79% 100% Y C-Corp Z and LLC are LLCs Members are unrelated LLC purchases Y stock from Z Has X blown its S Election? (under pre- 1996 law) (i.e., Are X & Y affiliated?) Ruling: X is not affiliated with Y 6

Breaking Affiliation Under 1502 PLR 9640010 (June 28, 1996) Trust Individuals Trust Individuals Cash 1% LLC F Sub 99% 81.2% Corp Sub All assets, including a Foreign subsidiary 18.8% Brothers/ Sisters Trust and Sub form a new LLC Sub liquidates 1% 81.2% LLC F Sub Corp 99% 18.8% (Corp replicated the LLC structure with other Brother/Sister subsidiary members) Can Corp make an S Election (under pre-1996 law)? Ruling: Corp is not affiliated with F Sub 7

Breaking Affiliation Under 1502 99% P 1% A LLC 100% T What if P and T are previously affiliated? 8

Breaking Affiliation Under 1502 P P S 1 S 2 S 1 S 2 99% LLC 1% Y Y P, S1, S2, and Y are members of the same affiliated group. Is there heightened concern when 1% ownership is not held by an unrelated party? 9

Breaking Affiliation Under 1502 Treas. Reg. 1.701-2(a) Requirements under Subchapter K (1) Bona Fide Partnership (2) Substance over Form (3) Clear Reflection or Income Treas. Reg. 1.701-2(e) Abuse of Entity Treatment 10

Incorporating a Partnership Rev. Rul. 84-111, Situation 1 Assets Over Assets Over X Y LLC 2 Stock 2 1 Assets Newco Stock Step 1 Assets of LLC are contributed to Newco in a section 351 transaction Step 2 Stock of Newco is distributed to X & Y in liquidation Result X & Y take basis in Newco under section 732(b) 11

Incorporating a Partnership Rev. Rul. 84-111, Situation 2 Assets Up X 1 Stock 2 Assets Assets Up LLC Newco Y 1 Stock 2 Assets Step 1 Assets of LLC are distributed to X & Y in liquidation Step 2 Assets are contributed to Newco in a section 351 transaction Result Transfer is in consolidation Section 357(c)/ELA 12

Incorporating a Partnership Rev. Rul. 84-111, Situation 3 Interests Over X Y LLC 1 Interest 1 Interest Assets Interests Over Newco Step 1 Interests of LLC are contributed to Newco in a section 351 transaction Result Partnership terminates Transfer within consolidation Section 357(c)/ELA See also Rev. Rul. 99-6 13

Rev. Rul. 99-6, Situation 1 P Interest X Y 50% 50% LLC Step 1 X transfers its interest in LLC to Y Result LLC Partnership terminates X treats this as a sale of LLC interests Y treats this as an acquisition of LLC assets from X after the LLC liquidates 14

Rev. Rul. 99-6, Situation 2 P Step 1 X and Y transfer their interests in LLC to Z Interest Result X Y Z LLC Partnership terminates X and Y treats this as a sale of LLC interests 50% 50% LLC Z treats this as an acquisition of LLC assets from X and Y after the LLC liquidates What if Z is a Newco? Compare with Rev. Rul. 84-111, Situation 3. 15

Rev. Rul. 99-6, Situation 2 (Variation) A 100% LLC Common Parent B LLC Interests US Newco Is this a reverse acquisition under Treas. Reg. 1.1502-75(d)(3)? - See PLR 200744006 (Nov. 2, 2007) - Compare with result under Rev. Rul. 84-111, Situation 3. If LLC had liabilities, could section 304 apply? - Compare with result under Rev. Rul. 84-111, Situation 3. A 100% LLC Common Parent B Facts A and B own 100% of LLC LLC owns stock of Common Parent Step 1 A and B transfer their interests in LLC solely to US Newco in exchange solely for 100% of US Newco stock. Result LLC Partnership terminates A and B treat this as a transfer of LLC interests for US Newco stock US Newco treats this as an acquisition of LLC assets, including stock of Common Parent from A and B after the LLC liquidates 16

Transactional electivity with Partnerships 1 P Assets Up 2 721 of Assets Investor 2 P Interest Up S Domestic Partnership S 1 721 of Assets Investor Built-in Gain Assets Built-in Gain Assets Domestic Partnership Step 1 - DIT in Assets Step 2 - DIT is accelerated under 1.1502-13(d) Step 1 Assets Step 2 - DIT in partnership interest 17

Notice 2015-54 1 P Assets Up S 2 721 of Assets Foreign Partnership Investor 2 P Interest Up S 1 721 of Assets Investor Built-in Gain Assets Built-in Gain Assets Foreign Partnership 18

II. Mid-Stream Life Cycle Issues A. Intercompany Sale of a Partnership Interest B. Allocating Partnership Items to Member Short Periods C. May Department Store Transaction and Treas. Reg. 1.337(d)-3T D. Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules E. Agency and Partnerships 19

Intercompany Sale of Minority Interest in a Partnership Scenario 1 P X S < 50 % B LLC 1245 Property and Land LLC makes a section 754 election. 20

Intercompany Sale of Minority Interest in a Partnership B obtains a stepped-up basis with respect to its share of LLC s assets (section 743(b)). As LLC depreciates its property, B s related depreciation deduction reflects the section 743(b) adjustment. Each year, S takes into account its intercompany gain on the sale of S s LLC interest to B to the extent of the difference between B s depreciation deduction related to LLC and the depreciation deduction that would have resulted if S and B were divisions of a single corporation. S s gain is characterized as ordinary gain. See Rev. Rul. 89-85; Treas. Reg. 1.1502-13(c), Example 9(a)-(c). Application of Acceleration Rule? Acceleration of S s intercompany item occurs to extent a nonmember reflects directly, or indirectly, any aspect of the intercompany transaction. Treas. Reg. 1.1502-13(d)(1)(i)(B). Section 743(b) adjustment solely with respect to B, not LLC. Thus, adjustment has no effect on a non-member. Compare with fact pattern where S sold assets to B at a gain, and B contributed the assets to LLC. What if LLC subsequently contributed property to a nonmember corporation? Or a lowertier partnership? See Treas. Reg. 1.743-1(h)(1),(2). 21

Intercompany Sale of Minority Interest in a Partnership Scenario 2 P X S < 50 % B LLC 1245 Property and Land Assume LLC has no section 754 election in effect. Does result differ from Scenario 1? 22

Intercompany Sale of Minority Interest in a Partnership The LLC assets do not obtain a stepped-up basis with respect to B s share of LLC s assets. LLC depreciation of property does not change. S takes into account its intercompany gain on the sale of S s LLC interest to B only upon B s sale of LLC interest to a non-member. See Treas. Reg. 1.1502-13(c), Example 9(d). Reflects fact that no difference between B s depreciation deduction related to LLC and the depreciation deduction that would have resulted if S and B were divisions of a single corporation. Acceleration rule apply if LLC contributes property to another partnership or a non-member corporation? 23

Intercompany Sale of 50%-or-Greater Interest in a Partnership P X S 50 % B LLC 1245 and Land Is the Treas. Reg. 1.1502-13 analysis different than the sale of a minority interest in LLC? 24

Intercompany Sale of a 50%-or-Greater Interest in a Partnership Section 708(b)(1)(B): a partnership shall be considered as terminated if within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits. Prior 708 regulations (pre-1997): basis of partnership assets adjusted. Immediate acceleration event on intercompany sale of LLC because non-member reflects intercompany transaction. Current 708 regulations (Treas. Reg. 1.708-1) LLC deemed to contribute assets to New LLC. 721 and 722. Old LLC deemed to liquidate. Treas. Reg. 1.708-1(b)(4). Partner basis in New LLC equal to its basis in LLC. Successor asset rule permits continued matching. Treas. Reg. 1.1502-13(j)(1). Acceleration rule apply? New LLC basis in property does not reflect intercompany transaction. 723. See Treas. Reg. 1.743-1(h)(1). But New LLC restarts recovery period of any amortizable or depreciable asset. 168(i)(7). 25

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Generally Cal yr P 12/30/20x1 Y A S S 60% 40% 40% LLC Cal yr P Group and LLC each have calendar year tax years On 12/30/20x1, P sells S to Y. How is S s share of LLC income for 20x1 divided between the P Group and Y Group? Unrelated Y. S joins Y Group. 26

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Generally When a member departs or joins a consolidated group during a taxable year, Treas. Reg. 1.1502-76 provides rules governing the allocation of the member s items for that year between the consolidated return and the member s separate return. Section 706(a): Partner must take into account its share of a partnership s items for any taxable year of the partnership ending within or with the taxable year of that partner. Thus, partnership items are generally allocated to partners at end of partnership taxable year. Treas. Reg. 1.1502-76(b)(2)(vi)(A): If S is a partner in a partnership or an owner of a similar interest with respect to which items of the entity are taken into account by S, S is treated, solely for purposes of determining the year to which the entity's items are allocated under paragraph (b)(2) of this section, as selling or exchanging its entire interest in the entity immediately before S's change in status. Section 706 would apply to require an allocation (using methods permitted under section 706 regulation) of partnership items to the selling group for the period ending on the date of sale. Section 706(c)(2)(A): the taxable year of a partnership shall close with respect to a partner whose entire interest terminates. (Recently finalized) Treas. Reg. 1.706-1(c)(2)(iii): A deemed disposition of the partner's interest pursuant to Treas. Reg. 1.1502-76(b)(2)(vi) shall be treated as a disposition of the partner's entire interest in the partnership solely for purposes of section 706. 27

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Generally Thus, in the example, either 364 days (or 364/365 of LLC s income for 20x1, if ratable allocation available and elected) allocated to P Group Absent the special rule for partnerships, the portion of the departing member s income (or deductions) from a partnership for the period that it was a member would include only income from partnership years that end within or with the taxable year of the partner. In the example, that would mean the full year of LLC income (or loss) allocated to S would be included on S s one-day return as a member of the Y Group 28

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Controlled Partnership Cal yr P 12/30/20x1 Y A S S 45% 55% 55% LLC Cal yr P Group and LLC each have calendar year tax years On 12/30/20x1, P sells S to unrelated Y. S joins Y Group. How is S s share of LLC income for 20x1 divided between the P Group and Y Group? 29

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Controlled Partnership Under Treas. Reg. 1.1502-76(b)(2)(vi)(B), there is an additional requirement that if departing member constructively holds 50% or more any stock held by the partnership, the method used to allocate the income of the departing member (i.e., closing of the books or ratable allocation) must also be used for the pass-through entity. If ratable allocation is elected for S s items, S would allocate its distributive share of each non-extraordinary item of LLC ratably between the two periods caused by S s departure from the P group to the Y G. If ratable allocation is not elected for S s items, the partnership must close its books to determine the portion of S s distributive share of the partnership s items allocable to the two periods. 30

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Partnership and Member Years Different Cal yr P 12/30/20x1 Y A S S 60% 40% 40% LLC 3/31 tax year P Group has calendar tax year. LLC has a 3/31 tax year On 12/30/20x1, P sells S to unrelated Y. S joins Y Group. How is S s share of LLC income for 3/31/20x1 year end and 3/31/20x2 year end divided between the P Group and Y Group? 31

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Partnership and Member Years Different Items from LLC tax year ending 3/31/20x2: Portion of items tiered up to S for P Group s 12/31/20x1 return Not a controlling interest, so LLC free to use any allocation method permissible under section 706 regulations to allocate its items between P Group and Y Group. For example, if LLC uses closing-of-the-books, S s share of each LLC item from 4/1/20x1 to 12/30/20x1 is allocated to the P Group, and S s share of each LLC item from 12/31/20x1 to 3/31/20x2 is allocated to the Y Group. Items from LLC tax year ending 3/31/20x1: Because LLC year ends within S s 20x1 tax year, LLC income is tiered up to S on 3/31/20x1 under section 706 Not addressed by Treas. Reg. 1.1502-76(b)(2)(vi). If ratable allocation chosen, are the LLC items allocated between P Group and Y Group for 20x1? Or instead, are the items allocated entirely to P Group? What if the items are losses that if earned directly by S would potentially be subject to section 382/SRLY? Consider Treas. Reg. 1.1502-76(b)(2)(ii)(C)(14) (includes as an extraordinary item any item which, in the opinion of the Commissioner, would, if ratably allocated, result in a substantial distortion of income in any consolidated return or separate return in which the item is included. ) 32

Allocating Partnership Items to Member Short Periods (Treas. Reg. 1.1502-76(b)(2)(vi)) Potential Application to Subpart F Income? Application of special rule in Treas. Reg. 1.1502-76(b)(2)(vi) be extended to subpart F income flows to a member shareholder of a CFC? -76(b)(2)(vi)(C): rules in -76(b)(2) do not apply to any foreign corporation generating the deemed inclusion of income, or to any passive foreign investment company generating a deferred tax amount on an excess distribution under section 1291. Deemed extraordinary items by -76(b)(2)(ii)(C)(11). Rationale for not extending? 33

May Department Store Transaction Public Cash Buyer contributes cash to LLC and Seller contributes appreciated business unit LLC uses the cash to purchase Seller s publicly-traded stock. Buyer Seller Cash Appreciated Business Unit LLC Seller s Stock 34

May Department Store Transaction Buyer Business Unit LLC Seller Stock Seller After mixing bowl period ends, LLC liquidates, distributing business unit to Buyer and Seller s stock to Seller. Buyer receives stepped-up basis in business unit. Seller takes stock with low basis, but the gain would be eliminated because the stock would be retired, thus avoiding gain recognition. IRS issues Prop. Treas. Reg. 1.337(d)-3 on theory that the transaction is inconsistent with the repeal of the General Utilities doctrine. 35

Temporary Regulations - Scope Apply to transactions occurring after the date of publication. Apply to section 337(d) transactions - transactions that effectively increase a corporate partner s interest in its stock and decrease its interest in other appreciated property. Examples: Partnership acquires stock of the corporate partner. Partnership allocations are changed. Partnership distributes stock of the corporate partner to the corporate partner. 36

Temporary Regulations Extend deemed redemption rule to distributions. Tax reductions to basis of distributed stock of the corporate partner if section 732(f) does not apply. Amend section 732 regulations to treat distributed stock of the corporate partner as cash for purposes of allocating basis (if section 732(f) does not apply). Apply to transactions occurring after publication date. 37

Example 1: Deemed redemption rule contribution of Stock of a Corporate Partner Treas. Reg. 1.337(d)-3T(d) Redemption Test: X s share of X stock immediately before contribution: $0. X A X s share of X stock immediately after contribution: $50. Thus, the partnership formation is a Section 337(d) Transaction. Results: Asset 1 FMV $100 Basis $20 AX X Stock FMV $100 Basis $100 Gain (Treas. Reg. 1.337(d)-3T(d)): X s share of gain in Asset 1: $80. X s Gain Percentage = $50 (X s share of Asset 1 effectively exchanged)/ $100 (X s share of Asset 1 immediately before contribution) = 50%. X stock Asset 1 X s gain = Gain Percentage (50%) * X s share of gain in Asset 1 ($80) = $40. FMV $100 Basis $100 FMV $100 Basis $20 38

Example 2: Distribution of Stock of the Corporate Partner pro rata distribution Results: Gain (Treas. Reg. 1.337(d)-3T(d)): X A Not a Section 337(d) Transaction because pro rata distribution of partnership assets and X s interest in its stock and Asset 1 do not change (not an exchange). 50% X Stock 50% Asset 1 X Stock FMV $200 Basis $100 FMV $200 Basis $60 AX Asset 1 FMV $200 Basis $100 50% X Stock 50% Asset 1 Basis consequences (Treas. Reg. 1.337(d)-3T(e)(2)): Ordering Rule - Under Treas. Reg. 1.732-1T(c)(1)(iii), the distribution to X of X stock is deemed to immediately precede the distribution of 50% of Asset 1 to X for purposes of determining X s basis in the distributed property. The basis of the distributed stock is $50. X s initial outside basis ($60) is greater than the basis of the distributed stock ($50) and therefore X recognizes no additional gain Treas. Reg. 1.337(d)-3T(e)(3). Asset 1 FMV $200 Basis $60 39

Example 3: Distribution of Stock of the Corporate Partner non pro rata distribution X 75% X Stock 25% Asset 1 X Stock FMV $200 Basis $100 FMV $200 Basis $60 AX Asset 1 FMV $200 Basis $100 A 25% X Stock 75% Asset 1 Treas. Reg. 1.337(d)-3T(d) Redemption Test: X s share of X stock immediately before distribution: $100 X s share of X stock immediately after distribution: $150. Thus, AX s liquidating distributions of X stock and Asset 1 to X are a Section 337(d) Transaction because the distributions have the effect of an exchange by X of $50 of Asset 1 for $50 of X stock. Results: Gain (Treas. Reg. 1.337(d)-3T (d)): Gain in Asset 1: $140. X s share of gain in Asset 1: $90 ($40 pursuant to section 704(c) plus $50 of $100 post-contribution appreciation). X s Gain Percentage = $50 (X s interest in Asset 1 effectively exchanged for X s stock)/ $100 (X s interest in Asset 1 immediately before exchange) = 50%. X s gain = Gain Percentage (50%) x X s share of gain ($90) = $45. Asset 1 FMV $200 Basis $60 40

Example 3: Distribution of Stock of the Corporate Partner non pro rata distribution X 75% X Stock 25% Asset 1 X Stock FMV $200 Basis $100 FMV $200 Basis $60 AX Asset 1 Asset 1 FMV $200 Basis $60 FMV $200 Basis $100 A 25% X Stock 75% Asset 1 Results (cont.): Basis consequences Treas. Reg. 1.337(d)-3T(d)(4)(i) and (ii): X s initial outside basis ($60) + X s gain under Treas. Reg. 1.337(d)-3T(d) ($45) = X s adjusted outside basis ($105). AX s initial basis in Asset 1 ($60) + X s gain under Treas. Reg. 1.337(d)-3T d) ($45) = AX s adjusted basis in Asset 1 ($105). Basis consequences (Treas. Reg. 1.337(d)-3T(e): Ordering Rule - Under Treas. Reg. 1.732-1T(c)(1)(iii), the distribution to X of X stock is deemed to immediately precede the distribution of 25% of Asset 1 to X for purposes of determining X s basis in the distributed property. The basis of the distributed stock is the greater of: (1) $75 (75% of the stock s $100 basis in the partnership), or (2) $100 (the fair market value of the distributed stock ($150) minus X s allocable share of gain in the X stock ($50). X s outside basis immediately before the distribution ($105) is greater than the basis of the distributed stock ($100) and therefore X recognizes no additional gain under Treas. Reg. 1.337(d)-3T(e)(3). X s basis in the distributed portion of Asset 1 is $5. 41

Example 4: Deemed redemption rule subsequent purchase of Stock of the Corporate Partner X A Results: AX s purchase of X stock has the effect of an exchange by X of appreciated property for X stock, and thus, is a Section 337(d) Transaction. X must recognize gain at the time, and to the extent, that X s share of appreciated property (other than X stock) is reduced in exchange for X stock. Thus, the consequences of the partnership s purchase of X stock are the same as those described in Example 1, resulting in X recognizing$40 of gain. 1 Asset 1 FMV $100 Basis $20 AX Cash $100 1 2 X Stock purchased with A s contributed cash FMV $100 Basis $100 Asset 1 42

Example 5: Change in allocation ratios amendment of partnership agreement Remaining BIG = $40 X X Stock FMV $200 Basis $100 FMV $200 Basis $60 80% of income, gain, loss, and deduction from the X stock AX FMV $200 Basis $100 X stock Asset 1 A 80% of income, gain, loss, and deduction from Asset 1 Asset 1 FMV $200 Basis $60 Facts: The facts are the same as Example 2, except that in Year 9, AX does not liquidate and the AX partnership agreement is amended to allocate 80% of income, gain, loss, and deduction from the X stock to X and 80% of income, gain, loss, and deduction from Asset 1 to A. If AX had sold the partnership assets immediately before the amendment to the agreement, X would have been allocated $90 of gain from Asset 1 ($40 BIG and 50% of $100) and $50 of gain from the X stock. Results: The amendment to the AX partnership agreement causes X s interest in its stock to increase from $100 (50% of the stock value immediately before the amendment of the agreement) to $160 (80% of stock value immediately following amendment of agreement) and its interest in Asset 1 to decrease from $100 to $40. Thus, the amendment of the partnership agreement is a Section 337(d) Transaction because it has the effect of an exchange by X of $60 of Asset 1 for $60 of its stock. X recognizes $54 of gain. 43

Example 6: Admission and exit of a partner X A B Facts: The facts are the same as Example 1: in Year 1, X corporation and A form AX as equal partners and X contributes Asset 1 with a fair market value of $100 and a basis of $20 and A contributes $100 cash. In Year 2, when the values of Asset 1 and the X stock have not changed, B contributes $100 of cash to AX in exchange for a 1/3 interest in the partnership. X Stock FMV $100 Basis $100 AX X stock Asset 1 Asset 1 FMV $100 Basis $20 Cash $100 Results: Upon the admission of B, X s interest in Asset 1 decreases from $50 to $33.33, and its interest in B s contributed cash increases. B s admission is not a Section 337(d) Transaction because it does not have the effect of an exchange by X of its interest in Asset 1 for X stock. Therefore X does not recognize gain under the deemed redemption rule. 44

Example 6: Admission and exit of a partner (cont.) X A B Facts (cont.): In Year 9, when the values of Asset 1 and the X stock have not changed, AX distributes $50 of cash and 50% of Asset 1 (valued at $50) to B in liquidation of B s interest. X and A are equal partners in all respects after the distribution. X Stock FMV $100 Basis $100 AX X stock Asset 1 Asset 1 FMV $100 Basis $20 Cash $100 Results: On liquidation of B s interest, X s interest in Asset 1 decreases from $33.33 to $25, and its interest in X stock increases from $33.33 to $50, and therefore the liquidation is a Section 337(d) Transaction. Under 1.337(d)-3T(d)(2), X s interest in X stock will never be less than it s largest interest (by value) in those shares of stock taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction (regardless of whether the Corporate Partner recognized gain in the earlier transaction). X s largest interest in the X stock previously taken into account under 1.337(d)-3T(d)(2) was $50. Therefore, X recognizes no gain. 45

Example 7: Plan to circumvent purpose of section 337(d) 2 X Asset 1 99% 3 X stock FMV $100 AX 1 Asset 1 Asset 1 FMV $100 Basis $20 3 1% A $100 Repay $100 3 $100 Cash Lender 2 Facts: 1. In Year 1, X corporation and A contribute a small amount of capital to newly-formed partnership AX, with X receiving a 99% interest in AX and A receiving a 1% interest in AX. 2. AX borrows $100 from a third-party lender and uses the proceeds to purchase X stock, which is Stock of the Corporate Partner. 3. Later, as part of a plan or arrangement to circumvent the purposes of section 337(d), A contributes $100 of cash, which AX uses to repay the loan, and X contributes Asset 1 with a fair market value of $100 and basis of $20. After these contributions, A and X are equal partners in AX in all respects. Results: X s interest in X stock will never be less than the its largest interest (by value) in the stock taken into account when the partnership previously determined whether there had been a Section 337(d) Transaction (regardless of whether the Corporate Partner recognized gain in the earlier transaction). This limitation does not apply, however, if the reduction in X s interest in X s stock occurred as part of a plan or arrangement to circumvent the purpose of section 337(d). Because the transactions described in this example are part of a plan or arrangement to circumvent the purpose of section 337(d), the limitation does not apply and X recognizes $40 of gain under the deemed redemption rule (same as Example 1) 46

Example 8: Tiered partnership X 80% 20% 1 1 Asset 1 Cash FMV $80 $20 Basis $0 2 Asset 1 & Cash $20 UTP A LTP B X Stock 2 FMV $100 Basis $100 Facts: 1. In Year 1, X corporation and A form UTP partnership. X contributes Asset 1 with a fair market value of $80 and a basis of $0 in exchange for an 80% interest in UTP. A contributes $20 of cash in exchange for a 20% interest in UTP. 2. UTP and B, an individual, form partnership LTP as equal partners. UTP contributes Asset 1 and $20 of cash. B contributes X stock, which is Stock of the Corporate Partner, with a basis and fair market value of $100. Results: Under 1.337(d)-3T(g), section 337(d) shall apply to tiered partnerships in a manner that is consistent with the purposes to prevent the circumvention of section 311(b) principles. The Formation of LTP causes X s interest in X stock to increase from $0 to $40 and its interest in Asset 1 to decrease from $64 to $32. Thus, LTP s formation is a Section 337(d) Transaction because the formation has the effect of an exchange by X of $32 of Asset 1 for $32 of X stock. Asset 1 Cash 47

Example 8: Tiered partnership (cont.) X 80% 20% 1 1 Asset 1 Cash FMV $80 $20 Basis $0 A Results (cont.): X s Gain Percentage is 50% (X s $32 interest in Asset 1 effectively exchanged for X stock over X s $64 interest in Asset 1 immediately before the Section 337(d) Transaction). If Asset 1 had been sold in a fully taxable transaction immediately before LTP s formation, X s share of gain would have been $80 pursuant to section 704(c). Therefore, X recognizes $40 of gain ($80 multiplied by 50%) under the deemed redemption rule. UTP B 2 Asset 1 & Cash $20 LTP X Stock 2 FMV $100 Basis $100 Asset 1 Cash 48

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules - Sale of Partnership Interest P Basis: $10 Value: $100 S Land Step 1 10% interest Land Step 2 $100 10% interest Land B NOLs subject to limitation under - 21(c). Step 4 B sells the partnership interest to a nonmember for $100 Step 3 Sale of land to X for $100 Treas. Reg. 1.1502-13(h)(2), Example 1. S owns raw land with a $10 basis and $100 value. B has NOLs from SRLYs subject to limitation under Treas. Reg. 1.1502-21(c). Pursuant to a plan to absorb the losses without limitation by the SRLY rules: 1: S transfers the land to an unrelated, calendar year partnership in exchange for a 10% interest in the partnership under section 721. The partnership does not make a section 754 election. 2: S sells the interest to B for $100. 49

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules - Sale of Partnership Interest (cont.) P Basis: $10 Value: $100 S Land Step 1 10% interest Land Step 2 $100 10% interest Land B NOLs subject to limitation under - 21(c). Step 4 B sells the partnership interest to a nonmember for $100 Step 3 Sale of land to X for $100 3: In the following year, the partnership sells the land to X for $100. Because the partnership does not have a section 754 election, its $10 basis in the land does not reflect B s $100 basis in the partnership interest. Under section 704(c), the partnership s $90 BIG is allocated to B, and B s basis in the partnership interest increases to $190 under section 705. 4: In a later year, B sells the interest to a nonmember for $100. Under -21(c), the partnership s $90 BIG allocated to B ordinarily increases the amount of B s SRLY limitation, and B s $90 loss from its sale of the interest ordinarily is not subject to limitation under SRLY. Conclusion: Because the contribution to the partnership and the sale of the interest were part of a plan, a principal purpose of which was to achieve a reduction in CTL, B s allocable share of the partnership s gain from its sale of the land is treated under the anti-avoidance rule as not increasing the amount of B s SRLY limitation. 50

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules Sale of Partnership Interest (cont.) Observations Would Treas. Reg. 1.701-2 apply here? See 1.701-2(d), Example 8 (absence of section 754 election considered evidence of abuse where partnership formed with a non-business principal purpose) But see 1.702-2(d), Example 9 (citing electivity of section 754 in context of businessmotivated partnership) Broad interpretation? Internal restructurings to avoid impact of SRLY limitation? Lack of broad SRLY anti-abuse, except regarding SRLY subgroups (Treas. Reg. 1.1502-21(c)(2)(iv)). Treas. Reg. 1.1502-13(h)(2), Example 5 (sale-leaseback with non-member to increase SRLY limit not recharacterized or subject to adjustment). 51

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules- Partnership Mixing Bowl P MI M2 Basis: $0 Value: $100 Intangible Intangible Land Land Value: $100 Basis: $100 Cash X PRS Intangible Land Treas. Reg. 1.1502-13(h)(2), Example 4. M1 owns a self-created, intangible asset with a $0 basis and a value of $100. M2 owns raw land with a basis of $100 and a value of $100. In Year 1, with a principal purpose of creating basis in the intangible asset (which would be eligible for amortization under section 197), M1 and M2 form PRS; M1 contributes the intangible asset and M2 contributes the land. X, an unrelated person, contributes cash to PRS in exchange for a partnership interest. PRS uses the contributed assets in legitimate business activities. 52

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules - Partnership Mixing Bowl (cont.) P MI M2 Land Intangible X Cash P/S Intangible Land After 5 ½ years, PRS liquidates, distributing the land to M1, the intangible to M2, and the cash to X. The group reports no gain under sections 707(a)(2)(B) or 737(a) and claims that M2 s basis in the intangible is $100 under section 732 and that the asset is eligible for amortization under section 197. Conclusion: A principal purpose of the formation and liquidation of PRS was to create additional amortization without an offsetting increase in CTI by avoiding treatment as an intercompany transaction. Thus, appropriate adjustments must be made. 53

Treas. Reg. 1.1502-13(h) Anti-Avoidance Rules - Partnership Mixing Bowl (cont.) Observations Lack of an intercompany transaction in form; Benefit obtained by virtue of Subchapter K, rather than the consolidated return regulations; Section 737 designed to address transactions that are in substance between partners since amended to 7 years Potential application of Treas. Reg. 1.701-2? Business motivation insufficient to prevent application of -13(h) anti-avoidance rule; Example not specific on the appropriate adjustments (or which party they would affect) Does not appear to disregard the existence of the partnership Broad interpretation? 54

Granite Trust planning within a Consolidated Group using Partnership P P S 1 S 2 S 1 S 2 x% LLC y% LLC S 3 S 3 LLC P, S1, S2, and S3 are members of the same Section 331; Granite Trust. consolidated group. Consider Treas. Reg. 1.1502-36. S2 s basis in S3 stock > fmv of S3 stock Application of Treas. Reg. 1.701-2? LLC conducts business operations Application of Treas. Reg. 1.1502-13(h)? Step 1: S2 transfers S3 to LLC in exchange for a y% interest in LLC What if LLC newly formed by S1 and S2? Step 2: S3 converts to an LLC and becomes a DRE 55

T.D. 9715 - Final 1.1502-77 Regulations Final Regulations Largely consistent with the proposed regulations issued in 2012 New provisions Permits the Commissioner to replace an agent that fails to perform its obligations and to designate a new agent Permits agents to resign and designate a replacement agent Clarify that an agent other than the common parent generally serves as agent under the same terms and with the same rights as the common parent Clarify that a terminating agent without a default successor may only designate an agent with respect to a completed year Changes the default rules applicable to consolidated group members that have an interest in a TEFRA partnership 56

T.D. 9715 - Final 1.1502-77 Regulations The 2002 Regulations (current 1.1502-77B) Specifically reserves to the Subsidiary that is the TMP of a TEFRA partnership the authority to take actions for such partnership (1.1502-77B(a)(3)(v)) Generally provides that the Service will deal directly with a Subsidiary that is a partner in a TEFRA partnership in the Sub's capacity as a partner in such partnership. But the common parent may request the IRS to deal directly with them as agent The 2015 Regulations (TD 9715) Specifically reserves to the Subsidiary that is the TMP of a TEFRA partnership the authority to take actions for such partnership (1.1502-77(f)(2)(iii)(B) Generally provides that the agent (common parent) will act as agent for a Subsidiary that is a partner in a TEFRA partnership but the IRS may interact directly with Subsidiary, agent, or TMP without breaking agency. 57

T.D. 9715-1.1502-77(g), Example 14 & Prop. Reg. 1.1502-77(g), Example 12 (withdrawn) A consents to extend period of assessment for PRS for tax year ending 12/31/Year 1 P 11/30 fiscal year Extends SoL for PRS items that are part of P's consolidated return for year ending 11/30/Year 2 IRS *may* contact directly P, S1 or A regarding PRS S S1 A However, if the IRS seeks to execute a settlement agreement with respect to S1 as a partner with respect to its liability as a partner in PRS, P would need to execute it PRS TMP calendar year 58

T.D. 9715 Final -77 Regulations Effective Date Applies to consolidated return years beginning on or after April 1, 2015 Old -77, now 1.1502-77B, applies to consolidated return years beginning on or after June 28, 2002 but before April 1, 2015 59

III. Partnership Termination Issues A. Intercompany Transfer of a Partnership Interest B. Intercompany Distribution of a Partnership Interest 60

Intercompany Transfer of a Partnership Interest PLR 200334037 (May 13, 2003) P S LLC interest $ B LLC S sells its LLC interest to B, causing the LLC become a DRE. See Rev. Rul. 99-6 Situation 1. "Under Rev. Rul. 99-6" S is deemed to sell its LLC interest under 741, while B is deemed to purchase S's share of the LLC assets from S. Is S gain deferred under -13? PLR 200334037 holds: Ruling (7): "The income, gain, and/or loss from the sale of [S's] partnership interest (the intercompany item) can be accounted for under the matching rule. [B's] corresponding items will be [B's] items with respect to the assets that [B] is described as acquiring [under Rev. Rul. 99-6]. Ruling (8): "[B's] recomputed corresponding items will be based on the bases that [S] would have had in the assets had those assets been received in a liquidating distribution" 61

Intercompany Transfer of a Partnership Interest PLR 200737006 (Sept. 27, 2006) P S1 S2 B LLC S1 and S2 sell their LLC interests to B, causing the LLC become a DRE. See Rev. Rul. 99-6 Situation 2. "Under Rev. Rul. 99xc -6" Similar language, rulings, and result as PLR 200334037 62

Intercompany Distribution of a Partnership Interest PLR 201528007 (Apr. 7, 2015) P S 1 S 2 % DIT % S2 distributes its LLC interest to S1, causing the LLC become a DRE. "Under the principles of Rev. Rul. 99-6" S2's 311(b) gain from the distribution of its LLC interest is determined under 741, while S1 is deemed to acquire S2's share of the LLC assets from S2 via distribution of such assets. Otherwise, similar language, rulings, and result as prior PLRs The DIT is "not taken into account as income or gain under the acceleration rule of 1.1502-13(d)." (cf. Treas. Reg. 1.1502-13(c)(7)(ii), example 9) LLC 63