The New York City (NYC) Department of Finance (Department) has released a Statement of Audit Procedure (SAP) discussing the applicability of basis adjustments under Internal Revenue Code (IRC) Sections 734 and 743 to the NYC Unincorporated Business Tax (UBT). More specifically, the Department explains the incorporation of the provisions of IRC Section 734 and 743 into the computation of unincorporated business taxable income (UBTI), and how this incorporation may affect a partnership's UBTI tax calculation.

For purposes of computing UBTI, the starting points for unincorporated business gross income and unincorporated business deductions are federal gross income and federal deductions of an unincorporated business (e.g., partnership, LLC treated as a partnership, sole proprietorship (but not an S corporation, which is treated as a C corporation for NYC purposes and subject to the NYC General Corporation Tax)). Overall, there are no specific NYC statutory modifications to the federal calculation of basis for purposes of determining UBTI. For federal income tax purposes, a partnership's basis in its assets generally cannot be adjusted following a property distribution or transfer of a partnership interest. An election under IRC Section 754, however, allows the partnership to: (i) adjust its "inside" basis in undistributed property in accordance with IRC Section 734(b) for property distributions, and (ii) adjust the "outside" basis of partnership property with respect to a particular transferee partner in accordance with IRC Section 743(b) for a transfer of partnership interests. In the former case, the SAP concludes that IRC Section 734(b) adjustments to a partnership's "inside" basis in undistributed property affect the partnership's own calculation of federal income, gain, loss, and deduction; therefore, such adjustments also affect UBTI for NYC UBT purposes. In the latter case, the SAP concludes that IRC Section 743(b) adjustments apply to a transferee partner only, and do not affect the "inside" basis of the partnership's assets; therefore, such basis adjustment should not affect the partnership's UBTI calculation.¹ According to the SAP, the Department stated it will follow this position on audit.

Notably, the SAP does not address whether a transferee partner that is itself a UBT taxpayer is entitled to incorporate the IRC Section 743(b) adjustments to its UBTI. Assuming such adjustments should apply to a transferee partner that is a UBT taxpayer, it also is unclear how an IRC Section 743(b) adjustment should be apportioned for UBT purposes. Under UBT regulations, a UBT-taxable partner must apportion distributive shares of income from another unincorporated entity in the same percentage as the partnership apportioned its income to NYC. While adjustments under IRC Section 743(b) to transferee partners relate to the assets of an underlying partnership, it is unclear whether such partner-specific adjustments should be apportioned by the UBT apportionment of such underlying partnership or the apportionment of the transferee partner only.

In analyzing transfers of partnership interests and assets, the SAP also provides that the Department will follow IRC Sections 707(a)(2)(B) and 755, related Treasury Regulations, and applicable legislative history and case law. The Department also will follow IRS Revenue Rulings 99-5 (addressing federal income tax consequences when a federally disregarded single member limited liability company converts to a multi-member limited liability company that is classified as a partnership for federal income tax purposes) and 99-6 (addressing federal income tax consequences when a person acquiring all of the ownership interests in a partnership causes the partnership tax status of that entity to terminate) in determining the tax consequences of transferring partnership interests that result in formation or dissolution of partnerships.

Implications

The SAP provides guidance on the Department's position on the application of IRC Sections 734 and 743 to the UBT. Consequently, taxpayers should evaluate their UBT returns for basis adjustments under IRC Sections 734(b) and 743(b) that may affect their UBT calculation. Specifically, UBT taxpayers should include IRC Section 734(b) basis adjustments for purposes of determining their UBTI. Alternatively, UBT taxpayers should be cautious in including the effects of IRC Section 743(b) basis adjustments in UBTI, particularly when a "push down" of basis step-up occurs within a multi-tiered partnership structure.

Taxpayers should, however, also consider that SAPs are merely an interpretation of the law by the Department. As such, SAPs cannot be relied on for an official tax position in the same manner as statutes and regulations.

———————————————

———————————————
ENDNOTES

¹ The NYC UBT treatment of IRC section 743(b) adjustments as partner-specific items is consistent with the former New York State UBT appellate court decision in Dolly Co. v. Tully, 65 A.D.2d 99 (N.Y. App. Div. 3d Dep't 1978), app. denied, 46 N.Y.2d 710 (N.Y. 1979), which is binding precedent on NYC per NYC Charter section 170(d).