In a recently published private letter ruling (PLR 201819001), the IRS addressed whether Section 965, as amended by the Tax Cuts and Jobs Act (the Transition Tax), would disqualify a publicly traded partnership (PTP) from partnership tax status. If the PTP requesting the ruling failed to meet Section 7704(c)(2)'s gross income requirements (the PTP Gross Income Test) solely because of the one-time mandatory inclusion resulting from the Transition Tax (the Transition Tax Inclusion), the IRS ruled, the failure was inadvertent within the meaning of Section 7704(e). Thus, the PTP would continue to satisfy the PTP Gross Income Test. PLR 201819001 is the first guidance addressing the impact of the Transition Tax Inclusion on PTP qualification.

Facts

X, a PTP classified as partnership for US federal income tax purposes, owns controlling indirect equity interests in Y and Z, which X represented are controlled foreign corporations (CFCs). X represented that the Transition Tax Inclusion could cause X to fail to satisfy the PTP Gross Income Test. X further represented that, without regard to the Transition Tax Inclusion, more than a certain percentage of X's gross income constitutes qualifying income under Section 7704(d).

Background

Section 965 transition tax liability

The Transition Tax, in conjunction with Section 951, requires a one-time mandatory inclusion in the gross income of US shareholders of the accumulated foreign earnings of CFCs and other foreign corporations with a 10% domestic corporate shareholder, collectively referenced as specified foreign corporations (SFCs). For the last tax year of a deferred foreign income corporation (DFIC) beginning before January 1, 2018 (the inclusion year), Section 965(a) provides that the subpart F income of the DFIC shall increase by the greater of the accumulated post-1986 deferred foreign income of the corporation determined as of: (1) November 2, 2017, or (2) December 31, 2017 (the measurement date). For purposes of Section 965, a DFIC is any SFC that has accumulated post-1986 deferred foreign income (as of a measurement date) greater than zero. (For more on the Transition Tax, see Tax Alerts 2017-2166, 2018-0251 and 2018-0602.)

Taxation of PTPs

Section 7704(b) defines a PTP as any partnership, if interests in that partnership are: (1) traded on an established securities market, or (2) readily tradable on a secondary market (or the substantial equivalent thereof). Under Section 7704(a), a PTP is generally taxed as a corporation for US federal income tax purposes. An exception to the general rule applies for partnerships with certain passive-type income. Under Section 7704(c)(1), a PTP may be classified as a partnership for US federal income tax purposes if it meets the gross income requirements of Section 7704(c)(2) (i.e., the PTP Gross Income Test) for the tax year and each preceding tax year beginning after December 31, 1987, during which the partnership (or any predecessor) existed. A partnership meets the PTP Gross Income Test for any tax year if 90% or more of the gross income of the partnership for the tax year consists of "qualifying income." Under Section 7704(d), qualifying income is defined as interest, dividends, real property rents, gains from the sale or other disposition of real property, income and gains derived from natural resources, gains from the sale or disposition of a capital asset, and income and gains from commodities.

Section 7704(e) provides relief for a partnership that inadvertently fails to meet the PTP Gross Income Test. Under this provision, the partnership is treated as continuing to meet the PTP Gross Income Test during the failure period if: (1) Treasury determines that the failure was inadvertent, (2) the partnership takes steps within a reasonable time to meet the PTP Gross Income Test, and (3) the partnership and each holder of an interest in the partnership during the failure period agree to make adjustments or pay amounts determined by the IRS.

Ruling

Based on the facts submitted and representations made by X, the IRS concluded that, if X failed to meet the PTP Gross Income Test for the relevant period solely due to the Transition Tax Inclusion, the failure would be inadvertent under Section 7704(e) and X would be treated as continuing to meet the PTP Gross Income Test for the relevant period.

The IRS emphasized that the PLR did not address whether: (1) X otherwise met the PTP Gross Income Test; or (2) the Transition Tax Inclusion is qualifying income under Section 7704(d).

Implications

PLR 201819001 is a favorable ruling for PTPs that could fail the PTP Gross Income Test solely as a result of the Transition Tax Inclusion. Unfortunately, the private letter ruling, which may not be used or cited as precedent, does not conclude that the Transition Tax Inclusion is qualifying income or can be excluded for purposes of the PTP Gross Income Test. Instead, the ruling merely concludes the PTP requesting the ruling was eligible for Section 7704(e) relief, and this relief requires the Treasury to determine that the failure was inadvertent. Thus, similarly situated taxpayers may want to consider making their own ruling request.

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