Section 754 Elections on Form 1065: Making Valid Elections ...media.straffordpub.com/products/section-754-elections-on-form-1065-making-valid...Oct 11, 2017 · Oct. 11, 2017 Section

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Section 754 Elections on Form 1065: Making Valid

Elections, Seeking Relief For Missed or Invalid Elections

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Oct. 11, 2017

Section 754 Elections on Form 1065

Simona Raulea, Tax Director

PricewaterhouseCoopers, New York

[email protected]

Dina A. Wiesen, Senior Manager, National Tax Office, Passthroughs

Deloitte Tax, New York

[email protected]

Pamela A. Fuller, JD, LLM (Tax Law), Counsel

Gremminger Law Firm, Washington, D.C.

[email protected]




Notice

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The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

Section 754 Elections on Form 1065 Making Valid Elections, Seeking Relief for Missed or Invalid Elections

October 2017

Gremminger Law Firm

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https://www.linkedin.com/pub/pamela-a-fuller/7/193/953



PwC | Deloitte | Gremminger Law Firm

Agenda

I. Reporting Timely Section 754 Election

A. Code and Regulations

B. Partners’ Consent Statements

C. Documentation required in the absence of partner consent filing

D. Calculations

E. Other Issues

F. Example

II. Relief under Treas. Reg. § 301.9100

III. Remedies for correcting defective or invalid elections after the filing year

IV. Revocation of a Section 754 Election

6

October 2017


Reporting Timely Section 754 Election

7

October 2017


Section 754 - Overview

• Under the aggregate theory, a partner’s basis in its partnership interest equals its share of the partnership’s basis in its assets

• However, this equality can be thrown off by the following:

- Sale of a partnership interest

- Distribution of cash in excess of basis

- Distribution of property with different tax basis

• To cure disparities, Section 754 allows partnership to adjust the inside basis of partnership property under Sections 734 and 743 and allocate those adjustments under Section 755

8

October 2017


Section 754 - Overview

• If a partnership files an election, in accordance with regulations prescribed by the Secretary, the basis of partnership property shall be adjusted, in the case of a distribution of property, in the manner provided in Section 734 and, in the case of a transfer of a partnership interest, in the manner provided in Section 743.

• Such an election shall apply with respect to all distributions of property by the partnership and to all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent taxable years.

• Such election may be revoked by the partnership, subject to such limitations as may be provided by regulations prescribed by the Secretary.

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October 2017


Section 754- Making the Election

• For a Section 754 Election to be valid, a written statement must be attached to the partnership return and filed no later than the return due date (including extensions).

• Two statements should be attached to the return for the taxable year during which the distribution or transfer occurs:

1. Statement of Section 754 Election

i. Name and address of the partnership making the election

ii. Signature of one of the partners

iii. A declaration that the “partnership elects under section 754 to apply the provisions of section 734(b) and section 743(b)”

2. Section 734(b) / Section 743(b)

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October 2017


Section 754 – Sample Statement Section 754 Election Statement

[Taxpayer Name] [Taxpayer Address] [Taxpayer City], [Taxpayer State] [ZIP Code] Identification Number: [Fed. ID#]

[Taxpayer Name] hereby elects under Code Sec. 754 and Reg. §1.754-1(b) to apply the provisions of Code Secs. 734(b) and 743(b). The election is effective beginning with the tax year ending [Year End]. A Code Sec. 754 election is not currently in effect.

________________________________________ Date:____________________ [Signing Partner]--Partner

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October 2017


Section 743(b) – Partnership’s Sample Statement

[Partnership Name] [Partnership Address] [Partnership City], [Partnership State] [ZIP Code] Identification Number: [Fed. ID#]

As required by Reg. §1.743-1(k)(1)(i), this statement is submitted by [Partnership Name] as an attachment to its

[Year] partnership return. The name of the transferee is [Transferee Name], TIN [Fed. ID#]. The computation of the basis adjustment is as follows: [Computation of Basis Adjustment] The basis adjustment has been allocated to the following partnership properties: [Partnership Properties]

________________________________________ Date: ____________________ [Partnership Representative] [Partnership Name]

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October 2017


Section 743(b) – Buying Partner’s Sample Statement

[Transferee Name] [Transferee Address] [Transferee City], [Transferee State] [ZIP Code] Identification Number: [Fed. ID#]

As required by Reg. §1.743-1(k)(1)(ii), this statement is submitted as an attachment to the [Year] federal income

tax return of [Transferee Name]. The name of the transferee is [Transferee Name], TIN [Fed. ID#]. The computation of the basis adjustment is as follows: [Computation of Basis Adjustment] The basis adjustment has been allocated to the following specific properties: [Properties]

________________________________________ Date: ____________________ [Transferee Name]

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October 2017


Section 743(b) – Buying Partner’s Notice of Transfer of Units

[Transferee Name] [Transferee Address] [Transferee City], [Transferee State] [ZIP Code] Identification Number: [Fed. ID#] Submitted to: [Partnership Name] [Partnership Address] [Partnership City], [Partnership State] [ZIP Code]

As required under Reg. §1.743-1(k)(2)(i), [Transferee Name] is notifying you of a sale or exchange of a partnership interest that occurred on [Date].

The transferor's information (if ascertainable) is as follows: [Enter the name, address and taxpayer identification number of the transferor (if ascertainable). If not ascertainable, state that fact. Also, describe the relationship (if any) between the transferee and the transferor.]

Liabilities assumed: [Enter the amount of any liabilities assumed or taken subject to by the transferee. If none, state that fact.]

Payment for the interest: [Enter the amount of any money or the fair market value of any other property delivered or to be delivered for the transferred interest in the partnership. If none, state that fact.]

Additional information: [Provide any other information necessary for the partnership to compute the transferee's basis. If none, state that fact.]

Under penalties of perjury, I declare that I have examined the information contained in this notice, and, to the best of my knowledge and belief, the facts presented in the notice are true, correct and complete.

________________________________________ Date: ____________________ [Transferee Name]

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October 2017


Calculating 743(b) Basis Adjustment

Step 1 – Compute the Buyer’s outside basis

Amount Paid + Liabilities

Step 2 – Compute Buyer’s Inside Basis

Previously Taxed Capital + Liabilities

Previously Taxed Capital=

Cash on Liquidation*

- Buyer’s taxable Gain on Liquidation

+ Buyer’s taxable Loss on Liquidation

15

October 2017 * Based on a hypothetical sale and liquidation for FMV


Section 743(b) Adjustment

• Section 743(b) allows basis of partnership property to be adjusted to reflect transferee partner’s outside basis.

• Adjustment is with regard to transferee partner only.

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October 2017


Allocation of Section 743(b) Basis Adjustment

Step 1 - Separate the partnership property into capital/1231 and ordinary classes

Step 2 – Calculate the amount of income, gain, loss allocated to Buyer from sale of all partnership’s property for FMV

Step 3 - Allocate the basis adjustment first, to the ordinary income class, and the excess to the capital asset class

Step 4 - Allocate the adjustment within the class

• Allocate basis adjustment between and among classes using a hypothetical sale approach

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October 2017


Allocation of the Basis Adjustment

Section 755

• The allocation of the basis adjustment generally reduces the difference between the FMV and basis of each asset adjusted.

• Two-way basis adjustments are permitted.

18

October 2017


Section 743 Mandatory Basis Adjustments

• Basis adjustments under Section 743 are mandatory for transfers of partnership interests where there is a substantial built-in loss.

• Substantial built-in loss = Partnership’s adjusted basis in its property

- FMV of partnership property by more than $250,000

• Effective date – Transfers of partnership interests occurring after October 22, 2004

• Exceptions:

- Securitization Partnerships

- Electing Investment Partnerships

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October 2017


Considerations – Section 743 Basis Adjustment

• Adjustments are reported on Line 13W of the partner’s Schedule K-1

• Partnership year does not close, but partner’s year does (Section 706)

• Partial Sales

- Unitary basis – allocate basis on relative FMV of interest sold

• Holding period – look to how long interest is held; asset holding period not relevant

• Anti-Churning Rules

• Ordering Implications:

- Distribution followed by Sale of Interest

- Sale of Interest followed by Distribution

20

October 2017


Section 734(b)– Distributions of property to partners

21

October 2017

Distributee recognizes §731(a)(1) gain

• Money > partner’s outside basis

• Partnership can increase basis in remaining assets by excess. § 734(b)(1)(A)

Distributee’s basis in distributed property is limited

• Basis of property distributed > partner’s outside basis

• Partnership can increase basis in remaining assets by excess. § 734(b)(1)(B)

• This rule does not apply if the distributed property is an interest in another partnership which does not have a § 754 election in effect


Optional basis adjustments – Distributions of property to partners

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October 2017

Distributee recognizes loss under § 731(a)(2)- Liquidating distributions only

• Partner’s outside basis > money, unrealized receivables and inventory received

• Partnership must decrease basis in remaining assets by loss recognized. § 734(b)(2)(A)

Distributee’s basis in distributed property increased - Liquidating distributions only

• Partnership property received takes on basis > basis of property when distributed

• Partnership must decrease basis in remaining assets by the excess. § 734(b)(2)(B)


Allocation of basis adjustment (continued)

23

October 2017

§734(b) adjustments

• May be allocated only to property of a character similar to that of distributed property

• Use a §732(c) approach to allocate the adjustment to property within a class in proportion to, and to the extent of unrealized appreciation/depreciation, then in proportion to FMV/ATB

• Adjustment must be allocated to capital gain class where cause is §731(a)(1) gain or §731(a)(2) loss


§ 734 mandatory basis adjustments

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October 2017

Basis adjustments under § 734(b) required for distributions where there is a substantial basis reduction.

• A substantial basis reduction means a downward adjustment of more than $250,000 that would be made to the basis of partnership assets if a § 754 were in effect

• Exception for Securitization partnerships

• Effective date – Distributions occurring after date of enactment (October 2004)


Example – 743(b) Basis Adjustment

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October 2017


§ 743(b) Basis adjustment – Example (continued)

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October 2017

• A recognizes gain of $35

• Without a § 743(b) basis adjustment, C’s outside basis would be $100 (the amount paid) and C’s inside basis would be $65.

• If ABC sold its assets, $35 of gain would be allocated to C

• $35 of gain would be taxed twice

ABC

A B 50%

FMV ATB BIG

100 50 50

100 80 20

200/2 = 100 130/2 = 65 70/2 = 35

100 65

100 65

200 130

Inventory

Building

Total Assets

Capital A

Capital B

Total Liabilities & Capital


Computation of § 743(b) adjustment (continued)

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October 2017

C’s Outside Basis = $100 = $100 Paid + $0 Liabilities

- C’s Inside Basis = $65 = Previously Taxed Capital + Liabilities

$65 $0

= § 743(b) Adjustment $35

Previously Taxed Capital = $100 Cash on Liquidation*

- $35 Buyer’s Gain on Liquidation

+ Buyer’s Loss on Liquidation


Example – 734(b) Basis Adjustment

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October 2017


Section 734(b) – Example 1, increase

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October 2017

• Partner A has a basis of $10,000 for his one-third interest in partnership ABC. The partnership has no liabilities and has assets consisting of cash of $11,000 and property with a partnership basis of $19,000 and a value of $22,000.

• A receives $11,000 in cash in liquidation of his entire interest in the partnership. He has a gain of $1,000 under section 731(a)(1).

Assets

Cash $11,000

Property

FMV $22,000

AB $19,000

ABC

FMV $11,000

AB $10,000 FMV $11,000

AB $10,000

C A B

FMV $11,000

AB $10,000 Cash

$11,000


Section 734(b) – Example 1, increase (cont’d)

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October 2017

• If the election under section 754 is in effect, the partnership basis for the property becomes $20,000 ($19,000 plus $1,000).

Assets

Property

FMV $22,000

AB $20,000

BC

FMV

$11,000

AB $10,000

C B

FMV

$11,000

AB $10,000


Section 734(b) – Example 2, decrease

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October 2017

• Partner D has a basis of $10,000 for his one-third interest in partnership DEF. Before the distribution, the partnership balance sheet shows the following:

Assets

Property

FMV $22,000

AB $20,000

BC

FMV

$11,000

AB $10,000

C B

FMV

$11,000

AB $10,000

Adjusted basis Value

Cash $4,000 $4,000

Property X 11,000 11,000

Property Y 15,000 18,000

Total 30,000 33,000

Liabilities $0 $0

Capital: Basis Value

D 10,000 11,000

E 10,000 11,000

F 10,000 11,000

Total 30,000 33,000

Assets

Liabilities and Capital


DEF

FMV $11,000

AB $10,000 FMV $11,000

AB $10,000

F D E

FMV $11,000

AB $10,000 Property X

FMV $11,000

AB $11,000

Assets

Cash $4,000

Property X: FMV $11,000; AB $11,000

Property Y: FMV $18,000; AB $15,000

Section 734(b) – Example 2, decrease (cont’d)

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October 2017

• In liquidation of his entire interest in the partnership, D received property X with a partnership basis of $11,000. D's basis for property X is $10,000 under section 732(b).


EF

FMV

$11,000

AB $10,000

F E

FMV

$11,000

AB $10,000

Assets

Cash $4,000

Property Y: FMV $18,000; AB $16,000

Section 734(b) – Example 2, decrease (cont’d)

34

October 2017

• Where the election under section 754 is in effect, the excess of $1,000 (the partnership basis before the distribution less D’s basis for property X after distribution) is added to the basis of property Y. The basis of property Y becomes $16,000 ($15,000 plus $1,000).


Relief under Treas. Reg. § 301.9100

35

October 2017


Missed Elections - Treas. Reg. § 301.9100 Relief

October 2017

36

• Treas. Reg. §§ 301.9100-1, 2 and 3 are equitable provisions that allow taxpayer an extension of time to make an election (often called “9100 Relief”)

• Treas. Reg. § 301.9100-1(c) – IRS discretion to grant a reasonable extension of time for making an election

• Treas. Reg. § 301.9100-2 – Automatic extensions of time for regulatory and statutory elections

• Treas. Reg. § 301.9100-3 – Non-Automatic extensions of time for regulatory elections that do not meet the requirements of Treas. Reg. § 301.9100-2


Automatic Relief - Treas. Reg. § 301.9100-2

October 2017

37

• 9100 Relief is granted automatically if corrective action is taken within 6 or 12 months of the due date of the return, including a valid extension, for certain regulatory elections.

- Treas. Reg. § 301.9100-2(a)(2)(vi) specifies Section 754 elections are eligible for an automatic 12 month extension

• Taxpayer must file an amended return with signed partner consent statements attached.

- The following should be written at the top of the amended return: “FILED PURSUANT TO § 301.9100-2”

• No letter ruling is required, thus no IRS user fees apply.


Discretionary Relief - Treas. Reg. § 301.9100-3

October 2017

38

• Requests for extension of time to elect § 754 that do not meet the requirements for “automatic” relief under Reg. § 301.9100-2, MUST be made under Reg. §301.9100-3

• Private Letter Ruling (PLR) request is required. (Note: Although IRC § 754 requires “the partnership” to file the § 754 election, it is usually “the taxpayer” (e.g., the surviving or succeeding partner) whose return is affected that is filing the PLR (on behalf of the partnership).

• User fee must be paid

• IRS, in PLRs, rule on points of law—not facts. IRS will not, in a PLR request, make factual inquiries. Thus, it is very important that the PLR request submission clearly set forth all relevant facts, substantiated by affidavits and other forms of proof. See Rev. Proc. 2017-1 (Appendix C) for check list of all requirements (updated each year).


Two-Part Substantive Test for Non-Automatic, Discretionary Relief - Reg. § 301.-9100-3

October 2017

39

• Reg. § 301.9100-3 sets forth a 2-part test for non-automatic, discretionary relief:

- “Requests for relief…will be granted when the taxpayers provides evidence (including affidavits…) to establish to the satisfaction of the Commissioner that

◦ The taxpayer acted reasonably and in good faith, and

◦ The grant of relief will not prejudice the interests of the Government.”

• Note flush language of Reg. § 301.9100-3(a):

“Requests for relief subject to this section will be granted when the taxpayer provides the evidence…” (Regulatory language implies that although the evidence must satisfy the Commissioner, if such evidence is adequate, the IRS must provide relief.)


Establishing “Reasonable Action and Good Faith” in the PLR Request - 5 Positive Benchmarks

October 2017

40

The Regs at 9100-3(b)(1) set forth 5 situations in which the taxpayer will be “deemed to have acted reasonably and in good faith.” The positive benchmarks, explicitly listed, include:

1. Taxpayer requests relief before the IRS discovers the failure to make a timely election;

2. Taxpayer failed to make the election because of “intervening events beyond the taxpayer’s control;”

3. Taxpayer failed to make the election because, after exercising reasonable diligence (taking into account taxpayer’s experience and complexity of return or issue), taxpayer was unaware of necessity of the election;

4. Taxpayer relied on the written advice of the IRS; or

5. Taxpayer relied on a qualified tax professional, and the tax professional both failed to make the election and failed to inform taxpayer of necessity of making the election.


Establishing “Reasonable Action and Good Faith” - the 3 Negative Benchmarks (really “exceptions”)

October 2017

41

Reg. § 301.9100-3(b)(3) sets forth 3 situations in which Tp will be “deemed to have not acted reasonably and in good faith.” Courts treat these as “exceptions” to relief, where Tp satisfies one or more of the 5 positive benchmarks. (E.g., Acar v. CIR, 545 F.3 727 (9th Cir. 2008)).

The 3 listed exceptions are as follows:

1. Taxpayer seeks to alter a return position for which an accuracy-related penalty either has been or could have been imposed under IRC §6662 at the time taxpayer requests relief, and the new position requires or permits a regulatory election for which relief is requested;

2. Taxpayer was informed in all material respects of the required election and related tax consequences, but chose not to file the election; or

3. Taxpayer uses hindsight in requesting relief.


Disjunctive Application of Positive and Negative Criteria

October 2017

42

• Both the 5 positive criteria (or “categories”) and the 3 negative criteria (or “exceptions” to 9100-3 relief) are applied disjunctively; they do not comprise a balancing test.

• Thus, the PLR request should analyze each of the positive criteria, and 3 regulatory exceptions one by one, to show satisfaction of as many positive criterions as possible, and that none of the negative criterions (i.e., the 3 exceptions) apply under the facts.

• Also, the PLR request might be made more persuasive if it asserts that the 2 underlying policies of discretionary relief mentioned in the Preamble to Reg. § 301.9100-3 will be served if relief is granted. Those 2 policies are: (1) promoting efficient tax administration with time limits on elections, and (2) fairness-collecting from taxpayers only the tax they would have paid if they had been well advised and fully informed.


Strict Application of Disjunctive Criteria in showing “Reasonable Action and Good Faith”

October 2017

43

• In 2006, the U.S. Tax Court held that “[t]he benchmarks for reasonableness and good faith in section 301.9100-3(b)(1)…are disjunctive; i.e., the taxpayer need satisfy only [one subdivision (i) –(v)] in order to be deemed to have acted reasonably and in good faith. L.S. Vines v C.I.R., 126 T.C. 279 (2006).

• But IRS, in its PLRs, applies each regulatory benchmark strictly.

• Example: “Failed to make election due to intervening events beyond taxpayer’s control”: taxpayer needs to supply affidavits and/or other proof to show that some event (e.g., Hurricane, Act of God, or a traumatic death of a partner) not only occurred, but that such event was the “cause” of taxpayer’s failure to timely elect § 754.

• Note difficulty of arguing “intervening events caused failure to make the election” if the relevant tax return, itself, was timely filed.


Taxpayer Requests Relief Before Failure to Make Election is Discovered by IRS

October 2017

44

• The first positive benchmark listed in Reg. § 301.9100-3(b)(1) is where Tp requests relief before the failure to elect is discovered by the IRS.

• Example 1 in Reg. § 301.9100-3(f) shows that taxpayer may be able to avail itself of this criterion although years had passed since the failure to make the election.

• In Example 1, taxpayer’s tax return preparer notices that regulatory election was not made 2 years prior. So, taxpayer promptly files for relief under 9100-3.

• Example 1 concludes that taxpayer is deemed to have acted reasonably and in good faith because taxpayer requested relief before the failure to make the regulatory election was discovered by the IRS (and assuming none of the negative benchmarks are applicable). Note: apparently the passage of time also does not imply Tp was relying on hindsight—a negative benchmark.


Taxpayer’s Unawareness of Necessity of § 754 Election

October 2017

45

• The 3rd positive benchmark in Reg. § 301.9100-3(b)(1) is where facts show taxpayer was reasonably unaware of making the regulatory election.

• Taxpayer must show he/she was unaware of the § 754 election despite reasonable diligence on the taxpayer’s part. (Cannot be willfully blind.)

• In K.Z. Acar v. CIR, where taxpayer attempted to make a late regulatory election post-audit (under § 475(f)) and without any claim of intervening events, US District Court found Acar had submitted no evidence he had exercised “reasonable diligence” in attempting to learn the tax law, no evidence of relying on a tax professional, and no evidence of relying on IRS.

• Thus, U.S. District Ct. in Acar held: “Ignorance of the tax laws, standing alone, is insufficient to warrant the grant of a retroactive extension of time” under Reg. § 301.9100-3. Acar v. CIR, LEXIS 60859 (N.D. Cal. 2006), aff’d 545 F.3d 727 (9th Cir. 2008).

Facts of ACAR v. CIR.


Reasonable Reliance on Written Advice of IRS

October 2017

46

• The 4th positive benchmark listed in Reg. § 301.9100-3(b)(1) is where facts show taxpayer “[r]easonably relied on the written advice of the IRS” in its failure to timely make the election.

• Reasonable reliance on written advice of the IRS could possibly occur in a complex tiered partnership structure where § 754 elections are required to be made for each partnership in a chain, and the IRS had issued something in writing indicating that the election was properly made for each partnership—but in fact, one of the § 754 elections with respect to one or more partnerships was not valid.

• If reliance on the IRS’s written “advice” (that all the elections were properly made) is reasonable, then such writing should constitute evidence that this 4th benchmark is satisfied.

• Other examples of “reasonable reliance on written advice of IRS”??


Reasonable Reliance on Qualified Tax Professional

October 2017

47

• The 5th positive benchmark in Reg. § 301.9100-3(b)(1) is where facts show taxpayer “[r]easonably relied on a “qualified tax professional” (including one employed by the taxpayer), and the tax professional failed both to (1) make the § 754 election, and (2) to advise taxpayer of opportunity to make the § 754 election.

• Reliance on tax professional, however, is not reasonable if taxpayer knew, or should have known, either that:

- Tax professional was not competent, or

- Tax professional was not aware of all relevant facts. (Reg. § 301.9100-3(b)(2); PLR 8817082.

• Example: If partner-spouse dies, triggering a transfer of a partnership interest to a surviving partner, and surviving partner fails to inform CPA of partner-spouse’s death, he/she may not be able to argue “reasonable reliance on tax professional” who failed to properly advise. PLR 8817082. (Maybe argue death was intervening event causing PTSD of surviving partner, who failed to inform CPA.)


1st Exception: Where Tp seeks to alter a tax return position for which an accuracy related penalty has been or could be imposed

October 2017

48

Under the 1st regulatory exception to the general rule, a taxpayer will be deemed NOT to have acted reasonably and in good faith where he is seeking to alter a tax return position for which an accuracy related penalty under § 6662 has been or could be imposed (and that new position, if allowed, triggers the opportunity to make the regulatory election—i.e., here, the § 754 election). Reg. § 301.9100-3(b)(3)(i).

• The accuracy related penalty under § 6662 must be asserted by the IRS at the time 9100-3 relief is sought.

• Example: Assume a partnership failed to take into account a deemed distribution of property to a partner which, if properly accounted for, would have triggered the opportunity to elect § 754. If the IRS has already asserted a penalty under § 6662, then the exception applies, and no discretionary relief will be granted for failure to timely elect § 754.


2nd Exception: Taxpayer was sufficiently informed and Simply Chose Not To Elect

October 2017

49

Under the 2nd regulatory exception, a taxpayer will be deemed NOT to have acted reasonably and in good faith where taxpayer “[w]as informed in all material respects of the required election and related tax consequences, but chose not to file the election[.]” Reg. § 301.9100-3(b)(3)(ii).

• PLR 8817082 (Feb. 3 1988) is instructive: It was issued under former Rev. Proc. 92-85 (predecessor to the § 9100 Regs, upon which the Regs are largely based), but outcome would be same under Reg. § 301.9100-3.

- Partner in P/S died; no § 754 election was made. Later, application for discretionary relief was made, but denied by IRS.

- IRS found P/S’s CPA did not make the § 754 election because he felt numbers on K-1 “were small” and suggested only a “nominal” interest (apparently because GP failed to inform CPA of sale of P/S property). IRS also found it took P/S over 3 months to request relief once failure to elect § 754 was discovered, suggesting that P/S never intended to make the election, and that CPA decided it was “not worth pursuing.” Relief denied.


3rd Exception: Taxpayer Uses “Hindsight” in requesting relief

October 2017

51

Under the 3rd regulatory exception, a taxpayer will be deemed NOT to have acted reasonably and in good faith where hindsight is used in requesting the extension of time to make the regulatory election (here a § 754 election).

Par. (b)(3)(iii) of Regulation § 301.9100-3 states that:

“If specific facts have changed since the due date for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief. In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer’s decision to seek relief did not involve hindsight.”

• Hindsight proscription seems to target situations where Tp is trying to use the election to hedge his bets or manage exposure to future tax consequences by deliberately waiting to see if election would be cost-efficient, and worth the effort and hassle (e.g., multi-bases assets).


IRS has often denied PLR relief on basis that “hindsight” was used where P/S assets were sold

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• PLR 8817082: IRS denied Tp’s request for a PLR to extend time to make a § 754 election because, among other things, the P/S’s main asset had been sold prior to seeking 9100 relief.

• PLR 8220115 (Feb. 22, 1982): Partner X died, and X’s estate did not make a § 754 election. Executor of X’s estate later learned about benefit of election, and directed P/S to seek discretionary relief under the predecessor to Reg. § 301.9100-3. IRS, however, refused to grant an extension of time to elect § 754 because the P/S’s main asset had been sold, and the IRS apparently found this meant that the taxpayer was impermissibly using hindsight in deciding whether or not to make the election.

• But do the above PLRs make sense given that the § 754 election takes a snapshot of the P/S’s assets’ bases and the value of the P/S interests on the date of the triggering property distribution or transfer of the P/S interest?

• Does the 754 election really provide an objective opportunity to “hedge” a partner’s exposure to tax—allowing the taxpayer to wait & see?


Seminal Tax Court case on Hindsight Proscription in Seeking 9100 Relief: Vines v. CIR (2006)

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Issue in Vines: Whether Tp should have been granted an extension of time, under Reg. § 301.9100-3, to make elect § 475(f) (a regulatory election), which was denied by IRS in PLR request.

Facts of Vines: Mr. Vines, an attorney, had realized > $ 35 M in fees in 1999 and 2000 from settling a class action lawsuit. Vines closed his law practice, and started “day trading” securities from his home office. But Vines used margin borrowing as part of his securities trading strategy. In April 2000, Vines realized net trading losses totaling > $25M and his securities accounts were liquidated.

Neither Vines nor his longtime CPA had heard of the 475(f) election which, if timely filed, allows a taxpayer engaged in the trade/biz of securities trading to elect the mark-to-market method of accounting—treating the securities as sold for FMV on last business day of taxable year.


Vines v. CIR (2006) – Seminal “Hindsight” Case involved the Mark-to-Market Election of § 475(f)

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§ 475(f) mark-to-market election has 2 critical features:

• Creates a taxable “income recognition” event (although securities are not sold to anyone), and

• Changes character of realized gains & losses from capital to ordinary. Thus, if trader has losses, electing § 475(f) will turn the year’s trading losses from restricted capital losses into “ordinary losses,” which can be deducted against ordinary income. But if trader has large gains, it is better not to elect §475(f), so those gains will be taxed at a lower capital gains rate. (Thus, hindsight could be useful.)

• § 475 election must be made on tax return for the year preceding the year in which the mark-to-market treatment will apply. (Ex. If securities trader wants to mark-to-market trades for 2017 calendar year, she must elect by April 15, 2017.) Thus, 3 months of hindsight opportunity are built-into the rule.

• § 475(f) election is revocable only with IRS permission.


Hindsight 0pportunity in § 754 elections analyzed in light of Vines v. CIR (2006)

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IRS argued in Vines: Granting Vines extension of time to elect 475(f) would give him the impermissible benefit of hindsight so as to turn unrealized capital losses into ordinary ones so as to offset the millions in ordinary income he had earned in 1999.

Tax Court found in Vines: Vines conducted no trading activities between the time his tax return was due (i.e, the date he could have made the 475(f) election had he known about it), and the date, months later, when he hired a law firm to file for 9100-3 relief through the PLR procedure. So, subjectively, Vines did not benefit from hindsight.

Tax Court stated: “the relevant inquiry is whether allowing a late election gives the taxpayer some advantage that was not available on the due date.”


Hindsight 0pportunity in § 754 elections analyzed in light of Vines v. CIR (2006) (cont’d)

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Tax Court, in Vines, held:

“the only fact that changed after the due date for making the election was the discovery of the availability of the election itself. * * * If a late election is allowed, [Vines] will not be entitled to anything more than that to which he would have been entitled had he timely made the election. The allowance of the election is consistent with the [policy enunciated in] the preamble to the regulations.” [Vines v. CIR, at 293].

Tax Court distinguished prior cases:

Taxpayers in Lehrer v. CIR (T.C.Memo 2005-167), according to court, were “classic example” taxpayers seeking to use benefit of hindsight by trying to use § 475(f) election as a hedge against volatility of the market--to “retroactively convert their capital losses into ordinary losses several years after the fact, with continued trading in the interim…”


Objective opportunity for Using Hindsight in § 754 Election as compared to § 475(f) Election

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§ 754 election does not create the same objective opportunities for using hindsight as does the § 475(f) election, for which the proscription against hindsight may have been tailor made.

• § 754 does not create trigger a conversion of capital losses into ordinary losses,

• § 754 does not create a taxable event

• § 754 takes a “snap shot” of partnership’s capital accounts on the date that the P/S either distributes property or date that a P/S interest is transferred, and then necessitates a comparison of those assets’ tax bases to the partner’s outside basis in the P/S interest.

• Arguably, the § 754 election cannot be used as a “hedging tool” because virtually all relevant facts are known on the day of the election…so there’s no advantage in “waiting to see”…what happens.


Is the decision of whether to elect § 754 informed by passage of time--such that IRS could argue impermissible hindsight was used ?

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• Electing § 754 creates multiple asset bases, which can be complicated and time consuming to allocate under § 755.

• There may be some advantage in taking time to weigh whether the time, complexity, and effort of electing § 754 is outweighed by getting a stepped up (or stepped down) basis in the partnership assets.

• Drawbacks to § 754 election include: - Recordkeeping is a burden - Can cause both a step-up and step-down in asset bases (thus, for e.g., election is

not desirable when discounts on outside P/S interest would reduce decedent’s share of inside basis of P/S assets to below her share of their cost basis.

- Election affects every partner from that point forward, and applies to distributions.

• But all these factors are capable of being weighed by the general partner, or his tax advisor on date that right to make the § 754 Election arises—the wisdom of making the Election is not further informed by the passage of time. Thus, there is not much objective opportunity for the use of hindsight!


Proposed Strategy: Argue absence of both objective opportunity and Tp’s subjective intent, to use hindsight in electing § 754

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Given the number of PLRs that have denied Taxpayer’s request to extend the time for electing 754 under Reg. § 301-9100-3 (especially when P/S assets are sold), it may be wise to argue both that

1. The § 754 election, by its nature, does not present an objective opportunity to use hindsight in a hedging manner, and

2. Taxpayer, subjectively, did not use hindsight in seeking to make retroactive § 754 election (because, for example, Tp did not know of election’s availability or significance).


IRS recently granted Tp PLR Request for more time to Elect § 754 (although P/S assets had been sold)

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PLR 109101-17: Very terse PLR (probably so it cannot be used as unofficial precedent).

Background facts: Involved complex tiered P/S structure, and a trust; 3 partners, including H & W; one partner died under particularly sad circumstances; Tp’s tax advisors failed to both make and inform surviving partner of opportunity to elect § 754; however, partner and P/S took a lot of time to seek relief and in meantime all the assets of the 8 partnerships in the structure were sold.

PLR is available at: https://www.irs.gov/pub/irs-wd/201736007.pdf (But many facts, seemingly key, are left out of the PLR. IRS maintains PLRs have no precedential value, although practitioners cite them frequently)

Involved 8 partnerships in tiered structure: PLR-109101-17, PLR-112201-17, PLR-112202-17, PLR-112203-17, PLR-112204-17, PLR-112205-17, PLR-112206-17, PLR-112207-17, PLR-112208-17

https://www.irs.gov/pub/irs-wd/201736007.pdf




Sept. 2017 PLR – IRS Grants more time to elect § 754 (despite fact P/S assets sold) (cont’d)

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In requesting relief in PLR 109101-17 (et seq.) Tp argued:

• 4 of the 5 positive benchmarks listed in Regs for “reasonableness and good faith” were present.

• None of the 3 regulatory exceptions applied.

• Govt’s interests would not be prejudiced (and Tp was willing to waive SOL as to any closed tax years if necessary). Tax policy arguments also were made.

• In particular, PLR request went into great detail as to fact that there was neither any objective opportunity in a § 754 election to use “hindsight” (distinguishing other mark-to-market/ 475(f) election cases), and regardless, Tp had no subjective opportunity to use hindsight because he did not know, despite his high level of education and evinced business acumen, what a § 754 election was, and his tax advisors failed both to tell him or make the election.

• Facts surrounding death of partner/spouse (which triggered right to elect §754) were particularly traumatic and sympathetic, so that may have swayed IRS in granting relief.


Tp must also show grant of relief under 9100-3 will “not prejudice interests of the Government”

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• To establish Tp acted “reasonably and in good faith,” IRS must also be satisfied that a reasonable extension of time to make the § 754 election will not whipsaw or “prejudice” the Govt’s interests.

• This part 2 of the 2-part test.

• Govt’s interests are prejudiced if “granting relief would result in a taxpayer having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made (taking into account the time value of money).” [emphasis added].


Govt’s Interests Cannot be Prejudiced by a Reasonable Extension of Time (cont’d)

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• “Similarly, if the tax consequences of more than one taxpayer are affected by the election, the Government’s interests are prejudiced if extending the time for making the election may result in the affected taxpayers, in the aggregate, having a lower tax liability than if the election had been timely made.” Reg. § 301.9100-3(c)(1)(i).

• But note: Inquiry is not whether a partner(s) would save money from having the § 754 election in effect. Rather, the inquiry is whether extending the time for making the election would necessarily make the aggregate taxes lower as compared to the results if the election had been made on time.

• Thus, because a § 754 election takes a snapshot of asset bases and relevant values (frozen in that time), it is difficult to imagine a situation where the results from making a late election will differ from results obtained in making a timely election.


Independent Auditor to help prove that Extension of Time would not be Prejudicial to IRS

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• IRS may condition grant of relief on Tp providing IRS with statement from independent auditor certifying that Gov’t will not be prejudiced because granting relief will not result in taxpayer (or other affected taxpayers) having a lower tax liability than if the election had been timely made.

• Policy arguments: not only will the Govt’s interests not be prejudiced, but the underlying policies of § 743(b), §734(b), and §754 would be well served if extension is granted.

• In cases where a co-partner dies, and P/S interest passes via his estate to a surviving beneficiary partner, the tax policy of § 1014(a) (and in community property states, the policy of §1014(b)(6), imputing a “transfer” of surviving spouse’s property for purposes of § 743(b)) would be undermined if §754 election is not allowed.

• The legislative history of the above provisions makes clear that Congress has long believed that surviving spouses and surviving business partners should not be taxed on the appreciation in the property they receive by reason of a partner’s (or partner/beneficiary’s) death.


Govt’s Interests Cannot be Prejudiced (cont’d)

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• § 754 Election following death of a partner does not affect cost basis of Buyer of P/S Assets. Reg. §1.743-1(j)(1) provides that the adjustment under § 743(b) is personal to the transferee partner, operates outside the partnership, and has no effect on the computation of the partnership’s income or loss at the partnership level.

• Thus all buyers of partnership assets following the transfer of a P/S interest and a § 754 election take a FMV basis in the assets sold, which value will be the same regardless of whether a § 754 election is timely made or made retroactively pursuant to 9100 relief.

• The basis adjustments of § 743(b) and/or § 734(b) that are triggered when § 754 is elected do not constitute “changes in accounting methods” or “changes in accounting periods.” Therefore, the special restrictions in Reg. §301.9100-3 stating that certain changes in accounting periods & methods cause the Govt’s Interests to be prejudiced do not apply to a request to extend the time to elect § 754.


Govt’s Interests Cannot be Prejudiced - Tax years at risk of being closed by § 6501 limitations period

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Reg. § 301.9100-3 provides that the interests of the Government are “ordinarily prejudiced” if–

• The taxable year in which the regulatory election should have been made or any taxable years that would have been affected by the election had it been timely made are closed by the periods of limitations on assessment under section 6501(a) before the taxpayer’s receipt of a ruling granting relief under this section.

• The § 6501(a) limitations period on tax assessments is generally tolled 3 years after tax return was actually filed.

• The § 6501(a) limitations period is not suspended by a request for §9100 relief. Therefore, IRS may condition relief on getting the taxpayer’s consent to extend the limitations period for the tax year(s) that would have been affected had the election been timely made. Reg. § 301.9100-3(d)(2).


Procedures for Requesting Relief under Reg. § 301.9100-3 – i.e., a Private Letter Ruling

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• Request for relief under Reg. § 301.9100-3 is a request for a private letter ruling, and thus must be submitted in accordance with procedures detailed in Rev. Proc. 2017-1 (a new Rev. Proc. is released each year).

• How long and detailed? PLR requests have no page limitation; requests may be as short as 12 pages, but are sometimes much longer, depending on circumstances.

• Timing of PLR Request: Request for relief can be submitted even after an exam of a return has begun, or when issues are being considered by IRS Administrative Appeals or a federal court. (But must disclose this status in the PLR request for relief.)

• Appendix C to the Rev. Proc. has “Checklist for a Letter Ruling Request” (p. 89 in Rev. Proc. 2017-1)


Procedures for Requesting Relief under Reg. § 301.9100-3 – (cont’d)

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• IRS will not engage in factual inquiries in PLRs, so very important to set forth all relevant facts, and substantiate them with affidavits and other documents. (Follow the Rev. Proc.!!)

• Rev. Proc. 2017-1 (Appendix C) explicitly requires the following:

- An affidavit of the taxpayer (or taxpayer’s rep) detailing the events that led to failure to make a valid election, and discovery of the failure.

- The affidavit must describe reliance on any tax professional, including the professional’s scope of engagement, competence, and knowledge of the facts.

- If Tp is relying on fact that tax professional failed to advise taxpayer of the § 754 election, or failed to timely elect § 754, should also include the professional’s affidavit admitting his/her or the CPA firm’s failure. (Some taxpayers offer to waive right to sue for malpractice if CPA firm “falls on its sword”.”


Procedures for Requesting Relief under Reg. §301.9100-3 – (cont’d)

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Rev. Proc. 2017-1 states that taxpayer’s request for relief must also include:

• Detailed affidavits from other individuals having knowledge of events that led to the failure to timely elect, and discovery of the failure.

• Other affidavits from relevant persons, including the tax return preparer, and any individual who made a substantial contribution to the preparation of the tax return(s).

• Identification and “discussion” of both “Supporting [legal] Authorities” and “Contrary [legal]Authorities”

• Supporting documents to substantiate all asserted facts. (Remember IRS will NOT make factual inquiries..and will deny 9100/PLR relief if asked to do so.)

• Relevant tax returns for all years affected by the § 754 election.

• A statement as to when the relevant tax return (or form) used to make the election was required to be filed, and the date it was actually filed.


Procedures for Requesting Relief under Reg. §301.9100-3 – (cont’d)

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The taxpayer’s request for relief must also include:

• Declaration (signed & date) by Taxpayer: “Under penalties of perjury, I declare that I have examined this request, including all accompanying documents, and to the best of my knowledge and belief, the request contains all the relevant facts relating to this request, and that these facts are true, correct, and complete.”

• Submission “user fees” for missed elections, which are (as of Jan. 2017):

– Currently, one missed election = $10,000

– If multiple requests with identical fact patterns, additional missed elections are $2,700 each.

• Tiered Partnerships: can submit one PLR requesting relief, but must include each P/S’s legal name, EIN, relationship to each other. Diagram is helpful.


Judicial Review of IRS’s Denial of Relief sought under Reg. § 301.9100-3

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• There is no separate, “stand alone” right to judicial review of a denial of non-automatic relief, sought by a taxpayer under Reg. § 301.9100-3.

• However, if IRS asserts a tax deficiency as a result of its denial of the request to extend the time for electing § 754, taxpayer can challenge that IRS denial in a tax deficiency procedure in court.

• Famous examples: U.S. Tax Court reviewed IRS’s decisions to deny taxpayers’ requests for § 9100-3 relief for missed regulatory elections in Vines v. CIR, 126 T.C. 279 (2006), in Mezrah v. CIR, TC Memo 2008-123 (did not involve §754)

• U.S. Tax Court has never announced a rule that taxpayer must seek administrative relief before seeking § 9100 relief in the Tax Court.

• In the tax refund context, however, Court of Federal Claims has held that a taxpayer cannot raise § 9100 relief for the first time under the “substantial variance doctrine,” which requires a taxpayer to first present all arguments administratively. E. Marandola, Jr., 76 Fed. Claims Ct. 237 (2007).


Revocation of a Section 754 Election

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Treas. Reg. § 1.754-1(c) Revocation of Election

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• Requests for revocation of a Section 754 election must be approved by the district director for the internal revenue district in which the partnership return is filed.

• Application should meet the following criteria:

- No later than 30 days after the close of the tax year in which the revocation is intended to apply

- Signed by any one of the partners

- Describe the grounds on which the revocation is desired

• Regulations specifically state that the avoidance of a step down in partnership assets is not an approved purpose.


About this presentation

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This presentation contains general information only and the respective speakers and their firms are not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. The respective speakers and their firms shall not be responsible for any loss sustained by any person who relies on this presentation.

Documents

Section 754 Elections on Form 1065: Making Valid Elections ...media.straffordpub.com/products/section-754-elections-on-form-1065-making-valid...Oct 11, 2017 · Oct. 11, 2017 Section