Partnership Related Party Loss Disallowance | Tax Lawyer & Attorney

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In a series of articles concerning Internal Revenue Code (“IRC”) §267, I discussed various rules concerning related party loss disallowance. In this article, I would like to focus on special rules concerning partnership related party loss disallowance.

Partnership Related Party Loss Disallowance: Main IRC Provisions

Three IRC sections are most relevant to special rules of partnership related party loss disallowance. §707(b)(1) governs the disallowance of losses with respect to transactions between a partnership and its members as well as certain transactions between partnerships with common partners. §267(a)(1) contains the main rule concerning losses on sales or exchanges between a partnership and any person other than a member of the partnership (a third party), including another partnership. Finally, there are special provisions under §267(a)(2) which are applicable to partnerships. Let’s discuss each of these provisions in more detail.

Partnership Related Party Loss Disallowance: §707(b)(1)

§707(b)(1) disallows a loss from a direct or indirect sale or exchange of property (other than a partnership interest) when such sale or exchange occurs between: “(A) a partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest, or the profits interest, in such partnership, or (B) two partnerships in which the same persons own, directly or indirectly, more than 50 percent of the capital interests or profits interests.”

It is important to note that the ownership the capital or profits interest in a partnership by a partner may be direct or indirect. For example, in TAM 201737011, the IRS disallowed the losses of a hedge fund upon its transfer of securities to trading accounts owned by taxpayer who held greater than 50% interest in capital or profits of hedge fund.

Furthermore, it should be noted that §707(b)(1) incorporates §267(d) in order to mitigate the impact of loss disallowance. This means that the transferee may offset future gain on a sale or exchange of the affected property by the disallowed loss.

Partnership Related Party Loss Disallowance: Expansion of §707(b)(1) to Related Persons

Prior to 1985, §707(b)(1) applied strictly to partners. In September of 1985, the IRS dramatically expanded the application of §707(b)(1) to certain persons related to partners by incorporating the constructive ownership rules of §267(c)(1), §267(c)(2), §267(c)(4) and §267(c)(5). “Under these rules, ownership of a capital or profits interest in a partnership may be attributed to a person who is not a partner as defined in section 761(b) in order that another partner may be considered the constructive owner of such interest under section 267(c).” Treas. Reg. §1.707-1(b)(3). Note, however, that §707(b)(1)(A) does not apply to a constructive owner of a partnership interest since he is not a partner as defined in §761(b). Id.

Treas. Reg. §1.707-1(b)(3) provides an illustration of this expansion of §707(b)(1):

“For example, where trust T is a partner in the partnership ABT, and AW, A’s wife, is the sole beneficiary of the trust, the ownership of a capital and profits interest in the partnership by T will be attributed to AW only for the purpose of further attributing the ownership of such interest to A. See section 267(c) (1) and (5). If A, B, and T are equal partners, then A will be considered as owning more than 50 percent of the capital and profits interest in the partnership, and losses on transactions between him and the partnership will be disallowed by section 707(b)(1)(A). However, a loss sustained by AW on a sale or exchange of property with the partnership would not be disallowed by section 707, but will be disallowed to the extent provided in paragraph (b) of § 1.267(b)-1.”

In this context, it should be noted that the validity of Treas. Reg. §1.267(b)-1(b)(1) is currently in question. There is definitely an unsettled conflict between these regulations and the expanded version of §707(b)(1).

Partnership Related Party Loss Disallowance: Transactions Between Partnerships and Third Parties

As it was mentioned above, the IRC §267(a)(1) contains a special rule concerning losses which occur between between a partnership and a third party (i.e. someone other than a partner). Under this rule, the transaction is treated as if it happened between the third party and individual members of the partnership; this is a type of a look-through rule.

The disallowance rules of §267 govern as long as the third party and a partner are considered to be related parties under any of the relationships described in §267(b). In other words, if 267(b) applies in this context, then no deductions will be allowed with respect to transactions between the third party and the partnership “ (i) To the related partner to the extent of his distributive share of partnership deductions for losses or unpaid expenses or interest resulting from such transactions, and (ii) To the other person to the extent the related partner acquires an interest in any property sold to or exchanged with the partnership by such other person at a loss, or to the extent of the related partner’s distributive share of the unpaid expenses or interest payable to the partnership by the other person as a result of such transaction.” Treas. Reg. §1.267(b)-1(b)(1).

Partnership Related Party Loss Disallowance: Transactions Between Certain Partnerships

As a result of the Tax Reform Act of 1984, §267(a)(1) rules were expanded to disallow loss realized on transactions between certain partnerships. “Certain partnerships” include two types of partnerships.

First, partnerships that have one or more common partners. A “common partner” is a partner who owns directly, indirectly, or constructively any capital or profits interest in each of the partnerships. Treas. Reg. §1.267(a)-2T(c) Q&A-2.

Second, a situation where a partner in one partnership and one or more partners in another partnership are related parties within the meaning of §267(b). Id.

The amount of the disallowed loss is generally the greater of: (1) either the amount that would have been disallowed if the transaction had occurred between the “selling partnership and the separate partners of the purchasing partnership (in proportion to their respective interests in the purchasing partnership)”; or (2) the amount that would have been disallowed if the transaction had occurred between “the separate partners of the selling partnership (in proportion to their respective interests in the selling partnership) and the purchasing partnership.” Id. There is an exception: there will be no disallowance of loss if the disallowed amount is less than 5% of the total loss from the sale or exchange. Id.

It should be noted that §267(a)(1) also applies to S-corporations. §267(a)(1) disallows losses realized in transactions between an S corporation and its shareholder holding more than 50%-in-value of the stock.

Partnership Related Party Loss Disallowance: Deferral of a Deductible Payment Under §267(a)(2)

The Tax Reform Act of 1984 affected not only §267(a)(1), but also expanded the deferral of an otherwise deductible payment between certain partnerships under §267(a)(2). These “certain partnerships” are the same as those described in the expanded rules of §267(a)(1): (i) partnerships that have one or more common partners and (ii) a partner in one partnership and one or more partners in another partnership are related parties within the meaning of §267(b) (without §267(e) modification). See Treas. Reg. §1.267(a)-2T(c) Q&A-3.

The amount of deferred deduction is the greater of: (1) the amount that would have been deferred if the transaction that gave rise to the otherwise allowable deduction had occurred “between the payor partnership and the separate partners of the payee partnership (in proportion to their respective interests in the payee partnership)”, or (2) the amount that would have been deferred if such transaction had occurred “between the separate partners of the payor partnership (in proportion to their respective interests in the payor partnership) and the payee partnership.” Id. Similarly to 267(a)(1), there is an exception: no deferral shall occur if the amount that would be deferred is less than 5% of the otherwise allowable deduction. Id.

It should be noted that the status of some provision of the expanded §267(a)(2) is unclear at this point, because §707(b)(1) was amended in 1986 specifically in reference to §267(a)(2) income-deduction matching rules. As amended, §707(b)(1) state that partnerships in which the same persons own more than 50% of the capital interest or profits interests are treated as related under §267(b). It appears that, with respect to such partnerships, §707(b)(1) overrides the rules described in Reg. §1.267(a)-2T(c) Q&A-3.

Partnership Related Party Loss Disallowance: Additional Deferrals Under §267(a)(2)

With respect to the §267(a)(2) limitations on deductions for payment to related persons, a partnership and its members are treated as related persons under §267(e). As already described above, §707(b)(1) (last sentence) extended this rule to transactions between commonly owned partnerships.

Additionally, under §§267(e)(1)(C) and §267(e)(1)(D), a partnership and a person owning any profits or capital interest in a partnership in which the partnership also holds such an interest (and any persons related to these parties within the meaning of §707(b)(1) or §267(b)) are also related persons.

Finally, §267(a)(2) also applies to S-corporations in an almost identical way as it applies to regular partnerships: the deduction for a payment to a related person is delayed until the recipient includes the payment in his gross income. As a result of the Tax Reform Act of 1984, §267(e) treats an S-corporation and any of its shareholders (regardless of amount of stock owned) as related persons.

§§267(e)(1)(C) and §267(e)(1)(D) further expand the definition of related persons to situations where a transaction occurs between an S-corporation and a person owning any profits or capital interest in a partnership in which the S-corporation also holds such an interest (and any persons related to these parties within the meaning of §707(b)(1) or §267(b)).

Contact Sherayzen Law Office for Professional Help With US Tax Law Concerning Partnerships and S-Corporations

US tax law concerning partnerships and S-corporations is incredibly complex. The rules concerning the partnership related party loss disallowance is just one example of this complexity.

This is why you need the professional help of the experienced tax law firm of Sherayzen Law Office. We have helped clients throughout the United States and the world with US tax laws concerning partnerships (domestic and foreign) and S-corporations. We can help you!

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§318 Relationship Categories | International Business Tax Lawyer & Attorney

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In a previous article I discussed the importance of the Internal Revenue Code (“IRC”) §318 constructive stock ownership rules. Today, I would like to introduce the readers to the various §318 relationship categories – i.e. what types of taxpayers are affected by this section’s constructive ownership rules.

§318 Relationship Categories: Related Persons

Congress created IRC §318 constructive ownership rules to prevent or minimize the possibility of using business transactions between related persons for tax avoidance purposes. In other words, in order for §318 to be relevant, there must be some type of a close relationship between persons engaged in a business transaction.

It is important to point out that one should not confuse §267 definition of related persons with the one described in §318. These are two completely separate sets of rules that apply to different situations.

§318 Relationship Categories: Six Main Categories

§318 deals specifically with six main categories of related individuals and entities. I will list them here with only a general description; in future articles, I will address each of these §318 relationship categories specifically.

  1. Family members: certain family members are treated as related persons for §318. Again, the §318 definition of “family” should not be confused with the §267 definition.
  2. Partnerships and partners: unlike §267, the constructive ownership rules of §318 are both “upstream” and “downstream”. In other words, the attribution of stock ownership works both ways: from partners to partnership and from partnership to partners. Additionally, one must remember that an S-corporation and its shareholders are treated respectively as a partnership and partners for the purposes of §318.
  3. Estates and beneficiaries: the IRS §318 constructive ownership rules with respect to estates and beneficiaries are quite unique and invasive. They also work downstream and upstream – i.e. the stocks owned by estate are attributed to its beneficiaries and vice-versa.
  4. Trusts and beneficiaries: again, the stock ownership attribution rules of §318 between a trust and its beneficiaries can be downstream and upstream. Stock owned, directly or indirectly, by or for a trust is considered owned by its beneficiaries in proportion to their actuarial interests in the trust. The upstream relationship is more complex: while generally all stocks owned directly or indirectly by a beneficiary of a trust is considered owned by the trust, there are important exceptions.
  5. Corporations and shareholders: surprisingly, §318 attribution rules between a corporation and its shareholders also contain both downstream and upstream provisions. The application of these rules, however, is limited to persons who own directly and indirectly 50% or more of the value of stocks in the corporation. Again, the corporate attribution rules under §318 apply only to C-corporations; S-corporations are treated as partnerships for the purposes of this section.
  6. Holders of stock options: unlike §267, the constructive stock ownership rules of §318 are expanded to options. §318(a)(4) classifies a holder of an option to acquire stock as the owner of that stock. There are detailed rules for defining what an “option” is for the §318 purposes. Interestingly, the stock option attribution rule supersedes the family member attribution rules (which often results in a more extensive constructive ownership).

Contact Sherayzen Law Office for Professional Help With US International Business Tax Law

US business tax law is incredibly complex. In fact, an ordinary taxpayer who attempts to decipher it on his own is likely to get himself into deep trouble; this is especially the case, if one deals with the international aspects of US business tax law.

This is why you need to contact Sherayzen Law Office for professional help. We have helped business owners around the world with their US tax planning and US tax compliance, and we can help you!

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IRC §318 Importance | International Tax Lawyer & Attorney

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It is difficult to overstate the significant role the Internal Revenue Code (“IRC”) §318 plays in US corporate tax law and US international tax law. In this article, I will explain the §318 importance and list out major IRC provisions which reference §318.

IRC §318 Importance: Fundamental Purpose

§318 sets forth the circumstances when the ownership of stock is attributed from one person or entity to another. This is one of the most important sections of the Internal Revenue Code, because it contains a set of constructive stock ownership rules which affect a bewildering variety of IRC tax provisions.

It is important to point out that §318 constructive ownership rules do not apply throughout the IRC. Rather, §318 applies only when it is expressly adopted by a specific tax section.

IRC §318 Importance: Non-Exclusive List of IRC Sections

The IRC §318 importance is extensive in both domestic and international tax provisions of the Internal Revenue Code. The CFC (controlled foreign corporation) rules, FIRPTA, FTC (foreign tax credit rules), BEAT, FATCA and so on – all of these US international tax laws adopted §318 for at least one purpose. The §318 importance can even be seen in the 2017 tax reform (for example, the FDII rules).

The following is a non-exclusive list of major IRC sections which adopted the §318 constructive stock ownership rules:

• §59A(g)(3) (related party under BEAT rules)
• §105(h)(5)(B)
• §168(h)(6)(F)(iii)(III)
• §250(b)(5)(D) (sales or services to related party under FDII rules by reference to §954(d)(3) and §958)
• §263A(e)(2)(B)(ii)
• §267A(b)(2) (related party amounts in hybrid transaction by reference to §954(d)(3) and §958)
• §269A(b)(2)
• §269B(e)(2)(B)
• §301(e)(2)
• §302(c) (stock redemptions)
• §304 (redemptions by related corporations)
• §306(b)(1)(A) (disposition or redemption of §306 stock)
• §338(h)(3)
• §355(d)(8)(A)
• §356(a)(2)
• §367(c)(2)
• §382(l)(3)(A) (net operating loss carryovers)
• §409(n)(1)
• §409(p)(3)(B)
• §414(m)(6)(B)
• §416(i)(1)(B) (key employee for top heavy plans)
• §441(i)(2)(B)
• §453(f)(1)(A)
• §465(c)(7)(D)(iii), §465(c)(7)(E)(i) (at-risk loss limitations)
• §469(j)(2)(B) (passive activity loss limitations)
• §512(b)(13)(D)(ii) (unrelated business taxable income from controlled entity)
• §856(d)(5) (REIT rental income)
• §871(h)(3)(C) (portfolio interest withholding tax exemption)
• §881(b)(3)(B) (portfolio interest withholding tax exemption)
• §897(c)(6)(C) (FIRPTA rules)
• §898(b)(2)(B) (adopting §958‘s modified §318 rules for determination of foreign corporation’s tax year)
• §904(h)(6) (foreign tax credit re-sourcing rules)
• §951(b) (U.S. shareholder of controlled foreign corporation (CFC) by reference to §958(b))
• §954(d)(3) (CFC related party rules by reference to §958)
• §958(b) (CFC rules)
• §1042(b)(2)
• §1060(e)(2)(B)
• §1061(d)(2)(A) (transfer of partnership interest received for performance of services)
• §1239(b)(2)
• §1372(b)
• §1471(e) (imposing FATCA reporting requirements on foreign financial institution members of an expanded affiliated group determined under §954(d)(3)’s control test, which adopts §958‘s modified §318 rules)
• §2036(b)(2)
• §6038(e)(2) (information reporting for controlled foreign corporations)
• §6038A(c)(5)
• §7704(d)(3)(B)

Contact Sherayzen Law Office for Professional Help With US International Tax Law

Trying to comply with the extremely complex provisions of US international tax law on your own is even worse than playing Russian roulette. In all likelihood, you will soon find yourself in the ever-deepening pit of legal problems and IRS penalties from which it will be very difficult to extricate yourself.

This is why, if you are US taxpayer with US international tax law issues, you need to contact Sherayzen Law Office for professional help. We have helped hundreds of US taxpayers around the globe to bring themselves into full compliance with US tax laws, and we can help you!

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The IRS Hiring Spree in 2019 and 2020 | Tax Lawyer & Attorney

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The IRS stated in December of 2019 that it hired about 9,500 people during the fiscal year 2019 and it is trying to add another about 5,300 employees as soon as possible. This new IRS hiring spree is meant to reverse the long-term declining trend in IRS employment.

The IRS Hiring Spree: 2009-2018 Trend

Between 2009 and 2017, the IRS suffered a spectacular loss in employees. From about 95,000 employees in 2009, the number of employees dropped to less than 75,000 in 2018. In other words, the IRS lost about 20,000 employees during these years. These losses were mostly due to budget cuts.

The IRS Hiring Spree: 2019-2020 Trend Change

While the IRS did not receive all of the funds it requested, the Trump administration was able to secure sufficient funds for the agency to start hiring again. The fiscal year 2019 saw a complete reversal in the trend with about 9,500 employees added. This is definitely not the end of the IRS hiring spree – the IRS is planning to add another 5,300 employees in early 2020.

The IRS Hiring Spree: What It Means to US Taxpayers

This huge hiring spree at the IRS will have a direct impact on US taxpayers. On the one hand, the IRS customer service should improve with the larger number of representatives.

On the other hand, such a huge inflow of future IRS agents means an inevitable rise in IRS enforcement efforts, particularly IRS audits. Reinforced by hundreds of additional examiners, the IRS will be able to expand audits everywhere, including international tax audits concerning FBAR and FATCA compliance.

US taxpayers with undisclosed foreign assets and foreign income should keep in mind this impending wave of IRS FBAR and FATCA audits. Rather than just wait for the IRS to discover their prior noncompliance with US tax laws, these taxpayers should explore their offshore voluntary disclosure options with an experienced international tax attorney as soon as possible.

Contact Sherayzen Law Office for Professional Help with IRS International Tax Audits

Mr. Eugene Sherayzen is a highly experienced international tax attorney and owner of international tax law firm, Sherayzen Law Office, Ltd. He and his law firm have successfully helped hundreds of US taxpayers to resolve their prior noncompliance with US international tax laws. We can help you!

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§267 Family Attribution | International Tax Lawyer & Attorney

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In a previous article, I introduced the constructive ownership rules of the Internal Revenue Code (“IRC”) §267. Today, I would like to discuss one of them in more detail – §267 family attribution.

§267 Family Attribution: General Rule

The §267 family attribution rule is described in §267(c)(2). It states that, for the purposes of determining whether an individual is a related party under §267, this individual is considered as a constructive owner of stocks owned, directly or indirectly, by or for his family.

§267 Family Attribution: Who is a Family Member

The critical question for §267(c)(2) is the definition of family. §267(c)(4) provides the answer to this question: “the family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants.”

Under Treas. Reg. §1.267(c)-1(a)(4), if any such family relationship was formed through legal adoption, such adoption is given full legal force for the purposes of §267(c)(2). “Ancestors” here include parents and grandparents; it appears that great-grandparents should also be family members for the purposes of §267 family member attribution. Id. The term “lineal descendants” includes children and grandchildren. Id.

Neither §267 and relevant Treasury regulations contain any reference to aunts and uncles. There is, however, a reason to believe that aunts and uncles are not family members for the purpose of §267(c)(2). This argument is based on the fact that, prior to its repeal in 2004, the definition of family in §544(a)(2) (which was part of the foreign personal holding company provisions) was identical to that of §267(c)(4). The IRS held in Rev. Rul. 59-43 that aunts and uncles are not family members for the purposes of §544(a)(2); hence, the same logic should apply to §267(c)(2).

Furthermore, neither step-parents nor step-children are family members for the purposes of §267(c)(2) (see Rev. Rul. 71-50 and DeBoer v. Commissioner, 16 T.C. 662 (1951), aff’d per curiam, 194 F.2d 289 (2d Cir. 1952)). Based on Tilles v. Commissioner, 38 B.T.A. 545 (1938), aff’d, 113 F.2d 907 (8th Cir. 1940), nieces or nephews are also not family members. Nor are the in-laws.

§267 Family Attribution: Attribution and Limitations

Under the §267 family attribution rule, any family member will be the constructive owner of any other family member’s stocks. This will be the case even if the person to whom the stock ownership is attributed has no direct or even indirect ownership of stock in the corporation (see Reg. §1.267(c)-1(a)(2)).

On the other hand, §267(c)(5) prevents the double-attribution of stock. In other words, a stock constructively owned under the family attribution rules may not be owned by another person under §267(c)(2). For example, if stock ownership is attributed to an individual’s wife under §267(c)(2), §267(c)(5) prevents further attribution of stock ownership to the wife’s mother.

§267 Family Attribution: Other Doctrines Should Be Considered

It is important to emphasize that a lawyer should always be on the lookout for other doctrines which may intervene with the attribution under §267(c)(2). For example, where a wife transfers property to her husband in anticipation of the sale of that property by the husband to her brother, §267(c)(5) double-attribution limitation may be ignored by the application of the “substance over form” principle by a court. The “step transaction” doctrine should always be a concern in such transactions.

Contact Sherayzen Law Office for Professional Help With US Tax Law

US tax law is extremely complex. An ordinary person will simply get lost in this labyrinth of tax rules, exceptions and requirements. Once you get into trouble with US tax law, it is much more difficult and expensive to extricate yourself from it due to high IRS penalties.

This is why it is important to contact Sherayzen Law Office for professional help with US tax law as soon as possible. We have helped hundreds of US taxpayers around the world to successfully resolve their US tax compliance and US tax planning issues. We can help you!

Contact Us Today to Schedule Your Confidential Consultation!