Introduction to Corporate Distributions | US Business Tax Law Firm

This essay opens our new series of articles which focuses on corporate distributions. The new series will cover the classification, statutory structure and tax treatment of various types of corporation distributions, including redemptions of corporate stock. This first article seeks to introduce the readers to the overall US statutory tax structure concerning corporate distributions.

Corporation Distributions: Legal Philosophy for Varying Treatment

In the United States, the tax code provisions with respect to corporate distributions were written based on the belief that stock ownership bestows on its owner an inherent right to determine the right to receive distributions from a corporation.

Generally, a corporation can make distributions from three types of sources. First, a corporation can distribute funds from its accumulated earnings, to be even more precise accumulated Earnings and Profits (E&P). Second, a corporation may also distribute some or all of the invested capital to its shareholders. Finally, in certain circumstances, a corporation may distribute funds or property in excess of invested capital.

Moreover, certain corporate distributions may in reality be made in lieu of other types of transactions, such as payment for services. Additionally, some corporate distributions may be made in the form of stocks in the corporation, which may or may not modify the ownership of the corporation and which may or may not entitle shareholders to additional (perhaps unequal) future distribution of profits.

This varied nature of corporate distributions lays the foundation for their dissimilar tax treatment under the Internal Revenue Code (IRC).

Corporation Distributions: General Treatment under §301

IRC §301 generally governs the tax treatment of corporation distributions. This section classifies these distributions either as dividends, return of capital or capital gain (most likely, long-term capital gain). In a future article, I will discuss §301 in more detail.

Corporation Distributions: Special Case of Stock Dividends

The IRC treats distribution of stock dividends in a different manner than distribution of cash and property. Under §305(a), certain stock distributions are not taxable distributions. However, §305 contains numerous exceptions to this general rule; if any of these exceptions apply, then such stock distributions are governed by §301.

Moreover, additional exceptions to §305(a) are contained in §306. If a stock distribution is classified as a §306 stock, then the disposition of this stock will be treated as ordinary income. In a future article, I will discuss §§305 and 306 in more detail.

Corporation Distributions: Special Case of Stock Redemptions

Stock redemptions is a special kind of a corporate distribution. §317(b) defines redemption of stock as a corporation’s acquisition of “its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.”

§302 governs the tax treatment of stock redemptions. In general, it provides for two potential legal paths of stock redemptions. First, if a stock redemption satisfies any of the four §302(b) tests, then it will be treated as a sales transaction under §1001. Assuming that the redeemed stock satisfied the §1221 definition of a capital asset, the capital gain/loss tax provisions will apply.

On the other hand, if none of the §302(b) tests are met, then the stock redemption will be treated as a corporate distribution under §301. Again, in a future article, I will discuss stock redemptions in more detail.

Corporate Distributions in the Context of US International Tax Law

All of these tax provisions concerning corporate distributions are relevant to US shareholders of foreign corporations. In fact, in the context of US international tax law, these tax sections become even more complex and may have far graver consequences for US shareholders than under purely domestic tax law. These consequences may be in the form of higher tax burden (for example, due to an anti-deferral tax regime such as Subpart F rules) or increased compliance burden (for example, triggering the filing of international information returns such as Form 5471 or Form 926).

A failure to recognize these differences between the application of aforementioned tax provisions in the domestic context from the international one may result in the imposition of severe IRS noncompliance penalties.

Contact Sherayzen Law Office for Professional Tax Help Concerning Corporation Distributions

Sherayzen Law Office is an international tax law firm highly-experienced in US and foreign corporate transactions, including corporate distributions. We have helped our clients around the world not only to engage in proper US tax planning concerning cash, property and stock distributions from US and foreign corporations, but also resolve any prior US tax noncompliance issues (including conducting offshore voluntary disclosures). We can help you!

Contact Us Today to Schedule Your Confidential Consultation!

Critical Business Exemption | Minnesota Shelter-In-Place Order

On March 25 , 2020, the Honorable Tim Walz, Governor of the State of Minnesota, issued a “Shelter-In-Place” Emergency Executive Order 20-20. The Executive Order mandates all persons in Minnesota to stay at home or in their place residence, unless they go out to engage in certain activities or do work for a business which is designated as a critical business (in some states, critical business is called “essential business”). I will first discuss the definition of the critical business exemption and its importance; then, I will provide a list of industries that fall under the critical business exemption based on NAICS codes.

Critical Business Exemption: Importance

The critical business exemption is very important for many business and tax reasons. Let’s briefly discuss the two most important of them.

First, from a business perspective, it is very important for business to continue to operate; a shutdown of two weeks may deal a critical blow to a business’ ability to remain profitable and meet all of its clients’ demands. Hence, the very existence of a business may depend on its eligibility for a critical business exemption.

Second, a non-exempt business will have to make a tough choice between laying off all of its employees and paying forced leave of absence. Prior to April 1, 2020, the forced leave of absence will not be compensated by the federal government. Starting April 1, 2020, however, pursuant to the Families First Coronavirus Response Act (“FFCRA”), employees are entitled to certain paid leave as well as potentially expanded family and medical leave for COVID-19 related reasons. In return, eligible employers will receive a compensation from the federal government in the form of a Paid Sick Leave Tax Credit.

These are just two of numerous examples of the importance of the critical business exemption.

Critical Business Exemption: Definition Sources

In order for a business to exempt its workers from the requirements of the Governor’s Executive Order 20-20, two conditions must be satisfied: (1) a business must fall within the definition of a critical business, and (2) a worker cannot perform work duties from home.

There are three resources that provide guidance to help you determine if your business is in a critical industry:

  1. The U.S. Department of Homeland Security’s Memorandum on Identification of Essential Critical Infrastructure Workers During COVID-19 Response (“CISA”). This is the federal government’s definition of critical industries.
  2. The aforementioned is Governor’s Executive Order 20-20. The order sets forth all sources of the critical business exemption definition as well as certain general categories of exempt businesses.
  3. The designation of critical industries based on NAICS Codes. This the most detailed and most comprehensive list of critical industries for many businesses. I provided the list below as it existed as of March 26, 2020.

The analysis should start from CISA categories. If your business does not fall within any of the CISA categories, then you proceed with the examination of the categories listed in the Executive Order 20-20. Finally, if neither of the first two sources provides an answer (for example, if you are a tax accountant, this would be the case), then you need to look at the NAICS Codes. If your business falls within any of the critical industry categories described in either of these documents, then, you will satisfy the first condition for exempting your workers from Minnesota Shelter-in-Place order.

Critical Business Exemption: Inability to Perform Work Duties from Home

If a business belongs to one of the critical industries, an employee can leave home to work only if he cannot perform his duties from home. It is important to understand that Executive Order 20-20 requires all employees who can work from home to do so, even if they are eligible for a critical business exemption.

Critical Business Exemption: NAICS Codes

For the convenience of the readers, I provided this list of companies eligible (and ineligible) for Minnesota critical business exemption based on NAICS Codes. This list was originally published by MN DEED (Minnesota Department of Employment and Economic Development); it is up-to-date through March 26, 2020.

As a Minnesota-based US international tax law firm which deals with highly-confidential information, Sherayzen Law Office falls within an exemption under NAICS code 5412.

Industry Description Industry Code Critical Industry
Oilseed and Grain Farming 1111 YES
Vegetable and Melon Farming 1112 YES
Fruit and Tree Nut Farming 1113 YES
Greenhouse, Nursery, and Floriculture Production 1114 YES
Other Crop Farming 1119 YES
Cattle Ranching and Farming 1121 YES
Hog and Pig Farming 1122 YES
Poultry and Egg Production 1123 YES
Other Animal Production 1129 YES
Timber Tract Operations 1131 YES
Forest Nurseries and Gathering of Forest Products 1132 YES
Logging 1133 YES
Fishing 1141 YES
Hunting and Trapping 1142 YES
Support Activities for Crop Production 1151 YES
Support Activities for Animal Production 1152 YES
Support Activities for Forestry 1153 YES
Oil and Gas Extraction 2111 YES
Metal Ore Mining 2122 YES
Nonmetallic Mineral Mining and Quarrying 2123 NO
Support Activities for Mining 2131 YES
Residential Building Construction 2361 YES
Nonresidential Building Construction 2362 YES
Utility System Construction 2371 YES
Land Subdivision 2372 YES
Highway, Street and Bridge Construction 2373 YES
Other Heavy and Civil Engineering Construction 2379 YES
Foundation, Structure and Building Exterior Contractors 2381 YES
Building Equipment Contractors 2382 YES
Building Finishing Contractors 2383 YES
Other Specialty Trade Contractors 2389 YES
Grain and Oilseed Milling 3112 YES
Sugar and Confectionery Product Manufacturing 3113 YES
Fruit and Vegetable Preserving and Specialty Food Manufacturing 3114 YES
Dairy Product Manufacturing 3115 YES
Animal Slaughtering and Processing 3116 YES
Bakeries and Tortilla Manufacturing 3118 YES
Other Food Manufacturing 3119 YES
Beverage Manufacturing 3121 YES
Fabric Mills 3132 NO
Textile Furnishings Mills 3141 NO
Other Textile Product Mills 3149 NO
Cut and Sew Apparel Manufacturing 3152 NO
Leather and Hide Tanning and Finishing 3161 NO
Sawmills and Wood Preservation 3211 NO
Veneer, Plywood and Engineered Wood Product Manufacturing 3212 NO
Other Wood Product Manufacturing 3219 YES
Pulp, Paper and Paperboard Mills 3221 YES
Converted Paper Product Manufacturing 3222 YES
Printing and Related Support Activities 3231 NO
Petroleum and Coal Products Manufacturing 3241 YES
Basic Chemical Manufacturing 3251 YES
Resin, Synthetic Rubber and Artificial Synthetic Fibers and Filaments Manufacturing 3252 NO
Pesticide, Fertilizer and Other Agricultural Chemical Manufacturing 3253 YES
Pharmaceutical and Medicine Manufacturing 3254 YES
Paint, Coating and Adhesive Manufacturing 3255 NO
Soap, Cleaning Compound and Toilet Preparation Manufacturing 3256 YES
Other Chemical Product and Preparation Manufacturing 3259 YES
Plastics Product Manufacturing 3261 YES
Rubber Product Manufacturing 3262 YES
Glass and Glass Product Manufacturing 3272 NO
Cement and Concrete Product Manufacturing 3273 NO
Other Nonmetallic Mineral Product Manufacturing 3279 NO
Steel Product Manufacturing from Purchased Steel 3312 YES
Alumina and Aluminum Production and Processing 3313 YES
Foundries 3315 YES
Forging and Stamping 3321 YES
Cutlery and Handtool Manufacturing 3322 NO
Industry Description Industry Code Critical Industry
Architectural and Structural Metals Manufacturing 3323 NO
Boiler, Tank and Shipping Container Manufacturing 3324 YES
Hardware Manufacturing 3325 NO
Spring and Wire Product Manufacturing 3326 NO
Machine Shops, Turned Product and Screw, Nut and Bolt Manufacturing 3327 YES
Coating, Engraving, Heat Treating and Allied Activities 3328 NO
Other Fabricated Metal Product Manufacturing 3329 NO
Agriculture, Construction and Mining Machinery Manufacturing 3331 YES
Industrial Machinery Manufacturing 3332 YES
Commercial and Service Industry Machinery Manufacturing 3333 YES
Ventilation, Heating, Air-Conditioning and Commercial Refrigeration Equipment Manufacturing 3334 YES
Metalworking Machinery Manufacturing 3335 NO
Engine, Turbine and Power Transmission Equipment Manufacturing 3336 NO
Other General Purpose Machinery Manufacturing 3339 NO
Computer and Peripheral Equipment Manufacturing 3341 YES
Communications Equipment Manufacturing 3342 YES
Audio and Video Equipment Manufacturing 3343 YES
Semiconductor and Other Electronic Component Manufacturing 3344 YES
Navigational, Measuring, Electromedical and Control Instruments Manufacturing 3345 YES
Manufacturing and Reproducing Magnetic and Optical Media 3346 NO
Electrical Equipment Manufacturing 3353 YES
Other Electrical Equipment and Component Manufacturing 3359 YES
Motor Vehicle Manufacturing 3361 NO
Motor Vehicle Body and Trailer Manufacturing 3362 NO
Motor Vehicle Parts Manufacturing 3363 NO
Aerospace Product and Parts Manufacturing 3364 NO
Railroad Rolling Stock Manufacturing 3365 NO
Ship and Boat Building 3366 NO
Other Transportation Equipment Manufacturing 3369 NO
Household and Institutional Furniture and Kitchen Cabinet Manufacturing 3371 NO
Office Furniture (including Fixtures) Manufacturing 3372 NO
Other Furniture Related Product Manufacturing 3379 NO
Medical Equipment and Supplies Manufacturing 3391 YES
Other Miscellaneous Manufacturing 3399 NO
Electric Power Generation, Transmission and Distribution 2211 YES
Natural Gas Distribution 2212 YES
Water, Sewage and Other Systems 2213 YES
Motor Vehicle and Motor Vehicle Parts and Supplies Merchant Wholesalers 4231 YES
Furniture and Home Furnishing Merchant Wholesalers 4232 NO
Lumber and Other Construction Materials Merchant Wholesalers 4233 YES
Professional and Commercial Equipment and Supplies Merchant Wholesalers 4234 YES
Metal and Mineral (except Petroleum) Merchant Wholesalers 4235 YES
Electrical and Electronic Goods Merchant Wholesalers 4236 YES
Hardware, Plumbing, Heating Equipment and Supplies Merchant Wholesalers 4237 YES
Machinery, Equipment and Supplies Merchant Wholesalers 4238 YES
Miscellaneous Durable Goods Merchant Wholesalers 4239 NO
Paper and Paper Product Merchant Wholesalers 4241 YES
Drugs and Druggists’ Sundries Merchant Wholesalers 4242 YES
Apparel, Piece Goods and Notions Merchant Wholesalers 4243 NO
Grocery and Related Product Merchant Wholesalers 4244 YES
Farm Product Raw Material Merchant Wholesalers 4245 YES
Chemical and Allied Products Merchant Wholesalers 4246 YES
Petroleum and Petroleum Products Merchant Wholesalers 4247 YES
Beer, Wine and Distilled Alcoholic Beverage Merchant Wholesalers 4248 YES
Miscellaneous Nondurable Goods Merchant Wholesalers 4249 YES
Wholesale Electronic Markets, Agents and Brokers 4251 YES
Automobile Dealers 4411 NO
Other Motor Vehicle Dealers 4412 NO
Automotive Parts, Accessories and Tire Stores 4413 YES
Furniture Stores 4421 NO
Home Furnishings Stores 4422 NO
Electronics and Appliance Stores 4431 NO
Building Material and Supplies Dealers 4441 YES
Lawn and Garden Equipment and Supplies Stores 4442 NO
Grocery Stores 4451 YES
Specialty Food Stores 4452 YES
Beer, Wine and Liquor Stores 4453 YES
Health and Personal Care Stores 4461 YES
Industry Description Industry Code Critical Industry
Gasoline Stations 4471 YES
Clothing Stores 4481 NO
Shoe Stores 4482 NO
Jewelry, Luggage and Leather Goods Stores 4483 NO
Sporting Goods, Hobby and Musical Instrument Stores 4511 NO
Book, Periodical and Music Stores 4512 NO
Department Stores 4522 YES
General Merchandise Stores, including Warehouse Clubs and Supercenters 4523 YES
Florists 4531 NO
Office Supplies, Stationery and Gift Stores 4532 NO
Used Merchandise Stores 4533 NO
Other Miscellaneous Store Retailers 4539 NO
Electronic Shopping and Mail-Order Houses 4541 NO
Vending Machine Operators 4542 NO
Direct Selling Establishments 4543 NO
Scheduled Air Transportation 4811 YES
Nonscheduled Air Transportation 4812 YES
Rail Transportation 4821 YES
Deep Sea, Coastal and Great Lakes Water Transportation 4831 YES
Inland Water Transportation 4832 YES
General Freight Trucking 4841 YES
Specialized Freight Trucking 4842 YES
Urban Transit Systems 4851 YES
Taxi and Limousine Service 4853 YES
School and Employee Bus Transportation 4854 YES
Other Transit and Ground Passenger Transportation 4859 YES
Pipeline Transportation of Crude Oil 4861 YES
Pipeline Transportation of Natural Gas 4862 YES
Other Pipeline Transportation 4869 YES
Scenic and Sightseeing Transportation, Land 4871 NO
Scenic and Sightseeing Transportation, Water 4872 NO
Support Activities for Air Transportation 4881 YES
Support Activities for Rail Transportation 4882 YES
Support Activities for Water Transportation 4883 YES
Support Activities for Road Transportation 4884 YES
Freight Transportation Arrangement 4885 YES
Other Support Activities for Transportation 4889 YES
Postal Service 4911 YES
Couriers 4921 YES
Local Messengers and Local Delivery 4922 YES
Warehousing and Storage 4931 YES
Newspaper, Periodical, Book and Directory Publishers 5111 YES
Software Publishers 5112 YES
Motion Picture and Video Industries 5121 NO
Sound Recording Industries 5122 NO
Radio and Television Broadcasting 5151 YES
Cable and Other Subscription Programming 5152 YES
Telecommunications Resellers 5173 YES
Data Processing, Hosting and Related Services 5182 YES
Other Information Services 5191 YES
Monetary Authorities – Central Bank 5211 YES
Depository Credit Intermediation 5221 YES
Nondepository Credit Intermediation 5222 YES
Activities Related to Credit Intermediation 5223 YES
Securities and Commodity Contracts Intermediation and Brokerage 5231 YES
Securities and Commodity Exchanges 5232 YES
Other Financial Investment Activities 5239 YES
Insurance Carriers 5241 YES
Agencies, Brokerages and Other Insurance Related Activities 5242 YES
Lessors of Real Estate 5311 YES
Offices of Real Estate Agents and Brokers 5312 YES
Activities Related to Real Estate 5313 YES
Automotive Equipment Rental and Leasing 5321 NO
Consumer Goods Rental 5322 NO
General Rental Centers 5323 NO
Commercial and Industrial Machinery and Equipment Rental and Leasing 5324 NO
Lessors of Nonfinancial Intangible Assets (except Copyrighted Works) 5331 NO
Legal Services 5411 YES
Industry Description Industry Code Critical Industry
Accounting, Tax Preparation, Bookkeeping and Payroll Services 5412 YES
Architectural, Engineering and Related Services 5413 YES
Specialized Design Services 5414 NO
Computer Systems Design and Related Services 5415 YES
Management, Scientific and Technical Consulting Services 5416 YES
Scientific Research and Development Services 5417 YES
Advertising and Related Services 5418 NO
Other Professional, Scientific and Technical Services 5419 YES
Management of Companies and Enterprises 5511 YES
Office Administrative Services 5611 NO
Facilities Support Services 5612 YES
Employment Services 5613 NO
Business Support Services 5614 NO
Travel Arrangement and Reservation Services 5615 NO
Investigation and Security Services 5616 YES
Services to Buildings and Dwellings 5617 YES
Other Support Services 5619 NO
Waste Collection 5621 YES
Waste Treatment and Disposal 5622 YES
Remediation and Other Waste Management Services 5629 YES
Elementary and Secondary Schools 6111 YES
Junior Colleges 6112 YES
Colleges, Universities and Professional Schools 6113 YES
Business Schools and Computer and Management Training 6114 YES
Technical and Trade Schools 6115 YES
Other Schools and Instruction 6116 YES
Educational Support Services 6117 YES
Offices of Physicians 6211 YES
Offices of Dentists 6212 YES
Offices of Other Health Practitioners 6213 YES
Outpatient Care Centers 6214 YES
Medical and Diagnostic Laboratories 6215 YES
Home Health Care Services 6216 YES
Other Ambulatory Health Care Services 6219 YES
General Medical and Surgical Hospitals 6221 YES
Psychiatric and Substance Abuse Hospitals 6222 YES
Specialty (except Psychiatric and Substance Abuse) Hospitals 6223 YES
Nursing Care Facilities (Skilled Nursing Facilities) 6231 YES
Residential Intellectual and Developmental Disability, Mental Health and Substance Abuse Facilities 6232 YES
Continuing Care Retirement Communities and Assisted Living Facilities for the Elderly 6233 YES
Other Residential Care Facilities 6239 YES
Individual and Family Services 6241 YES
Community Food and Housing and Emergency and Other Relief Services 6242 YES
Vocational Rehabilitation Services 6243 YES
Child Day Care Services 6244 YES
Performing Arts Companies 7111 NO
Spectator Sports 7112 NO
Promoters of Performing Arts, Sports, and Similar Events 7113 NO
Agents and Managers for Artists, Athletes, Entertainers and Other Public Figures 7114 NO
Independent Artists, Writers and Performers 7115 NO
Museums, Historical Sites and Similar Institution 7121 NO
Amusement Parks and Arcades 7131 NO
Gambling Industries 7132 NO
Other Amusement and Recreation Industries 7139 NO
Traveler Accommodation 7211 NO
RV (Recreational Vehicle) Parks and Recreational Camps 7212 YES
Rooming and Boarding Houses 7213 NO
Special Food Services 7223 YES
Drinking Places (Alcoholic Beverages) 7224 NO
Restaurants 7225 YES
Automotive Repair and Maintenance 8111 YES
Electronic and Precision Equipment Repair and Maintenance 8112 NO
Commercial and Industrial Machinery and Equipment (except Automotive and Electronic) Repair and Maintenance 8113 NO
Personal and Household Goods Repair and Maintenance 8114 NO
Personal Care Services 8121 NO
Death Care Services 8122 YES
Drycleaning and Laundry Services 8123 YES
Other Personal Services 8129 YES
Industry Description Industry Code Critical Industry
Religious Organizations 8131 YES
Grantmaking and Giving Services 8132 NO
Social Advocacy Organizations 8133 NO
Civic and Social Organizations 8134 NO
Business, Professional, Labor, Political and Similar Organizations 8139 NO
Private Households 8141 YES
Executive, Legislative and Other General Government Support 9211 YES
Justice, Public Order and Safety Activities 9221 YES
Administration of Human Resource Programs 9231 YES
Administration of Environmental Quality Programs 9241 YES
Administration of Housing Programs, Urban Planning and Community Development 9251 YES
Administration of Economic Programs 9261 YES
Space Research and Technology 9271 NO
National Security and International Affairs 9281 YES

§318 Partnership Attribution | International Corporate Tax Lawyers

This article continues a series of articles on the Internal Revenue Code (“IRC”) §318 constructive ownership rules. In this essay, we will discuss the §318 partnership attribution rules – i.e. attribution of ownership of shares from partnership to partners and vice versa.

§318 Partnership Attribution Rules: Two Types

There are two types of the IRC §318 partnership attribution rules: downstream and upstream. The downstream attribution rules attribute the ownership of corporate stocks owned by a partnership to its partners. The upstream attribution rules attribute the ownership of corporate stocks owned by partners to the partnership. Let’s explore both types of attribution rules in more detail.

§318 Partnership Attribution Rules: Attribution from Partnership to Partners

Pursuant to §318(a)(2)(A), corporate stocks owned, either directly or indirectly, by or on behalf of a partnership is deemed constructively owned by its partners proportionately. Interestingly, the attribution of corporate stock from a partnership to its partners continues to happen even if the partnership does not do any business or stops all of its operation. See Baker Commodities, Inc. v. Commissioner 415 F.2d 519 (9th Cir. 1969); Sorem v. Commissioner 40 T.C. 206 (1963), rev’d on other grounds, 334 F.2d 275 (10th Cir. 1964).

The biggest problem with applying §318(a)(2)(A) is determining what “proportionate attribution” means. Where a partner owns the same interest in capital, profits and losses of a partnership, the proportionality is easy to apply. However, in situations where a partner owns varying interests in capital, profits and losses, it is much more difficult.

Unfortunately, this problem is not addressed at all by the IRS or courts – the proportionality of attribution is not defined in any IRC provision, Treasury Regulations and even case law. Looking at Treas. Reg. §1.318-2(c) Ex. 1, however, it is likely that the IRS will accept a position where proportionality of attribution is based on the “facts-and-circumstances” test of §704(b).

§318 Partnership Attribution Rules: Attribution from Partners to Partnership

Under §318(a)(3)(A), a partnership constructively owns corporate stocks owned by a partner. There are no limitations on the attribution – all stocks held by a partner are deemed to be owned by the partnership irrespective of the percentage of an ownership interest in the partnership held by the partner. There is no de minimis rule that would apply to §318(a)(3)(A).

For example, assume that partner P (an individual) owns 25% in a partnership X. P also owns 100 shares out of the total 200 shares outstanding of Y corporation; X owns the remaining 100 shares. Under §318(a)(3)(A), X actually owns 100 shares of Y and constructively owns P’s 100 shares of Y; in other words, X owns 100% of Y.

§318 Partnership Attribution Rules: Certain Attributions Not Allowed

There are two special §318 rules concerning partnership attributions that I would like to mention in this article. First, there is no partner-to-partner attribution of stock under the §318 partnership attribution rules. In other words, stocks owned by a partner will not be owned by another partner simply by virtue of both partners having an ownership interest in the same partnership (however, this does not mean that stocks may not be attributed through another provision of §318).

Second, §318(a)(5)(C) prevents re-attribution of stocks that were already attributed from a partner to the partnership. This means that, where stocks are attributed from a partner to a partnership, they cannot be then re-attributed from the partnership to another partner.

§318 Partnership Attribution Rules: S-Corporations

Under §318(a)(5)(E), an S-corporation and its shareholders are respectively considered to be a partnership and its partners. Hence, corporate stocks owned by an S-corporation are attributed to its shareholders proportionately to each shareholder’s ownership of the S-corporation’s stock. Also, stocks owned by shareholders are deemed to be owned by the S-corporation.

It is important to emphasize that §318 partnership attribution rules do not apply to the stock of the S-corporation. Id. In other words, §318 does not treat shareholders in an S-corporation as being constructive owners of the stock of the S-corporation itself.

§318 Partnership Attribution Rules: Comprehensive Example

I would like to finish this article with a comprehensive example of how §318 partnership attribution rules work. Let’s suppose that A and B own Y partnership in equal portions (i.e. 50% each); Y owns 120 shares of X, a C-corporation, out of the total 200 outstanding shares; another 80 shares are owned by A.

Let’s analyze each parties’ actual and constructive ownership of X. A actually owns 80 shares and constructively owns half of Y’s ownership of X shares (60 shares) under §318(a)(2)(A) – i.e. he owns a total of 140 shares.

B constructively owns half of Y’s ownership of X shares – i.e. 60 shares. He does not constructively own any of A’s shares, because there is no partner-to-partner attribution of stocks and there is no attribution to B of A’s shares that were attributed to Y.

Finally, Y actually owns 120 shares and constructively owns all of A’s 80 shares. In other words, Y is deemed to be a 100% owner of X.

Contact Sherayzen Law Office for Professional Help With §318 Partnership Attribution Rules

The constructive ownership rules of §318 are crucial to proper identification of US tax reporting requirements with respect domestic and especially foreign business entities. Hence, if you are a partner in a partnership that owns stocks in a domestic or foreign corporation, contact Sherayzen Law Office for professional help with §318 partnership attribution rules.

Contact Us Today to Schedule Your Confidential Consultation!

Partnership Related Party Loss Disallowance | Tax Lawyer & Attorney

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!

Contact Us Today to Schedule Your Confidential Consultation!

Legal Entity Identifiers: Introduction to LEI | International Tax Lawyer & Attorney

The Legal Entity Identifiers (“LEI”) is a method to identify legal entities that engage in financial transactions. Let’s discuss LEI in more detail.

LEI: Background Information

The establishment of LEI was driven by the recognition by regulators around the world that there is a complete lack of transparency with respect to identifying parties to international transactions. Each business entity is registered at the national level, but another country’s authorities would have great difficulty identifying this entity in an international transaction, including whether this entity has taken consistent tax positions in both countries.

Establishment of LEI; Additional Initiatives

Hence, on the initiative of the largest twenty economies of the world (“G-20“), the Financial Stability Board (“FSB”) developed the framework of Global LEI System (“GLEIS”). FSB was created in 2009 in the aftermath of the financial crisis (it replaced the Financial Stability Forum or “FSF”).

Additionally, in January of 2013, a LEI Regulatory Oversight Committee (“ROC”) was created. ROC is a group of over 70 public authorities from member-countries and additional observers from more than 50 countries. The job of the ROC is coordination and oversight of the worldwide LEI framework.

On May 9, 2017, the ROC announced that it has launched data collection on parent entities in the Global Legal Entity Identifiers System – this is the so-called “relationship data”. The member countries (especially in the European Union (“EU”)) will use this data in a number of regulatory initiatives. For example, as of 2018, the EU uses the relationship data for the purposes of commodity derivative reporting.

How LEI Works

The LEI is a 20-character, alpha-numeric code, to uniquely identify legally distinct entities that engage in financial transactions. The code incorporates the following information:

1.the official name of the legal entity as recorded in the official registers;
2.the registered address of that legal entity;
3.the country of formation; for the representation of names of countries and their subdivisions;
5.the date of the first Legal Entity Identifier assignment; the date of last update of the information; and the date of expiration, if applicable.

Here is how the numbering system works:

•Characters 1–4: A four-character prefix allocated uniquely to each LOU.
•Characters 5–6: Two reserved characters set to zero.
•Characters 7–18: Entity—specific part of the code generated and assigned by LOUs according to transparent, sound, and robust allocation policies.
•Characters 19–20: Two check digits as described in the ISO 17442 standard.

Jurisdictions With Rules Referring to LEI

Over 40 jurisdictions have rules that refer to Legal Entity Identifiers: Argentina, Australia, Canada, 31 members of the European Union and European Economic Area, Hong Kong, India, Israel, Mexico, Russia, Singapore, Switzerland, and the United States. IGOs such as Basel Committee on Banking Supervision and International Organization of Securities Commissions also use Legal Entity Identifiers.

Could LEI Be Used for CRS and FATCA Purposes?

Sherayzen Law Office, like many other commentators, believes that there is a possibility that the LEI would be a better alternative than Global Intermediary Identification Number (GIIN) for CRS and FATCA purposes. First of all, it would be more efficient to have one identification system across all compliance terrains. Second, Legal Entity Identifiers are actually more popular than GIINs. As of December 7, 2017, there were 830,477 LEIs issued versus a mere less than 300,000 GIINs.