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Section 754 Elections on Form 1065: Making Valid Elections, Seeking Relief For Missed or Invalid ElectionsTHURSDAY, APRIL 23, 2020, 1:00-2:50 pm Eastern

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April 23, 2020

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

Jellia Dai, Manager

Ernst & Young

jellia.dai@ey.com

Pamela A. Fuller, JD, LLM, Of Counsel

Tully Rinckey PLLC & Royse Law

pfuller@rroyselaw.com

Dina A. Wiesen, Managing Director, National Tax Office, Passthroughs

Deloitte Tax

dwiesen@deloitte.com

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.

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.

Strafford

Section 754 Elections on Form 1065: Making Valid Elections, Seeking Relief for Missed or Invalid ElectionsMastering the Mechanics of Election Statements, Schedule K-1, Section 301.9100 Relief, and More

April 23, 20201:00pm-2:50pm EST, 10:00am-11:50am PST

Jellia DaiPamela FullerDina Wiesen

Agenda

6

I. Reporting timely Section 754 election

II. Relief under Treas. Reg. § 301.9100III.Remedies for correcting defective or invalid elections after

the filing yearIV. Revocation of a Section 754 election

V. Hot Topics

Reporting timely section 754 election

7

Basis Adjustments

Overview

• Section 754 – Election/mandatory

• Section 734(b) – Distribution of property/cash

• Section 743(b) – Transfer of partnership interest• Section 755 – Allocation of sections 734(b) and 743(b) adjustments

8

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

9

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.

10

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). See Treas. Reg. §301.9100-2 for 12-month extension of time to file election.

• Mandatory adjustments without section 754 election in some cases.

11

Section 754

Making the Election

• Treas. Reg. § 1.754-1(b)(1) provides the following: − An election under section 754 and this section to adjust the basis of

partnership property under sections 734(b) and 743(b), with respect to a distribution of property to a partner or a transfer of an interest in a partnership, shall be made in a written statement filed with the partnership return for the taxable year during which the distribution or transfer occurs.

• Two statements should be attached to the return for the taxable year during which the distribution or transfer occurs:− Statement of Section 754 Election

Name and address of the partnership making the election

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

12

Section 754

Making the Election

• Treas. Reg. § 1.754-1(b)(1) provides the following: − For the election to be valid, the return must be filed not later than the time

prescribed by paragraph (e) of § 1.6031-1 (including extensions thereof) for filing the return for such taxable year (or before August 23, 1956, whichever is later). Notwithstanding the preceding two sentences, if a valid election has been made under section 754 and this section for a preceding taxable year and not revoked pursuant to paragraph (c) of this section, a new election is not required to be made. The statement required by this subparagraph shall (i) set forth the name and address of the partnership making the election, (ii) be signed by any one of the partners, and (iii) contain a declaration that the partnership elects under section 754 to apply the provisions of section 734(b) and section 743(b). For rules regarding extensions of time for filing elections, see § 1.9100-1.

13

Section 754

Election Sample Statement

[Taxpayer Name][Taxpayer Address][Taxpayer City], [Taxpayer State] [ZIP Code]

Identification Number: [Fed. ID#][Taxpayer Name] hereby elects under Code Sec. 754 and Treas. 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.

14

Section 743(b)

Partnership’s Sample Statement

[Partnership Name][Partnership Address][Partnership City], [Partnership State] [ZIP Code]

Identification Number: [Fed. ID#]

As required by Treas. 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]

15

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 Treas. 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]

16

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 Treas. 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]

17

Section 743(b)

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

* Based on a hypothetical sale and liquidation for FMV

18

Section 743(b)

Overview

• 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.

19

Section 755

Allocation of the Section 743(b) Basis Adjustment

• 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

20

Section 743(b)

Allocation of the 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. Treas. Reg. § 1.743-1(d)

• Step 3 - Allocate the basis adjustment first, to the ordinary income class, and the excess to the capital asset class. Treas. Reg. § 1.755-1(b)(2)

• Step 4 - Allocate the adjustment within the class. Treas. Reg. § 1.755-1(b)(3)− Allocate basis adjustment between and among classes using a hypothetical

sale approach

21

Section 743(b)

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 exceeds by more than $250,000 the fair

market value of such property, or− Transferee partner would be allocated a loss of more than $250,000 if

the partnership assets were sold for cash equal to their fair market value immediately after such transfer.

• Exceptions:− Securitization Partnerships− Electing Investment Partnerships

22

Section 743(b)

Considerations

• 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

23

Section 743(b) Example #1: Sale of partnership interest

25

A

PS

B

Property 1*

FMV $100M Basis $40M

Cash

$100M

*$10 §1245 depreciation

A and B form a partnership (PS) each receiving a 50% interest in PS in exchange for the following:• A transfers Property 1 with a $100 FMV and $40 basis

− Assume Property 1 has previous depreciation of $10 under §1245

• B transfers $100 of cash

Section 734(b)

Distributions of property to partners

• Distributee recognizes section 731(a)(1) gain− Money > partner’s outside basis

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

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

26

$100 PS Interest

Example#1 : Sale of partnership interest (cont.)

A

PS

B

50% 50%

C $100 cash C

PS

B

50% 50%

A sells 50% interest to C Post-sale structure

*$10 §1245 depreciation

Assume PS makes a §754 election

Property 1*

FMV $100M Basis $40M

$100Property 1*

FMV $100M Basis $40M

$100

27

Example #1: Sale of partnership interest (cont.)

C steps into the shoes of A’s $60 §704(c) gain in Property 1

C also inherits A’s $100 §704(b) capital account

C receives a $60 §743(b) basis adjustment attributable to its share of gain in Property 1

The $60 basis adjustment is treated as a new asset placed in service on the date of purchase

C’s basis in its PS interest and share of basis in PS assets both equal $100, eliminating any basis disparity

C

PS

B

50% 50%

Post-sale structure

Property 1*

FMV $100M Basis $40M

$100

28

Example #1: Sale of partnership interest (cont.)

C’s Basis in PS InterestPurchase price 100Plus share of partnership liabilities 0C’s Basis in PS interest 100

C’s Share of Inside BasisCash received in hypothetical liquidation 100Plus hypothetical allocated loss 0Less hypothetical allocated gain 60Previously Taxed Capital 40Plus share of partnership liabilities 0C’s Share of Inside Basis 40

Section 743(b) Basis AdjustmentC’s Basis in PS interest 100Less C’s Share of Inside basis 40Section 743(b) Basis Adjustment 60

Note: The §743(b) adjustment may not equal share of gain/loss. Imperative to use the formula in Reg. §1.743-1.

Allocation of the §743(b) adjustment is determined under §755 and the accompanying regulations.

29

Section 734(b)

Distributions of property to partners

• Distributee recognizes loss under section 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. Section 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.Section 734(b)(2)(B)

30

Section 734(b)Allocation of basis adjustment

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

• Use a section 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 section 731(a)(1) gain or section 731(a)(2) loss

31

Section 734Mandatory basis adjustments

• Basis adjustments under section 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 section 754 were in effect

• Exception:− Securitization partnerships

32

Section 734(b)Example #2

• 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).

33

AssetsCash $11,000

Property

FMV $22,000AB $19,000

ABC

FMV $11,000 AB $10,000

FMV $11,000AB $10,000

CA B

FMV $11,000AB $10,000Cash

$11,000

Section 734(b)Example #2 (cont.)

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

34

AssetsProperty

FMV $22,000AB $20,000

ABC

FMV $11,000AB $10,000

CB

FMV $11,000AB $10,000

Section 734(b)Example #2 (cont.)

• 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:

35

AssetsProperty

FMV $22,000AB $20,000

ABC

FMV $11,000AB $10,000

CB

FMV $11,000AB $10,000

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 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

Section 734(b)Example #3

• 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).

36

AssetsCash $4,000

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

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

DEF

FMV $11,000 AB $10,000

FMV $11,000AB $10,000

FD E

FMV $11,000AB $10,000Property X

FMV $11,000AB $11,000

Section 734(b)Example #3 (cont.)

• 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).

37

AssetsCash $4,000

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

EF

FMV $11,000AB $10,000

FE

FMV $11,000AB $10,000

Section 754Foreign Partnerships

• Form 1065 filing requirement. Treas. Reg. § 1.6031(a)-1(b)(5) provides the following:− Certain partnership elections. For a partnership that is not otherwise

required to file a partnership return, if an election that can only be made by the partnership under section 703 (affecting the computation of taxable income derived from a partnership) is to be made by or for the partnership, a return on the form prescribed for the partnership return must be filed for the partnership. Unless otherwise provided in the form or the accompanying instructions, a return filed solely to make an election need only contain a written statement citing paragraph (b)(5)(ii) of this section, listing the name and address of the partnership making the election, and clearly identifying the specific election being made.

38

Section 754Foreign Partnerships

• Treas. Reg. § 1.6031(a)-1(b)(5) continues to provide the following:− A return filed under paragraph (b)(5)(ii) of this section solely to make an

election is not a partnership return. Thus, such a return is not a return filed under section 6031(a) for purposes of sections 6501 (except regarding the specific election issue), 6231(a)(1)(A), and 6233. The return must be signed by— (i) Each partner that is a partner in the partnership at the time the election is made; or (ii) Any partner of the partnership who is authorized (under local law or the partnership’s organizational documents) to make the election and who represents to having such authorization under penalties of perjury.

39

Relief under Treas. Reg. § 301.9100

40

Treas. Reg. § 301.9100 ReliefMissed Elections

• 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

41

Treas. Reg. § 301.9100-2Automatic Relief

• 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.

42

Treas. Reg. § 301.9100-3Discretionary Relief

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

• Private Letter Ruling (PLR) request is required. (Note: Although IRC section 754 requires “the partnership” to file the section 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. 2020-1 (Appendix C) for check list of all requirements (updated each year).

43

Discretionary relief under Treas. Reg. §301.9100-3

44

Treas. Reg. § 301.9100-3Two-Part Substantive Test for Non-Automatic, Discretionary Relief

• Treas. 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 Treas. 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.)

45

Treas. Reg. § 301.9100-3Establishing “Reasonable Action and Good Faith” in the PLR Request - 5 Positive Benchmarks

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.

46

Treas. Reg. § 301.9100-3Establishing “Reasonable Action and Good Faith” - the 3 Negative Benchmarks (really “exceptions”)

Treas. Reg. § 301.9100-3(b)(3) sets forth 3 situations in which taxpayer will be “deemed to have not acted reasonably and in good faith.” Courts treat these as “exceptions” to relief, where taxpayer satisfies one or more of the 5 positive benchmarks.

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 section 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.

47

Treas. Reg. § 301.9100-3Disjunctive Application of Positive and Negative Criteria

• 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 Treas. 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.

48

Remedies for correcting defective or invalid elections after the filing year

50

Treas. Reg. § 301.9100-3Strict Application of Disjunctive Criteria in showing “Reasonable Action and Good Faith”

• 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 section 754.

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

51

Treas. Reg. § 301.9100-3Taxpayer Requests Relief Before Failure to Make Election is Discovered by IRS

• The 1st positive benchmark listed in Treas. Reg. § 301.9100-3(b)(1) is when taxpayer requests relief before the failure to elect is discovered by the IRS.

• Example 1 in Treas. 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 Treas. Reg. § 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 taxpayer was relying on hindsight—a negative benchmark.

52

Treas. Reg. § 301.9100-3Taxpayer’s Unawareness of Necessity of Section 754 Election

• The 3rd positive benchmark in Treas. 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 section 754 election despite reasonable diligence on the taxpayer’s part. (Cannot be willfully blind.)

53

Treas. Reg. § 301.9100-3Reasonable Reliance on Written Advice of IRS• The 4th positive benchmark listed in Treas. 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 section 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 section 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.

54

Treas. Reg. § 301.9100-3Reasonable Reliance on Qualified Tax Professional• The 5th positive benchmark in Treas. 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 section 754 election, and (2) to advise taxpayer of opportunity to make the section 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. (Treas. 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.

55

Treas. Reg. § 301.9100-31st Exception • 1st Exception: Where Taxpayer seeks to alter a tax return position for which an accuracy

related penalty has been or could be imposed

• 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 section 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 section 754 election). Treas. Reg. § 301.9100-3(b)(3)(i).

• The accuracy related penalty under section 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 section 754. If the IRS has already asserted a penalty under section 6662, then the exception applies, and no discretionary relief will be granted for failure to timely elect section 754.

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Treas. Reg. § 301.9100-32nd Exception • 2nd Exception: Taxpayer was sufficiently informed and Simply Chose Not To Elect

• 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[.]” Treas. 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 section 9100 Regs, upon which the Regs are largely based), but outcome would be same under Treas. Reg. § 301.9100-3.

− Partner in partnership died; no section 754 election was made. Later, application for discretionary relief was made, but denied by IRS.

− IRS found partnership’s CPA did not make the section 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 partnership property). IRS also found it took partnership over 3 months to request relief once failure to elect section 754 was discovered, suggesting that partnership never intended to make the election, and that CPA decided it was “not worth pursuing.” Relief denied.

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Treas. Reg. § 301.9100-33rd Exception • 3rd Exception: Taxpayer Uses “Hindsight” in requesting relief

• 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 section 754 election).

• Par. (b)(3)(iii) of Treas. Reg. § 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 taxpayer 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).

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Treas. Reg. § 301.9100-33rd Exception “hindsight” • IRS has often denied PLR relief on basis that “hindsight” was used where partnership assets

were sold

• PLR 8817082: IRS denied taxpayer’s request for a PLR to extend time to make a section 754 election because, among other things, the partnership’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 section 754 election. Executor of X’s estate later learned about benefit of election, and directed partnership to seek discretionary relief under the predecessor to Treas. Reg. § 301.9100-3. IRS, however, refused to grant an extension of time to elect section 754 because the partnership’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 section 754 election takes a snapshot of the partnership’s assets’ bases and the value of the partnership interests on the date of the triggering property distribution or transfer of the partnership interest?

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

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Treas. Reg. § 301.9100-33rd Exception “hindsight” (cont.)• Objective opportunity for Using Hindsight in section 754 Election as compared to section

475(f) Election

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

− section 754 does not create trigger a conversion of capital losses into ordinary losses,

− section 754 does not create a taxable event

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

• Arguably, the section 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.

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Treas. Reg. § 301.9100-3Section 754

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

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

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

• Drawbacks to section 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 partnership interest would reduce decedent’s share of inside basis of partnership 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 section 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!

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Treas. Reg. § 301.9100-3Section 754

• Consider the absence of both objective opportunity and taxpayer’s subjective intent, to qualify for hindsight in electing section 754

• Given the number of PLRs that have denied taxpayer’s request to extend the time for electing 754 under Treas. Reg. § 301-9100-3 (especially when partnership assets are sold), consider the impact of both objective opportunity and taxpayer’s subjective intent

1. The section 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 section 754 election (because, for example, taxpayer did not know of election’s availability or significance).

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Treas. Reg. § 301.9100-3Section 754

• IRS recently granted taxpayer PLR Request for more time to Elect section 754 (although partnership assets had been sold)

− PLR 109101-17

− Background facts: Involved complex tiered partnership structure, and a trust; 3 partners, including H & W; one partner died; taxpayer’s tax advisors failed to both make and inform surviving partner of opportunity to elect section 754; however, partner and partnership 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

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Treas. Reg. § 301.9100-3Section 754

• IRS recently granted taxpayer PLR Request for more time to Elect section 754 (although partnership assets had been sold)

− In requesting relief in PLR 109101-17 (et seq.) taxpayer 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 taxpayer 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 the fact that there was neither any objective opportunity in a section 754 election to use “hindsight” (distinguishing other mark-to-market/ section 475(f) election cases), and regardless, taxpayer had no subjective opportunity to use hindsight because he did not know what a section 754 election was, and his tax advisors failed both to tell him or make the election.

Facts surrounding death of partner/spouse (triggered right to election under section 754).

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Treas. Reg. § 301.9100-3Section 754

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

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

− This is 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].

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Treas. Reg. § 301.9100-3Section 754

• Govt’s Interests Cannot be Prejudiced by a Reasonable Extension of Time

− “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.” Treas. Reg. § 301.9100-3(c)(1)(i).

− But note: Inquiry is not whether a partner(s) would save money from having the section 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 section 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.

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Treas. Reg. § 301.9100-3Section 754

• Independent Auditor to help prove that Extension of Time would not be Prejudicial to IRS (cont.)

− IRS may condition grant of relief on taxpayer 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 sections 743(b), 734(b), and 754 would be well served if extension is granted.

− In cases where a co-partner dies, and partnership interest passes via his estate to a surviving beneficiary partner, the tax policy of section 1014(a) (and in community property states, the policy of section 1014(b)(6), imputing a “transfer” of surviving spouse’s property for purposes of section 743(b)) would be undermined if section 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.

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Treas. Reg. § 301.9100-3Section 754

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

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

− The section 6501(a) limitations period is not suspended by a request for section Treas. Reg. § 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. Treas. Reg. § 301.9100-3(d)(2).

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

• Request for relief under Treas. 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. 2020-1 (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”

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Treas. Reg. § 301.9100-3Procedures for Requesting Relief i.e., a Private Letter Ruling (cont.)

• 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. 2020-1 (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 taxpayer is relying on fact that tax professional failed to advise taxpayer of the section 754 election, or failed to timely elect section 754, should also include the professional’s affidavit admitting his/her or the CPA firm’s failure.

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Treas. Reg. § 301.9100-3Procedures for Requesting Relief i.e., a Private Letter Ruling (cont.)

• Rev. Proc. 2020-1 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 section 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.

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Treas. Reg. § 301.9100-3Procedures for Requesting Relief i.e., a Private Letter Ruling (cont.)

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. 2020):

– Currently, one missed election = $10,900

– If multiple requests with identical fact patterns, additional missed elections are $3,000 each.

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

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Treas. Reg. § 301.9100-3Judicial Review

• There is no separate, “stand alone” right to judicial review of a denial of non-automatic relief, sought by a taxpayer under Treas. 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 section 754, taxpayer can challenge that IRS denial in a tax deficiency procedure in court.

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

• In the tax refund context, however, Court of Federal Claims has held that a taxpayer cannot raise section 9100 relief for the first time under the “substantial variance doctrine,” which requires a taxpayer to first present all arguments administratively.

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Revocation of a Section 754 Election

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

• 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.

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

• Types of situations that may be grounds for approval of a revocation application:− A change in the nature of the partnership business;

− A substantial increase in the assets of the partnership;− A change in the character of partnership assets; and

− An increased frequency of retirements or shifts of partnership interests, thereby increasing the administrative burden of the election.

• Where to file:− File at IRS Submission Processing Center where partnership's return is filed

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Hot Topics

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Hot Topics Reporting Changes

• Tax basis capital reporting. Item L and Box 20AH.

− Positive tax basis capital reporting postponed until 2020 under Notice 2019-66.

• Section 704(c)

– Net unrecognized section 704(c) gain or loss. Item N.

– Section 704(c) information. Box 20AA.

• Section 743(b) separate reporting. Box 11F for net increases and Box 13V for net decreases.

• Guaranteed payments are on three lines (services, capital, and total). Line 4, and page 2, line 4.

• More than one activity for at-risk activity purposes. Line 21.

• More than one activity for passive activity purposes. Line 22.

• Section 199A deduction. Box 20Z.

• Section 751(c) gain (loss). Box 20AB.

• Excess business losses under section 461(l).

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