On March 31, 2021, the White House released a factsheet describing the “American Jobs Plan”, a $2.3 trillion proposal for infrastructure spending that also contains certain significant tax credits, and the “Made in America Tax Plan”, a tax proposal that would generate revenue to pay for the American Jobs Plan

On January 7, 2021, the Internal Revenue Service (the “IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued final regulations[1] (the “Final Regulations”) providing guidance on Section 1061 of the Internal Revenue Code (the “Code”).[2] The Final Regulations modify the proposed regulations[3] (the “Proposed Regulations”) that were released in July of 2020. We previously discussed the Proposed Regulations with a series of “Key Takeaways” in our client alert published here. This post highlights certain changes made to the Proposed Regulations, and certain important provisions of the Proposed Regulations that remain unchanged in the Final Regulations.

On November 17, 2020, the U.S. Internal Revenue Service (“IRS”) posted new FAQs providing that an acquisition of the stock or assets of a company that has received a loan under the Paycheck Protection Program (the “PPP”) generally will not cause the acquirer and members of its aggregated employer group

On October 7, 2020, the U.S. Internal Revenue Service (“IRS”) and Treasury Department released final regulations[1] providing guidance on the rules imposing withholding and reporting requirements under the Code[2] on dispositions of certain partnership interests by non-U.S. persons (the “Final Regulations”). The Final Regulations expand and modify proposed regulations[3] that were published on May 13, 2019 (the “Proposed Regulations”), and which we described in a prior Tax Talks post.[4] Unless otherwise specified, this post focuses on the differences between the Proposed Regulations and the Final Regulations affecting transfers of interests in non-publicly traded partnerships.

Enacted as part of the “Tax Cuts and Jobs Act,” Section 1446(f) generally requires a transferee, in connection with the disposition of a partnership interest by a non-U.S. person, to withhold and remit ten percent of the “amount realized” by the transferor, if any portion of any gain realized by the transferor on the disposition would be treated under Section 864(c)(8) as effectively connected with the conduct of a trade or business in the United States (“Section 1446(f) Withholding”).[5]

Prior to issuing the Proposed Regulations, the IRS had issued Notice 2018-08 and Notice 2018-29 to provide interim guidance with respect to Section 1446(f) Withholding.

On June 24, 2020, the Internal Revenue Service (the “IRS”) and the U.S. Department of Treasury (“Treasury”) issued final regulations (the “Final Regulations”) on the application of the “passthrough deduction” under Section 199A[1] to regulated investment companies (“RICs”) that receive dividends from real estate investment trusts (“REITs”). The Final Regulations broadly allow a “conduit” approach, through which RIC shareholders who would have been able to benefit from the deduction on a dividend directly received from a REIT can take the deduction on their share of such dividend received by the RIC, so long as the shareholders meet the holding period requirements for their shares in the RIC. This confirms the approach of proposed regulations issued in February 2019 (the “Proposed Regulations”), on which RICs and their shareholders were already able to rely. Additionally, the preamble to the Final Regulations (the “Preamble”) notes that the IRS and Treasury continue to decline to extend conduit treatment to qualified publicly traded partnership (“PTP”) income otherwise eligible for the deduction. Please read the remainder of this post for background, a description of the technical provisions of the Final Regulations, and a brief discussion of policy issues discussed in the Preamble.

On December 19, 2019, the Internal Revenue Service (the “IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued final regulations (the “Final Regulations”) under section 1400Z-2 of the Internal Revenue Code[1] regarding the opportunity zone program, which was enacted as part of the law commonly referred to as the “Tax Cuts and Jobs Act”.[2] The opportunity zone program is designed to encourage investment in distressed communities designated as “qualified opportunity zones” (“opportunity zones”) by providing tax incentives to invest in “qualified opportunity funds” (“QOFs”) that, in turn, invest directly or indirectly in the opportunity zones.

The opportunity zone statute left many uncertainties regarding the fundamental operations of the opportunity zone program. The IRS and Treasury issued two sets of proposed regulations under section 1400Z-2 in October 2018 and April 2019 (the “Proposed Regulations”). The Proposed Regulations were discussed in two of our earlier blog posts, found here and here. The Final Regulations address the many comments received in response to the Proposed Regulations and retain the basic approach and structure set forth in the Proposed Regulations, but include clarifications and modifications to the Proposed Regulations. The Final Regulations are generally taxpayer-favorable, and incorporate many of the provisions requested by commentators. However, there are certain provisions that are worse for taxpayers than under the Proposed Regulations.

The Final Regulations will be effective on March 13, 2020, and are generally applicable to taxable years beginning after that date. For the portion of a taxpayer’s first taxable year ending after December 21, 2017 that began on December 22, 2017, and for taxable years beginning after December 21, 2017 and on or before March 13, 2020, taxpayers and QOFs generally may choose to apply the Final Regulations or the Proposed Regulations, so long as, in each case, they are applied consistently and in their entirety.

This blog summarizes some of the important aspects of the Final Regulations. It assumes familiarity with the opportunity zone program.

Summary

This section lists some of the most important changes in the Final Regulations.

  •  All gain on the sale of a QOF interest or underlying assets after 10 years is excluded, other than gain from ordinary course sales of inventory. The Proposed Regulations provided that if a taxpayer held an interest in a QOF for at least 10 years, then upon a sale of the QOF, all gain could be excluded, including any gain attributable to depreciation recapture or ordinary income assets. The Proposed Regulations also permitted an investor that held a qualifying interest in a QOF partnership or S corporation for at least 10 years to elect to exclude capital gains (but not other gains) realized by the QOF partnership or S corporation on the sale of underlying qualified opportunity zone property. The Final Regulations very helpfully provide that an investor that has held a qualifying interest in a QOF for at least 10 years may elect to exclude all gain realized upon its sale of an interest in a QOF as well as all gain realized upon the sale of assets by the QOF or a lower-tier partnership or S corporation QOZB, except to the extent the gain arises from the sale of inventory in the ordinary course of business.
  • Eligible gain includes gross section 1231 gain, and not net section 1231 gain. Section 1231 gains and losses generally arise when a taxpayer disposes of depreciable or real property that is used in the taxpayer’s trade or business and held for more than one year. The portion of any section 1231 gain that reflects accelerated appreciation is “recaptured” under sections 1245 or 1250 and is treated as ordinary income. If, at the end of the taxable year, the taxpayer has net section 1231 gains, then all section 1231 gains and losses are treated as long-term capital gains and losses. Alternatively, if, at the end of the taxable year, the taxpayer’s section 1231 losses equal or exceed its section 1231 gains, then all of the taxpayer’s section 1231 gains and losses are treated as ordinary income and losses. The Proposed Regulations provided that only net section 1231 gain would be eligible for deferral under section 1400Z2-(a)(1) (i.e., only section 1231 gain that would be characterized as long-term capital gain after the netting process had been completed). The Final Regulations very helpfully provide that eligible gains include gross section 1231 gains (other than section 1231 gain that is recaptured and treated as ordinary income under sections 1245 or 1250) unreduced by section 1231 losses.
  • New 62-month working capital safe harbor. The Proposed Regulations included a working capital safe harbor that permitted a QOZB that acquires, constructs, and/or substantially rehabilitates tangible business property to treat cash, cash equivalents and debt instruments with a term of 18 months or less as a reasonable amount of working capital for a period of up to 31 months if certain requirements are satisfied. The Final Regulations provide that tangible property may benefit from an additional 31-month safe harbor period, for a maximum of 62 months, in the form of either overlapping or sequential applications of the working capital safe harbor. To qualify for the 62-month safe harbor, the business must receive multiple non-de minimis cash infusions during each 31-month safe harbor period, and the subsequence cash infusion must form an integral part of the plan covered by the first working capital safe harbor.
  • Triple-net-lease. The Final Regulations contain an example concluding that a QOZB that owns a three-story mixed-use building, and (i) leases one floor of the building under a triple-net-lease, (ii) leases the other two floors under leases that are not triple-net-leases, and (iii) has employees with offices located in the building who meaningfully participate in the management and operations of building, is engaged in an active trade or business with respect to the entire leased building solely for purposes of the opportunity zone trade or business requirement. While this example is helpful because it confirms that a portion of an active trade or business may consist of a triple-net-lease, it leaves unanswered what level of activity is necessary for a real property rental business to qualify as a trade or business for purposes of the opportunity zone rules.
  • Asset aggregation approach for determining substantial improvement. In order for non-original use tangible property to be treated as zone business property, it must be “substantially improved”, which generally requires an original use investment of an amount at least equal to the property’s purchase price. For purposes of determining whether non-original use tangible property purchased by a QOZB has been substantially improved, the Final Regulations permit certain original use assets used in the same trade or business as the non-original use property and that improve the functionality of the non-original use property, to be counted for purposes of the substantial improvement test.  For example, a QOF that intends to substantially improve a hotel may now count the cost of mattresses, linens, furniture, and electronic equipment for purposes of the substantial improvement test.
  • Partnership interests valued at fair market value for purposes of the 90% test. For purposes of the 90% test, the Final Regulations require an asset that has a tax basis not based on cost, such as a partnership interest or other intangible asset, to be valued at its fair market value (rather than the unadjusted cost basis).  Accordingly, the fair market value of a carried interest or even a QOZB partnership must be re-determined at each semi-annual testing date.
  • Sin Businesses. The Final Regulations prohibit a QOZB from leasing more than a de minimis amount of its property to a sin business, but also provide that de minimis amounts of gross income (i.e., less than 5% of gross income) attributable to a sin business will not cause the business to fail to be a QOZB (e.g., a hotel with a spa that offers massage services).
  •  Tangible property that ceases to be zone business property.  The statute contains a special rule pursuant to which tangible property that ceases to be zone business property will nonetheless continue to be treated as such for the lesser of: (1) five years after the date such property ceases to be qualified as zone business property; and (2) the date on which the tangible property is no longer held by the zone business. The Final Regulations prohibit a QOZB from relying on this rule unless the zone business property was used by a QOZB in a QOZ for at least two years not counting any period during which the property was being substantially improved or covered by the working capital safe harbor.
  • Expanded anti-abuse rule. The Proposed Regulations included a general anti-abuse rule under which the IRS has broad discretion to disregard or recharacterize any transaction if, based on the facts and circumstances, a significant purpose of the transaction is to achieve tax results inconsistent with the purposes of section 1400Z-2. However, the Proposed Regulations did not explain the purposes of section 1400Z-2. The Final Regulations state that the purposes of section 1400Z-2 are (i) to provide specified tax benefits to owners of QOFs to encourage the making of longer-term investments, through QOFs and QOZBs, of new capital in one or more opportunity zones and (ii) to increase the economic growth of opportunity zones, and include seven new examples illustrating the application of the anti-abuse rule. These examples demonstrate that acquiring land with a significant purpose of selling it at a profit is abusive

On October 2, 2019, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued Revenue Produce 2019-40 (the “Revenue Procedure”) and proposed regulations (the “Proposed Regulations”) that provide guidance on issues that have arisen as a result of the repeal of section 958(b)(4) by the tax reform act of 2017.[1] The repeal of section 958(b)(4) was intended to prevent certain taxpayers from “de-controlling” their controlled foreign corporations (“CFCs”) and avoid paying current tax on earnings of those CFCs. However, the repeal has inadvertently caused a number of foreign corporations to be treated as CFCs for U.S. federal income tax purposes. As a result, U.S. persons who directly or indirectly own between 10% and 50% of the voting stock or value of foreign corporations that are now treated as CFCs are subject to tax on income (“subpart F income”) and 951A (globally intangible low-taxed income, or “GILTI”). The repeal has had other unintended consequences. For example, if a foreign corporation receives U.S.-source interest from a related person, the repeal of section 958(b)(4) may cause the interest to be subject to U.S. withholding tax (i.e., the interest would fail to qualify for the “portfolio interest exemption”).[2]

The Proposed Regulations “turn off” certain special rules that arise solely as a result of the repeal of section 958(b)(4). However, the Proposed Regulations do not prevent foreign corporations from being treated as CFCs as a result of the repeal of section 958(b)(4), do not limit the subpart F or GILTI income required to be reported as a result of the repeal of section 958(b)(4), and do not reinstate the portfolio interest exemption for foreign corporations affected by the repeal of section 958(b)(4).

The Revenue Procedure provides safe harbors for certain U.S. persons to determine whether they own stock in a CFC and to use alternative information to determine their taxable income with respect to foreign corporations that are CFCs solely as a result of the repeal of section 958(b)(4) if they are unable to obtain information to report these amounts with more accuracy.

The Proposed Regulations are generally proposed to apply on or after October 1, 2019. However, a taxpayer may rely on the Proposed Regulations for taxable years prior to the date they are finalized. The Revenue Procedure is effective for the last taxable year of a foreign corporation beginning before January 1, 2019.

The first official guidance on the taxation of cryptocurrency transactions in more than five years has been issued.

The guidance includes both a Revenue Ruling (Rev. Rul. 2019-24, 2019-44 I.R.B. 1) and answers to Frequently Asked Questions on Virtual Currency Transactions (the “FAQs,” together with Revenue Ruling 2019-24, the “Guidance”) was issued on October 9, 2019 by the U.S. Internal Revenue Service (the “IRS”).  The Guidance provides much sought information concerning the tax consequences of cryptocurrency “hard forks” as well as acceptable methods of determining tax basis for cryptocurrency transactions.  The Guidance also reasserts the IRS’s position, announced in Notice 2014-21, 2014-16 I.R.B. 938, that cryptocurrency is “property” for U.S. federal income tax purposes and provides information on how the rules generally applicable to transactions in property apply in the cryptocurrency context.  However, important questions remain unanswered.  It remains to be seen whether more definitive regulatory or administrative guidance is forthcoming.

The Guidance comes amidst an ongoing campaign by the IRS to increase taxpayer compliance with tax and information reporting obligations in connection with cryptocurrency transactions.  In 2017, a U.S. district court ordered a prominent cryptocurrency exchange platform to turn over information pertaining to thousands of account holders and millions of transactions to the IRS as part of its investigation into suspected widespread underreporting of income related to cryptocurrency transactions.  Earlier this year, the IRS sent more than 10,000 “educational letters” to taxpayers identified as having virtual currency accounts, alerting them to their tax and information reporting obligations and, in certain cases, instructing them to respond with appropriate information or face possible examination.  Schedule 1 of the draft Form 1040 for 2019, released by the IRS shortly after publishing the Guidance, would require taxpayers to indicate whether they received, sold, sent, exchanged, or otherwise acquired virtual currency at any time during 2019.[1]

Taxpayers who own or transact in cryptocurrency or other virtual currency should consider carefully any tax and information reporting obligations they might have.  Please contact the authors of this post or your usual Proskauer tax contact to discuss any aspect of the Guidance.  Read the following post for background and a detailed discussion of the Guidance.

The U.S. tax authorities have issued substantial guidance related to the phase-out of LIBOR – relevant to lenders, borrowers and parties to financial instruments of virtually every type.

In proposed regulations (“the Proposed Regulations”) released on October 9, 2019, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury (the “Treasury”) addressed market concerns regarding the U.S. tax effect of the expected transition from LIBOR and other interbank offered rates (“IBORs”) on debt instruments (e.g., loans, notes and bonds) and non-debt contracts (e.g., swaps and other derivatives). The key tax concern to date has been whether the replacement of an IBOR-reference rate in a debt instrument or non-debt contract with a different reference rate would result in a taxable exchange of the debt instrument or contract, potentially triggering a current U.S. tax liability to one or more of the parties.

The core of the Proposed Regulations provide some comfort – they detail the requirements for the rate replacement to not result in a taxable event (either in respect of the instrument itself or to certain integrated hedging transactions). The Proposed Regulations also contain transition guidance on other matters potentially impacted by the rate change, such as maintenance of REMIC status and the calculation of interest expense of a foreign bank with a U.S. branch.

While the Proposed Regulations are broadly taxpayer favorable – and indeed draw heavily on input from the Alternative Reference Rates Committee (“ARRC”),[1] which was charged with facilitating voluntary acceptance of alternative reference rates, as well as comments from other industry groups – their scope is limited enough that affected taxpayers should take care to ensure that amendments to their loans and other financial instruments are tailored to conform to the Proposed Regulations. In particular, in order to avoid a taxable event, affected taxpayers substituting an IBOR-referencing rate for a new rate, such as SOFR, will need to satisfy several tests, including a test of whether the fair market value of the affected loan or financial instrument is substantially equivalent both before and after the rate is changed, taking into account any lump-sum payment made.

Taxpayers may generally rely on the Proposed Regulations until final regulations are published, provided that the rules are applied consistently by taxpayers and their related parties. Read the rest of this post for background on the LIBOR transition, and a more complete description of the Proposed Regulations. Please contact any of the authors listed above or your usual Proskauer contact to discuss any aspect of the Proposed Regulations applicable to your specific circumstances.

On September 10, 2019, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued proposed regulations (the “Proposed Regulations”) on calculation of built-in gains and losses under Section 382(h) of the Internal Revenue Code of 1986, as amended.[1] In general, the Proposed Regulations replace the existing guidance on the calculation of net unrealized built-in gains (“NUBIG”), net unrealized built-in losses (“NUBIL”), realized built-in gains (“RBIG”) and realized built-in losses (“RBIL”) under Section 382(h). This guidance had largely taken the form of Notice 2003-65[2] (the “Notice”), which had been the key authority relied upon by taxpayers for purposes of the various calculations required under Section 382(h).

By eliminating the Notice’s 338 Approach and by making certain other changes, the Proposed Regulations, if finalized in their current form, could significantly cut back on a loss corporation’s ability to use pre-change losses and therefore could substantially diminish the valuation of this tax asset in M&A transactions and could hamper reorganizations of distressed companies. In fact, these proposed changes could put more pressure on companies in bankruptcy to attempt to qualify for the benefits of Section 382(l)(5) or to engage in a “Brunos-like” taxable restructuring transaction, and, when those options are not available, could lead to more liquidations rather than restructurings.

The Proposed Regulations are another factor in a series of changes and circumstances that affect the value of tax assets such as net operating losses for corporations. Both the current low applicable federal long-term tax-exempt rate (1.77% for October 2019)—which creates relatively small Section 382 limitations—and the new rule from the 2017 tax reform that limits the usability of net operating losses arising in tax years beginning after December 31, 2017 to 80% of taxable income are developments that, in conjunction with the Proposed Regulations, put downward pressure on the expected value of this tax asset.

The Proposed Regulations are not effective until they are adopted as final regulations and published in the Federal Register, and will apply only with respect to ownership changes occurring after their finalization. Until that happens, taxpayers may continue to rely on the Notice for calculations of NUBIG, NUBIL, RBIG and RBIL.