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IRS Targets Eight Regulations in Attempt to Reduce Regulatory Burden

(Parker Tax Publishing July 2017)

In furtherance of Executive Order 13789, the Treasury Secretary has identified eight tax-related regulations that will be evaluated for possible amendment or repeal. Included in the eight regulations are (1) the temporary partnership liability regulations under Code Sec. 752, which significantly changed the rules relating to partnership disguised sales and the allocation of partnership liabilities; (2) the proposed regulations under Code Sec. 2704, which would impose major restrictions on valuation discount planning for transfers among family members of interests in family owned businesses; and (3) the final and temporary regulations under Code Sec. 385, which were a dramatic deviation from decades of debt/equity law. Notice 2017-38.

Background

On April 21, 2017, President Trump issued Executive Order (EO) 13789, a directive designed to reduce tax regulatory burdens. The order instructed the Secretary of the Treasury to review all "significant tax regulations" issued on or after January 1, 2016, and submit two reports, followed promptly by concrete action to alleviate the burdens of regulations that meet the criteria outlined in the order. Specifically, Section 2 of EO 13789 directed the Treasury Secretary to submit a 60-day interim report identifying regulations that meet the following criteria:

(1) they impose an undue financial burden on U.S. taxpayers;

(2) they add undue complexity to the federal tax laws; or

(3) they exceed the statutory authority of the IRS.

The order further instructs the Treasury Secretary to submit a final report to the President by September 18, 2017, recommending specific actions to mitigate the burden imposed by regulations identified in the interim report.

Scope of the Treasury Department's Review

From January 1, 2016, through April 21, 2017, the IRS issued 105 temporary, proposed, and final regulations. According to the Treasury Secretary, 53 of the 105 regulations issued during the relevant review period are minor or technical in nature and generated minimal public comment. To ensure a comprehensive review, the Treasury Department treated the remaining 52 regulations as potentially significant and reexamined all of them for the purpose of formulating the interim report. Based on that reexamination, the Treasury Department identified regulations that meet the criteria of the President's order and qualify as significant in view of the Presidential priorities for tax regulations outlined in EO 13789.

The Treasury Department has concluded that the following eight regulations meet at least one of the first two criteria specified by Section 2 of EO 13789. Consistent with the order, the Treasury Department intends to propose reforms - potentially ranging from streamlining problematic rule provisions to full repeal - to mitigate the burdens of these regulations in a final report submitted to the President.

Temporary Regulations under Section 752 on Liabilities Recognized as Recourse Partnership Liabilities (T.D. 9788)

These temporary regulations generally provide:

(1) rules for how liabilities are allocated under Section 752 solely for purposes of disguised sales under Code Sec. 707; and

(2) rules for determining whether "bottom-dollar payment obligations" provide the necessary "economic risk of loss" to be taken into account as a recourse liability.

Practitioners said that the first rule was novel and would unduly limit the amount of partners' bases in their partnership interests for disguised sale purposes, which would negatively impact ordinary partnership transactions. Practitioners were also concerned that the bottom-dollar payment obligation rules would prevent many business transactions compared to the prior regulations and suggested their removal or the development of more permissive rules.

Proposed Regulations under Section 2704 on Restrictions on Liquidation of an Interest for Estate, Gift and Generation-Skipping Transfer Taxes (REG-16311302)

Code Sec. 2704(b) provides that certain noncommercial restrictions on the ability to dispose of or liquidate family-controlled entities should be disregarded in determining the fair market value of an interest in that entity for estate and gift tax purposes. These proposed regulations would create an additional category of restrictions that also would be disregarded in assessing the fair market value of an interest.

Practitioners expressed concern that the proposed regulations would eliminate or restrict common discounts, such as minority discounts and discounts for lack of marketability, which would result in increased valuations and transfer tax liability that would increase financial burdens. Practitioners were also concerned that the proposed regulations would make valuations more difficult and that the proposed narrowing of existing regulatory exceptions was arbitrary and capricious.

Final and Temporary Regulations under Section 385 on the Treatment of Certain Interests in Corporations as Stock or Indebtedness (T.D. 9790)

These final and temporary regulations address the classification of related-party debt as debt or equity for federal tax purposes. The regulations are primarily comprised of -

(1) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt among related parties to be treated as debt for federal tax purposes; and

(2) transactional rules that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result.

Practitioners criticized the financial burdens of compliance, particularly with respect to more ordinary course transactions and requested a longer delay in the effective date of the documentation rules. They also criticized the complexity associated with tracking multiple transactions through a group of companies and the increased tax burden imposed on inbound investments.

Proposed Regulations under Section 103 on Definition of Political Subdivision (REG-129067-15)

These proposed regulations define a "political subdivision" of a state (e.g., a city or county) that is eligible to issue tax-exempt bonds for governmental purposes under Code Sec. 103. The proposed regulations require a political subdivision to possess three attributes: (1) sovereign powers; (2) a governmental purpose; and (3) governmental control.

Practitioners said that the longstanding "sovereign powers" standard was settled law and had been endorsed by Congress, and additional limitations were unnecessary. Practitioners also argued that the proposed regulations would disrupt the status of numerous existing entities and that it would be burdensome and costly for issuers to revise their organizational structures to meet the new requirements of the proposed regulations.

Temporary Regulations under Section 337(d) on Certain Transfers of Property to Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs) (T.D. 9770)

These temporary regulations amend existing rules on transfers of property by C corporations to REITs and RICs generally. In addition, the regulations provide additional guidance relating to certain newly-enacted provisions of the Protecting Americans from Tax Hikes Act of 2015, which were intended to prevent certain spinoff transactions involving transfers of property by C corporations to REITs from qualifying for nonrecognition treatment.

Practitioners expressed concern that the REIT spinoff rules could result in over-inclusion of gain in some cases, particularly where a large corporation acquires a small corporation that engaged in a Code Sec. 355 spinoff and the large corporation subsequently makes a REIT election.

Final Regulations under Code Section 7602 on the Participation of a Person Described in Code Sec. 6103(n) in a Summons Interview (T.D. 9778)

These final regulations provide that persons described in Code Sec. 6103(n) and Reg. Sec. 301.6103(n)-1(a) with whom the IRS contracts for servicessuch as outside economists, engineers, consultants, or attorneysmay receive books, papers, records, or other data summoned by the IRS and, in the presence and under the guidance of an IRS officer or employee, participate fully in the interview of a person who the IRS has summoned as a witness to provide testimony under oath.

Practitioners objected to the IRS's ability to contract with outside attorneys and permit them to question witnesses under oath, and noted that the U.S. Senate Finance Committee approved legislation in 2016 that would prohibit the IRS from delegating to third-party contractors the authority under Code Sec. 7602.

Final Regulations under Section 987 on Income and Currency Gain or Loss With Respect to a Section 987 Qualified Business Unit (T.D. 9794)

These final regulations provide rules for (1) translating income from branch operations conducted in a currency different from the branch owner's functional currency into the owner's functional currency, (2) calculating foreign currency gain or loss with respect to the branch's financial assets and liabilities, and (3) recognizing such foreign currency gain or loss when the branch makes a transfer of any property to its owner.

Practitioners said that the transition rule in the final regulations imposes an undue financial burden on taxpayers because it disregards losses calculated by the taxpayer for years prior to the transition but not previously recognized. Practitioners also stated that the method prescribed by the final regulations for calculating foreign currency gain or loss was unduly complex and costly to comply with, particularly where the final regulations differ from financial accounting rules.

Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations (T.D. 9803)

Code Sec. 367 generally imposes immediate or future U.S. tax on transfers of property (tangible and intangible) to foreign corporations, subject to certain exceptions. These final regulations eliminate the ability of taxpayers under prior regulations to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income tax.

Practitioners complained that the final regulations would increase burdens by taxing transactions that were previously exempt, noting in particular that the legislative history to Code Sec. 367 contemplated an exception for outbound transfers of foreign goodwill and going concern value. Practitioners also argued that an exception should be provided for transfers of foreign goodwill and going concern value in circumstances that would not lead to an abuse of the exception.

Comments Requested

The Treasury Department and the IRS are requesting comments on whether the regulations described above should be rescinded or modified, and in the latter case, how the regulations should be modified in order to reduce burdens and complexity.

Comments from the public are due by August 7, 2017. Comments should be submitted to: Internal Revenue Service, CC:PA:LPD:PR (Notice 2017-38), Room 5205, P.O. Box 7604, Ben Franklin Station, Washington, DC 20224. Alternatively, comments may be hand-delivered Monday through Friday between the hours of 8:00 a.m. to 4:00 p.m. to: CC:PA:LPD:PR (Notice 2017-38), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC. Comments may also be submitted electronically via the following e-mail address: Notice.Comments@irscounsel.treas.gov. Commenters should include Notice 2017-38 in the subject line of any electronic submissions. Comments will be available for public inspection and copying.

Additionally, the IRS noted that in Notice 2017-28 it had invited public comment on recommendations for the 2017-2018 Priority Guidance Plan for tax rules and regulations, including recommendations relating to Executive Order 13777. The IRS said that taxpayers may submit recommendations for tax guidance at any time during the year.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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