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Monthly Archives: December 2012

IRS retroactively removes de minimis rule for testing partnership allocations

IRS has retroactively removed a de minimis rule in the partnership regs because it may have resulted in unintended tax consequences. The rule had provided that, for purposes of determining substantiality of a partnership allocation, the attributes of de minimis partners (those owning less than 10% of capital and profits and who are allocated less than 10% of each partnership item) need not be taken into account. IRS will study alternative approaches suggested by commentators.

Background. Under Code Sec. 705(b), a partner’s distributive share of income, gain, loss, deduction, or credit (or item thereof) is determined in accordance with the partner’s interest in the partnership (determined by taking into account all facts and circumstances) if the allocation to a partner under the partnership agreement of income, gain, loss, deduction, or credit (or item thereof) does not have substantial economic effect. The determination of whether an allocation of income, gain, loss, or deduction to a partner has substantial economic effect involves a two-part analysis that is made as of the end of the partnership tax year to which the allocation relates. (Reg. § 1.704-1(b)(2)(i)) (1) The allocation must have economic effect within the meaning of Reg. § 1.704-1(b)(2)(ii); and (2) the economic effect of the allocation must be substantial within the meaning of Reg. § 1.704-1(b)(2)(iii).

In general, for an allocation to have economic effect, it must be consistent with the underlying economic arrangement of the partners. This means that, if there is an economic benefit or burden that corresponds to the allocation, the partner to whom the allocation is made must receive such economic benefit or bear such economic burden. In general, the economic effect of an allocation (or allocations) is substantial if there is a reasonable possibility that the allocation (or allocations) will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences.

Removed de minimis partner rule. Under the de minimis partner rule, for purposes of applying the substantiality rules, the tax attributes of a de minimis partner did not need to be taken into account. A de minimis partner was any partner, including a lookthrough entity, that owned, directly or indirectly, less than 10% of the capital and profits of a partnership, and who is allocated less than 10% of each partnership item of income, gain, loss, deduction, and credit.

IRS says that commentators agreed with it that the de minimis partner rule was too broad, was easily abused, and/or was not consistent with sound tax policy. Accordingly, the rule has been removed from the final regs.

Alternative approaches. The preamble to the proposed regs requested comments on how to reduce the burden of complying with the substantial economic effect rules, with respect to lookthrough partners, without diminishing the safeguards the rules provide. In response to this request, IRS received a number of comments. Some commentators requested that future guidance in regs amend the de minimis rule, while others suggested alternative approaches for de minimis partners and look-through partners. IRS says it needs more time to consider these comments and may address them in future guidance.

Effective date. Whether an allocation is considered to be substantial is generally determined at the time the allocation becomes part of the partnership agreement. The final regs provide that the de minimis partner rule does not apply to allocations that become part of the partnership agreement on or after Dec. 28, 2012. (Reg. § 1.704-1(b)(2)(iii)(e)(1))

With respect to preexisting allocations, IRS agreed with one commentator who suggested that the de minimis partner rule was sufficiently flawed that it should not continue to apply to allocations that became part of the partnership agreement before its removal. Accordingly, the final regs are effective, and the de minimis partner rule is no longer applicable, for all partnership tax years beginning on or after Dec. 28, 2012, regardless of when the allocation became part of the partnership agreement. Thus, the substantiality of all partnership allocations, regardless of when they became part of the partnership agreement, must be retested without the benefit of the de minimis partner rule. For allocations in existing partnership agreements, the retest has to be as of the first day of the first partnership tax year beginning on or after Dec. 28, 2012. (Reg. § 1.704-1(b)(2)(iii)(e)(2); T.D. 9607)

References: For partnership allocations, see FTC 2d/FIN ¶ B-2400 ; United States Tax Reporter ¶ 7044 ; TaxDesk ¶ 586,100 ; TG ¶ 2162 .

(12/27/2012)
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Posted by on December 27, 2012 in Tax Relief

 

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IRS Proposes Regs on Additional Medicare Surtax

The Internal Revenue Service has issued proposed regulations on the 0.9 percent Additional Medicare Tax for upper-income taxpayers scheduled to take effect next year as a result of the Affordable Care Act.

The proposed regulations in REG-130074-11 provide guidance for employers and individuals relating to the implementation of Additional Medicare Tax. The guidance also contains proposed regulations relating to the requirement to file a return reporting Additional Medicare Tax, the employer process for making adjustments of underpayments and overpayments of Additional Medicare Tax, and the employer and employee processes for filing a claim for refund for an overpayment of Additional Medicare Tax. In addition, the document provides notice of a public hearing on the proposed rules.

In addition, the IRS posted a FAQ on the Net Investment Income Tax of 3.8 percent on the net investment income of individuals, estates and trusts above a certain threshold. It too takes effect next year as a result of the Affordable Care Act.

The IRS noted that calculating wages for purposes of withholding Additional Medicare Tax would be no different than calculating wages for FICA generally. Thus, for example, if an employee has amounts deferred under a nonqualified deferred compensation plan and the nonqualified deferred compensation is taken into account as wages for FICA tax purposes under the special timing rule, the NQDC would likewise be taken into account under the special timing rule for purposes of determining an employer’s obligation to withhold Additional Medicare Tax.

Similarly, when an employee is concurrently employed by related corporations and one of the corporations disburses wages for services performed for each of the employers and the arrangement otherwise satisfies the common paymaster provisions, the liability for FICA tax with respect to the wages disbursed by the common paymaster is computed as if there was a single employer. In this case, the obligation to withhold Additional Medicare Tax on wages in excess of $200,000 disbursed by the common paymaster would also be determined as if there was a single employer.

The proposed regulations provide rules for the withholding, computation, reporting and payment of Additional Medicare Tax on wages, self-employment income and Railroad Retirement Tax Act compensation. The proposed regulations also provide rules for when and how employers may make an interest-free adjustment to correct an overpayment or an underpayment of Additional Medicare Tax and how employers and employees may claim refunds for overpayments of Additional Medicare Tax. These procedural rules for interest-free adjustments and claims for refund track the existing rules that apply to income tax withholding rather than the rules that apply to FICA tax. The regulations take this approach because Additional Medicare Tax, like income tax withholding, does not include an employer portion, and the ultimate liability is reconciled on the individual employee’s income tax return.

The proposed regulations also update the rates of tax for the Social Security and Medicare tax on employees, and add a paragraph describing the rate of Additional Medicare Tax. The proposed regulations provide an updated example illustrating that the Social Security and Medicare rates applicable to the calendar year in which wages are received apply to compute the tax liability.

The proposed regulations describe the extent to which an employer is required to withhold Additional Medicare Tax. The proposed regulations provide that an employer must withhold Additional Medicare Tax from an employee’s wages only to the extent that the employee receives wages from the employer in excess of $200,000 in a calendar year. In determining whether wages exceed $200,000, an employer does not take into account the employee’s filing status or other wages or compensation which may impact the employee’s liability for the tax. An employee may not request that the employer deduct and withhold Additional Medicare Tax on wages of $200,000 or less.

However, an employee who anticipates liability for Additional Medicare Tax may request that the employer deduct and withhold an additional amount of income tax withholding under Section 31.3402(i)-2 on Form W-4. This additional ITW can apply against taxes shown on Form 1040, including any Additional Medicare Tax liability. An employee might request that the employer deduct and withhold an additional amount of ITW on wages that are not in excess of $200,000 if, for example, the employee is married and files a joint return, and anticipates liability for Additional Medicare Tax because the combined wages of the employee and the employee’s spouse will exceed $250,000.

The proposed regulations include examples illustrating the extent of the employer’s obligation to withhold Additional Medicare Tax.

Further, the proposed regulations under section 3102(f) provide that to the extent Additional Medicare Tax is not withheld by the employer, the employee is liable for the tax. The proposed regulations also provide that the IRS will not collect from an employer the amount of Additional Medicare Tax it failed to withhold from wages paid to an employee if the employee subsequently pays the Additional Medicare Tax.

However, the proposed regulations also specify that the employer would remain subject to any applicable penalties or additions to tax for failure to withhold Additional Medicare Tax as required.

Washington, D.C. (December 4, 2012)
By Michael Cohn

 
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Posted by on December 6, 2012 in Tax News