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Audit Firm Addresses Securities Dealer Definition in Section 199A Regs

OCT. 1, 2018

Audit Firm Addresses Securities Dealer Definition in Section 199A Regs

DATED OCT. 1, 2018
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October 1, 2018

The Honorable David J. Kautter
Assistant Secretary of Tax Policy
U.S. Department of Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William M. Paul
Chief Counsel (Acting)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Guidance Regarding Qualified Business Income Deduction (Section 199A) for Lenders

Dear Assistant Secretary Kautter and Chief Counsel Paul:

We are writing in our individual capacities as tax practitioners with RSM US LLP, the nation's fifth largest tax, audit, and consulting firm, to address issues we anticipate in applying Section 199A to taxpayers engaged as sole proprietors or pass-through entities in the trade or business of lending money. Our concerns apply both to traditional banking institutions and to non-bank finance companies that act as portfolio lenders.

There does not appear to be any doubt that Congress intended the business of lending money, by non-banks as well as banks, to be eligible for the 20 percent deduction authorized by Section 199A. At the same time, substantial uncertainty as to the availability of the deduction exists on account of the statutory rule denying the deduction (other than for taxpayers below certain income levels) for “dealers in securities.” As we read that statutory prohibition, the term “securities” is defined by reference to Section 475, but the terms “dealer” or “dealer in securities” are not defined by reference to Section 475. This is the nub of the technical issue we believe should be addressed in the final regulations.

1. In general, we would suggest that final regulations clarify that a lender will be considered to be a dealer in securities (for purposes of Section 199A) only to the extent that the loans (including a retail installment sales contract) acquired by the lender (whether by originating the loans or acquiring them in the secondary market) are held in inventory or held for sale to customers in the ordinary course of a trade or business within the meaning of Section 1221.

2. In addition, if a loan is not so acquired — and is instead acquired with a view towards holding the loan to maturity in the lender's portfolio — and the loan is later sold outside the normal course of business or in connection with a change in circumstances such as a work-out or a bulk sale of distressed loans or loans that no longer meet the taxpayer's business strategy or regulatory requirements — such sales will not result in the lender being viewed as a dealer in securities.

By way of background, prior to the enactment of the mark-to-market regime of Section 475, it was clear that only someone who both purchased and sold securities, including debt instruments, was considered a securities dealer. Thus, even a taxpayer that regularly held itself out as available to acquire debt instruments from its “customers,” either by originating the securities or acquiring them in the secondary market, but acquired those securities for its own portfolio and not for resale to customers in the ordinary course of its business, would not be considered to be a dealer in securities for purposes of determining the character of any gains or losses in the event there were occasional sales or dispositions from its portfolio.

The mark-to-market rules were not intended to change that result, as evidenced by the exclusion from the mark-to-market regime of loans that were properly identified as held for investment, or otherwise acquired (or originated) in the ordinary course of a trade or business but not held for sale. Notwithstanding this exemption, the starting point in applying Section 475 is that a taxpayer that regularly engages in the origination or acquisition of loans, even absent any sales, is considered a dealer in those loans for purposes of the mark-to-market rules of Section 475, absent certain regulatory exemptions.

In contrast, the statutory reference in Section 199A to dealers most likely contemplates taxpayers that regularly both purchase and sell securities, not taxpayers that regularly acquire loans primarily for their portfolios and do not regularly sell those loans. Indeed, we believe it is clear that the statutory reference to Section 475 in Section 199A was only intended to use the definition of securities in Section 475(c)(2), not to import wholesale its definition of a dealer.

Alternatively, for anyone who might argue that all of Section 475 was imported into Section 199A, we would suggest that the business of originating or acquiring loans that are properly identified as not held for sale to customers should not be considered to be a prohibited business of dealing in securities for purposes of Section 199A, and should instead be considered a separate business from any business or activity involving loans not properly identified as held for investment.

We believe the proposed regulations to Section 199A are consistent with our view of congressional intent with respect to these types of lenders. Specifically, we observe that Prop. Reg. Section 1.199A-5(b)(2)(xiii)(A) defines dealing in securities almost identically to Section 475, but with the critical replacement of “or” with “and,” in the phrase “regularly purchasing securities from and selling securities to customers.” Nevertheless, the similarity to the language in Section 475, as well as the reference to a form of the “negligible sales” exemption, is cause for concern amongst members of the lending industry that they may still be considered dealers in securities.

In addition to the clarifications described above, it would be helpful to clarify that portfolio lenders — those that purchase loans and installment sale contracts — are able to avail themselves of the negligible sales exemption. This could be done either by revising Prop. Reg. § 1.199A-5(b)(2)(xiii)(A) to replace the term “originates” in the phrase “regularly originates loans in the ordinary course of a trade or business” to “originates or purchases,” or by adding a clarifier that loan origination includes purchase of a loan close to origination and properly viewed as an integrated transaction with such origination.

We suggest that the final regulations clarify that all sales of loans outside the ordinary course of business are excluded from consideration in applying the negligible sales test. We note that the definition of negligible sales currently provides that “sales of securities that are necessitated by exceptional circumstances and that are not undertaken as recurring business activities” are not considered in applying the mechanical negligible sales test, per Treas. Reg. § 1.475(c)-1(c)(4). This language may have the same effect as excluding all transactions outside the ordinary course of business. However, it is also possible that this language does not cover transactions outside the ordinary course of business that are not strictly “necessary” (for example, the closure of an underperforming branch, the sale of charged off loans, or the sale of loans that no longer meet the taxpayer's business strategy). In any case, these types of sales lack the regularity that is generally necessary to be considered as sales in connection with the business of dealing in securities, and should be excluded from the mechanical test. In other words, the negligible sales test is in the nature of a safe harbor, and does not override the general test that a taxpayer must regularly both purchase securities from and sell securities to customers to be treated as a dealer in securities for purposes of Section 199A.

As stated before, we believe that these clarifications are merely that, clarifications — and are therefore consistent with both congressional and regulatory intent. If you would like to discuss any of these issues further, we are available to meet at your convenience, please contact Don Susswein at 202-370-8216 or Don.Susswein@rsmus.com. Furthermore, we would request to testify at the public hearing on October 16, 2018 concerning the contents of this letter. An outline of this testimony is attached.

Sincerely yours,

Donald B. Susswein, Esq.
Principal, RSM US LLP
1250 H Street NW, Suite 650
Washington, DC 20005

Scott Ruby, CPA
Senior Director, RSM US LLP
1201 Edwards Mill Road, Suite 300
Raleigh, NC 27607

Nicholas J. Passini, CPA
Senior Manager, RSM US LLP
201 N. Harrison Street, Suite 300
Davenport, IA 52801

Benjamin Wasmuth, CPA
Senior Manager, RSM US LLP
1 S. Wacker Drive, Suite 800
Chicago, IL 60606

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