To the Editor:
I write to express extreme surprise and disappointment in a recently issued private letter ruling (LTR 202016013). I believe that the ruling illustrates what happens when the IRS fails to write regulations on an important area of law and, as a result, it needs to disregard the currently written law to get the right tax policy result. I question whether such lawless action by the IRS in a letter ruling, which is written without any legal analysis and offers just a conclusion, was the right thing to do now.
The issue revolves around reg. section 1.351-1(c)(4), dealing with an entity that owns 50 percent or more of a corporate subsidiary. In that case, the regulation says that in testing whether the parent entity, corporation, or partnership is an investment company, one looks through such a corporate subsidiary to its underlying assets. At issue in the ruling was whether such look-through treatment applies as well to a publicly traded partnership (PTP) subsidiary. The ruling concludes that reg. section 1.351-1(c)(4) applies. Because it was a corporate ruling issued by the Office of Associate Chief Counsel (Corporate), there is no legal reasoning in the ruling; just a conclusion.
The policy rationale for the ruling is quite supportable and noble. Why should a parent entity that owns a significant interest in a PTP (taxed as a partnership) subsidiary that holds only business assets result in the parent entity being an investment company when, if the parent entity owned a corporate subsidiary, the parent would not be an investment company? The very clear answer, even though it leads to an odd result, is that the statute says so, and only regulations can change that answer.
Section 351(e)(1)(B)(iv) treats as stock or securities, and hence as a tainted asset, any interest in a PTP as defined in section 7704(b). The reference to section 7704(b) means that the entity could be taxed as either a corporation or a partnership, but because section 351(e)(1)(A) already references stock or securities, the reference is really intended to cover PTPs that are taxed as partnerships.
However, the last sentence of section 351(e)(1) grants authority to treat such a PTP interest, as well as other assets, as not being tainted assets. No such regulatory authority has been issued to date even though the enacting statute was part of the 1997 tax legislation.
Neither the legislative history nor the 1997 blue book (JCS-23-97, at 182-185) explain the reasoning behind treating a PTP interest as a tainted asset regardless of what the PTP holds. The “reasons for change” in the blue book state an intent to treat “high-quality investment assets of determinable value” as stocks or securities, and also explain the regulatory authority to exclude certain listed assets “in appropriate circumstances” without explaining what that means. Still, the statute says only regulations can provide otherwise — not letter rulings.
What about an argument that general partnership aggregate principles should apply, and one could look through the PTP because that is the “appropriate” answer? Well, the House and Senate reports and the 1997 blue book all contain a footnote that indicates that in certain circumstances interests in the partnership would and would not be treated as an aggregate (blue book at n.204). The threshold chosen there was between 20 and 90 percent where (1) if less than 20 percent of the partnership’s assets were tainted, then none of the partnership interest would be tainted; (2) if 20 percent or more but less than 90 percent of the partnership’s assets were tainted, then a proportionate part of the partnership interest would be tainted; and (3) if 90 percent or more of the assets were tainted, all of the partnership interest would be tainted. Although the footnote does not differentiate between a PTP and other partnerships, given the express reference to an interest in a PTP in the statute, the footnote reference must be to non-PTP partnerships.
Because of the reference to cases in the legislative history where the partnership would be treated as an entity in certain cases and as an aggregate in others, the general aggregate partnership authorities as reflected in reg. section 1.701-2(e) should not contravene a specific provision in both the statute and its legislative history, namely (1) the express reference to interests in PTPs and (2) the limited look-through rule in the footnote. In particular, these provisions show congressional intent to treat any partnership as an entity unless aggregate treatment under the terms of section 351(e) applies. It could not be clearer.
Why does the IRS refuse to issue regulations under sections 351(e) and 721(b)? I have advocated for regulations for years, but to no avail. (“A priority of first importance, however, is the issuance of implementing regulations that will bring the current statute into the modern age of business transactions.”) Could it be that issuing regulations could cause “political heartburn” because those new rules would circumvent some of the letter rulings that have been issued for multiple decades now?
Whatever the reason for not issuing regulations to implement the 1997 legislative changes, this does not excuse lawless behavior by the IRS even if done with the best of motives and fully compliant with the best tax policy. Allowing this to occur puts the IRS in the business of writing statutes, and this function exclusively belongs to Congress. It also allows the IRS to avoid the complexities and administrative headaches of regulations and to write the law through the issuance of letter rulings. Yes, that is correct. Rewriting the law based on either revenue rulings or revenue procedures would be bad enough. But using a letter ruling to do so, even though not technically precedential under section 6110(k)(3), is beyond the pale.
The regulations under section 6662 (reg. section 1.6662-4(d)(3)(iii)) list private letter rulings as an authority in defending a substantial understatement penalty, but the letter ruling ceases to be an authority if inconsistent with a subsequent proposed regulation, revenue ruling, or other administrative pronouncement published in the Internal Revenue Bulletin. The regulation also states that the reasoning and age of the letter ruling authority can matter as well. Given the lack of legal reasoning in LTR 202016013, it probably is entitled to little or no weight in the analysis.
Nowhere is it stated that a letter ruling ceases to be an authority because contrary to a statute. But that should be obvious.
The letter ruling should be withdrawn, and appropriate relief under section 7805(b) considered.
Monte A. Jackel
Apr. 20, 2020