PTP Trade Group Examines Partnership Tax Capital Reporting Proposal

August 3, 2020

Internal Revenue Service
CC:PA:LPD (Notice 2020-43)
Room 5207
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Notice 2020-43 — Comments on the Tax Capital Reporting Requirement

Dear Sir or Madam:

The Energy Infrastructure Council (“EIC”) is pleased to submit comments in response to the request for comments on the Tax Capital Reporting Requirement, set forth in Notice 2020-43 (the “Notice”).

EIC, formerly the Master Limited Partnership Association, is the nation's only trade association representing MLPs.¹ For more than three decades, the association has represented the interests of MLPs in Washington, D.C. and the states. MLPs are an integral way our nation's private sector finances the infrastructure needed to fully utilize newly discovered domestic energy resources — leading to greater energy independence for the United States — and to ensure that a wide variety of energy products make their way efficiently and safely from the production fields to American homes, businesses and communities.

We appreciate the continued efforts of the IRS and Treasury to provide taxpayers with guidance on the Tax Capital Reporting Requirement and are pleased to offer recommendations to facilitate proper administration of the rules with respect to MLPs.²

Background

MLPs have been part of the American energy infrastructure industry since 1981. As of June 30, 2020, there were 66 energy-related MLPs.³

MLPs are publicly traded partnerships within the meaning of section 7704 that are not subject to entity-level taxation, because 90 percent or more of their income is natural resource or passive-type income within the meaning of section 7704(c). Common interests in MLPs, generally referred to as “units,” are traded on an established security exchange, such as the NYSE or NASDAQ.

As discussed in the Notice, partnerships and certain other persons must report partner capital accounts in Box L on the Schedule K-1 (Form 1065) or in Box F on the Schedule K-1 (Form 8865), each as they currently appear on the 2019 forms (the “Tax Capital Reporting Requirement”). Draft instructions for the 2019 Forms 1065 and 8865 expanded partner tax capital reporting to require all partnerships and certain other persons using Form 8865 to report all partners' tax capital accounts using the tax basis method. Notice 2019-66 removed the requirement to use the tax basis method for reporting partner tax capital for 2019 and announced that the IRS would provide further guidance regarding the definition of partner tax capital.⁴ In lieu of providing a definition of “tax basis capital,” the Notice proposes two methods for satisfying the Tax Capital Reporting Requirement: the Modified Outside Basis Method and the Modified Previously Tax Capital Method. According to the Notice, the Treasury Department and IRS anticipate that these will be the only methods that meet the Tax Capital Reporting Requirement for partnership taxable years ending on or after December 31, 2020.

In general, the Modified Outside Basis Method allows a partnership to satisfy the Tax Capital Reporting Requirement by determining, or being provided by its partners, each partner's adjusted basis in its partnership interest, determined under subchapter K of the Code, and then subtracting the partner's share of the partnership's liabilities (within the meaning of section 752). The partners are required to notify the partnership in writing of “any changes to the partner's basis in its partnership interest during each partnership taxable year other than changes attributable to contributions to and distributions from the partnership and the partner's share of income, gain, loss, or deduction that are otherwise reflected on the partnership's schedule K-1.” Such written notice of changes to a partner's basis must be provided within 30 days or by the end of the partnership's tax year, whichever is later. For example, the Notice states that if a person purchases an interest in a partnership that uses the Modified Outside Basis Method, the purchasing partner must notify the partnership of its basis in the acquired partnership interest. In general, a partnership is entitled to rely on the information provided by its partners unless the partnership has knowledge of facts indicating that the provided information is clearly erroneous.

The Modified Previously Taxed Capital Method allows a partnership to satisfy the Tax Capital Reporting Requirement by reporting a modified version of “previously taxed capital” (as determined based on Regulations under section 743). In general, previously taxed capital is the amount of cash that a transferee partner would receive in a liquidation of the partnership following the sale of the partnership's assets for cash equal to their fair market value (the “hypothetical transaction), increased by the transferee's share of tax loss (including remedial allocations under Treas. Reg. § 1.704-3(d)) from the hypothetical transaction, and decreased by the transferee's share of tax gain from the hypothetical transaction (including remedial allocations). The Modified Previously Taxed Capital Method allows a partnership, if the fair value of its assets is not readily available, to use the section 704(b) bases of its assets, GAAP, or the basis set forth in the partnership agreement for purposes of determining what each partner would receive in the hypothetical transaction. In addition, to “avoid the burden of having to characterize the underlying debt and to simplify the computation” all of the partnership's liabilities are treated as nonrecourse for purposes of determining a partner's share of gain or loss from the hypothetical transaction.

In the Notice, the IRS has asked specifically “how, if at all, the Tax Capital Reporting Requirement should be modified to apply to partnerships that are treated as publicly traded partnerships under § 7704 of the Code.”

Summary of Recommendations

The Modified Outside Basis Method should be modified for MLPs to eliminate the requirement that partners of an MLP provide written notice of changes to their basis to the MLP. In lieu of such information, MLPs should be permitted to use information required to be reported by nominees to MLPs under Treas. Reg. § 1.6031(c)-1T and publicly available trading price data. In addition, forms and instructions should clarify that “modified outside basis” may differ from a partner's actual outside basis (without regard to the partner's share of liabilities).

The Modified Previously Taxed Capital Method should be modified to allow MLPs to calculate the amount of tax gain or loss allocated to a partner from the hypothetical transaction to take into account the portion of the partner's section 743(b) adjustment that offsets any remedial allocations under Treas. Reg. § 1.704-3(d) of tax gain or loss. In addition, guidance should clarify that MLPs may determine the value of the partnership's assets for purposes of the hypothetical transaction based on the low closing price for the month in which the transfer occurs.

Discussion of Recommendation

1. Changes to the Modified Outside Basis Method

A typical MLP has thousands or tens of thousands of partners who regularly sell or exchange their interests. Requiring these partners to notify the MLP directly of the details of such transactions would be extraordinarily costly and burdensome for partners and the MLP. Because MLPs have virtually all the data necessary to determine modified outside basis in a reasonably accurate manner, such notification from partners is ultimately unnecessary.

In general, MLPs do not gather information necessary for tax reporting directly from their partners. Instead, Treas. Reg. § 1.6031(c)-1T(a) requires the brokers through whom partners hold their interests to report to the MLP certain information about the identity and tax status of the partner (e.g., U.S. person, foreign person, or tax exempt entity) and certain details about the broker's acquisition of the partnership interest. Such information must be reported on or before the last day of the first month following the close of the partnership's taxable year.⁵

If the requirement for partners of an MLP to notify the MLP directly of changes to their basis were eliminated, MLPs generally would determine the modified outside basis of their partners in the following manner. For purposes of determining the initial basis of a partner in its interest, an MLP will have the requisite information for any partner acquiring its units directly from the MLP in exchange for a contribution of cash or property. For partners of the MLP that acquire their units by purchase on a public exchange, the MLP generally would use the acquisition cost reported to the MLP by the broker or nominee. In cases in which no acquisition cost information is reported or no acquisition cost information exists, e.g., the broker receives a partner's MLP units upon a transfer at death or in connection with a gift, other broker-to-broker transfers, or transfers of units not held by nominees, the MLPs still will have information regarding the approximate date of the transfer. In such cases, MLPs currently assume that the transferred units were acquired at the low closing price for the month of acquisition. Allowing the MLP to use the monthly low closing price to report a partner's modified outside basis is conservative (insofar as it likely understates outside basis) and practical, since the monthly low close information is readily available. In the absence of written notification from partners or actual knowledge of a different acquisition cost, MLPs should be entitled to rely on broker information reporting, if available, and use the low closing price for the month of the transfer when broker information is unavailable.

In the case of dispositions, although information on disposition proceeds generally is provided by brokers, MLPs' return preparers have not tracked it in their tax reporting systems or reported it to partners in the past. Currently, brokers report disposition proceeds directly to partners of MLPs on Form 1099-B, and the partners themselves determine their gain or loss on disposition and make any necessary adjustments to their basis (in the case of a partial disposition). To assist partners in this calculation, the MLP provides the partner with the MLP's calculation of the partner's basis in the transferred interest.

For purposes of tracking and reporting modified outside basis, MLPs should be permitted to reduce a transferor partner's modified outside basis by the MLP-calculated modified outside basis of the units transferred (an amount the MLP will be able to determine under the rules proposed above without regard to sale price and without further reporting by partners or brokers to the MLP). The partners themselves would remain responsible for accurately tracking their actual adjusted basis and reporting actual gain or loss in the case of taxable sales or exchanges.

Under the modifications we are proposing, the modified outside basis reported to each MLP partner on its schedule K-1 will in some cases differ from its actual adjusted basis in its units (without regard to its allocation of the MLP's liabilities). For this reason, forms and instructions should make it clear that modified outside basis is not necessarily the partner's actual adjusted basis without regard to its share of partnership liabilities. In the absence of such guidance, partners whose adjusted basis in their units (without regard to their allocation of the MLP's liabilities) differs from modified outside basis as reported on the schedule K-1 may need to file a notice of inconsistent treatment.⁶ In reality, partners are unlikely to identify any discrepancy in a year in which the partner does not dispose of any units; it is unclear whether the failure of a partner to identify a discrepancy in a prior year would preclude the partner from taking a different position in a year in which there is a disposition. Moreover, failure to distinguish clearly between the reported modified outside basis and actual adjusted basis (without regard to liabilities) would have the effect of shifting the burden for accurately tracking actual adjusted basis from the partner to the partnership. Because only the partner will have all of the information to make an accurate determination of actual outside basis, the responsibility for such determination should continue to rest with the partner.

2. Changes to the Modified Previously Taxed Capital Method

In the case of publicly traded units, section 704(c) remedial allocations to the unitholder and the portion of the unitholder's section 743(b) adjustment that offsets such allocations generally cannot be separately stated. Publicly traded units are fungible precisely because the sum of these two amounts is the same, regardless of which units a buyer acquires on a public exchange. Treasury has facilitated the proper operation of these rules to permit the fungibility of MLP units in regulations under section 743.⁷ And recent tax reporting guidance acknowledges the inability of MLPs to separately state section 704(c) amounts.⁸

Because the amount of remedial gain or loss that a partner would recognize in the hypothetical transaction is a component of previously taxed capital, an MLP could not report modified previously taxed capital if it had to determine the remedial gain or loss separately. However, MLPs could calculate and report modified previously taxed capital without regard to the portion of section 704(c) remedial gain or loss that is offset by a partner's section 743(b) adjustment. Guidance should provide that MLPs are permitted to calculate modified previously taxed capital with this additional modification.

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If you have any questions, please do not hesitate to contact Lori Ziebart at lori@eic.energy or 202-747-6570.

Sincerely,

Lori E. L. Ziebart
President & CEO
Energy Infrastructure Council
Washington, DC