Firm Suggests Changes to Proposed Regs on Automatic Extensions for Passthroughs

We would like to take this opportunity to provide comments on the Internal Revenue Service's recently issued temporary regulations amending the automatic filing extension period for pass-through entities. Under the temporary regulations, the extension period for filing tax returns for partnerships, trusts and estates is shortened from six months to five months. The purpose of this shortened extension, as stated by the Internal Revenue Service, is to alleviate the burden on individual taxpayers who may rely on the information provided by these entities to complete their individual tax returns.

Prior to the issuance of the temporary regulations, both individual taxpayers and partnerships were entitled to an automatic six-month extension (to October 15th) to file their respective returns. With the shortened extension period, partnerships and trusts will have to complete and file their returns by September 15th. While we endorse the shortened extension period for partnerships, we believe that the considerations supporting the shortened period for partnerships do not apply to trusts, and recommend the reinstatement of the six-month extension period for trusts.

We represent a number of clients who are trustees of trusts that have numerous investments in partnerships. While our comments express the concerns of these clients, we believe that their concerns are not unique to them and are shared by all trustees who have similarly invested in partnerships.

Many trusts today have multiple interests in partnerships, including operating companies, hedge funds, funds of funds, and private equity investment vehicles. It is our clients' experience that the number of partnership K-1s received by trusts far exceeds the number of K-1s issued by trusts to their beneficiaries. Where there are no distributions to beneficiaries, as is often the case, the trust pays the full tax liability and there are no Schedule K-1s provided to the beneficiaries. It is also noteworthy that trusts, unlike partnerships, are generally taxpaying entities, not simply flow-through entities. Based upon all of this, the purpose of the proposed shortened extension period is clearly less applicable to trusts than to partnerships. Since trusts are more similar to individual taxpayers in this regard, having the partnership return due date thirty days prior to the trust return due date would alleviate the tax return burden on trustees, much like the shortened extension period for partnerships is intended to alleviate the burden on individuals.

In addition, the relationship between a trustee and the trust's beneficiaries is usually a much more personal relationship than the relationship between a large partnership and its many partners. The partners often have no connection with the partnership beyond their mere status as investors/partners. Therefore, there is no relationship incentive for the partnership to deliver the Schedule K-1 information to the partners in advance of the extended due date to allow sufficient lead time for the partners to prepare and file their individual or trust returns. A trustee and a beneficiary, on the other hand, generally have a more personal relationship. The trustee has a fiduciary duty to act in the best interests of the beneficiaries and the identities of beneficiaries are in most cases personally known to the trustee. Many trustee-beneficiary relationships arise from long-term personal or familial relationships between the parties. These parties are in regular communication with each other and work closely together to meet tax compliance deadlines. In fact, the same tax return preparers often prepare the income tax returns for both the trust and its beneficiaries, or there are established and on-going communications between the tax return preparers serving both parties. Under these circumstances, there is little risk that a beneficiary will be burdened by a failure to receive his or her Schedule K-1 information from the trust in sufficient time to properly prepare his or her individual return.

Without this close, personal working relationship and sensitivity between large partnerships and their partners, the partnerships are more likely to issue Schedule K-1s to their partners on or near the extended due date without considering the personal impact on their partners. Thus, the need to shorten the filing extension period to ensure that holders of pass-through interests timely receive filing information is much more important in the context of partnerships than trusts. The reality is that trustees need the same thirty day window that individuals need to compile the K-1 information to enable them to prepare and file a complete and accurate tax return.

If a trustee receives Schedule K-1s from partnerships on the day that the trust return is due, it will be practically impossible for the trustee to properly complete the trust's tax return, properly compute its tax and furnish its beneficiaries with an accurate Schedule K-1 on a timely basis. This is particularly so where the trustee must make complex determinations of distributable net income and allocation of income and expense items between the trust and its beneficiaries. The result will likely be the filing of inaccurate returns, which will lead to the costly and time-consuming preparation and filing of amended returns and amended Schedule K-1s. This problem is exacerbated in the case of investments in tiered partnerships. Further, these amended returns would not only increase the burden on the trustee and the trust's beneficiaries but would also increase the burden on the Internal Revenue Service which would have to process these additional amended returns.

Finally, the trusts' investments in multistate partnerships often result in these trusts needing to file state income tax returns in several states. Many states adopt the federal due date as the due date for their state income tax returns. As such, in addition to the increased burdens of timely filing a federal trust tax return, many trustees would also have a significantly increased burden in attempting to timely file complete and accurate state returns.

For the foregoing reasons, we recommend reinstatement of the six-month extension period for the filing of Forms 1041 by trusts.

We appreciate this opportunity to present our comments and would be pleased to discuss our comments further with the Internal Revenue Service. Please feel free to contact me at (312) 269-8020.