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How are property contributions and distributions with respect to partnerships treated for adjusted financial statement income (AFSI) purposes?

The proposed regulations contain rules addressing "adjustments to apply certain subchapter K principles" in connection with contributions to and distributions from partnerships. In general, these rules require the Corporate Alternative Minimum Tax Regs (CAMT) entity, any other partner in the relevant partnership, and the partnership itself to include in their AFSI any income, expense, gain, or loss reflected in the financial statement income (FSI) as a result of the contribution to or distribution from the partnership. Rather than adopting the nonrecognition principles for regular tax purposes, Treasury adopted a “deferred sale method” that would take the FSI gain into the contributor's AFSI ratably (each month) over a period that depends on the type of property contributed. Acceleration rules apply upon the occurrence of certain events. A similar deferred sale rule applies to distributions.

In the case of part-sale, part-contribution transactions (e.g., partial disguised sales of property to a partnership), the proposed regulations permit partially taxable contributions to be split, and the deferred sale method to apply to the nontaxable portion.

Observation: Continuation funds have been increasing in the AM industry, and with such transactions, property contributions and distributions are common. AFSI would need to include the deferred sale inclusion and consider additional compliance on CAMT basis tracking as well.

What are the partnership reporting requirements related to CAMT based on the proposed regulations?

Requirements for CAMT entities to request information from partnerships

The proposed regulations require an entity that needs CAMT-related information from a partnership to submit a formal request within 30 days of the close of the partnership’s tax year.

For tiered partnerships, an upper-tier partnership must request information from a lower-tier partnership by the later of:

• 30 days after the close of the relevant tax year, or
• 14 days after receiving an information request from one of its partners.

If a partnership fails to provide the requested information, the partner estimate its distributive share amount using a good-faith approach based on reasonably available information. The partner must also file a form with its tax return indicating that it is taking an inconsistent position.

How does a partnership report CAMT information to a requesting entity?

Once a CAMT entity has made a request, the partnership is required to provide the CAMT information on Schedule K-1. This obligation continues until the CAMT entity provides notice that the information is no longer needed.

The CAMT information reported on a requesting partner’s K-1 includes:

1. Information to determine the denominator for the distributive share percentage (if not using fair value accounting)
2. The partnership’s modified FSI
   
3. Information for the partner to make AFSI adjustments
   
4. If the partner is a US Shareholder of a CFC, information required to make AFSI adjustment
   
5. If the partner is a CFC, information for the US Shareholder of the CFC to make AFSI adjustments.
   

NOTE: The rules addressing contributions to and distributions from partnerships have their own reporting requirements for partners to comply with the deferred sale approach, including recovery periods used to depreciate deferred sale property and the dates of disposition events and acceleration events.

Observation: Although a partnership is only required to report CAMT information if it receives a request from a partner, the partnership reporting requirements are burdensome and will affect any partnership in which a corporation potentially subject to CAMT directly or indirectly owns an interest. Partnerships subject to the requirements must track and report new information, essentially maintaining a fourth set of books and records for CAMT, in addition to the financial, tax, and Section 704(b) books and records. Because CAMT information will be reported to the IRS on Form 1065 and Schedule K-1, it will be a Bipartisan Budget Act of 2015 (BBA) item, and failure to properly report such information may result in penalties.

Observation: Asset managers should take inventory of partners that have previously made CAMT information requests for tax year 2023 and consider potential new requests. Although the proposed regulations implement a timeline for tiered requests, partnerships may receive requests well after year-end and should plan to cascade requests downward within 14 days. To the extent information is not timely received from lower-tier partnerships, a best-effort approach is required to estimate the AFSI with respect to a lower-tier partnership.

Observation: The proposed regulations include information that a US shareholder of a CFC would need to make AFSI adjustments as another data point that may need to be shared with a CAMT entity. Funds that hold CFCs classified as passive foreign investment companies (PFIC) typically receive pro forma Form 5471s or PFIC statements. This reporting now would need to include CAMT information, if requested. A CAMT entity generally would include its pro rata share of the CFC’s adjusted net income or loss in its AFSI calculation. Consideration should be given as to how to provide such information.

How to determine if a corporation is an applicable corporation?

While the rules above may apply to all partnerships to the extent they have an upper tier investor requiring information, the next two sections address how to determine if a corporation in the structure (e.g., a blocker corporation, taxable REIT subsidiary (TRS), or a corporate portfolio company) is an applicable corporation. For purposes of the $1B Test, the statute requires a corporation to include the average AFSI of all members of its single-employer group under Sections 52(a) and 52(b) (Single-Employer Rules). Similarly, a corporation that is a member of an FPMG includes the average AFSI of all members of the FPMG and the single-employer group for purposes of the FPMG Test.

Even if a corporation is an “applicable corporation,” it may not have a CAMT tax liability greater than its regular corporate tax liability. However, applicable corporation status will at a minimum require additional information reporting on Form 4626.

What is the impact of the Single-Employer Rules on determining if a corporation is an applicable corporation?

Section 52(a) defines a “controlled group of corporations” by reference to the definition in Section 1563(a) with the modifications provided in Section 52(a)(1) (substituting “more than 50 percent” for “at least 80 percent”) and Section 52(a)(2) (making the determination without regard to the special rules for insurance companies in Section 1563(a)(4) and the attribution rule in Section 1563(e)(3)(C)). Section 52(b) authorizes Treasury to treat employees of unincorporated entities, (e.g., partnerships), which are under common control, as employed by a single employer, based on principles similar to those in Section 52(a).

Section 1563(a) defines a controlled group of corporations to include a “parent-subsidiary controlled group,” a “brother-sister controlled group,” and a “combined group.” For purposes of Section 1563(a) and Section 52(a), stock owned directly or indirectly by or for a partnership is considered as owned by any partner having an interest of 5 percent or more in either the capital or profits of the partnership, in proportion to its interest in capital or profits (whichever is greater). See Reg. 1.1563-3(b)(2).

Regulations under Section 52(b) define the term “trades or businesses that are under common control.” Like the definition in Section 1563(a), the regulations under Section 52(b) define the group under common control to include a “parent-subsidiary group,” a “brother-sister group,” and a “combined group.” The rules apparently require each entity in the group to be a “trade or business.” For purposes of determining whether a parent-subsidiary group under common control exists, current, final regulations under Section 52(b) limit constructive ownership to situations in which a person owns an option (treating the option as exercised); there is no attribution from partnerships. Proposed regulations under Section 52(b) would expand the constructive ownership rules for parent- subsidiary controlled groups of trades or businesses to include a rule attributing ownership from a partnership if a partner has an interest in 5 percent or more in the profits or capital of the partnership. The CAMT proposed regulations would apply the rules as revised by these proposed regulations under Section 52.

The CAMT proposed regulations illustrate in an example that if a corporation owns a controlling interest in a second corporation through a partnership, the two corporations can be members of a Section 52(a) controlled group of corporations regardless of whether the partnership is engaged in a trade or business. In the example, X, a corporation, owns 80 percent of the profits and capital interests in PRS, a partnership for US tax purposes. PRS owns stock with 80 percent of the vote and value in Y, another corporation (see Figure 1 below). The example concludes that X and Y will be members of a Section 52(a) controlled group (a parent-subsidiary controlled group) but excludes PRS from the Section 52(a) controlled group since it is not a corporation. The example goes on to note that “if PRS is engaged in a trade or business, it may be a member of a group of trades or businesses under common control under Section 52(b) that includes X and Y.” The example does not specify whether PRS was engaged in a trade or business.

Figure 1                                   Figure 2

Application:

It is common for private equity funds to own investments in passthrough entities through a US “blocker” corporation to prevent effectively connected income (ECI) or unrelated business taxable income (UBTI) from passing through to foreign investors or tax-exempt investors, respectively. While it may be uncommon, if the blocker corporation is an investment vehicle above the fund that holds corporate portfolio companies, it may look similar to Figure 1, in which case, X would be a blocker corporation, PRS would be the fund, which is not in a trade or business, and Y would be a portfolio company. If the blocker corporation indirectly had greater than 50 percent of the vote or value in Y, then the AFSI of X and Y would be aggregated under Section 52(a) for purposes of determining whether X and Y are applicable corporations.

Alternatively, the blocker corporation may be below the partnership as illustrated in Figure 2. As noted in the proposed regulation example described above, if PRS and the blocker are engaged in a trade or business, the US blocker in Figure 2 would be a member of a group of trades or businesses that are under common control with PRS under Section 52(b). As a result, the AFSI of PRS and US Blocker would be part of a single-employer group and aggregated for purposes of determining whether the US Blocker is an applicable corporation. Neither US Corp investment nor ECI Pship would be included in the Section 52 group because PRS does not own stock with more than 50 percent of the vote or value of US Corp investment and US Blocker does not own more than 50 percent of the profits or capital interest in ECI Pship.

The type of fact pattern illustrated in Figure 1 also can be found in public REIT structures. X would be a public REIT, PRS would be the operating partnership with a real estate trade or business, and Y would be a taxable REIT subsidiary (TRS). Even though REITs are not subject to the CAMT, the REIT can be part of a single-employer group under Section 52(a) or (b) with the TRS. Therefore, REIT, the operating partnership, and TRS would be part of a single-employer group under Section 52(b) in this example. As a result, if the aggregate AFSI of the REIT, the operating partnership, and TRS meets the $1B Test, then TRS is an applicable corporation and may be subject to CAMT.

Observation: Under the proposed regulations, a corporation (other than an S corporation, a RIC, or a REIT) must maintain sufficient records to demonstrate whether it is an applicable corporation for any tax year. This includes identification of all persons treated as a single employer with such corporation under Section 52 and whether the corporation is a member of an FPMG. This places additional administrative burdens on taxpayers from a documentation perspective.

How do the FPMG rules broaden the scope of corporations subject to CAMT?

Section 59(k)(2)(B) defines an FPMG, with respect to any tax year, as two or more entities if (1) at least one of the entities is a domestic corporation and at least one of the entities is a foreign corporation; (2) the entities are included in the same AFS for that year; and (3) either the common parent of the entities is a foreign corporation, or if there is no common parent, the entities are treated as having a common parent that is a foreign corporation based on guidance from Treasury. In the proposed regulations, Treasury provides that one of the entities must be a FPMG common parent, which is defined as an ultimate parent that is a foreign corporation (deemed or actual). An ultimate parent is an entity that has a controlling interest in at least one other entity and no other entity has a controlling interest in the parent. A controlling interest is generally based on the entity’s applicable financial accounting standard.

The proposed regulations broaden the scope of the FPMG rule significantly by treating a non-corporate parent entity (foreign or domestic) as a deemed foreign corporation. This non-corporate parent entity rule applies if the entity directly or indirectly owns (other than through an actual domestic corporation) (1) a foreign trade or business, or (2) any equity in a foreign corporation in which it has a controlling interest.