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What's News in Tax

Analysis that matters from Washington National Tax

Tax Reform and Publicly Traded Partnerships

June 4, 2018

by Megan J. Whitlock, Robert A. Swiech, Washington National Tax* The passage of tax reform brought many substantive changes to the Internal Revenue Code. This article considers certain changes that affect natural resource publicly traded partnerships, discusses issues surrounding implementation of the new rules for these partnerships, and identifies issues for which further guidance may be necessary. Note that this article focuses solely on natural resource type publicly traded partnerships and does not examine financial publicly traded partnerships.

The 2017 Act

Tax reform1 signed by the president on December 22, 2017 (the "2017 Act") is viewed by the Master Limited Partnership Association as favorable2 for the publicly traded partnership ("PTP") industry. Importantly, the 2017 Act did not change the rules allowing PTPs to qualify for treatment as partnerships for federal income tax purposes. However, tax reform layers on additional complexities for

* Megan J. Whitlock is a senior manager in the Passthroughs group of Washington National Tax ("WNT") (Dallas). Robert A. Swiech is a director in the Tax Credits and Energy Advisory Services group of WNT (Houston).

1 Pub. L. No. 115-97. Unless otherwise indicated, section references are to the Internal Revenue Code of 1986, as amended (the "Code") or the applicable regulations promulgated pursuant to the Code (the "regulations").

2 Master Ltd. P'ship Assoc., MLPA Statement on Tax Bill (Dec. 23, 2017), .

? 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Tax Reform and Publicly Traded Partnerships

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PTPs and their unitholders. Key areas of the 2017 Act discussed in this article that affect PTPs3 and unitholders include:

Section 199A4 ? Deduction for Qualified Business Income Section 163(j)5 ? Business Interest Expense Limitation Section 168(k)6 ? Increased Expensing Section 708(b)(1)(B)7 ? Repeal of Technical Termination of Partnerships Section 743(d)8 ? Modification of Substantial Built in Loss Section 704(d)9 ? Loss Limitations Section 864(c)10 ? Gain or Loss of Foreign Persons from Sale or Exchange of Partnership

Interest Engaged in Trade or Business in the United States

Section 1446(f)11 ? Withholding on Dispositions of Partnership Interests Section 965(a)12 ? Mandatory Repatriation of Deferred Foreign Income Applicable to

U.S. Shareholders

Section 951A13 ? Current Year Inclusion of GILTI by U.S. Shareholders

3 Section 7704(a) - (c). Section 7704(a) of the Omnibus Budget Reconciliation Act of 1987 treats PTPs as corporations for federal income tax purposes except as provided under section 7704(c), which allows a PTP to be taxed as a partnership if 90 percent or more of its gross income consists of qualifying income.

4 Pub. L. No. 115-97, ?11011, effective for tax years beginning after December 31, 2017, and shall not apply to tax years beginning after December 31, 2025.

5 Pub. L. No. 115-97, ?13301, effective for tax years beginning after December 31, 2017. 6 Pub. L. No. 115-97, ?13201, effective for assets placed in service after December 31, 2017, but before December 31, 2027. 7 Pub. L. No. 115-97, ?13504, effective for tax years beginning after December 31, 2017. 8 Pub. L. No. 115-97, ?13502, effective for transfers of partnership interests after December 31, 2017. 9 Pub. L. No. 115-97, ?13503, effective for tax years beginning after December 31, 2017. 10 Pub. L. No. 115-97, ?13501, effective for sales, exchanges and dispositions on or after November 27, 2017. 11 Pub. L. No. 115-97, ?13501, conforming amendments, effective for sales, exchanges and dispositions after December 31,

2017. 12 Pub. L. No. 115-97, ?14103, effective for the last tax year of a deferred foreign income corporation beginning before January

1, 2018. 13 Pub. L. No. 115-95, ?14201, effective for tax years of foreign corporations beginning after December 31, 2017, and to tax

years of U.S. shareholders in which such tax years of foreign corporations end.

? 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

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Key Provisions for PTPs and Unitholders

Section 199A Deduction for Qualified Business Income

The 2017 Act added a new section 199A that creates a potential deduction of 20 percent of qualified business income from partnerships, S corporations, and sole proprietorships. To qualify for the new section 199A deduction, a taxpayer other than a C corporation must have qualified business income ("QBI") from a qualified trade or business ("QTB"), qualified REIT dividends, or qualified publicly traded partnership income ("QPTPI").14 Taxable income is first computed without regard to the section 199A deduction;15 consequently, QBI is computed after applying the basis limitation rules for partnerships under section 704(d), the section 465 at-risk rules, and the section 461(l) rules dealing with excess business losses.16 The definition of QPTPI17 in section 199A(e)(5) is the sum of:

? The net amount of the taxpayer's allocable share of each qualified item of income, gain, deduction, and loss (as defined in subsection 199A(c)(3)18 and determined after the application of 199A(c)(4))19 from a publicly traded partnership (as defined in section 7704(a))20 that is not treated as a corporation under section 7704(c),21 plus

? Any gain recognized by the taxpayer upon disposition of its interest in the partnership to the extent the gain is treated as an amount realized from the sale or exchange of property other than a capital asset under section 751(a).

A cursory reading of this Code section may lead one to believe that all qualifying income as defined in section 7704(d) from a PTP is potentially QBI.22 However, the application of section 199A(c)(3) and (4) imposes limitations on PTPs that are similar to those imposed on non-PTP entities by making investment type income ineligible for the deduction. In particular, items subject to the exception for

14 Section 199A(c)(1). 15 Section 199A(e)(1). 16 The deduction does not reduce net investment income under chapter 2A because section 199A is applicable only for income

taxes under chapter 1. Section 199A(f)(3). 17 Section 199A(e)(5). 18 Section 199A(c)(3) states that for purposes of this section qualified items of income, gain, deduction, and loss mean items of

such that are effectively connected with the conduct of a trade or business within the United States (within the meaning of section 864(c)) and included or allowable in determining taxable income for the year. 19 Section 199A(c)(4) states that qualified business income shall not include reasonable compensation paid to the taxpayer for services with respect to the trade or business, any guaranteed payments under section 707(c) and section 707(a) payments made to a partner for services rendered with respect to the trade or business. 20 Section 7704(a) generally, a publicly traded partnership shall be treated as a corporation. 21 Section 7704(c) provides an exception for a PTP to be taxed as a partnership if 90 percent or more of its gross income consists of qualifying income. 22 While the statute specifically references qualified business income it is important to note that in fact this amount may be a loss and this might be a detriment against other income.

? 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Tax Reform and Publicly Traded Partnerships

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investment type income23 include short and long term capital gains and losses, dividends, dividend equivalents, interest income other than interest income properly allocable to a trade or business, foreign currency gain,24 commodities transactions25 (including futures and forwards), amounts received from an annuity that is not in conjunction with a trade or business, and any item of deduction or loss allocable to the items previously described. For example, dividend income is qualifying PTP income as described in section 7704(d), but it is not QPTPI for purposes of section 199A because it is listed as an exception in section 199A(c)(3)(B)(ii).

Note that although mineral royalty income is not listed in the statutory language as excluded investment type income, given its classification as investment type income in other parts of the statute, it is reasonable to conclude that mineral royalty income is excluded for purposes of section 199A.26 Also note that in order to avoid a double benefit of lower rate treatment arising when 1231 gains exceed section 1231 losses and all of the gains and losses are generally treated as long-term capital gains and losses,27 it seems likely that 1231 gain is not treated as capital gain for purposes of section 199A as it arises from a trade or business.

On the other hand, PTPs receive more favorable section 199A treatment than other partnerships in two regards. First, section 199A deductions for partners in other partnerships are subject to significant limitations: the lesser of (1) 20 percent of QBI or (2) the greater of (a) 50 percent of W-2 wages with respect to the qualified trade or business or (b) the sum of 25 percent of W-2 wages of the qualified trade or business plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property. By contrast, partners in PTPs are not subject to these limitations on their section 199A deductions. Second, for partners in partnerships other than PTPs it is not entirely clear whether section 751(a) gain on the sale of a partnership interest is eligible for the section 199A deduction. This benefit is expressly allowed for partners in PTPs, however. It will be important for PTPs (barring further reporting guidance from the IRS) to identify for their unitholders the income that is potentially eligible for the deduction in footnote disclosures to each partner's Schedule K-1.

Section 163(j) Business Interest Expense Limitation

The 2017 Act amends section 163(j) to impose a new and substantial limit on the deductibility of business interest expense. The limitation is applied at the filer level and special rules are provided for the application of the limitation to partnerships.28 The calculation of the limitation excludes investment

23 Section 199A(c)(3)(B). 24 As defined in section 954(c)(1)(D). 25 As defined in section 954(c)(1)(C). 26 This conclusion does not apply to oil and gas royalties held by a taxpayer as a dealer or trader primarily for sale to customers

in the ordinary course of its trade or business, these royalties are not a capital asset by reason of section 1221(1) and any gain or loss on the sale or exchange of the royalties are ordinary gain or loss. 27 Section 1231(a). 28 Section 163(j)(4).

? 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Tax Reform and Publicly Traded Partnerships

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interest income and investment interest expense within the meaning of section 163(d). Generally, interest expense is now limited to the sum of business interest income for the tax year plus 30 percent of adjusted taxable income ("ATI").29

For tax years beginning after December 31, 2017, and before January 1, 2022, ATI is equal to taxable income other than items not allocated to a trade or business, business interest income and expense, and deductions for depreciation, amortization, and depletion,30 the 20 percent deduction for qualified business income under section 199A, and net operating losses. The computation of ATI changes for tax years beginning after December 31, 2021, because ATI will include items of depreciation, amortization, and depletion. In calculating ATI for midstream PTPs, the exclusion of depreciation will likely be a very material item and will tend to boost their section 163(j) limitations. However, these PTPs should be mindful that depreciation will be included in the calculation of ATI starting in 2022.31

If excess business interest expense ("Excess BIE") is allocated to a partner, it is subject to a carryforward, and is treated as business interest expense ("BIE") paid or accrued by the partner in a future tax year to the extent that the partner is allocated excess taxable income ("ETI") from the partnership. Additional rules are provided to take into account any Excess BIE upon disposition of the partnership interest.

It is worth highlighting that the new law does not contain a provision to "grandfather" existing liabilities or a provision to address intercompany obligations. The IRS has issued guidance in the form of Notice 2018-28 stating that it intends to issue regulations to clarify that taxpayers with disallowed business interest expense from years prior to 2018 will be able to carry that interest expense forward and then apply the new section 163(j) limitations to the disallowed amount.

It is also worth noting that a trade or business for purposes of this interest expense limitation does not include certain regulated public utilities including the trade or business of (1) electrical energy, water, or sewage disposal services; (2) gas or steam through a local distribution system; or (3) transportation of gas or steam by pipeline, if the rates for the furnishing or sale have been approved or established by governmental bodies (the "public utilities exclusion").32 PTPs should consider whether the public utilities exclusion applies. This exclusion is particularly relevant to PTPs engaged in the midstream business because these PTPs often operate pipelines subject to federal regulations. Such PTPs will face issues regarding how to allocate their interest expense between eligible and ineligible trades or businesses.

29 Section 163(j)(1)(A) and (B). 30 Note that any depreciation and depletion included in cost of goods sold, which is an adjustment to determine gross income,

cannot be added back for purposes of ATI. 31 Depletion and IDC are generally not included as partnership level items and thus not included as part of ATI. These items are

treated similarly to section 743(b) adjustments and are specially allocated to partners. 32 Section 163(j)(7)(A)(iv). As a trade-off, trades or businesses subject to the public utilities exclusion (and therefore not subject

to the interest expense limitations of section 163(j)) are not considered to have qualified property for purposes of full expensing under section 168(k) (described more fully below).

? 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved. The KPMG name and logo are registered trademarks or trademarks of KPMG International.

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