On January 5, 2021 the Treasury Department released Final Regulations (TD 9943) (the “2021 Final Regulations”) with additional guidance on the business interest expense limitation under IRC 163(j) as it specifically relates to partnerships engaged in trade or business activity (trading partnerships).
For background, in December of 2017, Section 163(j) was modified as part of the Tax Cuts and Jobs Act (TCJA). Later, in March of 2020 Senate passed the Coronavirus Aid, Relief and Economic Security Act (CARES Act) that temporarily modified TCJA. Then, in July of 2020 the IRS issued Final and Proposed Regulations (TD 9905) (REG-107911-18).” See previous article here where we provide more background and information on the CARES Act modifications and the 2020 Final and Proposed Regulations.
The 2021 Final Regulations preserved the 2020 Proposed Regulations for the application of 163(j) for partnerships engaged in a trade or business, requiring a trading partnership to bifurcate its interest expense from trading activity between partners that are passive and those that materially participate. In addition, the 2020 Proposed Regulations require a trading partnership to bifurcate all of its items of income, gain, loss and deduction from trading activity that is allocated to passive investors so it would not be taken into consideration as items from a trade or business activity when applying Section 163(j) at the partnership level. Therefore, any interest expense and all other items from such trade or business activities allocable to passive partners will be treated as items from investment activity. This provides much needed relief to passive partners of trading partnerships that had their allocation of excess business interest expense (EBIE) subjected to Section 163(j) at the partnership level and 163(d) at the partner level.
The 2021 Final Regulations provide relief and a transition rule that permits non-materially participating partners in a trading partnership to deduct, in the first taxable year ending after the effective date of the 2021 Final Regulations, previously limited EBIE allocated to them from the trading partnership in any taxable year without having any amount of future excess taxable income (ETI) allocated to them by the partnership.
Is It Too Good To Be True? Are You a Master – Feeder Structure?
There may be a feeder fund problem. In the preamble to the 2020 Proposed Regulations, this approach, in order to be effective, assumes that a trading partnership generally would have the information to determine whether its individual partners are passive investors. Issue being when the trading partnership looks to bifurcate its trading activity between passive and non-passive partners, there are no individuals to look to in a Master fund to make that determination. Since there are no individual investors in the trading partnership, it would seem as though all business interest expense would be subject to the 163(j) limitation and EBIE and ETI would continue to pass through to the feeder fund and then to the investor level. It would be no surprise that this may not be what investors are expecting when reading the rules regarding materially vs. non-materially participating partners.
We still expect more to come on Section 163(j) since the 2021 Final Regulations reserve to comment on other key issues impacting trading partnerships, including treatment for tiered partnerships.
Contact Withum’s Financial Services Team for any further questions.