Final regulations adopt 2015 temporary regulations with a few tweaks
Final regulations have been issued (T.D. 9833) preventing avoidance of corporate-level income via certain transactions involving a corporation’s transfer of appreciated property to a partnership. These regulations are commonly known as the “May Company” regulations, so named after the May Department Stores company which generally was known to have engaged in this sort of transaction in the 1980s.
Absent these regulations, a corporation transferring appreciated property to a partnership and later receiving its own stock in distribution from the partnership might end up avoiding tax on its disposition of the appreciated property. Here is an example:
C, a corporation, owns land which has a high value (say $10 million) and a low tax basis ($1 million). C contributed the property to a partnership, BC. The other partner in the BC partnership was B. Later, B contributed C stock to the BC partnership. B may have bought the C stock from C, or through a stock market. Afterwards, BC distributes C stock worth $10 million to C. C took the distributed C stock with a $1 million tax basis under section 732 of the Tax Code. C could then sell this C stock on the market for $10 million, use this stock to pay compensation of $10 million to employees, or to pay $10 million of consideration in an acquisition of another company. When C did so, C was protected from taxation on the $9 million of gain in the C stock by section 1032.
The IRS issued a Notice attacking the tax-free result of this type of transaction in 1989 (Notice 89-37). Temporary regulations governing these transactions have been in effect since 2015. Since then, occurrence of transactions seeking to eliminate corporate level tax that are addressed in the new final regulations has been very rare.
The May Company regulations do not limit themselves to transactions intended to avoid tax. They can also apply to some transactions seeking to restructure or combine multiple businesses originally operating in corporate and partnership form. Although they occur infrequently, any restructuring that leaves a partnership directly or indirectly owning an interest in the equity of a corporation that is a partner in the partnership (Corporate Partner Stock) can trigger applicability of the May Company regulations.
Where the May Company regulations apply, they generally characterize as taxable the transaction that triggers their applicability, or render certain subsequent events taxable. In addition, they may trigger tax basis adjustments. On balance, taxpayers generally are well-advised to steer clear of any transaction that triggers applicability of the May Company regulations. Taxpayers should take a careful look before leaping into any transaction in which a partnership acquires Corporate Partner Stock.
The new final regulations make only small changes to the 2015 regulations. For example, the final regulations add an anti-abuse rule to a de minimis exception carried forward from the temporary regulations on the theory that multiple entities operating in concert might otherwise use the de minimis exception to avoid the regulations’ gain recognition rules. The final regulations also clarify the broad range of equity interests treated as Corporate Partner Stock.
The preamble to the final regulations stated that the IRS and Treasury are considering proposing additional rules to include with the May Company regulations in the future. However, no additional proposed regulations were issued. Not proposing additional regulations addressing the rarely encountered transactions that invoke the May Company seems appropriate given the amount of federal tax guidance related to 2017’s Tax Cuts and Jobs Act, P.L. 115-97, (the TCJA) that the IRS and Treasury are working on.
Even though they made few changes to the temporary May Company regulations, issuing these final regulations was necessary to preserve the regulations rules, which otherwise would have ‘sunsetted’ (expired) soon. IRS and Treasury took a sensible approach here by finalizing the regulations with just a few tweaks. Doing so will hopefully allow the personnel involved to more on to the more compelling guidance needs under the Tax Cuts and Jobs Act (P.L. 115-97).