LexisNexis Tax Advisor - Federal Topical: Partnership Characterization Nuances Command Attention

LexisNexis Tax Advisor - Federal Topical: Partnership Characterization Nuances Command Attention

In Notice 2009-7, the Service designates the use of a domestic partnership to prevent inclusion of subpart F income as a transaction of interest that is a reportable transaction subject to the disclosure requirements of IRC Section 6011(a). Taxpayers and tax advisors must disclose, in writing, their direct or indirect participation in a reportable transaction with their federal income tax returns. The Notice describes the transaction and substantially similar transactions and indicates that the IRS believes, but has not concluded, that it is a tax avoidance transaction.

The transaction of interest involves a U.S. taxpayer that wholly owns two CFCs, (CFC1 and CFC2). CFC1 and CFC2 are partners in a domestic partnership (US Partnership) that owns 100 percent of the stock of another CFC (CFC3). Some income of CFC3 is subpart F income.FN The taxpayer maintains that the subpart F income of CFC3 is included in the income of US Partnership, but is not currently subject to U.S. tax and is not included in the taxpayer’s income. In effect, income otherwise be currently included in the taxpayer’s income under subpart F is not taxable because of the interposition of a domestic partnership in the CFC structure.

The Notice expresses the Service’s position that that exclusion of income by the taxpayer is contrary to the purpose and intent of the provisions of subpart F. Accordingly, the transaction, and substantially similar transactions, are identified as transactions of interest for purposes of the reportable transaction disclosure rules. The Service will announce the administrative actions it may take regarding these transactions. In the interim, the IRS may challenge the taxpayer's under subpart F, subchapter K, other Code provisions, or under judicial doctrines such as sham transaction, substance over form, and economic substance.

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