The AICPA has written a letter to the IRS requesting that the agency protect certain small businesses that are deemed to be syndicates from the loss of various small business benefits provided in the Tax Cuts and Jobs Act.
Various benefits are available under the Tax Shelter and Jobs Act to businesses with average revenues of less than $25 million over three years, including:
Use of the cash basis of accounting;
No longer required to use the uniform capitalization rules of §263A;
Allowed to use alternatives to the general inventory rules found at IRC §471(a); and
Exemption from the limitation on business interest expense under §163(j).
However, these benefits are not available if the entity is a tax shelter as defined by IRC §448(d)(3).
This issue was covered in our January 11, 2019 article (Syndicate Rules May Create Problems for Small Businesses and §163(j) Interest Limits) which noted the particular issues raised by the possibility such businesses might meet the definition of a syndicate under IRC §1256(e)(3)(B), one of the three categories of tax shelters.
That provision defines a syndicate as “any partnership or other entity (other than a corporation which is not an S corporation) if more than 35 percent of the losses of such entity during the taxable year are allocable to limited partners or limited entrepreneurs…” A limited entrepreneur is defined at IRC §461(k)(4) as:
(4) Limited entrepreneur
For purposes of this subsection, the term “limited entrepreneur” means a person who—
(A) has an interest in an enterprise other than as a limited partner, and
(B) does not actively participate in the management of such enterprise.
As was discussed in the earlier article, the IRS in regulations under §448 modified the definition of a syndicate to refer to 35 of the losses are allocated rather than being allocable, thus eliminating a problem for an entity that doesn’t have losses.
However, the expansion of the reach of this definition to potentially impact all types of businesses creates a situation where a business that has any significant percentage of inactive ownership could lose significant tax benefits should it have a loss year.
The AICPA letter calls on the IRS to blunt the impact of this provision by using its authority under IRC §1256(e)(3)(C)(v) to treat certain interests as not being treated as inactive if “the Secretary determines (by regulations or otherwise) that such interest should be treated as held by an individual who actively participates in the management of such entity, and that such entity and such interest are not used (or to be used) for tax–avoidance purposes.”
Specifically, the AICPA asks the IRS to issue regulations that exempt organizations from the syndicate rules if the organization meets the following three conditions:
Qualifies under the gross receipts test of section 448(c); and
Meets the definition of a syndicate under section 1256(e)(3)(B); and
Does not qualify “for making an election under section 163(j)(7)(B) to be an electing real property trade or business” or “an election under section 163(j)(7)(C) to be an electing farming business.”
It remains to be seen if the IRS will consider issuing such regulations and, if they do consider taking such action, what modifications they might make to the AICPA suggestion. But those advising businesses that appear to be at risk of being syndicates will want to watch for IRS action in this area.