2020 Filing Deadline for Calendar Year Partnerships

As part of its response to COVID, the IRS issued a series of notices, culminating with IRS Notice 2020-23, 2020-18 IRB (April 9, 2020), which generally extended the deadline to file tax returns and pay taxes to July 15, 2020. Pursuant to the Notice, any person with "a Federal tax return or other form filing obligation specified in this section III.A..., which is due to be performed (originally or pursuant to a valid extension) on or after April 1, 2020, and before July 15, 2020, is affected by the COVID-19 emergency for purposes of the relief described" in that section. Such "affected taxpayers" are entitled to the relief of the extended deadline.

The notice goes on to specify that the "filing obligations specified in this section III.A" include "[c]alendar year... partnership return filings on Form 1065, U.S. Return of Partnership Income...," which absent the Notice would normally be due on March 16, 2020. According, the Notice creates an ambiguity: Is the due date for calendar year partnership returns extended to July 15 because "calendar year partnership return filings" are specifically included on the list of specified federal form filing obligations entitled to relief, or does the due date for such returns remain at March 16 because they are not due on or after April 1, 2020? This ambiguity was noted shortly after the Notice was issued.

Unofficially resolving this ambiguity, the IRS website currently states, "Notice 2020-23 does not postpone any return filings that were due on March 16, 2020. If a fiscal year partnership or S-corporation has a return due to be filed on or after April 1, 2020, and before July 15, 2020, that filing requirement has been postponed to July 15, 2020." The website does not specifically mention "calendar year partnerships" like the Notice does.

As a practical matter, most partnership tax returns would have had extensions filed before March 16, 2020 anyway because the IRS guidance wasn't issued until after that due date. However, if an extension was not filed for your partnership's return, there is a good argument that binding guidance from the IRS granted an automatic extension to July 15, 2020.

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Introduction to Qualified Opportunity Funds

The 2017 Tax Cuts and Jobs Act added sections 1400Z-1 and 1400Z-2 to the Internal Revenue Code. The former provides for the designation of certain low-income communities as "qualified opportunity zones," and the later provides certain incentives for investment in such QOZs. IRS Notice 2018-48 provides a full list of population census tracts designated as qualified opportunity zones; investments within these zones can qualify for the new tax incentive.

The tax incentive permits a taxpayer who has realized a capital gain from the sale of property to an unrelated person to invest all or part of the gain amount into a "qualified opportunity fund" within 180 days of the realization event and elect to defer paying tax on the gain amount so invested. The deferral lasts until the earlier of (a) the date that the taxpayer sells the QOF investment or (b) December 31, 2026.

In addition, if the taxpayer holds the QOF investment for at least five years, ten percent of the deferred gain is permanently excluded from taxation, and if the taxpayer holds the QOF investment for at least seven years, a total of fifteen percent of the deferred gain is permanently excluded from taxation. Finally, if the taxpayer holds the QOF investment for at least ten years, all post-acquisition gain on the QOF investment can be permanently excluded from taxation.

A QOF is an entity organized as a corporation or a partnership for the purpose of investing in QOZ property. Such an entity uses IRS Form 8996 to initially certify that it is organized to invest in QOZ property as well as annually report that it meets the investment standards. Generally speaking, a QOF must hold 90% of its assets in QOZ property or pay a penalty. This tax incentive is a new and important opportunity for many taxpayers with capital gains.

See Maule, 597-2nd T.M., Tax Incentives for Economically Distressed Areas; Qualified Opportunity Zones.

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Avoiding a Partnership Tax Return Filing Requirement

According to the IRS, a partnership is a "relationship between two or more persons who join to carry on a trade or business..."  No formal agreement is required; in fact, a partnership can be formed inadvertently, in which case an IRS Form 1065 partnership tax return must be filed.  However, there are a few situations where two or more persons can carry on a trade or business without creating a partnership tax-filing requirement.

If two or more persons have a business relationship that, for tax purposes, constitutes a corporation or trust, obviously such an arrangement is not a partnership. However, a venture that is not a corporation or trust avoids partnership classification if the parties are merely sharing expenses. In addition, a married couple has the option of not filing a partnership tax return if they "materially participate as the only members of a jointly owned and operated business" and file a joint tax return.

Such an arrangement is known as a "qualified joint venture" and cannot be operated through a state-law entity. However, a husband and wife in a community property state may own and operate a business through a state law entity other than a corporation, such as an LLC, and elect to have that LLC disregarded for federal income tax purposes. The business entity must be owned as community property and have no other owners; if so, no partnership tax return is required. These rules are contained in Rev. Proc. 2002-69.

A final example of partnership-type arrangement that does not give rise to a partnership tax return requirement is co-ownership of real property, other than mineral property, but including rental property. Each co-owner must be a tenant-in-common, and title to the property as a whole may not be vested in a state-law entity. However, each tenant may own their interest in the property through an entity that is disregarded for tax purposes. A number of other requirements are set forth in Rev. Proc. 2002-22 which, if satisfied, will result in no partnership filing requirement.

In summary, a partnership can automatically arise for federal tax purposes even where no entity exists under local law. An arrangement of this kind includes a "syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on..." However, arrangements like those described above avoid partnership classification.

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Donations of Closely-Held Business Interests

A charitable donation of long-term capital gain property is a useful tax-planning technique for charitably-inclined individuals. The reason this works is because the donor (1) receives a deduction for the fair market value of the donated asset and (2) avoids paying tax on the built-in gain of the asset. However, in the case of a donation of an interest in a closely-held business taxed as a partnership, two issues often arise which impact this strategy: Business liabilities and ordinary-income property.

Because relief of debt is considered taxable income, a donor who has been allocated a share of a partnership's liabilities and who transfers the interest to a charity is deemed to have engaged in two separate transactions. First, a sale transaction has occurred, whereby the donor realizes income equal to the amount of debt relief. Second, a donation has occurred, whereby the donor makes a contribution equal to the fair market value of the interest less the amount of debt relief. The donor's basis is allocated pro-rata between the two transactions, meaning the donor will recognize and pay tax on the gain arising from the "bargain sale."

The donation is further complicated if the partnership owns ordinary-income property. This is because I.R.C. § 170 requires the amount of a charitable deduction to be reduced to the extent that a sale or exchange of the contributed property would generate ordinary income.

Chapter 7 of the IRS's Partnership Audit Technique Guide contains an example addressing the impact of the debt-relief issue, which I've modified below so that it also illustrates the impact of ordinary-income property, or "hot assets." In this example, an individual donor contributes a partnership interest valued at $50,000 to a public charity. The donor's basis in the interest is $40,000 and the donor is allocated $30,000 of partnership liabilities. In addition, the partnership owns a fully-depreciated piece of equipment which, if sold, would result in $2,000 of ordinary income allocated to the donor. The consequences of this donation on the donor should be as follows:

Bargain Sale:			Footnotes:
	Deemed Proceeds:	30,000	1.
	Allocated Basis (pro-rata):	-24,000	2.
	Gain on Bargain Sale:	=6,000
	Ordinary Income Portion:	1,200	3.
	Capital Gain Portion:	4,800
Donation:
	Gross Donation:	20,000
	Ordinary Income:	-800	4.
	Allowable Deduction:	=19,200

1. Rev. Rul. 75-194, 1975-1, C.B. 80.
2. Treas. Reg. § 1.1011-2(c).
3. The proper allocation of the gain on the bargain sale between ordinary income and capital gain is not clear. See Jonathan G. Tidd, Charitable Gifts of Limited Partnership and Limited Liability Company Interests, Trusts & Estates, October 2015.
4. I.R.C. § 170(e)(1)(A).

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