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IRS Issues Investment Company Pass-Through Write-Off Rules (3)

June 24, 2020, 12:48 PMUpdated: June 24, 2020, 8:51 PM

Shareholders of vehicles known as regulated investment companies can now get a better idea of whether they qualify for—and how to compute—a deduction for pass-through business owners.

The IRS released final rules (T.D. 9899) Wednesday for how the tax law’s 20% deduction works for regulated investment companies, many of which are mutual funds, that receive dividends from real estate investment trusts.

The final rules adopt several parts of a proposed version. The write-off must be reduced by losses or deductions that are partially disallowed in the same tax year, for instance, as well as “conduit treatment” of certain real estate investment trust dividends earned by regulated investment companies.

Stephen Hamilton, a partner at Faegre Drinker Biddle & Reath LLP in Philadelphia, praised the retention of the latter language, calling it “a reasonable interpretation” of the IRS’s authority under the 2017 tax law.

“That way, investors who invest in RICs will be treated the same as people who buy REIT shares directly, which I think is the desirable answer,” he said.

In a statement, the National Association of Real Estate Investment Trusts said it “commends the Treasury Department and the IRS for finalizing this helpful guidance that will continue to allow millions of Americans to obtain the tax deduction for REIT dividends as Congress intended.”

The IRS didn’t allow this treatment for publicly traded partnership income earned by regulated investment companies in the proposed rules and said it will “continue to consider” comments requesting such treatment and “whether it is appropriate and practicable” to provide it.

The Master Limited Partnership Association, now known as the Energy Infrastructure Council, laid out how this could work in an April 2019 letter to the agency, emphasizing that “it is increasingly important for MLPs to have RICs as investors” in light of tax policy changes and energy regulations affecting the industry.

The IRS’s decision not to extend this treatment to income these investment vehicles receive from investments in publicly traded partnerships was “not a surprise,” Joseph Opich, a partner at Paul Hastings LLP in New York, wrote in an email.

“The IRS has in the past been reluctant to extend its general rules in several areas to PTPs and frequently continues to leave the issues ‘reserved,’” he wrote, adding that he generally didn’t see the rules as controversial.

The tax law allowed owners of limited liability companies, sole proprietorships, partnerships, and other pass-through business structures to write off a fifth of their income from those sources, subject to limits based on income, employment, and line of work.

It was initially unclear under the tax code Section 199A provisions whether shareholders of regulated investment companies—which can avoid entity-level income tax and are subject to myriad restrictions—would qualify.

(Adds statement from National Association of Real Estate Investment Trusts in sixth paragraph.)

To contact the reporter on this story: Lydia O'Neal in Washington at loneal@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Kathy Larsen at klarsen@bloombergtax.com