related deductions bear to the total deductions. For this purpose, deductions for administrative expenses or general overhead relating to real estate and other activities are to be reasonably allocated. As an alternative to the method of allocation described above, if the fair rental value of the real property can be clearly established, taxpayers may elect to treat the fair rental value of the real property involved as the amount of income allocable to that property. The bill does not change the treatment provided under the Tax Reform Act of 1976 with respect to real estate used in one of the specified activities covered by the 1976 Act provisions (farming, oil and gas activities, motion pictures, or leasing of personel property). This real estate would be treated as part of the activity, rather than as a separate activity. Thus, for example, real property used in farming would be considered a part of the farming activity subject to the at risk rules. Loans from related and interested parties.-The Tax Reform Act of 1976 (sec. 465 (b) (3)) specifically requires that a taxpayer not be considered at risk with respect to amounts borrowed for use in an activity (or which are contributed to the activity) if the amounts are borrowed from any person who has an interest in the activity (other than that as a creditor) or who is related to the taxpayer (as described in sec. 267 (b)). Although this rule will continue to apply without change to the four specified activities, the bill provides that, in the case of the activities which are newly made subject to the at risk provision by the bill, this automatic nonrecourse provision shall apply only to the extent provided in regulations prescribed by the Treasury. The regulations may make this provision applicable to activities involving tax shelter characteristics, such as the presence of property the value of which is subject to substantial uncertainty, activities of a speculative nature, the unavailability of similar financing on similar terms from unrelated lenders and the presence of terms or conditions under which either the loan becomes nonrecourse in later taxable years or the taxpayer can convert the obligation from a recourse obligation to a nonrecourse (or guaranteed) obligation in later years. Repeal of partnership at risk rules.-Since all the activities currently covered by the partnership at risk rules would now be covered by the new expanded version of the specific at risk rules under 'For example, assume that an individual owns and operates a restaurant and the individual incurs a loss of $100,000 which is determined as follows: $500,000 gross income, $450,00 restaurant expenses (including depreciation on restaurant personal property) and $150,000 for real estate taxes, depreciation on the structure, repairs and maintenance to the structure, and interest on the mortgage secured by the real property. In this instance, $125,000 of the income would be allocated to the real property, computed as follows: $150,000 real property expenses divided by $600,000 total expenses multiplied by $500,000 income equals $125,000. Consequently, the real property activity would be treated as having incurred a loss of $25,000 ($125,000-$150,000) and the restaurant activity a loss of $75,000 ($375,000 $450,00). Only the restaurant activity loss would be subject to the at risk limitation. 4 Thus, if in the example set forth under footnote 3 the taxpayer could establish that the annual fair rental value of the land and structure involved was $100,000, that amount (as opposed to the $125,000 derived under the allocation formula) would be treated as the income allocable to the real property. section 465, section 704 (d) is repealed by the bill, effective for taxable years beginning after December 31, 1978. The bill provides that, to the extent losses have been disallowed for a taxable year pursuant to the partnership at risk rules of section 704 (d) prior to its amendment by this bill, these losses will be treated as if they had been disallowed by the specific at risk rule of section 465 and, as a consequence, will be treated as a deduction in the first taxable year beginning after December 31, 1978. Extension of at risk rules to closely held corporations Under present law, the only corporations to which the specific at risk rule (sec. 465) applies are subchapter S corporations and personal holding companies. The bill extends the application of this rule to all corporations in which five or fewer individuals own more than 50 percent of the stock." The stock ownership rule is determined by reference to the stock ownership rule for personal holding companies under section 542 (a) (2). Thus, a corporation will be subject to the at risk rule if, at any time during the last half of the taxable year, more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than 5 individuals. In applying this stock ownership rule, a pension trust, a supplemental employment benefit trust (sec. 501 (c) (17)), a charitable organization (described in sec. 509 (a)), or a portion of a trust permanently set aside or to be used exclusively for charitable purposes (described in sec. 642 (c)) shall be considered an individual. If a corporation meets these ownership requirements, it will be subject to the at risk rules even if it does not meet other definitional requirements of a personal holding company (see sec. 542 (a) (1)) or because it is excepted from personal holding company status (by sec. 542 (c)). Recapture of losses where amount at risk is less than zero Under a literal interpretation of present law, the at risk rules may only require the taxpayer to be at risk at the end of the taxable year for which losses are claimed. Thus, subsequent withdrawals of amounts originally placed at risk may be made without the recapture of previously allowed losses. However, in order to be consistent with the original intent of the at risk rules, the bill requires the recapture of previously allowed losses when the amount at risk is reduced below zero. Mechanically, this rule works by providing that, if the amount at risk is reduced below zero (by distributions to the taxpayer, by changes in the status of indebtedness from recourse to nonrecourse, by the commencement of a guarantee or other similar arrangement which affects the taxpayer's risk of loss, or otherwise), the taxpayer will recognize "The partnership at risk rule of present law applies to corporate partners in a partnership which is engaged in activities which are neither subject to the provisions of the specific at risk rule nor involve real property (other than mineral property). Consequently, the repeal of the partnership at risk rule (even with the extension of the specific at risk rule to certain closely-held corporations) results in the narrowing of the applicability of the at risk concept to more widely held corporations. "The provision would continue to apply to subchapter S corporations. income to the extent that his at risk basis is reduced below zero. However, the amount recaptured is limited to the excess of the losses previously allowed in that activity over any amounts previously recaptured. Since the deduction of losses is allowed only to the point where the at risk basis equals zero and further deduction of losses are suspended under the specific at risk rules, the types of events which can result in the at risk basis being reduced below zero include distributions to the taxpayer, changes in the amount of recourse indebtedness attributable to the taxpayer, or the commencement of guarantees or similar arrangements which would reduce the taxpayer's amount at risk. The effect of this rule is to treat the reduction in the amount at risk as if it had preceded the deductions which had been used to offset the original at risk amount. Consequently, a suspended deduction in the amount equal to the amount of income would be provided to the taxpayer. This suspended deduction would be allowed in a subsequent year if and to the extent the taxpayer's at risk basis is increased. A transitional rule provides that if the amount which the taxpayer is at risk in an activity as of the close of the taxpayer's last taxable year beginning before January 1, 1979, is less than zero, no immediate inclusion of the excess of zero over such amount is required. Rather, the provision would be applied as if this negative at risk amount were zero and only further decreases in the at risk basis would be required to be included in income. Effective date The amendments made to the at risk rule generally apply to taxable years beginning after December 31, 1978. Thus, activities and transactions entered into prior to such taxable years may be subject to the expanded at risk rule even though they were not subject to section 465 as in effect prior to taxable years beginning after December 31, 1978. In applying the at risk provisions to activities which were not subject to the at risk rule in taxable years beginning before January 1, 1979 (and not exempted from the at risk provision by transitional rules in the 1976 Act), amounts paid or incurred in taxable years beginning prior to that date and deducted in such taxable years will generally be treated as first reducing that portion of the taxpayer's basis which is attributable to amounts not at risk. On the other hand, withdrawals made in taxable years beginning before January 1, 1979, will be treated as reducing the amount which the taxpayer is at risk. Revenue effect It is estimated that this provision will reduce calendar year liabilities by $14 million in 1979, $10 million in 1980 and $6 million in 1983. Budget receipts will be reduced by $2 million in fiscal year 1979, $14 million in 1980, and $5 million in fiscal year 1983. 2. Partnership provisions (secs. 211 and 212 of the bill and secs. 6501, 6511 and 6698 of the Code) Present law For income tax purposes, partnerships are not taxable entities. Instead, a partnership is a conduit, in which the items of partnership income, deduction and credit are allocated among the partners for inclusion in their respective income tax returns. Partnerships are required to file an annual information return setting forth the partnership income, deductions and credits, names and addresses of the partners, each partner's distributive share of partnership income, deduction and credit, and certain other information required by the regulations. Neither the partnership nor any partner is subject to a civil penalty for failure to file, or for late filing of, a partnership information return. Since a partnership is a conduit rather than a taxable entity, adjustments in tax liability may not be made at the partnership level. Rather, adjustments are made to each partner's income tax return at the time that return is audited. A settlement agreed to by one partner with the Service is not binding on any other partner or on the Service in dealing with other partners. Similarily, a judicial determination of an issue relating to a partnership item generally is conclusive only as to those partners who are parties to the proceeding. The Code provides a period of limitations during which the Service can assess a tax or a taxpayer may file a claim for refund. Generally, the period is 3 years from the date the tax return is filed (if filed before the due date, the due date is treated as the date filed). If more than 25 percent of the gross income is omitted from a return, the statutory period for assessment is 6 years. In the case of a partnership, the income tax return of each of the partners begins that individual partner's period of limitations. The date of filing of the partnership return does not affect the period of limitations. In order to extend the period of limitations with respect to partnership items, the Service must obtain a consent for extension of the statute of limitations from each of the partners-not the partnership. Generally, an agreement to extend the period of limitations relates to all items on the returns of the partner who consents to the extension. Reasons for change The number of large partnerships (those with over 50 partners) increased dramatically in recent years. Many of these new large partnerships are complex tax shelter arrangements. In these arrangements, it is often difficult to identify the taxpayers who may ultimately be affected by an adjustment to a partnership item. The entity, for example, may be composed of several tiers, the partners being trusts, corporations, individuals and other partnerships. The Service has identified instances in which large complex partnerships have not filed the annual partnership information return or, if (74) filed, the return does not contain the information necessary to identify the ultimate taxpaying partners. Consequently, the Service has been forced to spend considerable time and resource attempting to determine who the partners are and whether they have reported their distributive shares of partnership items. If the audit of the partnership return is expected to take a considerable length of time, as it often does in the case of the large complex tax shelter arrangements, the Service must attempt to obtain waivers of the statute of limitations from each partner or other taxpayer who may be affected by the audit. Obtaining these waivers is complicated not only by the fact that it is difficult to identify these taxpayers, but also by the fact that in many cases the partners are widely dispersed geographically. The Committee believes that the Service would be better able to cope with auditing these large partnerships if it had complete and timely filed return information with which to work. The Committee believes that the period of limitations in the case of large tax shelter partnerships should not commence until a partnership return identifying the partners is properly filed. In addition, the committee believes that in these situations the period of limitations with respect to partnership items should be extended for an additional year. Explanation of provisions Penalty for failure to file partnership return The bill enacts a new provision (section 6698 of the Code) that imposes a penalty on the partnership for failure to timely file a complete partnership information return as required by existing Code sections 6031 (relating to the information to be included in a partnership return) and 6072 (relating to the time for filing the partnership return). The penalty is in addition to the criminal penalties imposed by Code section 7203 for willful failure to file a return, supply information or pay a tax. The penalty is assessed for each month, or fraction of a month (but not to exceed 5 months), that the partnership return is late or incomplete. The amount of penalty for each month, or fraction of a month, is $50 multiplied by the total number of partners in the partnership during the partnership's taxable year for which the return is due. The penalty is assessed against the partnership. Partners are to be individually liable for the penalty to the extent of their liability for partnership debts generally. The penalty will not be imposed if the partnership can show that failure to file a complete or timely return is due to reasonable cause. The Committee understands that small partnerships (those with 10 or fewer partners) often do not file partnership returns, but rather each partner files a detailed statement of his share of partnership income and deductions with his own return. Although these partnerships may technically be required to file partnership returns, the Committee believes that full reporting of the partnership income and deductions by each partner is adequate and that it is reasonable not to file a partnership return in this instance. The assessment of the penalty is not subject to the deficiency procedures of the Code. Thus, the partnership may not contest the assess |