Certain Investment Income

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-105163-97]

RIN 1545-AV15

Certain Investment Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the

treatment of certain investment income under the qualifying income

provisions of section 7704(d) and the application of the passive

activity loss rules to publicly traded partnerships. The regulations

would affect the classification of certain partnerships for federal tax

purposes and would also affect the passive activity loss limitations

with respect to items attributable to publicly traded partnerships.

This document also contains a notice of public hearing on these

proposed regulations.

DATES: Written comments must be received by March 19, 1998. Requests to

speak (with outlines of oral comments) at a public hearing scheduled

for April 28, 1998, at 10 a.m., must be received by April 7, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-105163-97), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R

(REG-105163-97), Courier's Desk, Internal Revenue Service, 1111

Constitution Avenue NW., Washington, DC. Alternatively, taxpayers may

submit comments electronically via the Internet by selecting the ``Tax

Regs'' option of the IRS Home Page, or by submitting comments directly

to the IRS Internet site at: http://www.irs.ustreas.gov/prod/tax__regs/

comments.html. The public hearing will be held in Room 2615, Internal

Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

Christopher Kelley, (202) 622-3080; concerning submissions and the

hearing, Evangelista Lee, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Introduction

This document proposes to add Sec. 1.7704-3 to the Income Tax

Regulations (26 CFR part 1) relating to the definition of qualifying

income for publicly traded partnerships under section 7704(d) of the

Internal Revenue Code (Code). This document also proposes to amend

Sec. 1.469-10 of the Income Tax Regulations relating to the application

of section 469 of the Code to publicly traded partnerships.

Explanation of Provisions

Qualifying Income

Section 7704 of the Code provides that a publicly traded

partnership is generally treated as a corporation for federal tax

purposes unless 90 percent or more of the gross income of the

partnership consists of qualifying income. Section 7704(d) defines

qualifying income to include certain types of passive investment

income, such as interest, dividends, real property rents, and income

that would qualify under the regulated investment company provisions in

section 851(b)(2) or the real estate investment trust provisions in

section 856(c)(2). Since section 7704 was enacted, however, several new

types of financial instruments have been developed that generate

passive-type investment income similar to interest and dividends. The

preamble to the regulations under Sec. 1.7704-1, issued December 4,

1995, (regarding the definition of public trading) requested comments

from the public on the definition of qualifying income for investment

partnerships and other partnerships engaged in various types of

securities transactions.

In response to comments received, the proposed regulations provide

that qualifying income for purposes of section 7704(c) includes income

from holding annuities, income from notional principal contracts (as

defined in Sec. 1.446-3), and other substantially similar income from

ordinary and routine investments to the extent determined by the

Commissioner. Qualifying income, however, includes income from a

notional principal contract only if the property, income, or cash flow

that measures the amounts to which the partnership is entitled under

the contract would give rise to qualifying income if held or received

directly by the partnership. The proposed regulations also confirm that

capital gain from the sale of stock is qualifying income, regardless of

whether the stock pays dividends. The proposed regulations also provide

that qualifying income (as defined in the proposed regulations) does

not include income derived in the ordinary course of a trade or

business by a broker, dealer, or market maker. Income derived by

traders and investors can be qualifying income under the proposed

regulations. The proposed regulations, including the trade or business

restriction, are consistent with the legislative history of section

7704, which indicates that the exception for passive investment income

was intended to distinguish between partnerships engaged in investment

activities and those partnerships engaged in active business activities

that are more typically conducted in corporate form. See H.R. Rep. No.

391 (Part 2), 100th Cong., 1st Sess. 1066-69 (House Report). The IRS

also requests comments on the appropriate way to determine how gains

should be measured for purposes of determining whether 90 percent or

more of the partnership's gross income is qualifying income when a

partnership makes a mixed straddle account election under

Sec. 1.1092(b)-4T. The IRS believes that use of the daily mark-to-

market method provided for by Sec. 1.1092(b)-4T would be inconsistent

with the congressional purpose behind section 7704.

Passive Activity Loss Rules

Section 469(a) generally provides that if for any taxable year the

taxpayer is an individual, estate, trust, closely held C corporation,

or personal service corporation, neither the passive activity loss nor

the passive activity credit for the taxable year is allowed. Section

[[Page 66576]]

469(k) provides that section 469 applies separately with respect to

items attributable to each publicly traded partnership. Section

469(k)(2) defines a publicly traded partnership in the same manner as

section 7704(b). The legislative history of section 469(k) indicates

that the term publicly traded partnership has the same meaning for

purposes of section 469(k) as it does for purposes of section 7704. See

H.R. Rep. No. 495, 100th Cong., 1st Sess. 952-53 (1987) (Conference

Report). In addition, Notice 88-75 (1988-2 C.B. 386) provided the same

guidance on the definition of a publicly traded partnership for

purposes of both sections 469(k) and 7704.

The recently issued regulations under Sec. 1.7704-1, however,

define a publicly traded partnership only for purposes of section 7704.

The proposed regulations implement the legislative history of section

469(k) by providing that the definition of a publicly traded

partnership for purposes of section 469(k) is the same as the

definition of publicly traded partnership under section 7704.

Proposed Effective Date

These regulations are proposed to apply for taxable years of a

partnership beginning on or after the date the final regulations are

published in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because the

regulations do not impose a collection of information on small

entities, a Regulatory Flexibility Analysis is not required. Pursuant

to section 7805(f) of the Internal Revenue Code, this notice of

proposed rulemaking will be submitted to the Chief Counsel for Advocacy

of the Small Business Administration for comment on its impact on small

business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (preferably a

signed original and eight (8) copies) that are submitted timely to the

IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for Tuesday, April 28, 1998, at

10 a.m., in Room 2615, Internal Revenue Building, 1111 Constitution

Avenue NW., Washington, DC. Because of access restrictions, visitors

will not be admitted beyond the Internal Revenue Building lobby more

than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons

that wish to present oral comments at the hearing must submit timely

written comments (preferably a signed original and eight (8) copies) by

March 19, 1998 and submit an outline of the topics to be discussed and

the time to be devoted to each topic by April 7, 1998.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information: The principal author of these regulations is

Christopher Kelley, Office of Chief Counsel (Passthroughs and Special

Industries). However, other personnel from the IRS and Treasury

Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *.

Par. 2. Section 1.469-10 is revised to read as follows:

Sec. 1.469-10 Application of section 469 to publicly traded

partnerships.

(a) [Reserved].

(b) Publicly traded partnership--(1) In general. For purposes of

section 469(k), a partnership is a publicly traded partnership only if

the partnership is a publicly traded partnership as defined in

Sec. 1.7704-1.

(2) Effective date. This section applies for taxable years of a

partnership beginning on or after the date final regulations are

published in the Federal Register.

Par. 3. Section 1.7704-3 is added to read as follows:

Sec. 1.7704-3 Qualifying income.

(a) Certain investment income--(1) In general. For purposes of

section 7704(d)(1), qualifying income includes capital gain from the

sale of stock, income from holding annuities, income from notional

principal contracts (as defined in Sec. 1.446-3), and other

substantially similar income from ordinary and routine investments to

the extent determined by the Commissioner. Income from a notional

principal contract is included in qualifying income only if the

property, income, or cash flow that measures the amounts to which the

partnership is entitled under the contract would give rise to

qualifying income if held or received directly by the partnership.

(2) Limitations. Qualifying income as defined in paragraph (a)(1)

of this section does not include income derived in the ordinary course

of a trade or business. For purposes of the preceding sentence, income

derived from an asset with respect to which the partnership is a

broker, market maker, or dealer is treated as income derived in the

ordinary course of a trade or business; income derived from an asset

with respect to which the taxpayer is a trader or investor is not

treated as income derived in the ordinary course of a trade or

business.

(b) Effective date. This section applies for taxable years of a

partnership beginning on or after the date final regulations are

published in the Federal Register.

Michael P. Dolan,

Acting Commissioner of Internal Revenue.

[FR Doc. 97-33105 Filed 12-18-97; 8:45 am]

BILLING CODE 4830-01-P