Making a Section 754 election is a common and often tax advantageous practice upon the transfer of a partnership interest under IRC Section 743(b) or to adjust the basis of partnership property following a distribution through IRC Section 734 (b). Many firms consider an annual analysis for these potential elections to be a mandatory part of the internal compliance review for all partnership tax returns prepared by their office and professional tax staff.
Treasury Regulation 1.754-1(b)(1) provides that a valid election shall be allowed by attaching a written election statement (filed timely – including all allowable extensions of time to file) to the partnership tax return for the year for which the transfer or distribution occurred.
This election must contain: the name and address of the partnership, a declaration that the partnership elects under Section 754 to apply the provisions of Sections 734(b) and 743(b), and be signed by a partner of the partnership.
IRS Publication 4163, entitled “Modernized e-file Information for Authorized IRS e-file Providers for Business Returns” provides guidance on elections such as these and their ability to be attached to and included within an e-filed return.
There are some automatic relief options available for taxpayers and tax preparers who realize after the initial return filing, either a need for the election or that one was omitted. Following Regulation 301.9100-2, a taxpayer is granted an automatic extension of 12 months from the return due date for making certain regulatory elections. To obtain relief under this provision, the taxpayer must file an original or amended return for the year the taxpayer intended the election to be effective which includes the election statement.
At the top of the document, you must write; “FILED PURSUANT TO Section 301.9100-2.” This filing must be sent to the same address that the original return would have or should have been filed. This process does not require a private letter ruling nor will it require any user fees to be paid. These regulations also provide that, in the year of and all subsequent years following the election, all taxpayers involved or affected by this election file their returns in full compliance with the election. Any deviation from this full compliance will (could) make the original election invalid.
If the taxpayer falls outside of this automatic 12-month extension window, they may seek relief pursuant to Regulation 301.9100-3. Through this provision, requests for relief will generally be granted if the taxpayer provides evidence that establishes the taxpayer acted reasonably and in good faith as well as that granting the extension will not prejudice the government’s interests.
A taxpayer will be deemed to have acted in good faith if the following occur: taxpayer requests relief before the IRS discovers the omitted election, failed to make the election because of extraordinary events beyond the taxpayers control, taxpayer failed to make the election because they were unaware of the necessity of the election, reasonably relied upon written advice from the IRS or reasonably relied on a qualified tax professional (including an employee) who failed to make or advised the taxpayer not to make the election. One caveat in this regulation is a taxpayer will not be afforded relief if they knew or should have known that the professional was not competent to render advice on this regulatory election or the professional was not aware of all relevant or underlying facts.
In summary, please discuss with your clients the potential need or future benefits for considering these elections for partnership tax returns. As many long time privately held partnership interests and relationships begin to change hands over the next 3 to 10 years (baby boomer planning), there will be many first time opportunities (and some which may get missed in the initial filing) out there for attorneys and accountants to work with their clients, especially in terms of planning.
James P. Schnell, CPA/ABV, CVA is a tax and business valuation partner with Mengel, Metzger, Barr & Co. LLP. He can be reached at (585) 423-1860 or JSchnell@mmb-co.com.