A taxpayer may revoke three elections treating capital gains as investment income

Plain-English summary

A taxpayer materially participated in a securities-trading partnership and received carried-interest income. The taxpayer's first accounting firm mistakenly reported partnership interest expense on Form 4952, which elected to treat part of the taxpayer's long-term capital gains as investment income for three years. A later accounting firm discovered the error and advised that the expense should instead have been reported on Schedule E. The IRS found that the taxpayer relied reasonably on the first firm, acted in good faith, and would not prejudice the government's interests by revoking the elections. It granted 60 days to file amended returns revoking all three elections, without deciding the deductibility of the interest expense, the character of the income, or the applicable tax rate.

Ruling snapshot

• Question: Could the taxpayer revoke three mistaken elections to treat long-term capital gains as investment income?
• Outcome: Approved, with 60 days to file amended returns.
• Key authorities: IRC § 163(d)(4)(B); Treas. Reg. §§ 1.163(d)-1, 301.9100-1, 301.9100-3; Rev. Rul. 83-74

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 201745007                                             Third Party Communication: None
Release Date: 11/9/2017                                       Date of Communication: Not Applicable
Index Number: 9100.00-00, 163.03-03
                                                              Person To Contact:
--------------------                                          -----------------, ID No. ------------------
----------------------------------------                      Telephone Number:
----------------------------------                            ----------------------
                                                              Refer Reply To:
                                                              CC:ITA:B02
                                                              PLR-115923-17
                                                              Date:
                                                              August 09, 2017

                  TY: ------------------------

Taxpayer           =        --------------------
Firm 1             =        -----------------------------------
Firm 2             =        -----------------------------------------------
Year 1             =        -------
Year 2             =        -------
Year 3             =        -------
Year 4             =        ----------------------------------------------------------------------------------------
Year 5             =        --------------



Dear --------------:

This is in response to your letter dated May 10, 2017 requesting permission to revoke
an election to treat net long-term capital gains as investment income for Year 1, Year 2,
and Year 3 under §§ 163(d)(1) and 163(d)(4)(B) of the Internal Revenue Code and
§ 1.163(d)-1 of the Income Tax Regulations.

FACTS

The information Taxpayer submitted and the representations made are as follows:

During Year 1, Year 2, and Year 3, Taxpayer was employed as an analyst for a financial
management services partnership and received income in the form of carried interest
from the partnership. The Schedule K-1, Partner’s Share of Income, Deductions, and
Credits, etc., takes the position that the partnership is engaged in the active conduct of
a business as a trader in securities. Taxpayer is actively engaged in the business of the
partnership and materially participates in the operations of the partnership.
PLR-115923-17                                  2

Taxpayer timely filed Forms 1040, Individual Income Tax Return, for Year 1, Year 2,
and Year 3. Taxpayer’s returns for Year 1, Year 2, and Year 3 were prepared by
Firm 1, an accounting firm. In preparing the returns, Firm 1 included Taxpayer’s share
of the partnership’s investment interest expense on Form 4952, Investment Interest
Expense Deduction. As a result, Taxpayer elected to treat a portion of the net long-term
capital gains as investment income as provided in §§ 163(d)(4)(B) and 1.163(d)-1.

In Year 5, Taxpayer engaged Firm 2 to prepare his Year 4 return. Firm 2 reviewed
Taxpayer’s prior returns for Year 1, Year 2, and Year 3, which had been prepared by
Firm 1, and discovered that Firm 1 erroneously included Taxpayer’s share of the
partnership’s investment interest expense on Form 4952 for those years. Firm 2
determined the amounts should have been reported in Part II, Column (h) of
Schedule E, Supplemental Income and Loss, of the Form 1040, and that Taxpayer’s
election to treat net long-term capital gains as investment income was not necessary
based on Taxpayer’s material participation in the partnership. Firm 2 then advised the
Taxpayer to file for relief with the IRS to revoke the elections. Firm 1 acknowledged that
Taxpayer provided all of the relevant facts to prepare Taxpayer’s returns, but Firm 1
neglected to consider this information when it prepared Taxpayer’s returns. Taxpayer
relied on Firm 1 to advise him on his tax returns. Taxpayer was not aware that Firm 1
made the elections, and did not become aware of the elections until Firm 2 brought to
his attention that the elections had been erroneously made. Taxpayer’s Forms 1040 for
taxable Year 1, Year 2, or Year 3 are not currently under examination.

LAW & ANALYSIS

Section 163(d) provides that, in the case of a taxpayer, other than a corporation, the
amount allowed as a deduction for investment interest shall not exceed the net
investment income of the taxpayer for the taxable year.

Section 163(d)(4)(B) defines the term, “investment income,” in general, as the sum of:

      (i)     gross income from property held for investment (other than gain taken into
              account under clause (ii)(I));
      (ii)    the excess (if any) of (I) the net gain attributable to the disposition of
              property held for investment, over (II) the net capital gain determined by
              only taking into account gains and losses from dispositions of property
              held for investment, plus
      (iii)   so much of the net capital gain referred to in clause (ii)(II) (or if lesser, the
              net gain referred to in clause (ii)(I)) as the taxpayer elects to take into
              account under this clause.

Section 1.163(d)-1(b) provides that an election for net capital gain under § 163(d)(4)(B)
must be made on or before the due date (including extensions) of the income tax return
PLR-115923-17                                3

for the taxable year in which net capital gain is recognized. The election is to be made
on a Form 4952, Investment Interest Expense Deduction.

Section 1.163(d)-1(c) provides that the election under § 163(d)(4)(B) is revocable with
the consent of the Commissioner.

Taxpayer is requesting permission to revoke the elections to treat net long-term capital
gains as investment income. This situation is analogous to situations concerning
taxpayers who did not make a particular election provided in the regulations because of
inadequate or incorrect advice from knowledgeable tax professionals and are
subsequently seeking extensions of time under §§ 301.9100-1 and 301.9100-3 of the
Procedure and Administration regulations. See Rev. Rul. 83-74, 1983-1 C.B. 112.

Sections 301.9100-1 through 301.9100-3 provide the standards the Commissioner uses
to determine whether to grant extensions of time for making regulatory elections.
Section 301.9100-1(b) defines the term “regulatory election” to include an election
whose due date is prescribed by a regulation, a revenue ruling, revenue procedure,
notice, or announcement published in the Internal Revenue Bulletin. Section 301.9100-
1(c) provides, in part, that the Commissioner may grant a reasonable extension of time
to make a regulatory election.

Section 301.9100-3(a) provides that requests for extensions of time for regulatory
elections will be granted when the taxpayer provides evidence (including affidavits
described in the regulations) to establish to the satisfaction of the Commissioner that
the taxpayer acted reasonably and in good faith and granting relief will not prejudice the
interests of the Government.

Section 301.9100-3(b)(1) states that a taxpayer will be deemed to have acted
reasonably and in good faith if the taxpayer—

      (i)     requests relief before the failure to make the regulatory election is
              discovered by the Internal Revenue Service (IRS);
      (ii)    failed to make the election because of intervening events beyond the
              taxpayer’s control;
      (iii)   failed to make the election because, after exercising reasonable diligence,
              the taxpayer was unaware of the necessity for the election;
      (iv)    reasonably relied on the written advice of the IRS; or
      (v)     reasonably relied on a qualified tax professional, and the tax professional
              failed to make, or advise the taxpayer to make, the election.

Under § 301.9100-3(b)(3), a taxpayer will not be considered to have acted reasonably
and in good faith if the taxpayer—
PLR-115923-17                                  4

       (i)     seeks to alter a return position for which an accuracy-related penalty has
               been or could be imposed under § 6662 at the time the taxpayer requests
               relief (taking into account any qualified amended return filed within the
               meaning of § 1.6664-2(c)(3)) and the new position requires a regulatory
               election for which relief is requested;
       (ii)    was informed in all material respects of the required election and related
               tax consequences, but chose not to file the election; or
       (iii)   uses hindsight in requesting relief. If specific facts have changed since
               the due date for making the election that make the election advantageous
               to a taxpayer, the IRS will not ordinarily grant relief.

Section 301.9100-3(c)(1)(i) provides, in part, that the interests of the Government are
prejudiced if granting relief would result in the taxpayer having a lower tax liability in the
aggregate for all taxable years affected by the election than the taxpayer would have
had if the election had been timely made (taking into account the time value of money).

Section 301.9100-3(c)(1)(ii) provides, in part, that the interests of the Government are
ordinarily prejudiced if the taxable year in which the regulatory election should have
been timely made, is closed by the period of limitations on assessment under § 6501(a)
before the taxpayer’s receipt of a ruling granting relief under this section.

Taxpayer’s election is a regulatory election, as defined in § 301.9100-1(b), because the
due date of the election is prescribed in § 1.163(d)-1(b). Based upon our analysis of the
facts and representations provided, Taxpayer acted reasonably and in good faith, and
granting relief will not prejudice the interests of the Government. Therefore, the
requirements of §§ 301.9100-1 and 301.9100-3 have been met. In addition, granting the
revocations in the present situation would not cause undue administrative burden, nor
would it be inconsistent with the objectives of the underlying statute and the regulatory
election.

CONCLUSION

The consent of the Commissioner is hereby granted to revoke the elections under
§ 163(d)(4)(B) to treat net long-term capital gains as investment income for Year 1,
Year 2, and Year 3. The extension of time to revoke these elections shall be for a
period of 60 days from the date of this ruling and is to be made by filing amended
returns for Year 1, Year 2, and Year 3.

This ruling is limited to providing an extension of time to revoke the elections Taxpayer
previously made under § 163(d)(4)(B). Except as expressly provided herein, no opinion
is expressed or implied concerning the tax consequences of any aspect of any
transaction or item discussed or referenced in this letter. In particular, no opinion is
expressed on (1) whether any of the interest expense would qualify as deductible
PLR-115923-17                                  5

interest expense, (2) the proper characterization of any income of Taxpayer (e.g. as
carried interest) and (3) which tax rate would be applicable to any income of Taxpayer.

The rulings contained in this letter are based upon information and representations
submitted by Taxpayer and accompanied by a penalty of perjury statement executed by
an appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.


                                       Sincerely,



                                       Norma C. Rotunno
                                       Senior Technician Reviewer, Branch 2
                                       (Income Tax & Accounting)



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