TAX & REPORTING UPDATE: AVOIDING FUND REPORTING TRAPS

NICSA members gleaned valuable insights from a recent #WebinarWednesday primer on the 2019 tax legislation and reporting landscape. The discussion, which featured professionals from State Street and EY, provided an in-depth look at changes that will significantly impact asset managers.

LAG Rule and Partnership Withholding

Maria Murphy, Principal, Tax Services at Ernst & Young LLP, kicked off the session with an overview of proposed regulations affecting the lag method for partnership Form 1042-S reporting. “In December 2018, the IRS issued proposed regulations that completely revamp how partnerships report under Section 1441 on undistributed U.S. source FDAP income that is allocable to non-U.S. partners,” she said.

“Under current regulations, the way Form 1042 works is the undistributed partnership income subject to Section 1441 withholding is reported on Schedule K-1 in year one, but the Section 1441 withholding and reporting occurs in year two,” Murphy continued. “There’s a year lag in between reporting on the K-1 and the 1042-S, and mismatch has caused many problems.”

Under the proposed regulations for calendar year 2019 reporting (schedule to be filed in 2020), the undistributed FDAP income will be reported on Form 1042 and Form 1042-S in the same year as the schedule K-1, even though the withholding will occur in the subsequent calendar year.

“As a result of all of this, we should not have any penalty notices due to a mismatch between the 1042-S deposit dates and the year in which it gets reported,” Murphy said. “That should be very significant to us in the industry.”

Regulated Investment Company Reporting

Nick Zarzoukis, Senior Manager at Ernst & Young LLP, discussed Section 199A of the Tax Cuts and Jobs Act, which provides a 20 percent deduction for REIT dividends (other than capital gain dividends and dividends taxable as qualified dividend income) and also MLP income to non-corporate individuals. “The Act, initially, did not clarify whether mutual funds could pass-through the 20 percent deduction to their shareholders.” Zarzoukis said.

Please note that after the live program, on January 18, the Treasury proposed final pass-through rules which indicated that REITs held by mutual funds would be able to pass-through the deduction.

The Tax Cuts and Jobs Act also introduced new interest deduction limitations under Section 163(j). “Basically, interest expense would be limited to its deductibility up to interest income plus 30 percent of your adjusted taxable income,” Zarzoukis said.

Recently, proposed regulations have clarified additional issues for regulated investment companies in calculating adjusted taxable income. In terms of limitations on interest expense deductions, Zarzoukis said he wouldn’t generally expect them to come into play for funds that invest in debt instruments.

“The only takeaway would be most people may forget about equity funds,” he said. “To the extent that they’re utilizing some type of leverage, you may have interest expense on these equity funds and no offsetting interest income.”

Kevin Collins, Senior Vice President at State Street Corporation, agreed. “It also is going to be a function of how these regs define that leverage, what creates interest, and what you might not normally think of as interest expense,” he said. “That’s a spot folks are going to want to make sure that they’re comfortable with.”

Note: Although the observations contained in this work represent the best thoughts of the individuals comprising the NICSA event panel, they do not necessarily reflect the views of NICSA or any of its member organizations. Matters addressed in this work may touch upon legal or regulatory matters, however nothing herein is intended to be or should be construed as legal advice. You should contact your own counsel in order to obtain legal advice regarding these or any other matters.



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