Treasury Department Issues Final Regulations Establishing New Qualifying Income Rules for Publicly Traded Partnerships
V&E MLP Tax Update E-communication, January 19, 2017
The Treasury Department (Treasury) and the Internal
Revenue Service (IRS) released final regulations on January 19, 2017, providing guidance
on the treatment of income from natural resource activities of publicly traded
partnerships as qualifying income for purposes of section 7704(d)(1)(E) of the
Internal Revenue Code.
final regulations supersede
proposed regulations issued in May 2015. The changes (redline available
here) provide a substantial improvement over the proposed regulations and address many, but not all, of the industry’s largest concerns regarding the proposed regulations.
UPDATE: On January 24, 2017, in a surprise to many, the final 7704 regulations were published in the Federal Register. Previously, on January 20, 2017, President Donald J. Trump imposed a government-wide regulatory freeze in a White House memorandum issued by the President’s Chief of Staff. The memorandum included an instruction to the heads of executive departments and agencies to immediately withdraw regulations that have been sent to the Federal Register, but not yet published, until a department or agency head appointed or designated by the President reviews and approves the regulations. Although it appeared that the 7704 regulations released by Treasury and the IRS on January 19, 2017 were subject to these instructions to be withdrawn, because they were published in the Federal Register on January 24, 2017, these regulations are now final.
While the proposed regulations generally reflected historical understanding of qualifying income concepts, they departed from the natural resource industry’s understanding – consistent with numerous private letter rulings issued by the IRS – of the scope of processing and refining of
natural resources. The Treasury and the IRS received nearly 50 substantive letters commenting on the proposed regulations, and ten witnesses spoke at a public hearing held in October 2015.
The final regulations address many, but not all, of the issues raised by the proposed regulations. We will release a more detailed outline of the changes in the coming days. In the interim, significant changes from the proposed regulations include the following:
- The concept of an exclusive list of qualifying activities included in the proposed regulations has been eliminated; instead, the final regulations provide a non-exclusive list that the IRS and the Treasury expect to be interpreted and applied in a manner consistent with their plain
meaning and the overall intent of Congress in providing the qualifying income exception but restricting the exception to activities traditionally carried out in partnership form.
- The bias in favor of fuels over other products of crude oil and natural gas has been eliminated, and the final regulations allow for similar treatment of all products of a type commonly produced in crude oil refineries, including lubricants, waxes, and olefins such as ethylene
and propylene, regardless of whether the specific taxpayer is producing them in a crude oil refinery.
- The regulations include as qualifying activities a number of activities that were not contemplated in the proposed regulations, including, for example, the provision of compression services, the sale of RINs, receiving cost reimbursements in connection with qualifying activities,
and income from passive or non-operating interests in minerals or natural resources.
- The regulations acknowledge that many MLPs earn income from hedging that should be qualifying income, but they reserve for future guidance the appropriate scope of such income.
- The regulations relax the “well-by-well” matching requirement for the provision of water and other injectants for use in oil and gas exploration, and instead allow for water and injectant provision if the MLP is also in the trade or business of collecting, cleaning, recycling, or
otherwise disposing of injectants within the same geographic area.
The final regulations are largely an improvement over the proposed regulations, but there are several areas where the final regulations can be viewed as a change in law that is inconsistent with the industry’s understanding of qualifying income activities:
- The final regulations retain a narrow interpretation of processing and refining hard minerals beyond activities that are treated as mining for depletion purposes.
- The final regulations do not treat LNG and LPG as natural resources, although they allow for the transportation of natural gas, including gasification and liquefaction.
The final regulations generally apply to income earned by a partnership in a taxable year beginning on or after January 19, 2017. To the extent that an existing publicly traded partnership’s activities do not meet the standards in the final regulations, the regulations provide a 10-year
transition period for publicly traded partnerships that (i) have received a private letter ruling from the IRS holding that an activity is qualifying income, (ii) have been engaged in an activity prior to May 6, 2015 and have reasonably treated the activity as giving rise to qualifying income under the
statute as interpreted prior to May 6, 2015; (iii) have entered into a binding agreement for construction of assets to be used in an activity that would give rise to qualifying income under the statute as reasonably interpreted prior to May 6, 2015; or (iv) engaged in an activity after May 6, 2015 but before
January 19, 2017 and the income from that activity was qualifying income under the proposed regulations.
Additional Background on Qualifying Income:
The Internal Revenue Code generally treats an MLP as a corporation, rather than a partnership, for federal income tax purposes unless 90 percent or more of the MLP’s gross income for every taxable year consists of “qualifying income.” For this purpose, "qualifying income" includes income derived from the exploration, development, mining, production, processing, refining, transportation, or marketing of minerals, natural resources, or industrial source carbon dioxide, and the transportation and storage of certain renewable fuels. Other types of qualifying income include dividends, interest (other than interest generated by a financial or insurance business), and certain income that would be qualifying to a real estate investment trust (REIT) or a regulated investment company (RIC).
Contact Info for MLP
If you have questions or would like to discuss the final regulations, please contact a member of the V&E MLP team:
To view prior MLP tax updates and all MLP Qualifying Income PLRs, visit