PLR 200144021: Oil and gas partnership receipts were not passive investment income

Plain-English summary

An S corporation with accumulated earnings and profits owned units in a publicly traded partnership involved in oil and gas activities. It asked how its share of the partnership's receipts counted under the S corporation rules for passive investment income and related tax. The IRS ruled that the corporation must include its share of the partnership's gross receipts, retaining their character from the partnership. Receipts from the partnership's stated energy activities were not passive investment income under section 1362(d)(3). The IRS separately noted that its conclusion did not change how the corporation's rental activity is treated under the passive activity rules.

Ruling snapshot

• Question: Were the corporation's share of the partnership's energy receipts passive investment income for S corporation purposes?
• Outcome: Approved. The receipts counted in gross receipts but were not passive investment income under section 1362.
• Key authorities: IRC §§ 702(b), 1362(d)(3), 1375(a), 7704(c).

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200144021
Washington, DC 20224
Release Date: 11/2/2001
Index Number: 1362.02-03
Person to Contact:

Telephone Number:

Refer Reply To:
CC:DOM:P&SI:3 PLR-112981-01
Date:
August 1, 2001

Company:

State:
a:

X:

Dear

This letter responds to a letter dated February 20, 2001, from your authorized representative, submitted on behalf of Company, requesting rulings under §§ 1362(d)(3) and 1375(a) of the Internal Revenue Code.

Company was incorporated under the laws of State on a. It has elected under § 1362(a) to be an S corporation. Company has accumulated earnings and profits.

Company is in the business of renting residential real estate. It also invests in various publicly traded entities either directly through ownership of stock or partnership units or indirectly through ownership of mutual fund shares. To diversify the market risk associated with equity investments, Company has purchased units in X, a publicly traded limited partnership (PTP). X is engaged in the business of purchasing, gathering, transporting, trading, storage, and resale of crude oil, refined petroleum products, natural gas liquids, and related activities.

Company represents that X meets the qualifying income exception of § 7704(c) and, thus, is taxed as a partnership for federal tax purposes. Company also represents that X is not an electing large partnership as defined by § 775 and, thus, the normal flowthrough provisions of subchapter K apply to its partners.

Except as provided in § 1362(g), § 1362(a)(1) provides that a small business corporation may elect, in accordance with the provisions of § 1362, to be an S corporation.

Section 1362(d)(3)(A)(i) provides that an election under § 1362(a) terminates 2
PLR-112981-01

whenever the corporation (I) has accumulated earnings and profits at the close of each of three consecutive tax years, and (II) has gross receipts for each of such tax years more than 25 percent of which are passive investment income.

Except as otherwise provided in § 1362(d)(3)(C), § 1362(d)(3)(C)(i) provides that the term "passive investment income" means gross receipts derived from royalties, rents, dividends, interest, annuities, and sales or exchanges of stock or securities.

Section 1375(a) provides that a tax is imposed on the income of an S corporation for any tax year in which the corporation has accumulated earnings and profits at the close of that year and gross receipts more than 25 percent of which are passive investment income.

Section 702(a)(7) provides that, in determining income tax liability, each partner shall take into account separately his distributive share of the partnership's items of income, gain, loss, deduction, and credit to the extent provided by regulations.

Section 1.702-1(a)(8)(ii) provides that each partner must take into account separately his distributive share of any partnership item that would result in an income tax liability for that partner different from that which would result if that partner did not take the item into account separately.

Section 702(b) provides that the character of any item of income, gain, loss, deduction, or credit included in a partner's distributive share under § 702(a)(1) through (7) shall be determined as if the item were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership.

Except as provided in § 7704(c), § 7704(a) provides that a PTP shall be treated as a corporation for federal income tax purposes.

Section 7704(b) provides that the term PTP means any partnership if interests in that partnership are traded on an established securities market or are readily tradable on a secondary market (or the substantial equivalent thereof).

Section 7704(c)(1) provides that § 7704(a) shall not apply to a PTP for any tax year if the partnership meets the gross income requirements of § 7704(c)(2) for that year and each preceding tax year beginning after December 31, 1987, during which the partnership (or any predecessor) was in existence. Section 7704(c)(2) provides that a partnership meets the gross income requirement for any tax year if at least 90 percent of the partnership's gross income for that year consists of qualifying income.

Section 7704(d)(1)(E) provides that income and gains derived from the exploration, development, mining or production, processing, refining, transportation 3 PLR-112981-01

(including pipelines transporting gas, oil, or products thereof), or marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber) is qualifying income. For purposes of this section, mineral or natural resource means any product of a character with respect to which a deduction for depletion is allowable under
§ 611, but is not a product described in § 613(b)(7)(A) or (B).

Rev. Rul. 71-455, 1971-2 C.B. 318, deals with an S corporation that operates a business in a joint venture with another corporation. In the tax year at issue, the total business expenses exceeded gross receipts. The revenue ruling holds that, in applying the passive investment income limitations, the S corporation should include its distributive share of the joint venture’s gross receipts and not its share of the venture’s loss. In accordance with § 702(b), the character of these gross receipts were not converted into passive investment income upon their allocation to the S corporation.

Company’s distributive share of gross receipts from X, if separately taken into account, might affect its federal income tax liability. Under § 1362(d)(3), the status of Company as an S corporation could depend upon the character of its distributive share of gross receipts from X. Thus, pursuant to § 1.702-1(a)(8)(ii), Company must take into account separately its distributive share of the gross receipts from X. The character of these partnership receipts for Company will be the same as the character of the partnership receipts for X, in accordance with § 702(b).

Based solely on the facts and representations submitted by Company, we conclude that–

(1) Company’s distributive share of the gross receipts of X will be included in its gross receipts for purposes of §§ 1362(d)(3) and 1375(a).

(2) Company’s distributive share of X’s gross receipts attributable to the purchasing, gathering, transporting, trading, storage, and resale of crude oil, refined petroleum products, natural gas liquids, and related activities will not constitute passive investment income as defined by § 1362(d)(3)(C).

Except for the specific rulings above, we express or imply no opinion concerning the federal income tax consequences of the facts of this case under any other provision of the Code. Specifically, we express or imply no opinion regarding Company's eligibility to be an S corporation. Further, the passive investment income rules of § 1362 are completely independent of the passive activity rules of § 469; unless an exception under § 469 applies, the rental activity remains passive for purposes of § 469.

In accordance with the power of attorney on file with this office, we are sending a copy of this letter to your authorized representative. 4 PLR-112981-01

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3), this ruling may not be used or cited as precedent.

Sincerely,
CHRISTINE ELLISON
Chief, Branch 3
Office of Associate Chief Counsel
(Passthroughs and Special Industries)

enclosure: copy for § 6110 purposes