What do I need to know about the final regulations on qualifying income?
If you’ve been following Alerian Insights, you know that this is something we’ve written about many times. Here is a quick timeline to refresh your memory on the history of what’s happened in relation to this topic:
2014
The IRS announced a pause in MLP private letter rulings (PLRs) on March 28.
2015
The IRS announced the pause was over on March 6 and said it would be issuing proposed regulations that would offer greater clarity on which companies could (or could not) form as an MLP.
The IRS issued the proposed regulations on May 6.
The public comment period on the proposed regulations ended on August 4.
2016
We waited.
Flash forward to January 19, 2017 and we all got a shocker when we found out that in the final hours of the Obama Administration, the IRS and Treasury released the final qualifying income regulations under Section 7704 of the US Code. cue the dramatic music
The story gets a bit more interesting because on January 20, 2017, our new President told all the heads of executive departments and agencies to intercept any regulations that’d been sent to the Federal Register but hadn’t been published. The purpose in doing this was for Trump or one of Trump’s staff to get their mitts on all regulations that were pending and have the opportunity to scrap anything misaligned with the administration’s plans.
Interestingly, despite the call for this freeze, the final regulations were published to the Federal Register on January 24. At first, I thought there might be some exciting/scandalous reason that these rules were published while others weren’t, but I learned it went through simply because the Office of Management and Budget (OMB) approved it. Evidently, the OMB has the power to override “freezes” like the one Trump put into play when the matter is “urgent.” In addition, the IRS said the effective date of the regulations was January 19, which predated the January 20 memo.
Anyhoo, the fact is that the rules are now published to the Federal Register, so it’s important for us to understand what they say. You might remember from previous posts that there were several hotly contested issues with the proposed regulations. Two of the most controversial were the idea that the proposed regulations contained an “exclusive list” of qualifying activities and that the processing of NGLs into ethylene wasn’t qualifying.
To the pleasure of many, the IRS addressed both of these issues in the final regulations. Those who’d shared opinions with the IRS during the comment period provided numerous logical reasons why an exclusive list of qualifying activities didn’t make sense. One great example is that technological advances may change the process by which something occurs without changing the final outcome. In other words, let’s say I wrote a report about elephants in 2nd grade using paper, pencil, and encyclopedias. Is my report substantially different from an elephant report my son wrote in 2017 using Word and the internet? The idea is that it is impossible for us to know how the means to the same end might look in the future, so it wouldn’t make sense for a list of limitations to exist. The IRS agreed with this logic and decided the list of activities should not be exclusive.
Also, in very happy news for Westlake Chemical Partners (WLKP) investors, the processing of NGLs into ethylene, propylene, and butadiene is now considered qualifying. If you look at this chart, it’ll help you understand what the problem was. Making ethylene, propylene, and butadiene from gas/NGLs wasn’t considered a qualifying activity, although creating the same three substances from crude oil was approved. It’d be like if you and a friend were both invited to a potluck dinner party and both asked to bring Sprite. You bought a two-liter bottle at Wal-Mart and your friend bought the same bottle at Target. When you arrived at the party, the hostess only accepted the friend’s bottle of Sprite. It wouldn’t make sense, right? Clearly, the IRS agreed with commenters’ assertions that the proposed regulations inappropriately favored crude oil over natural gas.
