Corporate Partnerships Face New Tax Deferral Rules
In 2011, the federal budget changed an important tax rule for corporate partnerships related to the deferral of tax on partnership income. For tax years ending after March 22, 2011, the new legislation eliminates the ability to defer corporate tax by selecting a fiscal period for the partnership that differs from the corporate partners’ tax years.
The rule applies to those with a “significant interest” in a partnership (generally defined as 10 percent of partnership income, loss or assets) and whose partners have tax year-ends that are different from the corporation’s fiscal year-end.
The Stub Period
The new rule allows the corporation and the partners to continue to have different year-ends, but the partners must accrue additional income based on the estimated income earned during the “stub period” between the end of the partnership’s fiscal period and the corporate tax year.
To avoid this complexity, some partnerships may elect to change their fiscal periods to match the tax years of the corporate partners. This election must be in writing and filed on or before the earliest of the partners’ tax filing dates.
Both of these options can generate significant tax consequences, particularly in the first year of implementation. For this reason, there are transitional rules in place to diminish the impact of the stub period accrual for the first year.
The transitional relief allows partners to spread the first year’s additional income over five years by claiming a reserve for future tax years. No additional income is required to be reported for 2011, which gives partnerships time to plan for and accommodate the additional tax burden.
Of course, every partnership will have different concerns and issues, so it is important to make an informed decision before deciding next steps.
There are plusses and minuses to changing year-ends. If you are involved in a partnership, please contact us to discuss your options.