The IRS proposed regulations [REG-132634-14] to provide guidance on what is “qualified income” from a publicly traded partnership’s (PTP) activities regarding minerals or natural resources, such as oil and gas fracturing (“fracking”).
The proposed changes provide some clarity and reaffirm that activities such as fracking can provide qualifying income, but they could also raise the requirements for income to be considered qualifying income or in some cases reverse previous private letter rulings (PLRs).
In order for a PTP to receive favorable tax status, 90 percent of its gross income for each taxable year must meet requirements for “qualifying income” (which includes income and gains from certain natural resource-related activities such as exploration, development, mining or production, processing, refining, transportation, and marketing of minerals and natural resources).
In recent years, the IRS has issued a number of PLRs reaffirming that certain natural resource-related income was qualifying income. However, PLRs can technically only apply to the specific PTPs that receive the rulings. Due to an increase in requests for PLRs, the IRS is proposing the new regulations to provide broad guidance for all natural resource-related partnerships.
In addition to qualifying activities (mineral or natural resource activities that generate qualifying income), the IRS recognizes that there are intrinsic support activities that may also produce qualifying income. The proposed regulations present a three-part test to determine “intrinsic activity.” Intrinsic activities must be specialized, essential and significant.
- Specialized: the personnel performing the activity must have received specialized training, unique to the mineral or natural resource industry, used only to support a qualifying activity.
- Essential: necessary to complete the activity or to comply with federal, state or local law requirements. For example, income derived from the water delivery and recycling/treatment of fracking wastewater is qualifying income because these are necessary to complete the activity and water disposal must comply with federal, state and local laws.
- Significant: services such as a partnership that requires personnel to have a frequent or constant presence at the activity site in order for the partnership to provide its services or to support the activity.
The regulations are proposed to apply to income earned by a partnership in a taxable year beginning on or after finalization, subject to a 10-year transition period in certain cases.