Final regs. address qualifying income exception for certain publicly traded partnerships

By Robert A. Swiech, CPA, J.D., Houston, and Megan J. Whitlock, CPA, Dallas

Editor: Mary Van Leuven, J.D., LL.M.

With a Jan. 19, 2017, effective date preceding President Donald Trump's Jan. 20 regulatory freeze memo, the final regulations on qualifying income of publicly traded partnerships from mineral or natural resources activities (T.D. 9817) appear to have squeezed in just under the wire at the Federal Register. Guidance on whether income from minerals or natural resources activities saves a partnership from being treated as a corporation has been 30 years in the making. This item explains how the final regulations differ from the proposed regulations.


Enacted by the Omnibus Budget Reconciliation Act of 1987, P.L. 100-203, and clarified by the Technical and Miscellaneous Revenue Act of 1988, P.L. 100-647, Sec. 7704 generally treats a publicly traded partnership (PTP) as a corporation for federal income tax purposes. A partnership is publicly traded if (1) interests in the partnership are traded on an established securities market, or (2) interests in the partnership are readily tradable on a secondary market (or the substantial equivalent thereof) (Sec. 7704(b)). In Sec. 7704(c), however, Congress provided an exception to this rule: A PTP is not treated as a corporation for federal tax purposes if 90% or more of its gross income consists of qualifying income. Qualifying income includes passive-type income such as interest, dividends, real property rents, and gain from the disposition of real property, as well as income and gains from certain natural resources activities (Sec. 7704(d)). With respect to natural resources activities, the statute states:

Except as otherwise provided in this subsection, the term "qualifying income" means . . . (E) income and gains derived from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil, or products thereof), or the marketing of any mineral or natural resource (including fertilizer, geothermal energy, and timber), industrial source carbon dioxide, or the transportation or storage of any fuel described in subsection (b), (c), (d), or (e) of section 6426, or any alcohol fuel defined in section 6426(b)(4)(A) or any biodiesel fuel as defined in section 40A(d)(1). . . .

For purposes of subparagraph (E), the term "mineral or natural resource" means any product of a character with respect to which a deduction for depletion is allowable under section 611; except that such term shall not include any product described in subparagraph (A) or (B) of section 613(b)(7). [emphasis added]

The language in italics was added by Section 208(a) of the Energy Improvement and Extension Act of 2008 (Division B), P.L. 110-343, effective for tax years ending after Oct. 3, 2008.

First, the statute requires the involvement of a mineral or natural resource that qualifies for depletion (except in the case of fertilizer and oil and gas products, which appear to receive de jure classification as a mineral or natural resource). The definition of "gas, oil, or products thereof" includes gasoline, kerosene, No. 2 fuel oil, refined lubricating oils, diesel fuel, methane, butane, propane, and similar products that are recovered from petroleum refineries or field facilities; it is not intended to encompass oil or gas products that are produced by additional processing beyond that of petroleum refineries or field facilities, such as plastics or similar petroleum derivatives (H.R. Conf. Rep't No. 100-495, 100th Cong., 1st Sess. 946-47 (1987)).

There is no general requirement that the mineral or natural resource be from deposits in the United States. A mineral or natural resource would not include soil, sod, dirt, turf, water, or mosses; nor does it include minerals from seawater, the air, or similar inexhaustible sources (although minerals (other than sodium chloride) extracted from brines pumped from a saline perennial lake within the United States are not considered minerals from an inexhaustible source) (Secs. 7704(d)(1)(E), flush language; 613(b)(7)(A) and (B); and 613(b)(7), flush language). So, for example, sodium chloride (i.e., salt) extracted from a mine would be considered a mineral or natural resource, but the same mineral extracted from seawater or the Great Salt Lake would not. The products of farming, ranching, and fishing and power generated from hydroelectric, nuclear, solar, and wind sources do not qualify as minerals or natural resources (S. Rep't No. 100-445, 100th Cong., 2d Sess. 424 (1988)).

Second, the income must be derived from the limited functions of exploration, development, mining, production, processing, refining, transportation, or marketing of a mineral or natural resource or industrial-source carbon dioxide or for the transportation or storage of certain fuels. There is no requirement that the PTP own the mineral or natural resource, industrial-source carbon dioxide, or certain defined fuels, only that it derive certain income or gains from it.


From the enactment of this law 30 years previously until the final regulations were published in January this year, there was no guidance that PTPs could rely on that defined specific activities that generate qualifying income. As a result, PTPs have had to obtain private letter rulings from the IRS or seek opinion letters from legal counsel. While the demand for qualifying income letter rulings from the IRS traditionally had been minimal, 2013 saw an increase in letter ruling requests from only a few or none each year to more than 30 requests. In March 2014, the IRS paused issuing letter rulings under Sec. 7704(d)(1)(E) for one year.

On May 6, 2015, the IRS published proposed regulations providing guidance on whether income activities involving minerals and natural resources generate qualifying income under Sec. 7704(d)(1)(E). On Jan. 24, 2017, Treasury and the IRS published the final regulations, with an effective date of Jan. 19, 2017 (with transition relief described below), adopting portions of the proposed regulations with modifications. Notably, the final regulations omit:

  • The modified accelerated cost recovery system (MACRS) consistency requirement;
  • Reference to North American Industry Classification System codes;
  • The general physical or chemical change limitation; and
  • A joint definition of processing and refining.

Other key modifications include:

  • The addition of the word "including" to the definitions of exploration and development, to show that the lists of activities are not exclusive;
  • A modified "Energy Information Administration" list to more specifically identify products solely produced in a petroleum refinery or natural gas processing plant (e.g., a lubricant that is not of a type generally produced by a refiner is not within the product list);
  • Ethylene is qualified as a product from natural gas and crude oil;
  • Methanol is still excluded because it is typically not considered a product of a refinery or natural gas processing plant; and
  • Qualified income includes bulk sales at wholesale prices to a company or government agency and sales to distribution centers that sell (in small quantities) to retail customers that are the end users, such as homeowners.

Additionally, the final regulations modified the proposed regulations by providing that:

  • Qualifying "transportation" activities include liquefaction and regasification of natural gas (although for Sec. 199 purposes both liquefaction and regasification of natural gas are generally considered qualified production activity).
  • The definition of mineral or natural resources includes industrial-source carbon dioxide, alcohol fuel defined in Sec. 6426(b)(4)(A), or biodiesel fuel defined in Sec. 40A(d)(1), without elaboration because no comments were received on the proposed regulations.
  • Certain other products are not qualified products of petroleum refining, including heat, steam, or electricity produced by a refining process.
  • Income from processing metallic ores and minerals that are generally refined to a high degree of purity before they are sold (e.g., the smelting of concentrates to produce doré bars (an alloy of gold and silver) or refining blister copper) is qualified income; however, refining does not include the introduction of additives that remain in the metal, such as manufacturing gold alloys or the application of nonmining processes to produce a specified metal that is considered a waste or byproduct of a nonspecified metallic ore or mineral.
  • Petroleum coke qualifies, but not if it is upgraded to calcined coke or anode-grade coke because it then is no longer considered a primary product of the natural resource.
  • Transportation of liquefied petroleum gas to retail customers is included as a qualifying activity.
  • Sand is recognized as a depletable mineral, and its sale to oil companies for well fracking is qualifying income.
  • Income from passive mineral interests such as production royalties, minimum annual royalties, net profits interests, delay rentals, and lease-bonus payments is qualifying income (surface and crop damage payments were not mentioned).
  • Production payments treated as loans under Sec. 636 do not qualify as natural resource income, but their interest income would be qualified as passive income.
  • Qualified income includes blending the same mineral, natural resource, or products thereof (crude oil and natural gas are considered as from the same natural resource). The preamble to the regulations states that "once asphalt is mixed with rock aggregate, it is no longer a product of a refinery or a product of mineral processing, but has become a new road paving product." Naturally occurring "rock asphalt" has a 14% depletion rate under Sec. 613(b)(3)(A). (But how would a transporter or a marketer of such a product know whether it produced PTP qualifying income?)
  • A new category of limited additization services is included as generating qualifying income.
  • Timber products with added chemicals or substances to manipulate their chemical or physical properties, such as pulp, paper, paper products, treated lumber, oriented strand board/plywood, and treated poles do not produce qualified income. (These limitations placed on timber effectively overturn the first letter rulings that were issued by the IRS on PTP qualifying income for treated wood products.See Letter Rulings 9008035, 9338028, 9450029, 9822034, 9822035, and 199932024.)
  • The final regulations include the extraction of minerals or natural resources from the waste deposits or residue of prior mining or production. Presumably, this would apply to a person that did not create the waste deposits or residue of prior mining, even though such a person would be ineligible to claim percentage depletion upon their sale (Sec. 613(c)(3)). The recycling of scrap or salvaged metals or minerals from previously manufactured products or manufacturing processes is not considered the extraction of ores or minerals from waste or residue and, therefore, does not give rise to qualifying income. (But how would a transporter or marketer of mineral products know whether they were from ores or from scrap or salvaged?)

Interestingly, Regs. Sec. 1.7704-4(f), Example (6), uses a corporation, but this entity type is already excluded from being a PTP. Thus, it would not qualify and should likely have been described as a partnership.

In the timber regulations, the example of impermissible income in Regs. Sec. 1.7704-4(c)(10)(v)(C) could be clarified by using additional terminology, such as noted by italics "pressure treatment with approved preservative products."

Intrinsic service activities

The final regulations recognize that intrinsic activities that support Sec. 7704(d)(1)(E) activities can also give rise to qualifying income because the income is derived from the Sec. 7704(d)(1)(E) activity. The final regulations specify three requirements for the support activity to be intrinsic (specialized, essential, and requiring significant services), with some modifications from the proposed regulations. Generally, these modifications seek to clarify elements of the requirements. The following are the key items for intrinsic activities:

  • Under the specialization prong of the test, company personnel includes employees of the partnership, an affiliate, subcontractor, or independent contractor performing work on behalf of the partnership who have received training to support the Sec. 7704(d)(1)(E) activity that is unique to the mineral or natural resource industry and of limited utility other than to perform or support the Sec. 7704(d)(1)(E) activity.
  • Under the "essential" prong of the test, an activity is essential if it is required to comply with federal, state, or local law regulating the Sec. 7704(d)(1)(E) activity or to physically complete a Sec. 7704(d)(1)(E) activity (including in a cost-effective manner).
  • Services are significant if they must be conducted on an ongoing or frequent basis, which is determined by facts and circumstances that include recognized best practices in the relevant industry.
  • It the partnership provides injection delivery and disposal services and provides an injectant to perform a Sec. 7704(d)(1)(E) activity that is commonly used outside that activity, the partnership operates its services within the same geographic region instead of a well-by-well basis. (Note that the preamble mentions the term "basin by basin," but the text of the regulations only states the services must be performed within the "same geographic area," without reference to basins.)
  • Guidance on the treatment of fertilizer and hedging was reserved for future regulations.
Effective date and transition rule

The final regulations apply to income earned by a partnership in tax years beginning on or after Jan. 19, 2017. However, the final regulations provide a 10-year transition period that ends on the last day of the partnership's tax year that includes Jan. 19, 2027.

To apply the transition rule, the partnership:

  • Must have a letter ruling from the IRS that the income from the activity is qualifying income;
  • Before May 6, 2015 (the date of the proposed regulations), the partnership was publicly traded, engaged in the qualifying activity, and treated it as giving rise to qualifying income under a reasonable interpretation of Sec. 7704(d)(1)(E) (e.g., a "will opinion" obtained from a competent tax adviser);
  • Before May 6, 2015, the partnership was publicly traded and had entered into a binding agreement for construction of assets to be used in an activity that would give rise to income that was qualifying income under the statute as reasonably interpreted prior to May 6, 2015; or
  • The partnership was publicly traded and engaged in the activity after May 6, 2015, but before Jan. 19, 2017, and the income from that activity was qualifying income under the proposed regulations.

There is also relief from a technical partnership termination. If a partnership technically terminates under Sec. 708(b)(1)(B), and the partnership satisfied the requirements for transition relief described above without regard to the technical termination, the resulting partnership will be treated as having satisfied the transition period requirements.


Mary Van Leuven is a director, Washington National Tax, at KPMG LLP in Washington.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. ©2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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