New IRS Rulings Show Further Clarification on the Definition of “Qualifying Income” Under the Proposed Regulations May Be Forthcoming

The Internal Revenue Service (IRS) previously issued certain proposed regulations under Section 7704(d)(1)(E) of the Internal Revenue Code providing an exclusive list of activities performed with respect to minerals or natural resources that constitute “qualifying activities” with respect to such minerals or natural resources.  Numerous public comments were submitted on or prior to August 4, 2015, commenting on such proposed regulations, urging the IRS to, among other things, consider adding other activities that are not addressed by the proposed regulations’ exclusive list. 

Earlier this week, the IRS released two new private letter rulings (PLRs) interpreting what constitute qualifying income for master limited partnerships (MLPs) under Section 7704(d)(1)(E).  While the PLRs are specific to the taxpayers requesting them and cannot be relied on by others as precedent, they are helpful in that they reflect the IRS’s current thinking with respect to a particular business activity.  The new PLRs show signs that the IRS is considering the public comments and further clarification on the proposed regulations may be forthcoming.

LNG Regasification and Liquefaction

In PLR 201537007, the IRS ruled that income derived from contracts for the processing, regasification, liquefaction, and storage of natural gas constitutes qualifying income within the meaning of Section 7704(d)(1)(E).  In this ruling, the taxpayer intends to become an MLP and is a partner in a partnership that owns and operates a liquefied natural gas (LNG) receiving and regasification terminal.  The partnership plans to construct and own additional liquefaction capabilities at the terminal that will enable it to process and convert natural gas into LNG. 

Liquefaction and regasification of natural gas are not included among the exclusive qualifying activities under the proposed regulations, even though the IRS has previously ruled, prior to the issuance of the proposed regulations, that such activities give rise to qualifying income.  PLR 201537007 confirms the IRS’s view that income derived from liquefaction and regasification of natural gas constitutes qualifying income.  The IRS is likely to clarify this issue in the final regulations.

Saltwater Disposal Services and Sale of Skim Oil

In PLR 201537014, the IRS ruled that income derived from (1) gathering, transporting, processing, treating and disposing of saltwater produced in the exploration and production of oil and natural gas (the “saltwater disposal service business”) and (2) the recovery and marketing of skim oil (i.e. residual oil and other hydrocarbon removed from drilling waste) other than to end users at the retail level (the “skim oil marketing business”) constitutes qualifying income under Section 7704(d)(1)(E).  In this ruling, the taxpayer intends to become an MLP whose primary assets will consist of ownership interests of saltwater disposal wells and associated assets including pipelines, rights of way and the equipment necessary to operate the saltwater disposal wells.  The taxpayer may redeliver produced water for continued oil recovery operations but will not charge a fee for redelivery.  As a component of the taxpayer’s saltwater disposal service business, the taxpayer will remove skim oil from drilling waste during the disposal process at its facilities.

The proposed regulations expand the definition of qualifying activities to include not only the list of core activities enumerated under Section 7704(d)(1)(E) such as exploration, development, mining or production, processing, refining, transportation and marketing of minerals or natural resources, but also limited support activities that are intrinsic to such core activities.  The taxpayer made representations with respect to its saltwater disposal service businesses that are consistent with the requirements provided under the proposed regulations in order for such activity to be treated as “intrinsic activities” and therefore give rise to qualifying income.  Specifically, the taxpayer represented that  (1) personnel are provided for produced water handling and the personnel received unique training for the operation of the saltwater disposal system; (2) the saltwater disposal system is dedicated to processing, treatment and disposal of produced water, the saltwater disposal system does not have other commercially viable uses, and is not easily converted for other uses; (3) processing and treatment of produced water is required prior to injection into a disposal well in order to comply with governmental regulations and industry standards; (4) the personnel provide necessary onsite services at all saltwater disposal wells on a daily basis; and (5) offsite monitoring services are performed on an ongoing basis and are offered exclusively for use with the taxpayer’s saltwater disposal system.

The taxpayer’s saltwater disposal service business is distinguished from Example 6 of the proposed regulations1 in that the taxpayer is not in the business of providing fresh water used in connection with the exploration and production of oil and natural gas, and while it may redeliver produced water to continued oil recovery operations, no revenue is derived from the provision of produced water.  This ruling indicates that the IRS will treat the saltwater disposal service business as giving rise to qualifying income if the intrinsic activity test is met.


It may be awhile before final regulations on qualifying income are promulgated. MLPs or business that desire to be MLPs should carefully examine whether their current business activities or future investments will generate qualifying income. 

Contact Information

If you have questions regarding the content of this alert or the proposed regulations, please contact:

Alison L. Chen

Daniel J. Paulos
New York

W. Thomas Weir

Patrick B. Fenn
New York

Stuart E. Leblang
New York

1 Prop. Reg. 1.7704-4(e). Example 6.