From Les Sparks:

Not really. It all depends on the definition of the tax. I have successfully argued with HUD in the past that some taxes are project expenses. However, in that particular case, the state of Texas had clearly defined that the tax was not due on the partners.

So, there is no specific discussion of the that is directly on point, but that is always how they have enforced that. They consider all of those entity expenses as you guessed.

From client:

Les: thanks; to summarize:

1. HUD views all entity expenses paid as “deemed distributions” to the owners; therefore, we need to deduct the actual/estimated expense from “gross” surplus cash and, accordingly, limit actual distributions to the net amount for that 6/12-mo. period; and the net effect going forward is really just the initial “correction” and then the subsequent 6mo/annual “delta” for that tax/cost because the initial amount, via distributing a lesser “surplus cash” amount, remains in cash [surplus or otherwise] going forward;

2. The only way to avoid this result is to make a case that the tax expense is a project expense & report it accordingly-problem solved; question: does HUD take and respond to a “ruling request” from us where we can – as you say – present our case/argument to get their opinion/ruling going forward? And if yes, who/where do we address the request to? Maybe our local field rep? REAC support?? HUD central/Washington?? Help!!

3. Our fact pattern: simply put, the City of Philly taxes ALL partnership entities as if they were a C-corporation [they also tax C-corp’s]; and the tax is based on – you guessed it: taxable income; and that figure is clearly 99.99999% project income [vs. entity income I guess]; and I think similar to your Texas case, it’s clear that the tax is on the entity/project operations & NOT on the owners individually; and because it’s a LOCAL tax, the LOCAL government gets the money which helps fund CITY/local operations [police, education; fire; roads; etc.] which clearly benefits the “project” as a whole; is this part of our argument as well? Or is our argument limited to making the case that it’s a project expense because (a) it’s based on project income, and (b) it’s NOT a tax on the owners per se, nor do they have a choice to NOT pay it, whereas the decision to pay a financing/entity cost IS an owner decision/choice, right?

4. Approximate annual amount in play [aka: the tax]: $180K, of which about $10K to $15K is a tax on “gross receipts” & the balance is income tax;

5. Related going forward issue IF the tax is an entity expense: the project just started a 4 to 5-year plan to gut & refurbish ALL 368 units [new kitchen cabinets, modern appliances, & new bath’s, etc.], most of which will be funded through project cash flow; accordingly, starting in 2016 and for the next 4-5 years, the owners will NOT take ANY distributions; and IF (a) the tax IS an entity expense, and therefore a deemed distribution, and (b) if surplus cash is LESS then tax amount-because it’s all spent on capital expenditures & demo costs, the owners will need to make capital contributions to avoid the “violation”, right?? Granted, the owners ARE prepared to contribute funds into the project to cover construction costs should it be necessary over the 4-5 year period, but if I’m right, then we need to plan accordingly to maybe pump in a little more.