Partnership Tax

Potential for Over- or Under-Taxing

(1) Absent a 754/743 election, if the buying partner's share of inside basis reflects built-in gain to the partnership, the buying partner will recognize gain when the partnership disposes of the appreciated assets. The partner will recognize his distributive share of taxable income from this sale, and his outside basis will be increased by the partner's distributive share of the gain from disposition of the partnership assets, and he will recognize loss when he disposes of his interest, or when the partnership liquidates.

Total Amount Realized When a Partnership Interest is Sold

(1) Seller recognizes the following amounts upon disposition of a partnership interest:

New Partner's Share of Inside Basis

(a) Purchasing partner succeeds to selling partner's capital account. Therefore, purchasing partner's share of inside basis = tax capital account + his share of liabilities.

Least Aggregate Deferral

1. If neither of the above two alternatives is available, use the taxable year of one or more partners that produces the least aggregate deferral.

Gain

1. Only recognized if money distributed exceeds the partner's outside basis. For these purposes, marketable securities are money.

Loss

1. Only recognized upon a liquidating distribution, to the extent that the amount of money (including marketable securities) and the basis of unrealized receivables and inventory is less than outside basis, provided that only money and unrealized receivables and inventory are distributed.

Sales of Interests

704(c) Gain is allocated to contributing partners when performing the hypothetical asset sale in connection with Sales of Partnership interests - 751(a).

Entity Classification

A foreign entity is generally classified as either a foreign branch or a foreign subsidiary

Certain Capital Contributions

A partner is not subject to the minimum gain chargeback provision to the extent that the partner's share of the net decrease in partnership minimum gain is caused by a contribution to capital of the partnership that is used to repay the non-recourse debt or is used to increase the basis of the property subject to the non-recourse debt

Conversions and Refinancings

A partner is not subject to the minimum gain chargeback provision to the extent that the partner's share of the net decrease in partnership minimum gain is caused by a guarantee, refinancing or other change of the debt instrument causing it to become recourse debt or partner non- recourse debt.

book capital account purposes

A partner's basis in contributed property is not relevant for ____________

Limitations on Losses

A partner's distributive share of partnership loss for a taxable year is limited to his outside basis. Disallowed loss is allowed in subsequent taxable years to the extent that the partner's outside basis at the end of the subsequent taxable year exceeds $0

Partner Contribution of His Own Note

A partner's note is a mere promise to pay; it is not property. Upon contribution, the note does not belong on the balance sheet. If the partnership sells the note, treat the partner as having personally borrowed cash from the note purchaser and having contributed it to the partnership.

Allocation of Non-recourse Liabilities

A partner's share of non- recourse liabilities consists of the sum of three amounts, i.e. (i) his share of partnership minimum gain, his share of "704(c) minimum gain", and (iii) his share of "excess non-recourse liabilities

Same Percentage Rule

A partnership must recover the same percentage of basis for book purposes as it does for tax purposes

Closing of Partner's Taxable Year

A partnership's taxable year does not close upon the disposition of an interest in the partnership

Naked assumptions

increase partners' capital accounts

Outside basis

increased by the partner's distributive share of income (taxable and tax-exempt), and decreased by his share of distributions.

basic test, alternate test,

two tests to determine if an allocation has economic effect:

Alternate Test

usually used for LPs.

Inventory Items

All gain or loss recognized by the partnership within 5 years of contribution of an item that is an inventory item in the hands of the contributing partner is ordinary.

Otherwise, Respects

All other material allocations and capital account adjustments must be respected under 1.704-1(b)

Allocation of Recourse Debt to Limited Partner with Make-up Obligation

An allocation of losses due to the 5-event test has economic effect to the extent that the limited partner has a make-up obligation.

Non-recourse Distributions

Any reasonable method may be used to allocate a distribution to the proceeds of a non-recourse borrowing

Inventories

Any taxpayer (not only partnerships) with inventories must use the accrual method.

Acceleration of Depreciation

For appraisal purposes, accrued depreciation is not caused by

Per Se corps

Incorporated entities and foreign per se corps.

704(c)

Keep track of _______ gain in individual assets (i.e. track book and basis), not just book & tax accounts, if property is sold after depreciation is taken.

Sales, Distributions (incl. 751(b)), Outside Basis, Retirements, Contributions

Liabilities include?

Capital Loss Property

Loss recognized by the partnership by disposition of an asset within 5 years of contribution by a partner with respect to whom the asset is a capital asset is capital.

Recognition of Loss

Loss with respect to a distribution is only recognized upon liquidation of a partnership interest, and only if the property received by a partner consists solely of money, unrealized receivables, and inventory items

Random Ordinary Gain Items

Most importantly, these include 1245 inclusions, 1250 inclusions, and 1248 inclusions, and 1239 items

Effect of Partnership Liabilities on Book Capital Accounts

No adjustments are made to book capital accounts when a partnership borrows or pays off a loan

Year of Inclusion

Partner includes income or loss from distributive share for the partnership taxable year ending with or within the partner's taxable year.

Initial Contribution

Partner's book capital account = amount of money

Inclusion

Partners must generally include their distributive share of taxable income and loss

Single Owner

Tax nothing or corp. Default rules are the same as with multiple owner entities.

MGCB Provision

The agreement must include a minimum gain chargeback provision

Calculation of Tax Capital Account

The amount in a partner's tax capital account can be stated in either

Minimum Gain

The amount of gain that would be allocated to a partner under 704(c) if the property were disposed of in a taxable transaction for no consideration other than the satisfaction of the non-recourse liability, i.e. the excess of non-recourse debt over basis upon contribution or revaluation

Strong Likelihood

The examples indicate that an allocation of losses to one partner of a start-up electronics business or an oil-drilling business until the point at which the business becomes net profitable do not create a "strong likelihood of an offsetting allocation", because of the inherent risk of the businesses involved

Capital Accounts - Deficits

The partner to whom an allocation is made need not be required to restore the deficit, or may be obligated to restore it only up to a limited amount

Basic or Alt. Test

The partnership agreement must otherwise satisfy either the basic or alternate tests for economic effect

(a) Money + FMV of Property Contributed, plus (b) Purchaser's Share of Liabilities Assumed in the Purchase.

The purchaser's outside basis in a partnership interest is the sum of the following:

Aggregate Amount of 743 Adjustments

The total amount of 743 basis adjustments = new partner's outside basis - new partner's share of inside basis

Elections

affecting the partnership's income must be made at the partnership level.

Receivables

amounts due from individuals and companies that are expected to be collected in cash

Inventory Item

applies to all inventory items. 751(b) (disproportionate distributions) applies only to substantially appreciated inventory

Tax capital accounts

are used to keep track of partners' share of inside basis.

Promissory Notes

written promise to pay back borrowed money

Maintenance of capital accounts

a way of accessing a safe harbor with respect to economic effect

Liquidations.

a) Goodwill is a 736 "hot" asset b) Non-Distribution Payments are Most Often Guaranteed Payments.

Timing of Curative Allocations

Curative allocations may be made any time so long as the time-frame for making them is reasonable and provision for them is made in the partnership agreement in effect for the year of contribution

Amount of Distributive Share

Determined by the partnership agreement

Non Per Se Corps

Domestic entities default to partnership status.

Revaluations

Book capital accounts are "booked up" with respect to all assets, upon the occurrence of certain events, given a substantial non-tax business purpose

1. Tax Capital = Partner's Share of Inside Basis - Partner's Share of Liabilities 2. Tax Capital = Book Capital - 704(c) Gain (+704(c) loss)

Calculation of Tax Capital Account

business activity and sharing of profits

Certain contractual relationships, such as joint ventures, can give rise to an entity. In order for there to be an entity rather than a mere co-ownership arrangement, there must be both (i) ____________ and (ii) __________ (Allison)

Cash Items

Certain enumerated items (interest, taxes, rent, and payment for services) that accrue prior to a partner's entry must be allocated to the partner by taking into account the partner's interest in the partnership for each day of the taxable year. Effectively, this forces cash method partnerships to accrue these items.

Date and Who Chooses?

Choice of Accounting Method

Depreciable Property

Gain from depreciable property is recovered over the property's economic life. In order to increase the contributing partner's share of taxable income (to bring her tax capital account in line with her book capital account), it is necessary to allocate depreciation away from the contributing partner

Unrealized Receivables

Gain from the disposition of a partnership of assets which were unrealized receivables in the hands of the contributing partner is ordinary.

Tax Shelters

Generally, anything other than a C corp. whose interests are issued in an offering that must be registered under the 33 Act or State Blue Sky laws is a tax shelter. This rather over-inclusive rule has the effect of requiring anything treated as a tax shelter to use the accrual method.

Installment Reporting

Generally, gain from sale of a partnership interest can be reported on the installment method. However, the portion attributable to 751 property may not. To allocate, take total amount realized with respect to 751 items and take them out of the sale. For these purposes, only the 1245 recapture gain is treated as "amount realized".

Reasonably Consistent

Generally, if there are two separate sharing arrangements, anything between the two is reasonably consistent. If there is only one sharing arrangement, it is best to share non-recourse deductions in the same proportion

PIP test

I(f allocations of deductions in Y1 and Y2 doe not have SEE, and the partnership is profitable in Y3. Add "phantom" negative capital account balance to the partner who actually bore the deduction in Y1 and Y2 to the amount deemed distributed in the Orrisch distribution at the end of Y3. 1.704-1(b)(5), ex. 15(ii)/(iii).

Closing of Partner's Partnership Taxable Year Upon Complete Disposition

If a partner's entire interest in a partnership terminates (by disposition, death or redemption), the partnership taxable year will close with respect to him

Transitory Allocations

If a partnership agreement provides for the possibility that one or more allocations (the "original allocation(s)") will be largely offset by one or more other allocations (the "offsetting allocation(s)"), and, at the time the allocations become part of the partnership agreement

Taxable Year of All Principal Partners

If all principal partners (i.e., those owning 5% or more of either profits or capital) have the same taxable year, then the partnership must use that taxable year.

Variation: More than One Type of Loss

If losses exceed basis, losses are allocated to the limitation amount pro rata. In other words, an amount equal to each loss multiplied by a fraction, the numerator of which is the partner's outside basis, and the denominator of which is the partner's total losses, to obtain total losses of that character

Effect of Lack of 754 Election on Purchase Price

If no 754 election were in effect, a purchaser may require that the purchase price be reduced by the amount of taxes due on the purchasing partner's share of the built-in gain

Majority Taxable Year

If one or more partners with the same taxable year own, in the aggregate, more than 50% of the profits and capital interests in the partnership, the partnership must use their taxable year

De Minimis Kickout

If the partner who makes the loan has a 10% or less interest in each item of gain, loss, deduction or credit for each taxable year, the loan is 100% non- recourse to the partner and the partnership.

Partner Non-recourse liabilities

Partnership losses and deductions attributable to a particular partner non-recourse liability must be allocated to the partner who bears the risk of economic loss associated with the liability.

Allocation of Income Among Partners for Year of Change

Policy: pre 1974, 1984, tax shelter promoters would allow LPs who joined partnerships late in the taxable year to be allocated their full share of deductions that allocated prior to their entry.

five-year rule and value-equals basis rule

Presumptions Used in Applying the Transitory Allocation Rule. In applying the transitory allocation rule, the following safe-harbors apply

transferability of interests, limited liability, centralized management, and unlimited life

Prior Regs. 4 characteristics

First, Adjust Basis under

Prior to applying the loss limitation rules, apply the basis adjustment rules of 705(a). Then apply the loss limitation rules

Capital Accounts - Positive Balances

Requirements (1) and (2) of the Basic test must be met with respect to the keeping of capital accounts and payments in liquidation to members with positive capital account balances.

basic or alt test, reasonably consistent, MGCB provision, otherwise respects

Safe Harbor requirements

Non-Depreciable Property

Simplest case. Built in tax gains, to the extent thereof, are allocated to the contributing partner.

Pledge of Partner Property To Secure Non-recourse Debt

Sometimes, partners will contribute property to a partnership to secure partnership debt as an indirect pledge. This is treated as recourse to the extent of the pledged property

Excess Non-recourse Liabilities

These are non- recourse liabilities other than minimum gain and 704(c) minimum gain. Generally, these are allocated in accordance with the partners' interests in partnership profits

Accounts Receivable

These are not rights to payment for goods or services if already accrued by an accrual-method partnership. However, they may be inventory

Partnership Minimum Gain

This is equal to the aggregate of gain that the partnership would realize if it disposed of all properties subject to non- recourse liabilities for an amount no more than the amount of the liability

Book Capital Accounts

This is used to track whether partnership allocation have substantial economic effect

Partner Disposes of Less than Entire Interest

This will not cause the partnership taxable year to close with respect to that partner. However, income and loss allocated to the partner during the taxable year will be determined by taking into account his varying interest in the partnership during the taxable year in which the sale or reduction occurred.

Basic Test

Three requirements to meet this test: 1. capital accounts 2. positive capital account 3. negative capital account

Loan by Partner to the Partnership

To the extent that a partner or a related person makes (or guarantees) a non-recourse loan to the partnership, the partner bears the economic risk of loss with respect to the loan, and the loan is treated as recourse to the partner

Ceiling Rule

Total income, gain, loss or deduction allocated to the partners for a taxable year with respect to a property cannot exceed the total partnership income, gain, loss or deduction for the taxable year

751 Items

Unrealized receivables, and inventory items.

Tiered Partnerships

Upper-tier partner's distributive share of upper-tier partnership's distributive share of items from lower-tier partnership are determined by assigning the appropriate portion of each item to the appropriate days of the taxable year during which the upper tier partnership is a partner in the lower tier partnership and by allocating the portion assigned to the partners in the upper-tier partnership in proportion to their interests in the upper tier partnership at the close of each day.

Non-depreciable Property

Using this method, partnerships may create offsetting tax allocations to match book allocations, with the result that the net amount allocated will equal the partnership entity's total gain, loss or deduction

Payables

What are not partnership liabilities for 752 purposes?

Naked assumptions

a _________ by a limited partner of recourse debt of the partnership will make the limited partner bear the risk of economic loss associated with the borrowing

partnership liability

a recourse liability to the extent that any partner or related person bears the risk of economic loss for the liability under 1.752-2(b).

Capital accounts

do not reflect liabilities, since they keep track of partners' equity, but outside basis does

tax character

does not affect book capital account

Shifting Tax Consequences

the economic effect of an allocation (or allocations) in a partnership taxable year is not substantial if, at the time the allocation (or allocations) becomes part of the partnership agreement

Minimum Gain

this is the sum of the partner's share of non-recourse deductions and non-recourse distributions made to the partner.