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Partnerships — Current and Liquidating Distributions; Death or Retirement of a Partner (Portfolio 811)

Product Code: TPOR42
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Partnerships — Current and Liquidating Di s tributions; Death or Retirement of a Partner , written by Elliott Manning, University of Miami School of Law, provides a detailed discussion of the tax consequences of distributions by partnerships to partners, including those arising from distributions of a partner's share of the results of partnership operations, and other distributions by the partnership that do not result in termination of the distributee's interest in the partnership even though accompanied by a change in the distributee's and remaining partners' shares of capital or profits and losses, whether in money or property—all called current distributions—and distributions of money or property on the withdrawal of a partner whether on death or withdrawal—called liquidating distributions. Liquidating distributions may be accompanied by other retirement payments that do not represent consideration for the withdrawing partner's interest in partnership property, and may be deferred compensation, or other claims against past or future partnership income. When the withdrawal is a result of death, there may be other collateral income and transfer tax consequences. Distributions, usually liquidating distributions, are important components of major partnership restructurings, including divisions, mergers, incorporations, and changes in legal form.

As with all other aspects of partnership taxation, the dual nature of a partnership for tax purposes—as at times an aggregation of its partners, and at times an entity—complicates the discussion, particularly because no one, including the author, has been able to articulate a comprehensive statement of when the aggregate, and when the entity, aspect should predominate. Further complication arises because the “tax” partnership includes not only entities organized as general partnerships or limited partnerships (“LP”) under state law, but also the newer forms of limited liability partnerships (“LLP”), initially primarily for professionals, and the increasingly popular limited liability company (“LLC”). The newer forms, particularly the LLC, have many more entity characteristics, particularly when full advantage of the freedom to contract that is part of the latest revisions of the governing statutes in most commercial states is taken into account, so that it is hard to distinguish them from corporations. All but the traditional general partnership have limited liability, and a general partnership can, in most states, achieve limited liability by a simple filing to become an LLP, but, particularly for professionals that limited liability protects against vicarious liability but not against liability for one's own malpractice, including, of course malpractice in giving advice related to partnership tax matters. All but the general partnership can also have continuity of life, centralized management and free transferability of interest, subject only to the usual practical problems of transferring interests in closely held businesses. Even the general partnership can achieve most of these characteristics by a carefully drafted partnership agreement. Nevertheless, Subchapter K has not been amended to recognize these changes. Despite these factors, the Check-the-Box regulations, Regs. §§301.7701-2 and -3, recognize partnership as the default tax classification for all domestic entities that are not organized as corporations or joint stock companies, or engaged in certain regulated businesses like banking and insurance. A number of problems have emerged, particularly for LLCs treated as disregarded entities, including a controversial decision by the IRS to treat the disregarded entity as the one responsible for payroll taxes for its employees, and questions about the status of recourse liabilities of a disregarded entity, particularly one that owns a partnership interest.
This Portfolio analyzes not only the relevant statutory and regulatory materials, but also the large body of case law, revenue rulings, and other IRS pronouncements, including technical advice memoranda and private letter rulings, that are all part of this, unfortunately complex, body of tax law.

Part I, Introduction, briefly discusses important general principles not directly related to distributions, but that will nevertheless frequently be referred to throughout the Portfolio, including partnership capital accounts, §704(c) and reverse §704(c) allocations. Part I then addresses the vexing question of distinguishing a partner withdrawal from sale of a partnership interest (which are considered in more detail in 718 T.M. Partnerships—Disposition of Partnership Interests or Partnership Business; Partnership Termination). Part I concludes with a brief discussion of the general anti-abuse regulations. Part II discusses the principles applicable to all distributions—current and liquidating—including distinguishing between them—and the general principles for nonrecognition of gain or loss on distributions of partnership property in kind, and the effect of partnership liability shifts as part of distributions. Part III deals with the specific tax consequences of current distributions, including the basis of distributed property, the effects on the outside basis of the distributee partner's interest of money and property distributions, and the effects on the inside basis of the partnership's assets of in-kind distributions, as well as the effects of §751 to recharacterize non-pro rata distributions by partnerships that have §751 property and other property as taxable exchanges instead of nonrecognition distributions. The tax consequences of liquidating distributions are discussed in Part IV, including the different rules for the basis of distributed property, and the effect on the partnership's inside basis of gain or loss recognized by the distributee partner. Finally, Part V analyzes §736, which characterizes partnership payments made to a retiring partner or the successors of a deceased partner, dividing them between those that are liquidating distributions allocable to the retiring or deceased partner's interest in the partnership (including goodwill and similar intangibles) that are governed by the principles discussed in Part IV, and any other withdrawal payments, which are classified as either distributive share payments, with their character determined by the allocable share of partnership income, or guaranteed payments, which are ordinary income to the distributee without regard to partnership income, depending on whether their amount is determined by partnership income or not, and are, in effect, deductible (or excludible) by the partnership (remaining partners). It also addresses estate and income tax considerations relevant to a deceased partner's successors, other than those involving §736.

For a discussion of related federal tax rules applied to partnerships, see 710 T.M., Partnerships—ConceptualOverview; 711 T.M., Partnerships—Formationand Contributions of Property or Services ; 712 T.M., Partnerships—TaxableIncome; Allocation of Distributive Shares Capital Accounts; 714 T.M., Partnerships—Allocation of Liabilities; Basis Rules; 718 T.M., Partnerships—Disposition of Partnership Interests or Partnership Business; Partnership Termination; and 720 T.M., Partnership Transactions—Section 751 Property. For a discussion of the specific tax issues related to limited liability companies, see 725 T.M., Limited Liability Companies. For a discussion of the specific tax issues raised by foreign partners or foreign partnerships, see 910 T.M., Partners and Partnerships—InternationalAspects (Foreign Income Series).

Partnerships — Current and Liquidating Distributions; Death or Retirement of a Partner allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
  • Alternative approaches to both common and unique tax scenarios

This Portfolio is part of the Estates, Gifts and Trusts Portfolios Library, a comprehensive series containing more than 80 Portfolios, which covers critical transactions in estate, gifts and trusts planning. This highly-regarded resource library offers commentary on a wide range of estate planning topics including: Generation Skipping Tax, Family Limited Partnerships, Charitable Remainder Trusts, Estate Planning for Closely-Held Businesses, Exempt Organizations and Private Foundations, Life Insurance, Valuation, and more.

Detailed Analysis

I. Introduction

Introductory Material

A. Capital Accounts

B. Section 704(c) (and Reverse § 704(c)) Adjustments

C. Distribution or Withdrawal v. Sale

D. Anti-Abuse Regulations

II. Partnership Distributions-In General

Introductory Material

A. Nonrecognition of Gain or Loss

B. Basis and Holding Period

1. Partner's Outside Basis

2. Holding Period of a Partnership Interest

C. Payments and Transfers That Are Not Distributions

1. Partnership Loans to Partners

2. Guaranteed Payments

3. Actual and Disguised Sales

D. Partnership Liabilities and Obligations

1. Liability Defined

2. Transfer

3. Sharing Partnership Liabilities

a. Recourse Liability Shares

b. Nonrecourse Liability Shares

c. Liability Shares Follow the Losses

4. Reducing Outside Basis for Unsatisfied Assumed Partner Obligations

a. Definitions and Rules

b. Exceptions

III. Current Distributions

Introductory Material

A. Nonrecognition of Gain or Loss

1. Money Distributions

2. Property Distributions

a. Distributee's Indebtedness

b. Encumbered Property

B. Distributee's Basis, Holding Period and Character

1. Distributee's Transferred Basis in Distributed Property

a. Outside Basis Limitation

b. Effect on Distributee's Outside Basis

c. Inside Basis Reduction for Corporation Distributed to Controlling Corporate Partner

2. Character and Holding Period of Distributed Property

a. Character of Distributed Property-§ 735(a)

b. Holding Period of Distributed Property-§ 735(b)

C. Effect on Partnership's Inside Basis-§ 754

1. Partnership's Inside Basis Adjustment under § 734(b)

2. Allocating the Inside Basis Adjustment

a. Tiered Partnerships

(1) Adjusting Through the Tiers

(2) Distribution of Lower-Tier Partnership Interest

b. Basis Adjustment Without § 754 Election: Current Distributions-§ 732(d)

D. Nonâ€"Pro Rata Distributions in Kind-§ 751(b)

1. Determining Gain or Loss

2. Shares of Partnership Assets

3. Section 751 Property

E. Mixing Bowl Transactions-§ § 704(c)(1)(B) and 737

1. Contributed Property Distributed to Another Partner-§ 704(c)(1)(B)

2. Other Property Distributed to Contributing Partner-§ 737

F. Distribution of Marketable Securities-§ 731(c)

1. Amount of Gain

2. Basis Consequences

3. Marketable Securities

4. Exceptions

5. Distribution by Investment Partnership

a. Investment-Type Assets

b. No Trade or Business

c. Eligible Partner

6. Coordination with Mixing Bowl Rules

7. Anti-Abuse Rule

G. Disguised Sales

1. Disguised Sale by Partnership to Partner

a. Entrepreneurial Risk

b. Liabilities

2. Disguised Sales of Partnership Interests

a. Disguised Sale Factors

b. The Disguised Sale

H. Assumption of § 1.752-7 Liability by Another Partner

IV. Liquidating Distributions

Introductory Material

A. Nonrecognition of Gain or Loss

1. Series of Distributions

2. Liability Relief

3. Liquidating Distribution to a § 1.752 Liability Partner

4. Collectibles and Unrecaptured § 1250 Gain

B. Basis of Distributed Property

1. Allocation of Basis to Distributed Property

2. Basis Allocations in a Series of Liquidating Distributions

3. Section 737 in Liquidating Distributions

4. Anti-Abuse

C. Effect on Partnership's Inside Basis-§ 754 and Substantial Basis Reduction

1. Substantial Basis Reduction

2. Allocating the Inside Basis Adjustment

3. Basis Adjustment Without § 754 Election: Liquidating Distributions-§ 732(d)

a. Elective Application of § 732(d) in Liquidating Distributions

b. Mandatory Application of § 732(d) in Liquidating Distributions

D. Suspended Losses

E. Closing the Tax Year

F. Partnership Termination

1. Sale or Exchange

2. Effect of Termination

G. Structural Changes

1. Partnership Divisions

a. Distribution and Contribution of Partnership Assets (Assets-Up)

b. Transfer of Partnership Assets (Assets-Over)

c. Collateral Consequences

2. Partnership Mergers

a. Transfer of Partnership Assets (Assets-Over)

b. Distribution and Contribution of Partnership Assets (Assets-Up)

c. Collateral Consequences

3. Incorporating the Going Partnership

a. Transfer of Partnership Assets (Assets-Over)

b. Distribution and Contribution of Partnership Assets (Assets-Up)

c. Transfer of Partnership Interests (Interests-Up)

d. Acquisitive § 351 Transaction

4. Recapitalization

5. Changing the Legal Form of a Tax Partnership

a. Changing the State Law Form of a Tax Partnership

b. Partnership to Disregarded Entity

c. Unincorporated Tax Partnership Entity to Corporation

V. Withdrawal Payments-§ 736

Introductory Material

A. Payments for Interest in Partnership-§ 736(b)

B. Distributive Share or Guaranteed Payments-§ 736(a)

1. Service Partnerships

a. Unrealized Receivables

b. Unspecified Goodwill

c. Deductible Obligations

2. Capital Partnerships

a. Section 736(a) Payments in Capital Partnerships

b. Deductible Obligations

C. Allocating § 736 Withdrawal Payments

1. Agreement

2. Ordinary Losses

3. Deferred Payments or Distributions

4. Section 736 Distributions in Kind

D. Successor to a Deceased Partner

1. Section 754 Election or Substantial Built-In Loss

2. Successor's Basis Adjustment Without § 754 Election-§ 732(d)

3. Valuing Deceased Partner's Interest

a. Buy-Sell Agreements

b. Valuation Discounts and Premiums

4. Income in Respect of a Decedent

5. Income in Year of Death

6. Suspended Losses

Working Papers

Table of Worksheets

Worksheet 1 Disguised Sale Disclosure Statement (Regs. § 1.707-8(b)(1))

Worksheet 2 Election to Adjust Basis of Partnership Property under § 754 (Regs. § 1.754-1(b))

Worksheet 3 Request for Revocation of § 754 Election to Adjust Basis of Partnership Property (Regs. § 1.754-1(c))

Worksheet 4 Preamble, T.D. 9207, Assumption of Partner Liabilities, 70 Fed. Reg. 30334, 30340 (5/26/2005)

Worksheet 5 Preamble, REG-107872-99, Assumption of Partner Liabilities, 68 Fed. Reg. 37434 (6/24/2003)

Worksheet 6 Preamble, REG-106736-00, Assumption of Partner Liabilities, 68 Fed. Reg. 37434 (6/24/2003)

Worksheet 7 Preamble, T.D. 8925, Partnership Mergers and Divisions, 66 Fed. Reg. 715 (1/4/2001)

Worksheet 8 Preamble, REG-111119-99, Partnership Mergers and Division, 65 Fed. Reg. 1572 (1/11/2000)

Worksheet 9 Preamble, REG-143397-05, Partner's Distributive Share, 72 Fed. Reg. 46932 (8/22/2007)

Worksheet 10 Draft Form Representation Letter

Worksheet 11 Checklist of Principal Tax Consequences of Current and Liquidating Distributions

Worksheet 12 Chart: Partner Withdrawal by Death or Retirement

Worksheet 13 Sample Redemption Agreement for the Interest of a Partner in a Service Partnership

Bibliography

OFFICIAL

Treasury Rulings:

Cases:

Federal Register:

Congressional Reports:

Text and Treatises:

UNOFFICIAL:

Periodicals:

1971

1979

1983

1985

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2007

2008

Elliott Manning
Elliott Manning, AB (with honors) Columbia College (1955), JD m.c.l., Harvard Law School (1958). Author of Tax Management Portfolios 710 T.M., Partnerships — Conceptual Overview; and 711 T.M., Partnerships — Formation and Contributions of Property or Services. Author of Choosing the Business Entity (Little Brown 1995); and Corporate Buy-Sell Agreements (Little Brown 1995).