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Partnerships—Current and Liquidating Distributions; Death or Retirement of a Partner (Portfolio 716)

Product Code: TPOR41
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Partnerships—Current and Liquidating Distributions; Death or Retirement of a Partner, written by Elliott Manning, 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.

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 U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which cover every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.

Buy Partnerships—Current and Liquidating Distributions; Death or Retirement of a Partner (Portfolio 716) now.

Detailed Analysis

I. Introduction

II. Overview of the Rules Governing Partnership Distributions

A. General Rules Applicable to Partnership Distributions

B. Classifying the Distribution

1. Current Distribution vs. Liquidating Distribution

2. Comparison of a Current Distribution with a Loan Transaction

3. Characterization as a Sale Transaction or a Distribution

4. Guaranteed Payments

5. Unrealized Receivables and Inventory Items

C. Subchapter K Anti–Abuse Regulations

III. Tax Consequences of a Current Distribution

A. General Definition

B. Recognition of Gain or Loss

1. General Rule

a. Distribution of Marketable Securities

(1) In General

(2) Definition of Marketable Securities

(3) Exceptions

(a) Marketable Securities Contributed By Distributee Partner

(b) Securities Not Marketable When Acquired By Partnership

(c) Securities Acquired In a Nonrecognition Transaction

(d) Anti–Stuffing Rule

(4) Distribution By Investment Partnership

(a) Investment Partnership

(b) Eligible Partner

(5) Limitation on Gain

(6) Basis Rules

(a) Basis of Distributed Securities

(b) Partner's Basis in Partnership and Partnership's Basis in Other Assets

(7) Character of Gain Recognized

(8) Anti–Abuse Rule

2. Distribution to Contributing Partner - Section 737

C. Partnership Liabilities - Gain Recognition

1. Deemed Cash Distribution

2. Ordering Rules - Liabilities Assumed and Relieved

D. Basis of Distributee Partner's Interest

E. Cash Advances During the Year

F. Basis of Property Received in a Current Distribution

1. General Rules

2. Basis Reduction in Distributed Corporations

IV. Tax Consequences of a Liquidating Distribution

A. General Definition

B. Recognition of Gain or Loss

1. Interaction of Sections 736 and 731

2. Taxation Under Section 731

3. Deemed Cash Distribution

4. Timing of Gain or Loss

5. Distribution to Contributing Partner - Section 737

C. Basis of Property Received in Liquidation of a Partner's Interest

1. General Rules

a. Rules Applicable to All Partners

b. Certain Liquidating Distributions to Corporate Partners

2. Basis Allocated to Encumbered Property

3. Basis Allocations in a Series of Liquidating Distributions

4. Basis Allocated to Debt Instruments

V. Special Basis Adjustment

A. General Rule - No Basis Adjustment

B. Adjustment to Partnership's Basis in Assets Under 734(b)

1. Measure of Adjustment

a. In General

b. Distributee's Recognition of Gain or Loss

c. Disparity in Basis of Distributed Property

2. Allocation of Section 734(b) Adjustment Among Partnership Assets

a. Transfers After December 14, 1999

(1) Allocations Between Asset Classes

(2) Allocations Within Asset Classes

(3) Increases

(4) Decreases

(5) Special Rule for Stock of Corporate Partners: 755(c)

(6) Requirement that Difference Between Value and Basis Be Reduced

b. Transfers Before December 15, 1999

3. Timing of Basis Adjustments Caused by Liquidation of Partner's Interest

4. Application of 734(b) to Tiered Partnerships

5. Making and Revoking the 754 Election

6. Mandatory 734(b) Adjustment

C. Distribution of Property Subject to a 743(b) Basis Adjustment

D. Section 732(d) Adjustment

1. Elective Adjustment

a. Form of Election

b. Computation of Basis Adjustment

2. Mandatory Adjustment

VI. Subsequent Sales of Distributed Property

Introductory Material

A. Unrealized Receivables and Inventory Items

B. Property Subject to Recapture

C. Holding Period of Distributed Property

VII. Death or Retirement of a Partner - Section 736

A. Alternatives Upon Death or Retirement

B. Section 736 in General

C. Scope of 736

D. Classifying 736 Payments

1. Liquidation of a Partnership Interest for Cash

a. Payments in Respect of Partnership Property - Section 736(b)

(1) Definition of 736(b) Payments

(2) Valuation of a Partner's Interest in Partnership Property

(3) Tax Consequences of 736(b) Payments

(4) Section 736(b) Payments Attributable to 751 Property

(5) Section 736(b) Payments - Effects on Partnership

(6) Series of 736(b) Payments

b. Payments Other Than 736(b) Payments - 736(a)

(1) Definition of 736(a) Payments

(2) Tax Consequences of 736(a) Payments

(a) Distributive Share of Partnership Income

(b) Guaranteed Payments

c. Allocation of Payments Between 736(a) and 736(b)

d. Payments for Goodwill

(1) Post January 5, 1993 Withdrawals

(2) Payments For Goodwill For Which 736(b)(2) Applies

2. Liquidation of a Partnership Interest for Property

E. Alternatives to Liquidating Interest

1. Sale or Exchange

a. Sale to Unrelated Party

b. Sale to Remaining Partners

2. Successor Continues as Partner

3. Partnership Is Liquidated

VIII. Death of a Partner - Tax Considerations Other Than Section 736

Introductory Material

A. Determination of Amount Includible in Gross Estate

1. Valuation of Partnership Assets

2. Buy-Sell Agreements

3. Insurance

a. Insurance Owned by Partners (Cross-Insurance)

b. Insurance Payable to Partnership (Funded Buy-Out)

4. Value of a Future Profits Interest

B. Income Tax Considerations Other Than 736

1. Income in Year of Death

2. Basis of Successor in Partnership Interest

3. Section 743(b) Basis Adjustment

4. Income in Respect of a Decedent

a. Section 736(a) Payments

b. Distributive Share of Partnership Income

c. Judicially Created IRD

Working Papers

Table of Worksheets

Worksheet 1 Excerpts from House Ways and Means Committee Report to H.R. 8300 [1954 Code]; H.R. Rep. No. 1337, 83d Cong., 2d Sess. A230–A231, A237 (1954).

Worksheet 2 Excerpts from Senate Report to H.R. 8300 [1954 Code]; S. Rep. No. 1622, 83d Cong., 2d Sess. 389–396 (1954).

Worksheet 3 Excerpt from Committee on Ways and Means, U.S. House of Representatives on H.R. 10612; H.R. Rep. No. 658, 94th Cong., 1st Sess. 122–125 (1975).

Worksheet 4 Excerpt from Senate Report of the Committee on Finance on H.R. 10612; S. Rep. No. 938, 94th Cong., 2d Sess. 95–98 (1976).

Worksheet 5 Section 737 - Recognition of Precontribution Gain in Case of Certain Distributions To Contributing Partner (As Added by the Energy Policy Act of 1992) (P.L. 102–486). [As Added by the Energy Policy Act of 1992 (P.L. 102–486)]

Worksheet 6 Omnibus Budget Reconciliation Act of 1993 Conference Report Section 13262 - Modify Special Treatment of Certain Liquidation Payments (P.L. 103–66).

Worksheet 7 Omnibus Budget Reconciliation Act of 1993 Conference Report Section 13206(e) - Definition of “Substantially Appreciated” Inventory (P.L. 103–66).

Worksheet 7A General Agreement on Tariffs and Trade, Section 741 of the Revenue Provisions (Title VII), Relating to Partnership Distributions (Act Language and Technical Explanation) (1994).

Worksheet 7B Taxpayer Relief Act of 1997

Worksheet 8 ABCD Partnership Agreement (Liquidation Article).

Bibliography

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Regulations:

Treasury Rulings:

Cases:

Text and Treatises:

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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).