PORTFOLIO

Partnerships — Taxable Income; Allocation of Distributive Shares; Capital Accounts (Portfolio 712)

Tax Management Portfolio, No. 712-3rd T.M., Partnerships — Taxable Income; Allocation of Distributive Shares; Capital Accounts, analyzes the tax considerations relating to the determination of a partnership's taxable income and loss and the allocation of such income and loss among its partners. Because a partnership is not a taxable entity, but instead flows through its income and losses to its partners, partnership taxable income and loss (or items thereof) are treated as received directly by the partners in their respective portions (or distributive shares) of each item.

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DESCRIPTION

Tax Management Portfolio, No. 712-3rd T.M., Partnerships — Taxable Income; Allocation of Distributive Shares; Capital Accounts, analyzes the tax considerations relating to the determination of a partnership's taxable income and loss and the allocation of such income and loss among its partners. Because a partnership is not a taxable entity, but instead flows through its income and losses to its partners, partnership taxable income and loss (or items thereof) are treated as received directly by the partners in their respective portions (or distributive shares) of each item.


In general, partnerships are granted substantial flexibility in allocating items of partnership income and loss among their partners. If, however, the partnership agreement does not provide for the allocation of such items or such allocation does not have “substantial economic effect,” the determination of the partners' distributive shares is made in accordance with the partners' interests in the partnership (taking into account all facts and circumstances). This Portfolio discusses extensively §704(b) and the regulations thereunder, which contain detailed rules for the determination of the partners' distributive shares.


The Portfolio also describes the special rules regarding the allocation of tax items in respect of appreciated or depreciated property contributed to a partnership and regarding the apportionment of allocations between transferors and transferees that are necessitated by a mid-year transfer of an interest in a partnership (including the sale or exchange of an interest, liquidation of an interest, death of a partner, admission of a new partner, transfers to and from corporations, and gifts and intra-family sales of partnership interests). It also discusses the unique treatment of guaranteed payments (generally salaries and interest-type payments to partners) under §707(c).


Related discussions of partnership topics may be found in 710 T.M., Partnerships — Conceptual Overview (classification of partnerships and determination of partnership income), 711 T.M., Partnerships — Formation and Contributions of Property or Services, and 718 T.M., Partnerships — Disposition of Partnership Interests or Partnership Business; Partnership Termination (effect on the allocation of partnership profits and losses upon the sale or exchange of partnership interests).


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AUTHORS

ERIC B. SLOAN
Eric B. Sloan, B.A. (with honors), Northwestern University; J.D., University of Chicago Law School; LL.M. (with distinction), Georgetown University Law Center; former associate, Irell & Manella LLP; Sutherland, Asbill & Brennan LLP; a member of the Tax Section of the American Bar Association and member and Immediate Past Chair of the Tax Section's Committee on Partnerships and LLCs; admitted to practice in California, Illinois, and the District of Columbia; author and co-author, various articles in Tax Notes, Journal of Taxation, Tax Executive, TAXES, Major Tax Planning (The Law School of the University of Southern California), Journal of Passthrough Entities, Tax Management Memorandum, and Tax Planning for Domestic & Foreign Partnerships, LLCs, Joint Ventures, & Other Strategic Alliances (Practising Law Institute); lecturer, Practising Law Institute, the American Bar Association, the Tax Executive Institute, The University of Chicago Law School's Federal Tax Conference, the University of Southern California Law School's Institute on Federal Taxation, and the California Bar Association; member of the planning committee for the University of Chicago Law School's Annual Federal Tax Conference and member of the advisory board of NYU Institute on Federal Taxation; Adjunct Professor, Georgetown University Law Center.

MATTHEW J. SULLIVAN
Matthew J. Sullivan, J.D. (magna cum laude), Georgetown University Law Center; LL.M. (Taxation), Georgetown University Law Center; member, American Bar Association and the District of Columbia Bar Association; speaker, various conferences; author, various articles in NYU Institute of Taxation and Tax Notes, and Tax Planning for Domestic & Foreign Partnerships, LLCs, Joint Ventures, & Other Strategic Alliances (Practising Law Institute).

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Computation of Partnership Income

A. Partnership Taxable Income or Loss

B. Segregation of Items

1. In General

2. Items Specifically Provided for by Statute and Regulations

3. Other Items that Must Be Separately Reported

a. CFC Partners and Subpart F Income

b. Section 179 Expenses

c. ECI and FDAP Items

d. Investment Interest Expense

e. Rev. Rul. 71-455

f. Income Subject to Foreign Earned Income Exclusion

g. Cancellation-of-Indebtedness Income

h. Meals, Travel, and Entertainment Expenses

i. Net Operating Loss Deduction

j. Accelerated Depreciation

k. Two-Percent Floor for Miscellaneous Itemized Deductions

l. Depletion

m. Income Attributable to Domestic Manufacturing

n. Items Required To Be Reported Separately Under Aggregate Theory of Partnerships

C. Taxpayer Elections

D. Method of Accounting

E. Taxable Year

1. In General

2. Least-Aggregate-Deferral Rule

3. Disregard of Certain Partners for Determination of Taxable Year

4. Partnership Owned by Consolidated Group Member

5. Establishing a Business Purpose for Different Taxable Year

6. Elections Under Section 444

7. Closing of Partnership's Taxable Year

8. Sale, Exchange, or Liquidation of Entire Interest

a. General

b. Reduction of Partner's Interest

c. Effect of Closing of Taxable Year

F. The Varying Interest Rule

1. General Rule

2. Methods of Allocating Partnership Items to Entering Partners

3. Provisions Addressing Avoidance Techniques

a. Cash Basis Items

b. Treatment of Tiered Partnerships

c. Special Items

G. Applicability of the Allocation Rules of § 706 to Particular Events

1. Death of a Partner

a. Tax Years Beginning After 1997

b. Pre-1998 Tax Years

c. Distributions by Estates

2. Distributions by Trusts

3. Gifts and Intra-Family Sales

4. Conversions of Partnership Interests

5. Transfers To and From Corporations

6. Transfers To and From Partnerships

7. Abandonment

III. Partners’ Distributive Shares

A. Identifying the Partners

B. Meaning of Distributive Shares

1. In General

2. Bottom-Line Allocation

C. Limitations on the Deductibility of a Partner's Distributive Share of Losses

1. In General

2. Basis Limitations

3. “At Risk” Limitations

4. Passive Loss Limitations

D. General Rules for Determining Distributive Shares

1. The Partnership Agreement

2. Amendments to the Partnership Agreement

3. Reallocations Under § 482

IV. Allocations Pursuant to the Partnership Agreement - Section 704

A. Introduction

B. Development of the Rules Governing Allocations

1. Pre-1976 Code, Regulations, and Major Cases

2. The 1976 Amendments

3. The Regulations

C. Substantial Economic Effect

1. Background

2. Economic Effect

a. General Rule

b. Limited Deficit Restoration Obligations

c. Alternate Test

d. “Disappearing” Deficit Restoration Obligations

e. Economic Effect Equivalence

3. Determination and Maintenance of Capital Accounts

a. General Maintenance Rules

b. Contributions and Distributions of Promissory Notes

c. Contributions and Distributions of Other Property

d. Revaluations of Partnership Property

e. Determination and Allocation of Book Items Attributable to Contributed Property - Section 704(b)

(1) In General

(2) Allocation of Book Cost Recovery Deductions

f. Depletion and Gain or Loss in Respect of Oil and Gas Properties

g. Transfers of Partnership Interests

4. Substantiality

a. Shifting Allocations

b. Transitory Allocations

c. Overall-Tax-Effects Test

d. Look-Through Rule

D. Partners’ Interests in the Partnership

1. The Objective Standard

2. The Subjective Standard

E. Deductions in Respect of Nonrecourse Debt

1. Introduction

2. Definitions

3. General Requirements

4. Determination of Nonrecourse Deductions

a. Amount of Nonrecourse Deductions

b. Ordering Rules for Nonrecourse Deductions

5. Determination of Partnership Minimum Gain

6. Minimum Gain Chargeback

a. In General

b. Each Partner's Share of Net Decrease in Minimum Gain

c. Ordering Rules for Determining Items Subject to Minimum Gain Chargeback

d. Exceptions to Minimum Gain Chargeback

(1) Recharacterization of Liabilities

(2) Capital Contributions

(3) Waiver of Minimum Gain Chargeback in Event of Economic Distortion

7. Determination of a Partner's Share of Partnership Minimum Gain

8. Distribution of Proceeds from Nonrecourse Liabilities

9. Partner Nonrecourse Debt

10. Tiered Partnerships

F. Allocations of Certain Items that Do Not Have Economic Effect

1. Allocations to Reflect Book/Tax Disparities

2. Allocation of Credits

3. Allocation of Excess Percentage Depletion for Minerals Other than Oil and Gas

4. Recapture Items

a. Depreciation Recapture

b. Natural Resource Recapture Property

G. Contingent Allocations, Convertible Securities, and Options

1. Contingent Allocations

2. Convertible Securities and Options

a. In General

b. Noncompensatory Options

H. Subchapter K Anti-Abuse Regulations

V. Tax Allocations in Respect of Contributed Property - Sections 704(c) and 737

A. Historical Background

1. In General

2. The Ceiling Rule in Pre-1984 Deficit Reduction Act Regulations

B. Determination and Allocation of Tax Items Attributable to Contributed Property - Current Law - In General

C. Allocations Under § 704(c)(1)

1. In General

2. The Traditional Method

3. The Traditional Method with Curative Allocations

4. The Remedial Allocation Method

5. Layering Issues

6. Tiered Partnerships

7. Special Rules

a. Small Disparities

b. Aggregation of Property

(1) In General

(2) Special Rule for Securities Partnerships

(3) Qualified Master Feeder Structures

(4) Aggregation from Expanded Class of Qualified Financial Assets: Rev. Proc. 2007-59

8. Determining the Fair Market Value of Contributed Property

9. Tax Character of Contributed Property

10. Contributed Built-in Loss Property.

a. Section 704(c)(1)(C)

b. Regulations on Assumptions of Partner Obligations

D. Distribution of Property to Partner - Sections 704(c)(1)(B) and 737

1. In General

2. Distributions of Contributed Property to Non-Contributing Partner - Section 704(c)(1)(B)

3. Regulations Under Section 704(c)(1)(B)

a. In General

b. Seven-Year Period

c. Character of Gain or Loss

d. Exceptions

e. Special Rules

f. Basis Adjustments

g. Anti-Abuse Rule

4. Distribution of Other Property to Contributing Partner - Section 737

a. In General

b. Distribution of Marketable Securities

5. Regulations Under § 737

a. In General

b. Excess Distribution

c. Net Precontribution Gain

d. Character of Gain

e. Exceptions and Special Rules

f. Basis Adjustments

g. Anti-Abuse Rule

VI. Guaranteed Payments

A. Overview

B. Legislative Background

C. Definitional Requirements

1. Identity of the Payor and Payee

2. Consideration for the Payment

3. Manner of Computation of the Payment

4. Partner Capacity Transaction

D. Tax Effects of Guaranteed Payments

1. Deductibility and Inclusion Under § 707(c)

2. Other Effects of Guaranteed Payments: Treatment as Distributive Share

a. Treatment as Interest in Partnership Profits

b. Guaranteed Payment Recipient as “Employee”

c. Section 911 Exclusion

d. Self-Employment Taxes

3. Transfer of Property: Treatment as § 1001 Sale or Exchange


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Preamble to T.D. 8065, 50 Fed. Reg. 53423 (12/31/85) (Regs. § 1.704-1(b))

Worksheet 2 Preamble to T.D. 8385, 56 Fed. Reg. 66978 (12/27/91) (Regs. § 1.704-2)

Worksheet 3 Preamble to T.D. 8437, 57 Fed. Reg. 43897 (9/23/92) (Regs. § 1.613A-3)

Worksheet 4 Preamble to T.D. 8500, 58 Fed. Reg. 67676 (12/22/93), and Preamble to T.D. 8585, 59 Fed. Reg. 66724 (12/28/94) (Regs. § 1.704-3)

Worksheet 5 Preamble to T.D. 8501, 58 Fed. Reg. 67684 (12/22/93) (Regs. § 1.704-3T)

Worksheet 6 Preamble to T.D. 8642, 60 Fed. Reg. 66727 (12/26/95) (Regs. § § 1.704-4 and 1.737)

Worksheet 7 Preamble to T.D. 8717, 62 Fed. Reg. 25498 (5/9/97) (Regs. § § 1.704-1(b), 1.704-3(a), 1.704-4(a), 1.708-1, and 1.737-2)

Worksheet 8 Rev. Proc. 2001-36, 2001-23 I.R.B. 1326

Worksheet 9 Sample Special Allocations

Worksheet 10 Sample Targeted Allocations

Worksheet 11 Sample Section 482 Allocations

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Public Laws:

Committee Reports:

Staff of Joint Committee on Taxation Publications:

Treasury Rulings:

Cases:

UNOFFICIAL

Texts and Treatises:

Articles:

1958

1972

1980

1986

1987

1992

1997

1998

2000

2001

2002