Proposed Regulations Issued on Amortizing Start Up and Organizational Expenses After Technical Termination of a Partnership

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By David I. Kempler, Esq. and Elizabeth Carrott
Minnigh, Esq.
 

Buchanan Ingersoll & Rooney PC, Washington, DC

Under §708(b)(1), a partnership is considered as terminated only
if (i) no part of any business of the partnership continues to be
carried on by any of its partners or (ii) within a 12-month period
there is a sale or exchange of 50% or more of the total interest in
partnership capital and profits. A termination under §708(b)(1) is
often referred to as a "technical termination," since it terminates
the partnership for federal tax purposes only. Regs. §1.708-1(b)(4)
provides that, if a partnership is terminated by a sale or exchange
of an interest, then the partnership is deemed to have contributed
all of its assets and liabilities to a new partnership in exchange
for an interest in the new partnership; and immediately thereafter,
the terminated partnership is deemed to have distributed interests
in the new partnership to the partners in proportion to their
respective interests in the terminated partnership in liquidation
of the terminated partnership, either for the continuation of the
business by the new partnership or for its dissolution and winding
up.

The Treasury Department and the IRS became aware that some
taxpayers were taking the position that a technical termination
under §708(b)(1)(B) entitles a partnership to deduct unamortized
start-up expenses and organizational expenses to the extent
provided under §165. The Treasury Department and the IRS concluded
that this result was contrary to the congressional intent
underlying §§195, 708, and 709. To address this concern, on
December 9, 2013, the Treasury Department released proposed rules
amending Regs. §1.708-1 to provide that a new partnership formed
due to a transaction, or series of transactions, described in
§708(b)(1)(B) must continue amortizing §195 and §709 expenses using
the same amortization period adopted by the terminating
partnership.

Under §195(b)(1)(A) and Regs. §1.195-1(b), an entity is deemed
to elect to deduct the lesser of: (i) the amount of start-up
expenditures with respect to the active trade or business; or (ii)
$5,000, reduced (but not below zero) by the amount by which such
start-up expenditures exceed $50,000. Under §195(c)(1)(A), start-up
expenditures include expenses paid or incurred in connection with:
(i) investigating the creation or acquisition of an active trade or
business; (ii) creating an active trade or business; and (iii) any
activity engaged in for profit and for the production of income
before the day on which the active trade or business begins.
Section 195(b)(1)(B) provides that any start-up expenditures not
deductible under §195(b)(1)(A) may be treated as deferred expenses
amortizable ratably over a 180-month period beginning in the month
in which the trade or business begins. Section 195(b)(2) provides
that, if a trade or business is completely disposed of by the
taxpayer before the end of the amortization period, then any
deferred expenses attributable to such trade or business that were
not allowed as a deduction by reason of §195 may be deducted to the
extent allowable under §165.

Under §709(b)(1)(A) and Regs. §1.709-1(b)(2), an electing
partnership is deemed to elect to deduct organizational expenses in
the year in which the partnership begins business up to the lesser
of (i) the amount of the organizational expenses of the
partnership, or (ii) $5,000, reduced (but not below zero) by the
amount by which the organizational expenses exceed $50,000. Under
§709(b)(3), organizational expenses are expenditures which are (i)
incident to the creation of the partnership; (ii) chargeable to
capital account; and (iii) of a character which would be
amortizable. Section 709(b)(1)(B) provides that any organizational
expenses that are not deductible under §709(b)(1)(A) shall be
allowed as a deduction ratably over the 180-month period beginning
with the month in which the partnership begins business. Section
709(b)(2) provides that, if a partnership is liquidated before the
end of the amortization period, then any deferred expenses
attributable to the partnership that were not allowed as a
deduction by reason of §709 may be deducted to the extent allowable
under §165.

In the preamble to the proposed regulations, the Treasury
Department stated that legislative purpose behind §§195 and 709 was
to allow expenses incurred in the formation of a partnership to be
deducted ratably over the period during which the partnership
benefits from those initial expenses. Sections 195 and 709 provide
that this period begins with the commencement of business and
closes upon the earlier to occur of 180 months or when the business
ceases.  The Treasury Department and the IRS concluded that a
technical termination under §708(b)(1)(B) should not constitute a
cessation of a trade or business that should trigger deduction of
deferred §195 or §709 expenses. Accordingly, the proposed
regulations provide that a new partnership formed due to a
transaction, or series of transactions, described in §708(b)(1)(B)
must continue amortizing §195 and §709 expenses using the same
amortization period adopted by the terminating partnership.

The regulations would not apply on or after the date of the
publication of the final regulations. If adopted, these regulations
will prevent taxpayers from taking the position that a technical
termination under §708(b)(1)(B) entitles a partnership to deduct
unamortized start-up expenses and organizational expenses to the
extent provided under §165 and instead require them to use the same
amortization period adopted by the partnership terminating under
the technical termination rules.

For more information, in the Tax Management Portfolios, see
Starczewski, 714 T.M.
, Partnerships - Allocation of
Liabilities; Basis Rules, and in Tax Practice Series, see
¶4060, Termination of a Partnership.