Transcript Partnership Distribution Rules - Review

Partnership Distribution Rules - Review
1. No gain or loss on non-liquidating distribution, except to extent money
distributed exceeds partner’s basis before distribution. 731.
2.
Decrease is partner’s share of liabilities deemed distribution of cash equal to
amount of decrease.
3. Partner’s basis reduced by amount of money distributed and the
partner’s basis of property distributed, as determined under 732.
4. Partner’s basis of property other than money distributed in nonliquidating distribution is partnership’s adjusted basis, but can’t
exceed partner’s basis in partnership less money distributed in same
transaction. 732
Corporate & Partner Tax
Instructor: Dwight Drake
Special Allocation Items
1. Bottom line losses of partnership
2. Bottom line income of partnership
3. Specialty income items:
- Tax-exempt interest
- Built-in gain on contributed items per 704(c)
- Gains or losses on specific assets
- Royalties or special income items
4. Special deduction items:
- Depreciation
- Charitable contributions
- R&D and other extraordinary expense items.
Corporate & Partner Tax
Instructor: Dwight Drake
Special Allocations
Big Question: When will they
work for tax purposes?
Corporate & Partner Tax
Instructor: Dwight Drake
The 704 Rules
704(a): Partner’s share of income, gain, loss deduction or credit determined by
partnership agreement unless otherwise provided in Subchapter K
704(b): Partner’s share of all items determined by partner’s interest in
partnership, based on all facts and circumstances, if:
- The partnership agreement does not spell out allocations, or
- Partnership agreement lays out allocation, but it does not have
“substantial economic effect”.
Hence, big issue: What is “substantial economic effect”?
Corporate & Partner Tax
Instructor: Dwight Drake
Economic Effect – Safe Harbor
Three elements:
1. Capital accounts maintained for each partner per Reg. 1.7041(b)(2)(iv).
2. Upon liquidation of partnership or any partner’s interest,
distributions made in accordance with positive balances in capital
accounts.
3. Partner with negative balance in account after liquidation has
unconditional obligation to restore by later of end of year or 90 days
after liquidation.
Corporate & Partner Tax
Instructor: Dwight Drake
Capital Account Maintenance Per 704 Regs.
Increase by:
- Amount of money contributed by partner
- FMV of property contributed by partner
- Allocations of partnership income or gain, including tax-exempt income.
Decrease by:
- Amount of money distributed to partner
- FMV of property distributed to partner
- Allocations to partner of expenditures that are neither deductible not
capitalized (gambling losses, bribes, charitable contributions, related-party
losses, etc)
- Allocations of partnership losses and deduction items
Note: Looks like outside basis, but not the same.
Corporate & Partner Tax
Instructor: Dwight Drake
Example of Three Element Safe Harbor
Basic Facts: A & B contribute 15k cash to AB partnership. Starting balance
sheet and capital accounts as follows:
Assets:
Cash
30k
Total Assets
30k
Liabilities
0
A Capital account
15k
B Capital account
15k
Total Capital
30k
Corporate & Partner Tax
Instructor: Dwight Drake
Example of Three Element Safe Harbor
Basic Facts: Year 1, partnership losses 10k; Year 2, partnership losses 10k.
Agreement provides losses allocated 90% to A, 10% to B.
Assets:
Starting
Year 1
Year 2
Cash
30k
20k
10k
Total Assets
30k
20k
10k
Liabilities
0
A Capital account
15k
6k (15-9)
-3k (6-9)
B Capital account
15k
14k (15-1)
13k (14-1)
Total Capital
30k
20k
10k
Corporate & Partner Tax
Instructor: Dwight Drake
Example of Three Element Safe Harbor
If liquidate at the end of year 2 with agreement that says allocate all liquidation
proceeds 50-50, what happens?
- A & B each get 5k?
- A books losses of 18k, but really only lost 10k (15-5). Thus, 8k of A’s
losses never had any “economic effect”. They never cost A anything. So,
those losses not allowed under 704(b).
If liquidate at end of year two with safe harbor clauses:
- All 10k of assets paid to B because B is only partner with positive capital
account.
- A would have to contribute 3k to make up deficit.
- 3k contributed by A would be paid to B to zero B capital account. Thus,
B ends up getting 13k, full capital account balance.
- 18k losses allocated to A had “economic effect” because A paid in end.
Corporate & Partner Tax
Instructor: Dwight Drake
The Alternative to Deficit Restoration
Situation: Partner wants special allocation, but no deficit
restoration risk
Alternative Safe Harbor:
- First two elements of present: Maintain capital
accounts and distribute liquidation proceeds in
accordance with positive capital account balances.
- Agreement contains “Qualified Income Offset”.
Corporate & Partner Tax
Instructor: Dwight Drake
Qualified Income Offset
Sample Provision:
“ If at the end of any taxable year any Partner shall have
a negative balance in such Partner’s Deemed Capital
Account, then notwithstanding anything herein to the
contrary, there shall be reallocated to each such Partner
each item of Company gross income (unreduced by any
deductions) and gain in proportion to such negative
balance until the Deemed Capital Account of such Partner
is increased to zero.”
So what is “Deemed Capital Account”? Capital account
adjusted by “reasonably expected” future distributions
that exceed corresponding capital account increases – and
other items to come.
Corporate & Partner Tax
Instructor: Dwight Drake
Example Under Alternative with Qualified Income Offset
Year One: Capital accounts all positive, so no problem.
Year Two: A’s account goes negative by 3k. Gross income of 3k reallocated to
A to take A’s account to zero. Effect on B is a bigger share of loss by 3k, so
B’s capital account goes to 10k from 13k.
Economic effect test: If liquidate at end of Year 2, all 10k assets would go to
B, only partner with positive balance. This would equal balance in A’s
account. A would not have to restore a deficit. Extra losses allocated to A
would have had economic effect because A gets nothing on liquidation.
Corporate & Partner Tax
Instructor: Dwight Drake