700 Leagues Under The Sea

1

Oceans 1120
2006 Tax Season Kickoff January 19-20, 2006

• 700 Leagues Under The Sea
• Partnership Taxation An Overview

2
What Is A Partnership?

• Trade or business/other venture entered into for
  profit

3
What Is A Partnership?

• Trade or business/other venture entered into for
  profit
• More than one owner

4
What Is A Partnership?

• Trade or business/other venture entered into for
  profit
• More than one owner
• Not a corporation under law

5
What Is A Partnership?

• Trade or business/other venture entered into for
  profit
• More than one owner
• Not a corporation under law
• Hasnt elected out of Subchapter K

6
What Is A Partnership?

• Trade or business/other venture entered into for
  profit
• More than one owner
• Not a corporation under law
• Hasnt elected out of Subchapter K
• Does not elect to be taxed as a corporation
• Check the box rules
• Default rules
• More than one owner partnership
• Single owner disregarded entity

7
How Is A Partnership Taxed?

• Partnership itself isnt taxed
• Pass-through

8
Basis Why Is It Important?

• Distribution of cash in excess of basis creates
  taxable gain Section 731(a)(1)
• Actual distribution
• Constructive distribution
• Decrease in allocated debt

9
Basis Why Is It Important?

• Distribution of cash in excess of basis creates
  taxable gain Section 731(a)(1)
• Actual distribution
• Constructive distribution
• Decrease in allocated debt
• Partnership losses deductible only to extent of
  adjusted basis under 704(d)

10
Basis Why Is It Important?

• Distribution of cash in excess of basis creates
  taxable gain Section 731(a)(1)
• Actual distribution
• Constructive distribution
• Decrease in allocated debt
• Partnership losses deductible only to extent of
  adjusted basis under 704(d)
• Basis offsets amount realized upon sale or
  disposition of partnership interest in
  determining taxable gain/loss

11
Basis How Is It Computed?

• Increases
• Cash plus tax basis of property contributed

12
Basis How Is It Computed?

• Increases
• Cash plus tax basis of property contributed
• Partner share of partnership taxable income and
  tax-exempt income

13
Basis How Is It Computed?

• Increases
• Cash plus tax basis of property contributed
• Partner share of partnership taxable income and
  tax-exempt income
• Increase in liabilities allocated to partner
  under Section 752

14
Basis How Is It Computed?

• Increases
• Cash plus tax basis of property contributed
• Partner share of partnership taxable income and
  tax-exempt income
• Increase in liabilities allocated to partner
  under Section 752
• Assumption of partnership debt

15
Basis How Is It Computed?

• Decreases
• Cash and tax basis of property distributed

16
Basis How Is It Computed?

• Decreases
• Cash and tax basis of property distributed
• Partner share of partnership tax losses and
  nondeductible, non capital expenditures

17
Basis How Is It Computed?

• Decreases
• Cash and tax basis of property distributed
• Partner share of partnership tax losses and
  nondeductible, non capital expenditures
• Decrease in liabilities allocated to partner
  under Section 752

18
Basis How Is It Computed?

• Decreases
• Cash and tax basis of property distributed
• Partner share of partnership tax losses and
  nondeductible, non capital expenditures
• Decrease in liabilities allocated to partner
  under Section 752
• Partnership assumption of partner debt

19
Basis Relationship To At-Risk Rules

• Liability allocation that creates basis does not
  automatically create at-risk basis
• (more later on at-risk)

20
Basis Relationship To Capital

• Capital account does not include liabilities
• Tax basis includes liabilities
• Negative capital account basis limitation or
  gain recognition flag

21
Basis Relationship To Capital

• Tax basis never negative
• Capital account can be negative
• Negative basis gain or limitation of deductions
• Actual distributions
• Deemed distributions reduction in liabilities
  allocated to partner under Section 752

22
Basis Relationship To Capital

• Tax capital account balance not necessarily K-1
  capital account balance
• Book/tax differences

23
Basis Relationship To Capital

• Tax capital account balance not necessarily K-1
  capital account balance
• Book/tax differences
• Outside/inside basis differences
• acquisition of interest by other than
  contribution to capital (i.e. purchased in a
  transaction outside the partnership)
• Contribution of appreciated property (K-1
  ordinarily will reflect agreed-upon value vs. tax
  basis)

24
Basis Relationship To Capital

• Tax capital account balance not necessarily K-1
  capital account balance
• Book/tax differences
• Outside/inside basis differences
• acquisition of interest by other than
  contribution to capital (i.e. purchased in a
  transaction outside the partnership)
• Contribution of appreciated property (K-1
  ordinarily will reflect agreed-upon value vs. tax
  basis)
• Tax basis should be tracked separately

25
Basis In Liabilities/Liability Allocations

• Recourse liability
• any partner (or person related to a partner
  within the meaning of Reg. Section 1.752-4(b))
  bears the economic risk of loss

26
Basis In Liabilities/Liability Allocations

• Recourse liability
• any partner (or person related to a partner
  within the meaning of Reg. Section 1.752-4(b))
  bears the economic risk of loss
• Includes guaranteed nonrecourse liability
• Consider use of bottom-side guarantee to provide
  basis while minimizing economic risk

27
Basis In Liabilities/Liability Allocations

• Recourse liability
• any partner (or person related to a partner
  within the meaning of Reg. Section 1.752-4(b))
  bears the economic risk of loss
• Includes guaranteed nonrecourse liability
• Consider use of bottom-side guarantee to provide
  basis while minimizing economic risk
• Includes nonrecourse loan from partner

28
Basis In Liabilities/Liability Allocations

• Allocation of recourse liabilities
• Economic risk of loss
• atom bomb test constructive liquidation of
  partnership, all assets worthless
• Person w/payment obligation bears economic risk
  of loss for that liability (Reg. Section
  1.752-(b)(1)
• Related person rule

29
Basis In Liabilities/Liability Allocations

• Nonrecourse liability
• No economic risk of loss
• Partner or related person
• Includes recourse liabilities of LLC unless
  guaranteed by a member or person related to a
  member

30
Basis In Liabilities/Liability Allocations

• Allocation of nonrecourse liabilities
• Three tiers
• Partner share of partnership minimum gain

31
Basis In Liabilities/Liability Allocations

• Allocation of nonrecourse liabilities
• Three tiers
• Partner share of partnership minimum gain
• Partner 704(c) minimum gain allocation
  appreciated property contributed
• Minimum gain nonrecourse debt gt tax basis

32
Basis In Liabilities/Liability Allocations

• Allocation of nonrecourse liabilities
• Three tiers
• Partner share of partnership minimum gain
• Partner 704(c) minimum gain allocation
  appreciated property contributed
• Minimum gain nonrecourse debt gt tax basis
• Excess using one of the methods under Reg.
  Section 1.752-3(a)(3) (partnership agreement
  should specify)
• most common based on profits

33
Basis In Liabilities/Liability Allocations

• Liabilities of a disregarded entity
• Prop. Reg. 1.752-2(k)(1) in determining the
  extent to which a partner bears the economic risk
  of loss for a partnership liability, obligations
  of the partners disregarded entity are taken
  into account only to the extent of the net
  value of the disregarded entity (unless the
  owner has a payment obligation for the
  liabilities of the disregarded entity) which does
  not include the value of the partnership interest
  or the value of any property pledged to secure a
  partnership liability
• So, even though the owner of the disregarded
  entity is treated as the owner of the assets and
  liabilities of the disregarded entity, including
  the partnership interest, the owner is not
  automatically eligible to receive the liability
  allocation related to this debt, rather,
  additional analysis is required under the reg.
• If not allocable to disregarded entity owner
  who gets it?
• Treated as nonrecourse

34
At-Risk Rules - Section 465

• Losses from activities to which Section 465
  applies allowable only to the extent taxpayer is
  at risk
• Disallowed at-risk loss carries forward
  indefinitely

35
At-Risk Rules

• Losses from activities to which Section 465
  applies allowable only to the extent taxpayer is
  at risk
• Disallowed at-risk loss carries forward
  indefinitely
• Applies to individuals and closely held C corps
  (with qualifying business exception)

36
At-Risk Rules

• Losses from activities to which Section 465
  applies allowable only to the extent taxpayer is
  at risk
• Disallowed at-risk loss carries forward
  indefinitely
• Applies to individuals and closely held C corps
  (with qualifying business exception)
• Exception - activity of holding real estate if
  ownership in the pass through acquired before
  12/31/86 and property placed in service before
  that date by the entity

37
At-Risk Rules

• At-risk basis different than under Sect. 752
• No at-risk basis for nonrecourse debt

38
At-Risk Rules

• At-risk basis different than under Sect. 752
• No at-risk basis for nonrecourse debt
• Exception for Qualified nonrecourse debt

39
At-Risk Rules

• At-risk basis different than under Sect. 752
• No at-risk basis for nonrecourse debt
• Exception for Qualified nonrecourse debt
• related to activity of holding real property and
  secured by the real property
• Lender must be qualified person person
  actively engaged in business of lending, not
  related unless borrowing on commercially
  reasonable terms, not purchase money debt, not a
  person who receives a fee with respect to
  taxpayers investment in the property, or person
  related to any of the above
• Debt cannot be convertible debt

40
At-Risk Rules

• Decrease in at-risk basis
• Recapture (rare, since Sect 731/752 gain triggers
  first)

41
At-Risk Rules

• Decrease in at-risk basis
• Recapture (rare, since Sect 731/752 gain triggers
  first)
• Replaced by at-risk loss carryforward

42
At-Risk Rules

• Decrease in at-risk basis
• Recapture (rare, since Sect 731/752 gain triggers
  first)
• Replaced by at-risk loss carryforward
• Ordinary income

43
At-Risk Rules

• Decrease in at-risk basis
• Recapture (rare, since Sect 731/752 gain triggers
  first)
• Replaced by at-risk loss carryforward
• Ordinary income
• Possible cause
• Conversion of recourse debt to nonrecourse

44
Partnership Income/Loss Allocations

• Must have substantial economic effect
• Not respected for tax purposes if they dont
• Consistent with economic arrangement
• Simplest terms allocations based on economic
  benefit/burden
• Partnership/op agreement will provide, we apply

45
Special Allocations Under 704(c)

• Purpose - to prevent shifting of tax consequences
  of pre-contribution gain/loss

46
Special Allocations Under 704(c)

• Contribution of appreciated or depreciated
  property
• Book value in excess of or less than tax basis
• 704(c) requires that tax benefits and burdens of
  this unrealized gain or loss be allocated to
  contributing partner

47
Special Allocations Under 704(c)

• Non-depreciable property
• Special allocation of gain or loss on sale or
  disposition

48
Special Allocations Under 704(c)

• Depreciable property
• Special allocations
• depreciation non-contributing partner allocated
  up to its share of book depreciation

49
Special Allocations Under 704(c)

• Depreciable property
• Special allocations
• depreciation non-contributing partner allocated
  up to its share of book depreciation
• gain/loss on sale or disposition

50
Disguised Sales - Section 707

• Disguised sale of property
• Contribution of property by one partner followed
  by distribution of cash or other property

51
Disguised Sales - Section 707

• Disguised sale of property
• Contribution of property by one partner followed
  by distribution of cash or other property
• Proper characterization as sale when viewed
  together

52
Disguised Sales - Section 707

• Disguised sale of property
• Contribution of property by one partner followed
  by distribution of cash or other property
• Proper characterization as sale when viewed
  together
• 2 year presumption
• within 2 years presumed sale,
• not within two years, not presumed sale
• subject to facts and circumstances determination

53
Disguised Sales - Section 707

• Exceptions to two year presumed sale rule
• Reasonable guaranteed payments
• Reasonable preferred returns
• Operating cash flow
• Reimbursement of Preformation expenditures

54
Disguised Sales - Section 707

• Disguised sale of property
• Can be caused by actual or deemed distribution
• Reallocation of liabilities

55
Disguised Sales - Section 707

• Disguised sale of property
• Sale for all purposes of the code (i.e. Sect.
  453, 1031, 483, 1274)

56
Disguised Sales - Section 707

• Disguised sale of property
• Disclosure required if transfer within two year
  period not treated as disguised sale and not
  subject to one of the exceptions

57
Disguised Sales - Section 707

• Disguised sale of partnership interest
• Proposed regs. 1.707-7
• Some exceptions money in full liquidation
  excepted if not really a sale

58
Hot Assets Rules - Section 751

• Purpose to prevent conversion of partner
  ordinary income to capital gain

59
Hot Assets Rules - Section 751

• 751(a)
• Sale of partnership interest

60
Hot Assets Rules - Section 751

• 751(a)
• Sale of partnership interest
• Appreciated or depreciated assets
• no substantial appreciation requirement as under
  751(b)

61
Hot Assets Rules - Section 751

• 751(a)
• Sale of partnership interest
• Appreciated or depreciated assets
• no substantial appreciation requirement as under
  751(b)
• Recharacterizes partner gain/loss on sale
• Overrides general rule of section 741

62
Hot Assets Rules - Section 751

• 751(b)
• Disproportionate distribution

63
Hot Assets Rules - Section 751

• 751(b)
• Disproportionate distribution
• Substantially appreciated inventory
• More than just inventory
• 1231 property held one year or less
• FMV gt 120 of adj. basis

64
Hot Assets Rules - Section 751

• 751(b)
• Disproportionate distribution
• Substantially appreciated inventory
• More than just inventory
• 1231 property held one year or less
• FMV gt 120 of adj. basis
• Unrealized receivables
• More than just cash basis receivables
• Depreciation recapture

65
Hot Assets Rules - Section 751

• 751(b)
• Disproportionate distribution
• Can create gain to partnership
• Distribution of 751(b) asset in exchange for
  partner share of other property
• Treated as purchase of asset by distributee
  partner
• Gain allocable to non-distributee partners

66
Hot Assets Rules - Section 751

• 751(b)
• Disproportionate distribution
• Can create gain to distributee
• Distribution of other property in exchange for
  partner share of 751(b) property
• Treated as purchase of partner share of asset by
  partnership

67
Basis Adjustments

• Step-up/step-down on transfer of partnership
  interest
• 754 election in effect or
• Substantial built-in loss/substantial basis
  reduction

68
Basis Adjustments

• 754 election
• Binding, irrevocable applies to subsequent
  transfers/distributions

69
Basis Adjustments

• 754 election
• Binding, irrevocable applies to subsequent
  transfers/distributions
• Increases/decreases inside basis of assets
• Special allocation depreciation gain/loss on
  sale

70
Basis Adjustments

• 754 election
• Applicable to
• Transfer from sale or death of partner
• Section 743
• Distribution to partner
• Section 734

71
Basis Adjustments

• Substantial built-in loss
• Transfer (Section 743(d))
• Adjusted basis in property exceeds FMV by more
  than 250,000

72
Basis Adjustments

• Substantial basis reduction
• Distribution (Section 734(d))
• Loss to distributee partner excess basis to
  distributee (under Section 732) over adj basis
  prior to distribution exceeds 250,000

73
Partnership Interest In Exchange For Services

• Section 83 historically only applied to capital
  interest (Rev. Procs. 2001-43 and 93-27)

74
Partnership Interest In Exchange For Services

• Section 83 historically only applied to capital
  interest (Rev. Procs. 2001-43 and 93-27)
• Definition of capital interest
• Partner entitled to share of proceeds complete
  liquidation for FMV (including goodwill)
• As of date of issuance

75
Partnership Interest In Exchange For Services

• Section 83 historically only applied to capital
  interest (Rev. Procs. 2001-43 and 93-27)
• Consequences issuance of profits interest
• No taxable event
• Certain exceptions (income stream, PTP, 2 yr.
  disposition)

76
Partnership Interest In Exchange For Services

• Section 83 historically only applied to capital
  interest (Rev. Procs. 2001-43 and 93-27)
• Consequences issuance of profits interest
• No taxable event
• Certain exceptions (income stream, PTP, 2 yr.
  disposition)
• No 83(b) election needed (non-event for tax
  purposes)

77
Partnership Interest In Exchange For Services

• Section 83 historically only applied to capital
  interest (Rev. Procs. 2001-43 and 93-27)
• Consequences issuance of profits interest
• No taxable event
• Certain exceptions (income stream, PTP, 2 yr.
  disposition)
• No 83(b) election needed (non-event for tax
  purposes)
• No wage deduction

78
Partnership Interest In Exchange For Services

• Prop. regs. sect. 83 applies to transfer of
  profits interest
• Notice 2005-43 proposed procedure under new regs.
• Elective safe harbor
• Same liquidation value approach as Rev. Procs.
  93-27/
• 2001-43
• Requires prov in p/s agreement or written
  partners consent
• Same exceptions as under old rules
• Need affirmative election
• Absent election valuation
• Non vested need 83(b) election to be treated as
  partner
• Not effective until final regulations issued
• Until then rules of Rev. Procs. 2001-43 and 93-27
  apply

79
Self Employment Taxes

• Proposed reg. 1.1402(a)-2 only guidance for
  LLCs

80
Self Employment Taxes

• Proposed reg. 1.1402(a)-2 only guidance for
  LLCs
• Controversial provisions subjects LPs to SE
  tax

81
Self Employment Taxes

• Proposed reg. 1.1402(a)-2 only guidance for
  LLCs
• Controversial provisions subjects LPs to SE
  tax
• Final regs delayed further study

82
Self Employment Taxes

• Proposed reg. 1.1402(a)-2 only guidance for
  LLCs
• Controversial provisions subjects LPs to SE
  tax
• Final regs delayed further study
• Final rules could affect S corps.

83
Self Employment Taxes

• Prop. Reg. (continued)
• Tests
• Liability for debt of partnership under state law
  (i.e. GP)

84
Self Employment Taxes

• Prop. Reg. (continued)
• Tests
• Liability for debt of partnership under state law
  (i.e. GP)
• Authority to contract on behalf of partnership
  under state law (i.e. GP or managing member of
  LLC)

85
Self Employment Taxes

• Prop. Reg. (continued)
• Tests
• Liability for debt of partnership under state law
  (i.e. GP)
• Authority to act on behalf of partnership under
  state law (i.e. GP or managing member of LLC)
• 500 hour test

86
Self Employment Taxes

• Prop. Reg. (continued)
• Bifurcation rule
• Substantial (gt20) ownership by LPs (under above
  tests) with identical rights (not identical
  ownership))
• Only applies if partner is LP due to third test
  above, not first two

87
Self Employment Taxes

• Prop. Reg. (continued)
• Holder of more than 1 class of interest
• Not treated as LP under 3 tests
• Substantial interest in that class owned by other
  LPs
• Identical rights/obligations w/respect to class
• Will be LP if w/respect to class of interest if
  above three conditions met

88
Self Employment Taxes

• Prop. Reg. (continued)
• Service partners/service partnerships
• Wont qualify for LP treatment

89
Miscellaneous Other Issues

• 1250 recapture (25 tax rate) disposition of
  partnership interest
• Applies to sale not redemption

90
Miscellaneous Other Issues

• Small partnership late filing penalties
• Available waiver under Rev. Proc. 84-35
• Fewer than 10 partners
• Info provided to partners for return filings

91
Miscellaneous Other Issues

• UBTI
• Acquisition related debt allocable partnership
  liabilities creates UBTI under these rules unless
  entity is exempt from rule such as qualified
  plans

92
Miscellaneous Other Issues

• Charitable donation
• Partnership interest w/allocable liabilities
  bargain sale to charity

93
Miscellaneous Other Issues

• No wages to partners guaranteed payments

94
Miscellaneous Other Issues

• Technical termination Section 708(b)(1)(B)
• 50 change in ownership over 12 month period
• Assets/liabilities deemed contributed to new
  partnership w/subsequent distribution of
  resulting interest in new partnership to
  purchasing partner and other remaining partners
• Same FEI
• Cutoff of tax year/short period return Notice
  2001-5
• Terminating P/S makes 754 election
• To apply to incoming partner