Bracket Busters - Changes for Partnership Tax Law, Rulings and Decisions

Patricia Greenhouse, CPA (Mar, 2017)

As the week of March 15th has come and gone, those dwelling in the partnership world are breathing a sigh of relief that the big change in partnership taxation has been accomplished.  Recently enacted legislation had changed the due date for filing a partnership tax return to the 15th day of the third month after year end, i.e. 3/15 for nearly all partnerships.  Previously the due date was the 15th of the fourth month after year end.  The 2016 partnership tax returns (hopefully) were either filed or extended by 3/15/17.  Yes, there were those few extra days of grace period thanks to the blizzard, but for the most part the partnership world was resting easy and able to focus on the completion of their NCAA brackets before the tournament started.  Well…not so fast.  In a similar manner to the NCAA upset wins which broke our brackets last weekend, failure to be aware of the numerous other changes in partnership tax law, rulings, and decisions could be virtual bracket busters for partnerships, both now and in the future. The February 2017 issue of the Tax Advisor featured an article written by Hughlene A. Burton, Ph. D. CPA, Current Development in Partners and Partnerships, which provided an in-depth analysis of these changes. Do any of these affect your partnership?

Late Sec. 754 Elections

In several IRS letter rulings the IRS granted an extension of time to make a Sec. 754 election.  Under this election a partnership elects to adjust the basis of partnership property when property is distributed or when a partnership interest is transferred. This results in a step-up or a step-down in basis.

Partnership Audit Issues- Bipartisan Budget Act of 2015 (BBA) IRC Sec. 6221

Under the new rules partnership adjustments are determined at the partnership level and the partnership will be liable for any underpayment of tax. This contrasts to the old rules under which the partners were liable.  

Impacting Partnership Income

Lamas-Richie, T.C. Memo. 2016-63. The Tax Court ruled that the taxpayer had to report his distributive share of the partnership profits even though he received no cash distributions. The taxpayer held a 41% limited partnership interest and his Schedule K-1 showed 41% as his distributive share of the partnership’s profits.  The taxpayer argued that the partnership did not provide him with a timely Schedule K-1.  This was not sufficient to relieve him of the requirement to report his distributive share.  

Chief Counsel Advice (CCA) 201640014.  The IRS determined that a franchisee receiving a guaranteed payment for services was not a limited partner in an LLC under the meaning of Sec. 1402(a)(13) because he actively participated in operations, and performed extensive executive and operational management services as a partner. Thus he is subject to self-employment tax on his distributive share from the LLC.

T.D. 9776; REG-102516-15. This temporary regulation relates to disregarded entities owned by partnership and the employment status of the partners. 

Impacting Partner Basis

T.D. 9788; REG-122855-15. The proposed regulations look at the determination of recourse liabilities, economic risk and requires a facts-and-circumstances analysis. 

In CCA 201606027 and (GLAM) 2016-002.  The IRS considered the matter of non-recourse carve-outs or bad boy guarantees and the impact on the determination of nonrecourse and recourse liabilities.

In Letter Ruling 2016080005, the IRS agreed that the receipt of “Notice to Proceed” payments gave rise to liabilities under Sec.752 for a construction contractor reporting income under the percentage of completion method. Progress payments from a third party were based on a schedule in which payments were tied to the completion of certain work. “Notice to Proceed” payments were required at the time that the third party issued certain notices to the partnership. Before receiving these payments the partnership was required to provide guarantees and standby letters of credit in order to secure its obligation to perform. The progress payments correlated to the reporting of income under the percentage of completion method, however, the “Notice to Proceed” payments did not as they were not tied to performance.  The IRS ruled that the “Notice to Proceed” payments were liabilities to the extent that the partnership had not reported the related income.  

Definition of Partnership and Partner – AD Investment 2000 Fund, T.C. Memo 2015-223

In this case the taxpayer argued that the LLCs met the test for partnership recognition and that the transactions had economic substance or business purpose.  The IRS argued that the LLCs should not be treated as partnerships under the sham partnership doctrine, the economic substance doctrine, and the Sec. 701 anti-abuse rules. The court agreed with the IRS and found that the LLCs were created for tax avoidance. 

Disguised Sales

T.D. 9787 and T.D. 9788. The regulations provide guidance on disguised sales in general and how to allocate liabilities for purposes of the disguised sale rules

Route 231, LLC 810 F.3d 247 (4th Cir. 2016).  Money contributed to a valid LLC by a member of the LLC and related distribution of tax credits to the member was a disguised sale.

Related Party Losses

Letter Ruling 201613002. A trust would only have to recognize gain to the extent that it exceeded the disallowed loss allocable to the property sold by the funds previously owned by an LLC. 

Publicly Traded Partnerships Treated as Corporations and Gross Income Test

Several private letter rulings this year addressed the determination of whether the income generated by a partnership would qualify as income and gains derived from the exploration, development, mining, etc. of depletable products under Sec. 7704 (d)(1)(E).

If you feel your head is “circling the rim”, do not despair – the “shot clock” has not run out.  Call your tax advisor at Dermody Burke and Brown for further details.  Avoid these bracket busters and stay ahead of the competition. 

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