WHEREFORE SECTION 736?

Transcription

1 WHEREFORE SECTION 736? HOWARD ABRAMS DEBORAH FIELDS KAREN LOHNES ERIC SLOAN

2 SECTION 736(a) (a) Payments considered as distributive share or guaranteed payment. Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, except as provided in subsection (b), be considered (1) as a distributive share to the recipient of partnership income if the amount thereof is determined with regard to the income of the partnership, or (2) as a guaranteed payment described in section 707(c) if the amount thereof is determined without regard to the income of the partnership.

3 SECTION 736(b)(1) (b) Payments for interest in partnership. (1) General Rule. Payments made in liquidation of the interest of a retiring partner or a deceased partner shall, to the extent such payments (other than payments described in paragraph (2)) are determined, under regulations prescribed by the Secretary, to be made in exchange for the interest of such partner in partnership property, be considered as a distribution by the partnership and not as a distributive share or guaranteed payment under subsection (a).

4 SECTION 736(B)(2)-(3) (2) Special rules. For purposes of this subsection, payments made in exchange for an interest in partnership property shall not include amounts paid for (A) unrealized receivables of the partnership (as defined in section 751(c)), or (B) goodwill of the partnership, except to the extent that the partnership agreement provides for a payment with respect to goodwill. (3) Limitation on application of paragraph (2). Paragraph (2) shall apply only if (A) capital is not a material income-producing factor for the partnership, and (B) the retiring or deceased partner was a general partner in the partnership.

5 WHAT IS A PAYMENT? Must a payment be made in cash to be captured by Section 736? Section 736(b)(1) provides that some payments shall be treated as distributions, suggesting that payments and distributions are not synonymous. Section 707(c) also uses the word payment as opposed to distribution. All examples under sections 736 and 707(c) use only cash payments. The regulations under section 736 tacitly take inconsistent positions. Rev. Rul , C.B. 1426, treats satisfaction of a guaranteed payment obligation with property as a taxable sale of the property.

6 PAYMENT IN PROPERTY Suppose a partner exits in exchange for an unrealized receivable worth $1,000. Assuming this does not work a shift of ordinary income, if it is treated as a distribution the receivable takes a zero basis in the exiting partner s hands and will generate ordinary income when it is collected. If the transfer is treated as a payment, then the exiting partner will recognize $1,000 of ordinary income immediately and the partnership is entitled to an immediate $1,000 deduction. This effectively eliminates income from the receivable and so either the exiting partner taxes a zero basis (unlikely) or the partnership also recognizes $1,000 of ordinary income. Why the bother?

7 PAYMENT IN PROPERTY (continued) Now suppose the distribution consists of a capital asset having an inside basis of $100 and value of $1,200, and assume the exiting partner s share of receives equals $1,000 and of capital assets equals $200. The exiting partner again will have ordinary income of $1,000, the partnership will be entitled to a deduction of $1,000, the partnership will recognize capital gain of $900 (?), and the exiting partnership will take the asset with an adjusted basis of $1,000. Again, why?

8 STUFFING ALLOCATIONS? Consider the XYZ partnership in which X, Y and Z are equal partners and the partnership owns a capital asset (Blackacre) with an adjusted basis and book value of $120 and a fair market value of $270. Assume XYZ transfers Blackacre to an unrelated party in exchange for cash of $90 along with Whiteacre having a current fair market value of $180. Z does not desire to continue in the venture after the exchange, and so Z will be distributed the cash of $90 in liquidation of Z s interest in the partnership. Immediately prior to the exchange, the books of the partnership should look as follows:

9 STUFFING ALLOCATIONS? (Initial Books) X Y Z CA OB CA OB CA OB $ 40 $ 40 $ 40 $ 40 $ 40 $ 40 Asset Book Value Adjusted Basis Blackacre $120 $120

10 STUFFING ALLOCATIONS (Pro-Rata Allocations) X Y Z CA OB CA OB CA OB $ 40 $ 40 $ 40 $ 40 $ 40 $ $ 90 $ 70 $ 90 $ 70 $ 90 $ 70 Asset Book Value Adjusted Basis Whiteacre $180 $120 Cash $ 90 $ 90 Total $210 $210

11 STUFFING ALLOCATIONS (Taxable Gain to Z) X Y Z CA OB CA OB CA OB $ 40 $ 40 $ 40 $ 40 $ 40 $ $ 70 $ 40 $ 70 $ 40 $130 $130 Asset Book Value Adjusted Basis Whiteacre $180 $120 Cash $ 90 $ 90 Total $210 $210

12 STUFFING ALLOCATIONS (The Right Answer?) X Y Z CA OB CA OB CA OB $ 40 $ 40 $ 40 $ 40 $ 40 $ $ 90 $ 60 $ 90 $ 60 $ 90 $ 90 Asset Book Value Adjusted Basis Whiteacre $180 $120 Cash $ 90 $ 90 Total $210 $210