If you are considering transferring a partnership interest or admitting a new partner to a partnership, considerations need to be made regarding the allocation of each partner’s distributive share. A Denver tax attorney we assist you and your partnership in understanding the Varying Interest Rule and other partnership issues. Although, such issues are discussed briefly below, it is recommended that you contact your tax attorney or business attorney to discuss these issues and how they relate to your circumstances.
If a partner transfers their partnership interest, or a partnership admits a new partner(s) based upon the new partner’s contribution of capital, a shift in the partner’s interest will occur. This shift in interest creates issues regarding the closing of the partnership’s taxable year, the allocation of partnership items between the transferor and transferee, and retroactively allocating items to the incoming or “new” partner. The closing of the partnership taxable year is governed by I.RC. § 706(c) and § 706(d), the varying interest rule, governs the allocation of each partner’s distributive share. Although, the substantial economic effect doctrine under I.R.C. § 704(b) can also impact the allocation of a partner’s distributive share, the substantial economic effect doctrine and related issues will not be discussed in this article.
Under §706(c)(1), except upon the termination of the partnership, the partnership’s taxable year does not close upon the death or entry of a partner, the sale or exchange of a partner’s interest or the liquidation of a partner’s interest. However, under 706(c)(2), the taxable year of a partnership does close with respect to a partner whose entire interest in the partnership terminates due to death, liquidation or another reason.
When partners interest in the partnership change during a taxable year, the partner’s distributive share of partnership income, gain, loss or deduction are determined by taking into account the partner’s varying interest in the partnership during the taxable year. I.R.C. §706(d) applies to changes amongst partner’s interest during the taxable year. These changes include sales, partial sales, gifts and reductions in the partner’s interest. Under the code, cash basis partnerships are also forbidden from deferring certain payments for deductible items until the end of the year. For example, if a new partner was admitted on December 1st, and rent for the entire year was paid December 15th, the newly admitted partner may not be able to receive the benefit of the entire years rent payment as they were only a partner for one month of the taxable year. Additionally, under I.R.C. 706(d)(2)(D), when items are attributable to periods of time prior to the beginning of the tax year and are later assigned to the first day of the taxable year thereafter, such items should be allocated to the partners who were partners during the period of time each item is attributable. If any partner is not a partner when the item is being allocated, this partner’s portion of the item should be capitalized by the partnership and allocated to the basis of the partnership assets under I.R.C. §755.
As a Denver tax attorney and business attorney, John McGuire works with partners and partnerships regarding the issues discussed above and other partnership issues. Please feel free to take advantage of our free consultation at anytime.
Schedule a free consultation with a business attorney by contacting the McGuire Law Firm.