A partnership is a very common entity format for a small business. Small business owners can form a partnership as a general partnership, limited partnership, limited liability limited partnership (LLLP) and a limited liability company (LLC) is a partnership as well. The treatment of partnership liabilities can have large impact to the taxation of the individual members as items of gain, loss and deductions etc. are passed through to the individual members or partners. John McGuire, as a Denver small business attorney has drafted articles relating to partnership liabilities in certain contexts, but the article below is specific to what constitutes a partnership liability and how “liability” is defined in the context of a partnership and the applicable Internal Revenue Code sections and Treasury Regulations.
The Section 752 Treasury Regulations define the term “liability” by referring to the term “obligation.” The term “obligation” is defined as any contingent or fixed obligation to make payment without regard to whether the obligation is otherwise taken into account for purposes of the Internal Revenue Code.
Below are examples of obligations:
– Short Sale Obligation
– Debt through a loan or note or other contract obligation
– Tort obligation
– Pension obligation
– Derivative financial instruments- forward contract, an option or options, futures contracts
For the purposes of Internal Revenue Code Section 752 and in the context of a partnership, an obligation is a liability if, or when and to the extent that the obligation: creates or increases the basis of any obligor’s assets (including cash); gives rise to an immediate deduction to the obligor; or, allows for an expense that is not deductible in computing the obligor’s taxable income and is not properly chargeable to capital. In Revenue Rule 88-77, the Internal Revenue Service ruled that unpaid expenses and accounts payable of a cash method partnership were not partnership liabilities or obligations.
For partners to share an IRC Section 752 liability, the partnership must be the obligated party. If for example, another individual or entity is obligated and thus the obligor, the liability would not be considered a partnership liability unless an agent-principal relationship exists between the obligor and the partnership.
Under Section 1.752-5 of the Federal Treasury Regulations, a liability is an obligation to the extent that either: the obligation is not a Section 752 liability or the amount of the obligation exceeds the amount taken into account when incurring the obligation. For these purposes the amount of the obligation is the amount a willing assignor would pay to a willing assignee in assuming the obligation via an arm’s length transaction.
Recourse Liability: A liability is treated as recourse to the extent any partner or a related person bears the economic risk of loss for the liability. A related person is defined in Regulations Section 1.752-4(b).
Non-Recourse Liability: A liability is treated as non-recourse liability to the extent that no partner or related party bears the risk of economic loss for the liability.
A Denver small business attorney at The McGuire Law Firm can assist you and your partnership in understanding what constitutes a partnership liability, the type of liability and the impact of such liability. Mr. McGuire holds an advanced degree in taxation, which is applied to business issues given the close relationship of business and tax. Law offices in Denver and west metro.
Contact The McGuire Law Firm to speak with a Denver small business attorney and schedule your free consultation.