Lind Chapter 5 Solutions

Lind Chapter 5 Solutions - Page 234: 1(a). Chapter 5...

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Unformatted text preview: Page 234: 1(a). Chapter 5 TRANSACTIONS BETWEEN PARTNERS AND PARTNERSHIPS PROBLEMS This question raises a "where do you draw the line" issue between services which fall within § 707(a)(1) and those which are rendered as a partner and are taxed under § 707(c) or as a share of profits. Armstrong v. Phinney may leave an impression that almost any services rendered by a partner to a partnership are in a nonpartner capacity and thus are governed by § 707(a)(1). The Service has promulgated Rev. Rul. 81—301 , 1981-2 CB. 144, holding that § 707(a)(1) is applicable to an advisor general partner who (1) provided similar services to outsiders and (2) could be removed by the managing general partners. ThePratt decision, however, holds that continuous services related to the partnership's function that are provided for in the partnership agreement are not within § 707(a)(1) when compensated by a fixed fee. This substantially limits the scope of § 707(a)(1). It is difficult to draw any lines in this area. Query whether the amount of the partner's interest (5% in Armstrong v. Phinney) is a relevant factor? The type of services which fall outside of § 707(a)(1) (ongoing and within the normal scope of the partnership) are usually those for which the partnership will pay a fixed fee and, possibly, award the type of benefits listed in Problem 1(b), below. Although "employee" status will not exist for a partner in such a situation, the payments will fall under § 707(a)(1) if § 707(a)(2)(A) applies. After a period of reflection (over the first five editions of this text), we have come to the view that Armstrong v. Phinney is a very questionable holding insofar as it rules that a partner can achieve "employee" status. The text at page 232 reflects our modified position. It is more appropriate (and more common) to treat partners who render services to their partnerships in a nonpartner capacity to do so as independent contractors rather than employees. See, e.g., Rev. Rul. 69-184, 1969-] CB. 256. As discussed below, however, partners may be deemed (by statute) to have employee status for purposes of qualifying for certain excludable fringe benefits. “‘4 ‘\ r-‘\\ r Jr’s. CB 234-240 1(b). Page 240: 1(a). 1(b). 1(c). CHAPTER FIVE In the unlikely event that "employee" status is achieved under "common law" principles, examples of possible exclusions include: (1) § 79 (group term life insurance up to $50,000 of coverage); (2) § 105 and § 106 (health insurance and benefits); (3) § 119 (meals and lodging; see Armstrong v. Phinney); (4) § 132 (excludable fringe benefits; but see § 132(h)). The more likely route to employee status is via a specific statutory provision deeming a partner to be an employee for certain purposes. See note 6 at page 232 of the text. For example, the recent trend in fringe benefit legislation has been to extend tax benefits to self-employed individuals. See, e.g., § 120(d)(1) (qualified group legal services plan); § 127(c)(2) (educational assistance programs); § 129(c)(3) (day care assistance programs). As a result of this trend and Code provisions designed to achieve "parity" between corporate and noncorporate pension and profit sharing plans, the importance of "common law" employee status has diminished. Under the principles of Rev. Rul. 81-301, 1981-2 CB. 144, these services, which are not integral to the partnership's operations, should be governed by § 707(a)( 1). The fee is ordinary income to B when received. The payment must be capitalized by the partnership and may be added to its basis in the land. PROBLEMS A is renting the property to the partnershi . ABCD deducts $1,000 of ordinary rental expenses and its net income is 9,000 ($2,250 per partner; the character depends on the character of ABCD's income). A also has $1,000 of ordinary rental income. Because § 267 is potentially applicable (See §§ 267(a)(2) and (e)), the partnership's deduction will be deferred if payments are not actually made during the year. Section 267 will apply to disallow the $1,000 rental expense deduction until the following year when A includes the amount in his gross income. §§ 267(a)(2). (e)- If the partnership's net income is sufficiently questionable so that § 707(a)(2)(A) will not apply, A‘s distributive share is $1,000 plus $2,250, or $3,250, and B, C, and D each have a distributive share of $2,250. The character of all of A's income will be governed by the character at the partnership level. Section 267 will not apply. If § 707(a)(2)(A) and therefore § 707(a)( 1) applies, the results are the same as in Problem 1(a), above. A has $1,000 of ordinary income and A, B, C and D each have $2,250 of income characterized by the partnership‘s income after a $1,000 ordinary rental deduction. The change in facts (a $3,000 first year allocation) would seem to be a factor to push the payment into § 707(a)(1) via § 707(a)(2)(A). If so, A has $3,000 of ordinary income in year one. The partnership would have a $3,000 78 Page 250: 1(a). TRANS. BETWEEN PARTNERS & PARTNERSHIPS CB 240-250 expense which would be amortized over three years (see § 461(h)), leaving it with $9,000 of income to be spread among A, B, C and D in each of the years. The result would be income in year one: A $5,250; B, C and D each $2,250; years two and three: A, B, C and D each $2,250 of income. If the $3,000 payment were a share of profits, then it would be characterized at the partnership level and A would have $3,000 plus 1/4 of $7,000, or $1,750, for a total of $4,750 in year one and B, C and D would each have $1,750 in year one. A, B, C and D would each have $2,500 in years two and three, again characterized by the partnership's income. In its explanation of the Tax Reform Act of 1984, the Senate Finance Committee said the following about the situation: The purported gross income allocation and partnership distribution should be treated as a fee under sec. 707(a), rather than as a distributive share. Factors which contribute to this conclusion are (l) the special allocation to the architect is fixed in amount and there is a substantial probability that the partnership will have sufficient gross income and cash to satisfy the allocation/distribution; (2) the value of his interest in general and continuing partnership profits is relatively small in relation to the allocation in question; (3) the distribution relating to the allocation is fairly close in time to the rendering of the services; and (4) it is not unreasonable to conclude from all the facts and circumstances that the architect became a partner primarily for tax motivated reasons. If, on the other hand, the agreement allocates to the architect 20 percent of gross income for the first two years following construction of the building a question arises as to how likely it is that the architect will receive substantially more or less than his imputed fee of $40,000. If the building is pre—leased to a high credit tenant under a lease requiring the lessee to pay $100,000 per year of rent, or if there is low vacancy rate in the area for comparable s ace, it is likely that the architect will receive approximately 20,000 per year for the first two years of operations. Therefore, he assumes limited risk as to the amount or payment of the allocation and, as a consequence, the allocation/distribution should be treated as a disguised fee. But if the project is a " Spec building, " and the architect assumes significant entrepreneurial risk that the partnership will be unable to lease the building, the special allocation might (even though a gross income allocation), depending on all the facts and circumstances, properly be treated as a distributive share and partnership distribution. PROBLEMS A ' 5 payments for services are "determined without regard to the income of the partnership" and are therefore guaranteed payments under § 707(c). See Reg. § 1.707-1(c) Example (1). Thus, A has $15,000 of ordinary income. Since 79 CB 250-251 1(b). 1(c). 1(d). CHAPTER FIVE his services are not of a capital nature, the partnershi has a § 162 ordinary deduction of $15,000 and after that deduction, it has 3,000 of ordinary loss and $8,000 of long-term capital gain for the year. Those amounts are split between A and B according to their interests in profits and losses. Thus each has $1,500 of ordinary loss and $4,000 of long-term capital gain in addition to A‘s $15,000 of ordinary income. In 1(a), above, the partnership may not currently deduct the $15,000 paid to A. It must capitalize the payment. A still has $15,000 ordinary income. In addition, A's and B's distributive shares of partnership income each would be $6,000 ordinary income and $4,000 LTCG. This problem is patterned after Reg. § 1.707—1(c) Example (2) and Rev. Rul. 69-180 at page 245 of the text. Since A would receive 50% of the $20,000 rofits without the agreement, only the excess received over that amount, or I$5,000, is a guaranteed payment. This results in ordinary income of $5,000 to A and $5,000 of ordinary deduction to the partnership, leaving the partnership with $7,000 of ordinary income and $8,000 of long-term capital gain. Since $10,000 of the remaining $15,000 of profits go to A, A will receive 10/15 or 2/3 of the $7,000 ordinary income or $4,667 of ordinary income and 2/3 of the $8,000 of long-term capital gain or $5,333 of long-term capital gain. B will receive 1/3 of the ordinary income or $2,333 and 1/3 of the long—term capital gain or $2,667. The partners receive the following total income: A § 707(c) ordinary income 3 5,000 Ordinary income profits 4,667 LTCG profits 5,333 Total 15 000 B Ordinary income profits $ 2,333 LTCG profits 2,667 Total 5 000 The results in Problems 1(a) and (b), above, will not change. The guaranteed payment would simply be for contributed property instead of contributed servrces. G is taxed on his $10,000 § 707(c) payment in year one, even though he does not receive it. See Reg. § 1.707-1(c), second sentence and the Gaines case. This problem raises the issue whether G's right to a guaranteed payment is a share of profits or an unrelated unrealized receivable. If it is the former, G's outside basis for his interest is $10,000 and the $5,000 is a mere recovery of capital in year two. See footnote 16 of the Gaines case and §§ 731(a)(1) and 80 CB 251-257 4(d). CHAPTER FIVE The results would be the same as in Problem 4(b), above: $75,000 of ordinary income and $25,000 of long-term capital gain for Partnership and $10,000 of potential income to Partner and potential deduction by Partnership. Page 253: Page 257: 1(a). 1(b). Prop. Reg. § 1.707-7 provides rules relating to disguised sales of partnership interests. See REG - 149519—03, 2004-2 CB. 1009. The proposed regulations treat transactions between a partnership and its partners as disguised sales of partnership interests between partners. For an article discussing the proposed regulations, see Lipton, "Controversial Prop. Regs. on Disguised Sales of Partnership Interests - IRS Jumps Into the Deep End," 102 J. Tax'n 71 (2005). PROBLEMS The first issue is whether § 707(b)(l) disallows the loss on the partnership's sale of the land to A. The answer is yes. A owns the following interests in the partnership directly or by attribution: (1) A‘s 25% owned directly: 25% (2) A‘s Wife's 25%: §§ 707(b)(3), 267(c)(2) and (4): 25% (3) A's Wife's Father's 25 %: no attribution because of denial of double attribution, § 267(c)(5): 0 (4) X Corp.'s 25%: §§ 707(b)(3), 267(c)(1): w Total 62. 5 % Since A is deemed to own 621/2% of the interests in the partnership, § 707(b)(1)(A) will disallow the $10,000 loss on the sale from the partnership to A. Even though the loss is disallowed, the partners will be required to reduce their outside bases for their portions of the loss. § 705(a)(2)(A); Cf. Reg. § 1.267(b)-1(b)(2) Example (1). If this is not done, the loss is merely postponed, not disallowed. When A resells the land to B for $45,000, the last sentence of § 707(b)(1) brings § 267(d) into play, and A's gain is not recognized to the extent of the partnership's previously disallowed loss. Thus, A has a $5,000 gain which is not recognized because of the partnership's $10,000 disallowed loss. Since the same parties own 75 % of both partnerships, § 707(b)(1)(B) disallows the $10,000 loss on the sale between the two partnerships. As in Problem 1(a), above, even though the loss is disallowed the partners will be required to reduce their outside bases for their portions of the loss. § 705(a)(2)(A); Cf. Reg. § l.267(b)—1(b)(2) Example (1). If this is not done, the loss is merely postponed, not disallowed. 82 1(c). 1(d). 1(e). TRANS. BETWEEN PARTNERS & PARTNERSHIPS CB 257 On the sale by the second partnership, it is not required to recognize its $5,000 gain because of § 267(d) which is made applicable by § 707(b)(1), last sentence. Rev. Rul. 96-10, 1996—1 CB. 138 also makes it clear that the partners in the second partnership increase their outside bases by their respective shares of the $5,000 of gain that is not recognized under § 267(d) and § 707(b)(1), last sentence. A has a $10,000 gain on the sale of the machinery. Under the results of Problem 1(a), above, A owns a 62V: % interest in the partnership and since that is greater than 50%, § 707(b)(2) characterizes the gain as ordinary income, assuming (as is obviously the case) that the property is not a capital asset to the transferee partnership. If it is a capital asset to the partnership, then gain on the sale of the property will be determined by the character of the property. It nevertheless still may be ordinary income under § 1245, or possibly § 1231 or § 1221 gain. A's wife has a $20,000 gain on her sale. Under the attribution rules she is deemed to own 87‘/2% of the partnership as follows: A's Wife's 25% interest: 25% A's 25% interest: §§ 707(b)(3), § 267(c)(2) and (4) 25% A's Wife's Father's 25% interest: §§ 707(b)(3), 267(c)(2) and (4): 25% 1/2 of X Corp.'s 25% interest: §§ 707(b)(3), 267(c)(2) and (4), 267(c)(1): 12.5% (Note that § 267(c)(5) does not deny double attribution between § 267(c)(1) and (c)(2).) Total 87.5 o In addition, since the partnership is in the business of renting houses, A's rental property would not be a capital asset to the partnership. See § 1221(2). Consequently, the requirements of § 707(b)(2)(A) are met and A's Wife's $20,000 gain on the sale would be characterized as ordinary income under that section. The results are the same as in Problem 1(d), above: $20,000 of ordinary income. Again, A's Wife is an 871/2 % owner and since the partnership is in the business of selling real estate, the residential rental property is not a § 1221 capital asset in its hands. See § 1221(1). Note that § 1239 would be inapplicable because the property is not depreciable to the transferee as required by § 1239(3). Cf. §453(g), which applies only to a § 1239 situation. If C recognizes a loss on a sale of property to CD, the loss will not be disallowed by § 707(b)(1)(A) since C does not own more than 50% of the capital interest or profits interest in CD. However, if F makes the sale, he is not protected by § 707(b)(1)(A) since that provision only applies to sales by actual partners. Reg. § 1.707-1(b)(3). Therefore, F's sale must be tested 83 ...
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Lind Chapter 5 Solutions - Page 234: 1(a). Chapter 5...

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