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Lind Chapter 8 Solutions

Lind Chapter 8 Solutions - CB 349 CHAPTER EIGHT Page 349...

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Unformatted text preview: CB 349 CHAPTER EIGHT Page 349: PROBLEMS 1(a). Assets Cash First, we must consider the extent to which §§ 736(a), 751(b) and 731 are applicable. Since the partnership is one in which capital is a material income- producing factor, A's share of the receivables and unstated appreciation on the goodwill are within § 736(b). Thus, accepting the valuation of the assets, A's § 736(b) amount is $18,000, 1/3 of the value of all of the assets. Only the $2,000 premium payment is a § 736(a) payment. Because the § 736(a) amount of $2,000 is to be paid without regard to partnership income, it is a guaranteed ayment under § 736(a)(2), treated as $2,000 ordinary income to A and a $2,000 § 162 deduction to the partnership that passes through $1,000 each to B and C. As a result of the deduction, B and C each will reduce their outside basis to $11,000. Cf. §§ 707(c) and 705(a)(2)(A). The premium also reduces the value of B‘s and C‘s interests to $17,000 each. Turning to § 736(b), § 751(b) applies because A receives all § 741 assets and no § 751 receivables. Since his interest in the receivables is worth $3,000, A has a phantom distribution of $3,000 of receivables with a zero basis and $3,000 of ordinary income on the constructive sale. The partnership transfers cash and recognizes no gain, and it acquires the receivables with a $3 ,000 cost basis. On the distribution of the remaining $15,000 of cash, A reduces his remaining $12,000 outside basis to zero and recognizes $3,000 LTCG under § 731(a)(1). The partnership recognizes no gain on the cash distribution. Since no § 754 election is in effect, no § 734(b)(1)(A) adjustment is made to the partnership's assets. The final balance sheet of the partnership will be: Partners' Capital A.B. F.M.V. A.B. F.M.V. $4,000 $4,000 B $ 11,000 $17,000 ’A/C Rec. 3,000 9,000 C 11,000 17,000 Cap. Asset 9,000 15,000 Goodwill 3,000 6,000 19 000 S 34,000 $ 22;000 3 34;@§ The answers above accepted the valuation of the assets and resulted in a $2,000 § 736(a) payment. The regulations provide that the valuation of assets arrived at by the partners in an arm's length agreement generally will be regarded as correct. Reg. § 1.736-l(b)(1) & (3). This rule opens the possibility for the partners to shift distributions between § 736(b) and § 736(a) through favorable valuations. For example, if the partners agreed that the goodwill were worth $3,000 then the premium and the § 736(a) payment would be $5,000. A would have more ordinary income and B and C would receive larger deductions. That might be a favorable result if A had other deductions to offset the additional income or B and C were in higher tax 116 1(b). LIQUIDATING DISTRIBUTIONS CB 349 brackets than A. Thus, despite the attempt by Congress in § 736(b)(2) and (3) to limit the flexibility of partners to characterize payments under § 736, it seems that mutually favorable valuations of assets may still be used to obtain tax benefits under § 736. The problem assumes that the goodwill is not an amortizable § 197 intangible. If it had been amortized, prior amortization deductions would be § 751(c) unrealized receivables that would have to be accounted for in the § 751(b) exchange. A secondary issue is whether a partnership could have self-created goodwill (i.e. , goodwill that is not amortizable) that has a basis. Our sense is that the term "goodwill" in § 736 is not synonymous with "goodwill" under § 197(d)(1)(A). We believe the term is broader under § 736 and could include various § 197 intangibles. For example, a customer-based intangible or a supplier-based intangible under § 197 would be within the concept of goodwill in § 736. Thus, we have included goodwill with basis in the partnership's balance sheet to illustrate some of the rules under § 736. Since substantially all of the income of the partnership consists of fees for services rendered by the partners, A is a general partner in a services partnership. Thus, neither A's share of the receivables nor A's share of the appreciation on the goodwill (since there is no designation of the goodwill) is within § 736(b). §736(b)(1), (2) and (3). See Reg. § l.736—1(b)(2) and (3). Thus, A's § 736(b) amount is $14,000, 1/3 of the value of the cash, the capital assets, and the basis in the goodwill, or 1/3 of $24,000 plus $15,000 plus $3,000. The remaining $6,000 that A receives ($20,000 less $14,000) is 3 § 736(a) amount, essentially made up of $3,000 of receivables, $1,000 of goodwill, and $2,000 of premium payments. The premium payment will reduce the value of B's and C's interests to $17,000 each. The § 736(a) amount of $6,000 is to be paid without regard to the partnership income and therefore it is a guaranteed payment under § 736(a)(2), taxable as ordinary income to A and deductible to B and C (the partnership). As a result of the deduction, B and C will indirectly reduce their outside bases to $9,000. Cf. §§ 707(c) and 705(a)(2)(A). Turning to § 736(b), § 751(b) is inapplicable because there are no inventory items. Technically, the receivables are inventory but they have been classified under § 736(a)(2). Final] , A will receive $14,000 of cash under § 731. Since his outside basis is 12,000 he will recognize a $2,000 LTCG under § 731(a)(1). The partnership recognizes no gain on a transfer of cash and in the absence of a § 754 election, makes no § 734(b) adjustment to the bases of its assets. Thus A will recognize $6,000 of § 736(a)(2) ordinary income and $2,000 of LTCG under § 731(a)(1). The partnership (B and C) will have $6,000 of ordinary deductions. See § 736(a)(2). The final balance sheet of the partnership is: CB 349 CHAPTER EIGHT Assets Partners' Capital A.B. F.M.V. A.B. F.M.V. Cash $4,000 $ 4,000 B $ 9,000 $ 17,000 A/C Rec. 0 9,000 C 9,000 17,000 Cap. Asset 9,000 15,000 Goodwill 3,000 6,000 22 000 m m m 1(c). This question considers the timing of the recognition of the income and deductions under the facts of Problem (b), above. Since the payments are fixed in amount, $14,000/$20,000 or 7/10 of each payment is treated as a § 736(b) payment. Reg. § 1.736-1(b)(5)(i). The other 3/ 10 of each payment is treated as a § 736(a) payment. Thus, on receipt of the first $10,000, A has $3,000 of ordinary income under § 736(a)(2), and B and C each have a $1,500 § 162 ordinary deduction with a concurrent reduction in their outside bases. Cf. §§ 707(c) and 705(a)(2)(A). The other $7,000 of the initial payment is within 736(b). Under that section, A can either treat the first $7,000 as a recovery of his outside basis, or he can elect to prorate his eventual § 731(a)(1) gain. Reg. § 1.736-1(b)(6). If he elects to prorate, 12/14 (the ratio of his outside basis ($12,000) to the total § 736(b) amount ($14,000) of $7,000, or $6,000 is a recovery of capital and $1,000 is a § 731(a)(1) LTCG. As to each of the succeeding ten $1,000 payments, 3/ 10 of them, or $300 is a § 736(a)(2) guaranteed payment taxed as ordinary income to A and deductible ($150 each by B and C). As to the other $700 amount received each year, if A uses Reg. § 1.736-l(b)(6) and spreads his gain, he has $100 of LTCG in each year. If A does not prorate his § 731(a)(1) gain, he will have a recovery of capital on the first $12,000 of § 736(b) payments ($7,000 in year one, $700 in each of the next 7 years and $100 in the 9th year), followed by $600 of § 731(a)(1) gain in year 9 and $700 of § 731(a)(1) gain in each of the succeeding two years. 1(d). If A has a $16,000 basis for his interest and no special inside basis, A‘s § 736(a)(2) and § 736(b) amounts would still each make up 30% and 70% of each payment, respectively, for the reasons explained in Problem (c), above. Thus, on receipt of the § 736(a)(2) payments, A has $3,000 of ordinary income in the first year and $300 of ordinary income in each of the next ten years, with B and C each having concurrent $1,500 and $150 deductions and indirect bases reductions. Under § 736(b), A has a $2,00010ng-term capital loss under § 731(a)(2), which he would either recognize in the final year of payments or which he could elect to spread over the 11 year period. Reg. § 1.736-1(b)(6). If he so elects, A has a $1,000 LTCL in year one and a $ 100 LTCL in each of the succeeding 10 years; if not, he has a $2,000 capital loss at the end of the eleventh year. 118 1(e). 1(f). 2(a) . LI Q UIDATING DISTRIBUTIONS CB 349-350 If the amount in Problem (b), above, is not " fixed," then under Reg. § 1.736—1(b)(5)(ii), an open transaction analysis is used. Payments received are first treated as § 736(b) payments followed by § 736(a), payments. The $10,000 A receives in the first year constitutes a $10,000 recovery of capital. The $1,000 received in each of the two succeeding years is also a recovery of capital. In each of the following two years A recognizes $1,000 of LTCG under § 731(a)(1). Up to this point, in the absence of a § 754 election there are no consequences to the partnership. In each of the next six years, under § 736(a)(1) A has $1,000 of profits (characterized by the profits), leaving only $9,000 profits in each of those six years to be taxed to B and C. If there is a specific provision for the goodwill and A receives a $20,000 lump sum payment, the goodwill will be included as § 736(b) property. § 736(b)(2)(B). In that event A's total § 736(b) property is worth $15,000 and his § 736(a)(2) amount is $5,000. As a result, A has $5,000 of ordinary income under § 736(a)(2) and a $3,000 § 731(a)(1) LTCG. B and C each have a $2,500 deduction and an indirect $2,500 reduction in their outside bases. In the absence of a § 754 election, they have no other consequences. A would prefer such a provision in his agreement because it would reduce his ordinary income with a corresponding increase in his LTCG. B and C would prefer the result in (b), above, because it would give them a greater § 162 deduction. Since this is a pro rata distribution of partnership assets to A, neither § 736(a) nor § 751(b) applies. First, A receives the receivables in kind and not as "payment" for the receivables. Nor does A receive any premium payment. Second, § 751(b) is inapplicable because A receives his share of both § 751 and § 741 assets. Thus, we turn to the § 731 and § 732 rules to determine the tax consequences to A, B, and C. Under § 731(a)(1) A recognizes no gain, and under § 731(a)(2) he recognizes no loss. Under § 732(b) the cash uses up $10,000 of his $13,000 outside basis. The remaining outside basis is allocated under § 732(c)(1) to the inventory. Thus A receives: Assets A.B. F.M.V. Cash $10,000 $10,000 Receivables 0 5,000 Inventory 3,000 5 ,000 There are no consequences to the partnership under § 731(b). Its final balance sheet is: '\‘\. 1" “I: J \V \ i", \\ Q\ .\\ CB 373-391 CHAPTER EIGHT distributions occurring after January 19, 2005. Thus, the effect of revoking Rev. Proc. 2004—43 and issuing new regulations will be to grandfather prior transactions under the mixing bowl rules. Whatever the confusion, the result in the Rev. Rul. 2004—43 is certamly defensible from a policy perspective. If C and D had contributed Asset 2 directly to the AB partnership the mixing bowl rules would have applied. Why should the result be different if the property is transferred via a merger? The analysis in Rev. Rul. 2004—43 also raises one planning issue. The ruling makes clear that Asset l and Asset 2 are treated differently under the mixing ‘ bowl rules because the AB partnership survives the merger. This suggests the possibility of structuring a merger between partnerships to achieve the best results under the mixing bowl rules (e.g. , assets with the smallest amounts of gain or taxpayers in the best tax position (with other losses or paying the lowest marginal rates) being subject to the rules) by planning which partnership will survive the merger. For example, if the partners in Rev. Rul. 2004—43 decided that it would be advantageous for the CD partnership to survive the merger, that partnership could transfer additional assets to ensure that it is the resulting partnership. This and other planning strategies are discussed in Lohnes & Schmalz, "Controversial Ruling Requires Gain to be Recognized on Distributions from Merged Partnership," 101 J. Tax'n 71 (2004). The Lohnes & Schmalz article also discusses the potential effect of Rev. Rul. 2004-43 on an assets-over division of a partnership. For those wishing to read more on the Revenue Ruling 2004-43 controversy, see Gary, "Officials Defend Partnership Anti-Mixing-Bowl Ruling," 103 Tax Notes 788 (2004); Jones, "Semantics and Substance in Partnership Mergers," 104 Tax Notes 1523 (2004); Lipton, "IRS Ruling Creates Tax Controversy for Partnership Mergers, " 73 Prac. Tax Strategies 93 (2004); Rubin & Macintosh, "Partnership Mergers, the Anti—Mixing-Bowl Rules, and Rev. Rul. 2004-43: How Could the IRS be so Wrong?," 104 Tax Notes 739 (2004); Sheppard, " News Analysis: Added Sugars in the Partnership Built-in Gain Rules," 104 Tax Notes 595 (2004); Simmonds, "Practitioners Request Withdrawal of Partnership Merger Guidance," 104 Tax Notes 399 (2004); Stratton, "Officials Higdhiight Recent, Forthcoming Partnership Guidance," 103 Tax Notes 1329 (2 ). Page 390: . PROBLEMS 1(a). This question involves the application of § 708(b)(1)(B). As a result of D's sale, there is a sale of 50% of capital and profits interests (of C and D) within a 12 month period and § 708(b)(1)(B) applies. Under Reg. § 1.708-1(b)(4), the old partnership would contribute its assets to a new partnership, and the new partnership interests would be distributed to A, B, E and F. Under § 731, no gain or loss would be recognized by the partners and, under § 732(b), A and B would each have a $4,000 basis in their new partnership interest, and E and F would each have a $6,000 basis in their ?fiEF partnership interest. The new partnership's balance sheet would be as o ows: Assets Cash A 000 Acct. Rec. 8,000 8,000 6 000 Inventory 8,000 12,000 E 6,000 6,000 F 6 000 1(b). Assets Cash LIQUIDATING DISIRIBUT IONS CB 391 Partners' Capital A.B. F.M.V. A.B. F.M.V. $ 4,000 $ 4,000 $ 4,000 $ 6, 4,000 , 6,000 m m m m Where there is a § 754 election, E and F each may take advantage of a § 743(b) upward adjustment to their inside bases. See Rev. Rul. 86-73, 1986- 1 CB. 282. E and F are each allowed a $1,000 § 743(b) upward adjustment to their inside bases in their assets. The amount of the adjustment is the excess of their $6,000 outside basis over their share of partnership's inside bases. Their share of inside basis is equal to their interests in the partnership's previously taxed capital which would be $5,000 ($6,000 of cash they would receive on a sale of all assets for cash followed by a liquidation of the partnership less their $1,000 share of gain in the inventory). See § 1.743- 1(d)(1) and (2). Under § 755 the full adjustment goes to the inventory, the only appreciated asset, because E and F would be each allocated $1,000 of ordinary income in a hypothetical sale of the inventory. § l,755-l(b)(3)(i). The ABEF partnership would have the following assets: t Assets A.B. Cash $ 4,000 Acct. Rec. 8,000 Inventory _19_,9_O_Q F M V $ 4,000 8,000 12,000 22 000 $24,000 The old partnership would have a $22,000 basis in the deemed newly formed ABEF partnership under § 722. On liquidation of the old partnership, the partners would not recognize gain or loss under § 731 and would take a § 732(b) basis in the distributed interests with A and B having a $4,000 basis in their interests and E and F having a $6,000 basis in their interests. The newly formed ABEF partnership balance sheet would be as follows: Partners' Capital A.B. F.M V A.B. F.M.V. $4,000 $ $ 4,000 $ 6,000 Acct. Rec. 8,000 Inventory 10,000 4,000 8,000 12,000 6,000 6,000 6,000 3 22:000 S Z4,@ $ 20:000 24 000 There would be no § 734(b)(1)(B) adjustment with respect to the distributions to A and B and no § 734(b)(2)(B) adjustment with respect to the distributions to E and F because § 734 has no application to a complete liquidation of a 135 CB 391 CHAPTER EIGHT partnership. Even if newly formed ABEF made a § 754 election, the flush language at the end of § 734(b)(2) would not change this result because the old partnership is terminated and there is no partnership property to adjust. 1(c). If 21 § 732(d) election were made by E and F, the results to all parties are identical to part (a), above. A § 732(d) election by E and F would be of no consequence. 1(d). The liquidation of a partner's interest can never cause the termination of a partnership. Reg. § 1.708-1(b)(2). In addition, a contribution to a partnership in exchange for an interest in the partnership will not trigger a termination. Id. See McKee, Nelson & Whitmire, 113.03[1][b], [3]. However, the combination might well be recast as a sale or exchange between D and F under § 707(a)(2)(B). 2(a). This problem raises issues related to the McCauslen case. We should first consider that case, where the taxpayer, who had owned a one-half interest in a partnership, purchased the other one-half in a buy-out arrangement on the death of his partner. Within six months, the taxpayer sold the assets of the business and claimed a long-term capital gain using § 735(b). The court stated that there was no dispute as to the basis of the property, but it concluded that one-half of the property was acquired, in essence, by purchase (which resulted in an immediate, § 708(b)(1)(B) termination) and not by a distribution. Therefore § 735(b) was inapplicable to one-half of the gain. Part of the result of this case is questionable. The court breaks the transaction into two separate transactions. When the court treats one-half of the property G "i as acquired by purchase, that one-half should be separated for purposes of - k' g; determining gains. In essence, under § 732(b) the recently purchased one-half / should have its own separate basis providing it with a § 1012 cost basis. The C3”: other one-half interest held long-term and qualifying for § 735 treatment (1 should have a separately computed basis under § 732(b). Consequently, on d’ "" sale of the one-half interest recently purchased there should be gain only to the '—— ”" extent of the post-acquisition appreciation. The court inappropriately simply divided the total gain in half and characterized one-half of it as long-term and the purchased one-half as short-term. (See footnote 3 of the case). A second aspect of McCauslen is the scope of its application. It clearly applies in a liquidating situation to which § 708(b) applies. See Rev. Rul. 99—6, at page 361 of the text. But is McCauslen limited to § 708(b) termination situations? Or does it apply to other liquidating situations and to operating distributions as well, i.e., to any situation where there is a purchase of a partnership interest with an intent within a short period of time to distribute an asset to the purchasing partner in either an operating or liquidating distribution? Cf. Kimbell-Diamond v. Commissioner, 14 T.C. 74 (1950), aff'd per curiam, 187 F.2d 718 (5th Cir. 1951), cert. denied. 342 US. 827 (1951). If it applies to operating distributions, is it limited to a situation where the purchasing partner receives the asset on the distribution with a cost basis as a result of the application of § 743(b) because of either a § 754 election by the partnership or a § 732(d) election by the distributee partner? Perhaps it 136 ...
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