o Pratt v. Commissioner : Two partners were paid management fees which were a percentage of rentals. The issue was that the taxpayers were cash-method while the partnership was accrual. This allowed the partners to defer tax payment. Held: they were performing the basic duties of a partner and were therefore acting as a partner. Important Factor: whether they are performing the basic duties of a partner. Further, if you're doing something unusual, it's more likely to be considered a capital expenditure which will be double taxed. o Architect Partner - Problem 2 Example (Page 235) : A commercial office building constructed by a partnership is projected to generate gross income of at least 100k per year indefinitely. Architect, whose normal fee for architectural services is 40k contributes cash for a 25% interest in the partnership and receives both: a 25% distributive share of net income for the life of the partnership and 16
an allocation of 20k of partnership gross income for each of the first 2 years of the partnership operations after the property is leased. The partnership expects to have sufficient cash available to distribute 20k to Architect in the first 2 years and the agreement requires such a distribution. This is a § 707(a) transaction because: The 20k/year of gross income looks like a fee The allocation is only for 2 years. There is a tax motive/advantage to treat it as pass through income This is NOT a §707(c) guaranteed payment because this is based on gross income rather than without regard to income. o Legislative History Factors that Make a Transaction a §707(a): Not "basic duties" of partnership Little or no risk of not getting paid Short-lived allocation Payment close in time to service Tax-avoidance motive Special allocation large compare to regular allocation Guaranteed Payments §707(c) : To the extent determined without regard to the income of the partnership, payments to a partner for services or use of capital shall be considered as made to a stranger. o Timing Purpose : If you have a guaranteed payment, it's treated just like a § 707(a) payment for income vs. capital gain, but it doesn't change the timing. If you have a guaranteed payment,the partner has to report it as income as soon as the partnership deducts it or adds it to the basis even if the partner hasn't yet been paid. o Example Problem 1 Page 246 : AB equal partnership earns 12k ordinary income and 8k LTCG. (a) What if A is required to be paid 15k for services regardless of income. This will be considered a §707(c) guaranteed payment. A will report 15k ordinary income and the partnership will get this as a deduction. Thus, they will have an operating loss of 3k. This 1.5k loss passes through to each partner and a 4k LTCG passes through.
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