IRC Sect. 704(b): Partnership Allocations Navigating Complex Rules - PowerPoint PPT Presentation

IRC Sect. 704(b): Partnership Allocations Navigating Complex Rules to Determine Valid Allocation of Income, Gain, Loss, Deductions or Credits WEDNES DAY, OCTOBER 8, 2014, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection and phone line (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). S trafford accepts American Express, Visa, MasterCard, Discover . • Respond to verification codes presented throughout the seminar . If you have not printed out the “ Official Record of Attendance” , please print it now. (see “ Handouts” tab in “ Conference Materials” box on left -hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form . • Complete and submit the “ Official Record of Attendance for Continuing Education Credits,” which is available on the program page along with the presentation materials. Instructions on how to return it are included on the form. • To earn full credit, you must remain on the line for the entire program. WHOM TO CONTACT For Additional Registrations : -Call S trafford Customer S ervice 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 (“ star” zero) If you get disconnected during the program, you can simply call or log in using your original instructions and PIN.

Tips for Optimal Quality FOR LIVE EVENT ONLY S ound Qualit y If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-320-7825 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail sound@ straffordpub.com immediately so we can address the problem. If you dialed in and have any difficulties during the call, press *0 for assistance. Viewing Qualit y To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

Program Materials FOR LIVE EVENT ONLY If you have not printed the conference materials for this program, please complete the following steps: • Click on the ^ symbol next to “ Conference Materials” in the middle of t he left- hand column on your screen. • Click on the tab labeled “ Handouts” that appears, and there you will see a PDF of the slides and the Official Record of Attendance for today's program. • Double-click on the PDF and a separate page will open. • Print the slides by clicking on the printer icon.

IRC Sect. 704(b): Partnership Allocations Oct. 8, 2014 David Forst Amanda Wilson Fenwick & West Lowndes Drosdick Doster Kantor & Reed dforst@ fenwick.com amanda.wilson@ lowndes-law.com

Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE S PEAKERS ’ FIRMS TO BE US ED, AND CANNOT BE US ED, BY A CLIENT OR ANY OTHER PERS ON OR ENTITY FOR THE PURPOS E OF (i) AVOIDING PENALTIES THAT MA Y BE IMPOS ED ON ANY TAXP A YER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER P ARTY ANY MATTERS ADDRES SED HEREIN. Y ou (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subj ect to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 5

Today’s Program Review of Partnership Allocation Rules S lide 7 – S lide 50 [Amanda Wilson] Partnership Non-Recourse Debt Allocations S lide 51 – S lide 66 [David L. Forst ] Two Approaches to Capital Account Maintenance S lide 67 – S lide 72 [David L. Forst ]

Amanda Wilson, Lowndes Drosdick Doster Kantor & Reed REVIEW OF PARTNERSHIP ALLOCATION RULES

Orlando, Florida | www.lowndes-law.com Circular 230 To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing or recommending to another party any transaction, arrangement, or other matter. 8

Orlando, Florida | www.lowndes-law.com Allocations – Section 704(a) One of the key benefits of a partnership is the flexibility in allocating partnership items among the partners. Section 704(a) provides that a partner’s distributive share of partnership income, gain, loss, deductions or credit shall, except as otherwise required by the IRC, be determined by the partnership agreement. 9

Orlando, Florida | www.lowndes-law.com Allocations – Section 704(b) Section 704(b) requires a partner’s distributive share of partnership income, gain, loss, deductions or credit to be determined in accordance with the partner’s interest in the partnership if (1) Partnership agreement does not provide for distributive share or (1) Partnership agreement allocations do not have substantial economic effect. 10

Orlando, Florida | www.lowndes-law.com Allocations Thus, allocations of a partner’s distributive share of partnership income, gain, loss, deductions or credit will be respected if they (1) are either in accordance with the partners’ interests in the partnership or (2) if they have substantial economic effect. 11

Orlando, Florida | www.lowndes-law.com Partners’ Interest in the Partnership Factors to consider: • The partners' relative contributions to the partnership, • The interests of the partners in economic profits and losses (if different than that in taxable income or loss), • The interests of the partners in cash flow and other non-liquidating distributions, and • The rights of the partners to distributions of capital upon liquidation. 12

Orlando, Florida | www.lowndes-law.com Partners’ Interest in the Partnership Allocations are generally in accordance with the partners’ interests in the partnership if all allocations are being made in accordance with the respective contributions of the partners. For example, if A and B each contributed $100, allocations would be in accordance with the partners’ interests in the partnership if all partnership items are shared 50-50. Liquidating distributions can be made in accordance with the partners’ respective interests in the partnership. 13

Orlando, Florida | www.lowndes-law.com Substantial Economic Effect AB is a partnership that owns 3 properties. All income allocated 50% to A, except 60% of income from property 1 is allocated to A. This is a special allocation. Special allocations will be respected if they have substantial economic effect. Substantial economic effect is a safe harbor. Two part analysis. Allocations must (1) Have economic effect; and (2) The economic effect must be substantial. 14

Orlando, Florida | www.lowndes-law.com Economic Effect General principle: If there is an economic benefit or burden that corresponds to an allocation, the partner to whom the allocation is made must receive the economic benefit or burden. More simply, if a partner gets the benefit of an allocation of $100 of tax loss, the partner must suffer the $100 economic loss. If a partner suffers the burden of $100 of tax gain, the partner must get the $100 of cash. This is accomplished by maintaining capital accounts and liquidating in accordance with those accounts. 15

Orlando, Florida | www.lowndes-law.com Basic Test for Economic Effect There are three requirements to satisfy the basic economic effect test: (1) Capital account requirement (2) Liquidation requirement (3) Deficit make up requirement 16

Orlando, Florida | www.lowndes-law.com Capital Account Requirement To have economic effect, the partnership must maintain its capital accounts in accordance with the rules of Reg. §1.704-1(b)(2)(iv). Generally, this is accomplished with a provision in the partnership agreement stating that “a capital account will be established and maintained for each partner in accordance with Treasury Regulation §1.704-1(b)(2)(iv).” What does this do? A partner’s capital account tracks and reflects the partner’s equity investment in the partnership. 17

Orlando, Florida | www.lowndes-law.com Capital Account Maintenance Rules A partner’s capital account equals • FMV of contributions • Plus allocable share of partnership income • Less FMV of distributions • Less allocable share of partnership loss Partnership liabilities generally are not taken into account in calculating capital account balances. 18