Many successful professionals and business owners have selected the partnership as the form of organization for their business. Compared to other entity forms, the partnership provides for certain tax advantages. Chiefly, the partnership is a pass-through entity that allows all profits and liabilities realized by the entity to pass through to a partner’s individual income tax. Essentially, the partnership acts as an extension of the general partner’s finances for tax purposes.
However, the pass-through nature and other aspects of the partnership entity means that it can be used by certain individuals to avoid paying tax that is legally owed. This may be accomplished by mischaracterizing income received from the partnership, misstating partnership income, mischaracterizing transactions, and a variety of other potentially fraudulent acts.
In particular, the IRS is concerned about business owners who may mischaracterize certain transfers of property involving a partnership. IRS concerns include the potential for a business owner to mischaracterize a compensated transfer or sale of property as an uncompensated transfer. New final tax rules intended to detect and prosecute these types of transfers may require partners and partnerships to reassess their approach to certain transactions. CPA Ted Kleinman and U.S. Tax Help can help business partnerships assess their compliance with the new rule.
How Will The Final Rule Impact Transactions Involving Partnerships?
The final rule T.D. 9787, finalizes most of the proposed rules that were originally announced as part of REG-119305-11 in 2014. Essentially, the final rule makes changes to certain aspects of the tax code including changes to §707 and §752. In general, the changes to these sections went into effect on October 5, 2016. However, with respect to Regs. Sec. 707-5(a)(2), comments received by the IRS have delayed implementation of the final rule. Rather, this provision will continue to be interpreted under temporary regulations.
When Does the New Disguised Partnership Transfer Rule Apply?
Ordinarily, contributions made by a partner, to a partnership are not subject to a recognition of gain or loss. This is the due to the ordinary operation of the non-recognition rule under §721. Thus, individuals who make qualified contributions to a partnership can generally defer or avoid tax. However, the non-recognition rule will not apply if the transfer was actually a sale that was mischaracterized as a contribution. Thus, a partner may have significant tax motivation to mischaracterize a transaction involving a partnership.
The new rules are applicable only when a deemed sale has occurred. Per the U.S. Tax Code, a deemed sale or disguised partnership transfer has occurred when two conditions are met. First, a partner must have transferred property into the partnership (or vice-versa) that would not have occurred but for the payment received from the partnership. Second, the transactions must occur in a series such that the exchange of assets and money do not occur simultaneously. The IRS will assess a variety of factors to determine whether a transaction was actually a disguised sale including:
- Whether the transfer or of the property was granted a legal right to receive compensation for the property transfer.
- The timing of the transfer.
- Whether any party has made loans to the partnership necessary to permit it to make the transfers.
- Whether the transaction has been secured in any way.
- Whether partnership distributions or allocations are designed to compensate for the burdens of property ownership.
- The present value of the property received in relation to the likelihood of collection.
A number of additional considerations will also be assessed prior to determining the proper tax treatment for the transfer. For instance, one must also assess whether the consideration transferred was less than the fair market value of the property. In this type of scenario a mixed deemed sale and contribution scenario may exist. However, it is essential to note that for all potential disguised sale scenarios, a deemed sale and application of appropriate regulations can involve sales from the partner to the partnership, sales from the partnership to a partner, and sales between or among the partners.
Work with an Experienced U.S. CPA to Address Business Partnership Tax Concerns
For more than 20 years, CPA Ted Kleinman and U.S. Tax help have provided tax preparation and guidance to individuals and businesses. Ted can assist you partnership with assessing whether current practices regarding transfers are likely to lead to tax compliance concerns, tax returns or even an audit. To schedule a confidential consultation with an experienced CPA, call U.S. Tax Help at (541) 923-0903 or online.