The IRS has been putting more focus on partnerships in recent times. Back in June 2024, the IRS released a statement were the Agency would put more focus on “high-income compliance issues” and “… to combat abusive partnership transactions” which mainly related to basis shifting transactions. Then, the IRS targeted specifically three groups:

  1. ” Transfer of partnership interest to related party: In this transaction, a partner with a low share of the partnership’s “inside” tax basis and a high “outside” tax basis transfers the interest in a tax-free transaction to a related person or to a person who is related to other partners in the partnership. This related-party transfer generates a tax-free basis increase to the transferee partner’s share of “inside” basis.
  2. Distribution of property to a related party: In this transaction, a partnership with related partners distributes a high-basis asset to one of the related partners that has a low outside basis. After this, the distributee partner reduces the basis of the distributed asset and the partnership increases the basis of its remaining assets. The related partners can arrange this transaction so that the reduced tax basis of the distributed asset will not adversely impact the related partners, while the basis increase to the partnership’s retained assets can produce tax savings for the related parties.
  3. Liquidation of related partnership or partner: In this transaction, a partnership with related partners liquidates and distributes (1) a low-basis asset that is subject to accelerated cost recovery or for which the parties intend to sell to a partner with a high outside basis and (2) a high-basis property that is subject to longer cost recovery (or no cost recovery at all) or for which the parties intend to hold to a partner with a low outside basis. Under the partnership liquidation rules, the first related partner increases the basis of the property with a shorter life or which is held for sale while the second related partner decreases the basis of the long-lived or non-depreciable property, with the result that the related parties generate or accelerate tax benefits.”

As part of the second item in the list released by the IRS above, the IRS released the draft form 7217 at the end of September 2024 for public comment. Effective 2024, the partners will have to report all the distribution of property received from the business as they are related parties. Note that distributions of money or securities do not need to be reported on this form.

Link IRS June 2024 – New IRS teams being established; new guidance designed to stop partnerships from using sophisticated tax-free transactions that lack economic substance

Link IRS June 2024 – Three groups of focus for partnerships –  New IRS, Treasury guidance focuses on “basis shifting” transactions used by partnerships

Link IRS – IRS releases draft Form 7217, Partners Report of Property Distributed by a Partnership, for public comment

 

BONUS – Partnership – Special transactions

In the past, the partnerships were considered by many tax professionals as simpler versus other types of passthrough business entities. From an operating point of view, there were no payroll requirement to partners (S Corp requires a reasonable officer salary), distributions could be different for partners (S Corporation require same distributions based on one class of shares as you cannot discriminate), more flexibility on the decision of the partners, among others factors. From a compliance point of view, in many States, there is no Corporate or similar business fee for partnerships and usually there are less stringent requirements.

In the recent months, there has been plenty of articles, posts and other tax guidance (some examples below) on partnerships as it relates to more complex transactions and jurisprudence from recent Tax court cases.

Remember partnerships are getting more and more attention from the IRS, plus compliance is only increasing and becoming more complicated. If you are unsure in the tax implications for your partnership, please, reach out to our tax professionals.

The Tax Adviser – Partnership distributions: Rules and exceptions

The Tax Adviser – The BBA’s ‘ceases-to-exist’ rule in partnership termination transactions

The Tax Adviser – Partnerships in distress: Raising capital and debt exchanges

The Tax Adviser – Partnership elected BBA procedures; TEFRA FPAA invalid