IRS Proposes Removal of Temp Regs on a Partner's Share of a Partnership Liability for Disguised Sale Purposes

(Parker Tax Publishing June 2018)

The IRS issued proposed regulations relating to the way partnership liabilities are allocated for disguised sale purposes. The new proposed regulations, if finalized, would replace existing temporary regulations with final regulations that were in effect prior to the temporary regulations. REG-131186-17 (6/19/18).

Background

On January 30, 2014, the IRS amended partnership disguised sale regulations under Code Sec. 707, as well as regulations under Code Sec. 752 relating to the treatment of partnership liabilities (2014 Proposed Regulations). The 2014 Proposed Regulations provided certain technical rules intended to clarify the application of the disguised sale rules and also contained rules regarding the sharing of partnership recourse and nonrecourse liabilities under Code Sec. 752.

Based on a comment received on the 2014 Proposed Regulations requesting that guidance under Code Sec. 752 regarding a partner's share of partnership liabilities apply for disguised sale purposes, final and temporary regulations were issued in October of 2016 in T.D. 9788 and those regulations implemented a new rule on the allocation of liabilities for Code Sec. 707 purposes (the 707 Temporary Regulations). Those regulations also contained rules on the treatment of ''bottom dollar payment obligations'' (752 Temporary Regulations). Also in October of 2016, the IRS published final regulations under Code Sec. 707 and Reg. Sec. 1.752-3 in T.D. 9787 (707 Final Regulations).

The 707 Temporary Regulations adopted an approach that requires a partner to apply the same percentage used to determine the partner's share of excess nonrecourse liabilities under Reg. Sec. 1.752-3(a)(3) (with certain limitations) in determining the partner's share of all partnership liabilities for disguised sale purposes. The 707 Temporary Regulations also provide that a partner's share of a partnership liability for Code Sec. 707 purposes cannot exceed the partner's share of the partnership liability under Code Sec. 752 and applicable regulations. The 707 Temporary Regulations reserved on the treatment, for disguised sale purposes, of an obligation that would be treated as a recourse liability under Reg. Sec. 1.752-1(a)(1) or a nonrecourse liability under Reg. Sec. 1.752-1(a)(2) if the liability was treated as a partnership liability for purposes of Code Sec. 752.

Executive Order

On April 21, 2017, President Trump issued Executive Order (EO) 13789, a directive designed to reduce tax regulatory burdens. The order instructed the Secretary of the Treasury to review all "significant tax regulations" issued on or after January 1, 2016, and submit two reports, followed promptly by concrete action to alleviate the burdens of regulations that meet the criteria outlined in the order. Specifically, Section 2 of EO 13789 directed the Treasury Secretary to submit a report identifying regulations that meet the following criteria:

(1) they impose an undue financial burden on U.S. taxpayers;

(2) they add undue complexity to the federal tax laws; or

(3) they exceed the statutory authority of the IRS.

Subsequently, the Treasury Department issued a report which said that, while it believes that the 707 Temporary Regulations' novel approach to addressing disguised sale treatment merits further study, such a change should be studied systematically. In another report, the Treasury Department and the IRS proposed removing the 707 Proposed Regulations and 707 Temporary Regulations and reinstating the regulations under Reg. Sec. 1.707-5(a)(2) as in effect before the 707 Temporary Regulations (Prior 707 Regulations).

Proposed Regulations

On June 19, the IRS issued REG-131186-17. In that guidance, the IRS withdrew the 707 Proposed Regulations and proposed removing the 707 Temporary Regulations and reinstating the Prior 707 Regulations relating to the allocation of liabilities for disguised sale purposes.

In determining a partners' share of a partnership liability for disguised sale purposes, Reg. Sec. 1.707-5(a)(2) of the Prior 707 Regulations prescribed separate rules for a partnership's recourse liability and a partnership's nonrecourse liability. In REG-131186-17, the IRS adopts those same rules. Under Reg. Sec. 1.707-5(a)(2)(i) of the Prior 707 Regulations and, if finalized, the proposed regulations in REG-131186-17, a partner's share of a partnership's recourse liability equals the partner's share of the liability under Code Sec. 752 and the regulations thereunder. A partnership liability is a recourse liability to the extent that the obligation is a recourse liability under Reg. Sec. 1.752-1(a)(1). Under Reg. Sec. 1.707-5(a)(2)(ii) of the Prior 707 Regulations and, if finalized, the proposed regulations in REG-131186-17, a partner's share of a partnership's nonrecourse liability is determined by applying the same percentage used to determine the partner's share of the excess nonrecourse liability under Reg. Sec. 1.752-3(a)(3). A partnership liability is a nonrecourse liability of the partnership to the extent that the obligation is a nonrecourse liability under Reg. Sec. 1.752-1(a)(2).

The 707 Final Regulations limited the available methods for determining a partner's share of an excess nonrecourse liability under Reg. Sec. 1.752-3(a)(3) for disguised sale purposes. Under the 707 Final Regulations, a partner's share of an excess nonrecourse liability for disguised sale purposes is determined only in accordance with the partner's share of partnership profits and by taking into account all facts and circumstances relating to the economic arrangement of the partners. Thus, the significant item method, the alternative method, and the additional method as defined in Reg. Sec. 1.752-3(a)(3) do not apply for purposes of determining a partner's share of a partnership's nonrecourse liability for disguised sale purposes.

In addition, Reg. Sec. 1.707-5(a)(2)(i) and (ii) of the Prior 707 Regulations provided that a partnership liability is a recourse or nonrecourse liability to the extent that the obligation would be a recourse liability under Reg. Sec. 1.752-1(a)(1) or a nonrecourse liability under Reg. Sec. 1.752-1(a)(2), respectively, if the liability was treated as a partnership liability for purposes of Code Sec. 752 (Reg. Sec. 1.752 - 7 contingent liabilities). In the proposed regulations issued on June 19, the IRS reinstates the rules concerning Reg. Sec. 1.752-7 contingent liabilities.

Finally, the proposed regulations reinstate Examples 2, 3, 7, and 8 under Reg. Sec. 1.707-5(f) of the Prior 707 Regulations. Example 2 relates to a partnership's assumption of recourse liability encumbering transferred property; Example 3 relates to a subsequent reduction of a transferring partner's share of liability; Example 7 relates to a partnership's assumptions of liabilities encumbering properties transferred pursuant to a plan; and Example 8 relates to a partnership's assumption of liability pursuant to a plan to avoid sale treatment of partnership assumption of another liability. However, the proposed regulations add language to Example 3 to reflect an amendment to Reg. Sec. 1.707-5(a)(3) in the 707 Final Regulations regarding an anticipated reduction in a partner's share of a liability that is not subject to the entrepreneurial risks of partnership operations.

Effective Date

The 707 Temporary Regulations are proposed to be removed 30 days following the date the regulations in REG-131186-17 are published as final regulations in the Federal Register. The amendments to Reg. Sec. 1.707-5 are proposed to apply to any transaction with respect to which all transfers occur on or after 30 days following the date the regulations in REG-131186-17 are published as final regulations in the Federal Register. However, a partnership and its partners may apply all the rules in these proposed regulations in lieu of the 707 Temporary Regulations to any transaction with respect to which all transfers occur on or after January 3, 2017.

For a discussion of the partnership disguised sale rules under Code Sec. 707, see Parker Tax ¶25,520.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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