IRC Sect. 704(b): Allocations to Partners - …

1 presenting a live 110 minute teleconference with interactive Q&A. irc sect . 704(b): Allocations to Partners Navigating Complex Rules on Determining Validity of Partnership Allocations WEDNESDAY, MARCH 2, 2011. 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today's faculty features: Amanda Wilson, Wilson Lowndes Drosdick Doster Kantor & Reed, Reed Orlando, Orlando Fla Fla. Jeremy Naylor, partner , White & Case, New York Jorge Otoya, Senior Manager, KPMG, Washington, For this program, attendees must listen to the audio over the telephone. Please refer to the instructions emailed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at1-800-926-7926 ext. 10. Conference Materials If you have not printed the conference materials for this program, please complete the following steps: Click on the + sign next to Conference Materials in the middle of the left- hand column on your screen.

2 Screen Click on the tab labeled Handouts that appears, and there you will see a PDF of the slides for today's program. Double click on the PDF and a separate page will open. Print the slides by clicking on the printer icon. Continuing Education Credits FOR live EVENT ONLY. Attendees must listen to the audio over the telephone. Attendees can still view the presentation slides online but there is no online audio for this program. Please refer to the instructions emailed to the registrant for additional information. If you have any questions, please contact Customer Service at 1. 1-800-926-7926. 800 926 7926 ext. 10. Tips for Optimal Quality S. Sound d Quality Q lit For this program, you must listen via the telephone by dialing 1-866-871-8924. and entering your PIN when prompted. There will be no sound over the web co ect o . connection. If you dialed in and have any difficulties during the call, press *0 for assistance. You may also send us a chat or e-mail immediately so we can address the problem.

3 Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again. again irc sect . 704(b): Allocations to Partners IRC S t (b) All ti t P t Webinar March 2, 2011. Amanda Wilson, Lowndes Drosdick Doster Jeremy Naylor, White & Case Kantor & Reed d il @l d l Jorge Otoya, KPMG. j y p g Today's Program Material Aspects Of 704(b) Rules Slide 7 Slide 35. [Amanda Wilson and Jeremy Naylor]. Associated Regulatory Sections Slide 36 Slide 69. [Jeremy Naylor and Jorge Otoya]. Relevant And Recent IRS Administrative Guidance Slide 70 Slide 72. [Jorge Otoya]. Amanda Wilson, Lowndes Drosdick Doster Kantor & Reed A d Wil L d D di k D K & R d Jeremy Naylor, White & Case MATERIAL ASPECTS OF 704(b) RULES. Orlando, Florida | Allocations One of the key benefits of a partnership is the flexibility in allocating partnership items among the Partners . 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 Partners ' interests in the partnership, or (2) Have substantial economic effect.

4 Allocations are not the same as distributions. irc sect . 704(b): Allocations to Partners Webinar 8. Orlando, Florida | Partners ' Interest In The Partnershipp 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 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. irc sect . 704(b): Allocations to Partners Webinar 9. Orlando, Florida | 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.

5 Substantial economic effect is a safe harbor. Under a two-part analysis, Allocations must : (1) Have economic effect, and (2) The economic effect must be substantial. irc sect . 704(b): Allocations to Partners Webinar 10. Orlando, Florida | Economic Effect General p principle: p If there is an economic benefit or burden that corresponds to an allocation , then the partner to whom the allocation is made must receive the economic benefit or burden. More simply, 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. cash This is accomplished by maintaining capital accounts and liquidating in accordance with those accounts. irc sect . 704(b): Allocations to Partners Webinar 11. Orlando, Florida | Basic Test For Economic Effect (1) Capital account requirement: The partnership must maintain its capital accounts in accordance with the rules of Reg.

6 1(b)(2)(iv). (2) Liquidation requirement: Upon liquidation of the partnership agreement, the liquidating distributions must be made in accordance d with ith the th positive iti b l balances off the th partner 's t ' capital it l account. (3) Deficit make make-up up requirement: If a partner has a deficit in his capital account upon liquidation of the partnership, the partner must have an unconditional obligation to restore the deficit. irc sect . 704(b): Allocations to Partners Webinar 12. Orlando, Florida | Capital Account Maintenance Rules A partner 's capital account reflects the partner 's equity investment. It must be adjusted as follows: Increased by (1) FMV of contributions and (2) allocable share of partnership income D. Decreased db by (1) FMV off di distributions t ib ti and d (2) allocable ll bl share of partnership loss For economic effect effect, liquidating distributions to the Partners must be made based on capital accounts adjusted according to these rules.

7 irc sect . 704(b): Allocations to Partners Webinar 13. Orlando, Florida | Deficit Restoration Obligation The deficit restoration obligation (DRO) may be provided for in the partnership agreement or by state law. A DRO may be imposed to the extent of any outstanding principal balance of a promissory note (if the partner is the maker). k ) that th t is i contributed t ib t d to t the th partnership t hi and d the th amountt off any unconditional obligation of the partner (whether imposed by the partnership agreement of state law) to make subsequent contributions to the partnership. A partner can have a limited DRO. irc sect . 704(b): Allocations to Partners Webinar 14. Orlando, Florida | Example A and B contribute $100 each to AB partnership. The partnership agreement provides that 60% of partnership items are allocated to A. and 40% are allocated to B. AB has a $200 loss. A's CA B's CA. Contribution 100 100. Income (120) (80). (20) 20. For the entire allocation to have economic effect, effect A must have a DRO.

8 DRO. Otherwise, B is bearing the economic risk for $20 of the losses. irc sect . 704(b): Allocations to Partners Webinar 15. Orlando, Florida | Planning Opportunity Treas. Reg. 1(c) provides that a partnership (c) partnership agreement agreement can be modified or amended with respect to a taxable year after the close of the taxable year, as long as the amendment occurs on or before the due date for the partnership return (without extension). This gives Partners a planning opportunity to amend how they allocate income and losses after the close of the year, in particular to provide for a limited DRO to the extent necessary to support a loss allocation . allocation irc sect . 704(b): Allocations to Partners Webinar 16. Orlando, Florida | Alternate Test For Economic Effect (1) Capital account requirement (2) Liquidation requirement (3) Partnership agreement has a qualified income offset (QIO). provision. The QIO must require that any partner with an unexpected t d negative ti capital it l accountt be b allocated ll t d allll off the th nextt items of partnership income, so as to eliminate the negative balances as quickly as possible.

9 (4) The allocation does not create or increase a deficit in a partner 's capital account in excess of the partner 's obligation to restore a deficit. irc sect . 704(b): Allocations to Partners Webinar 17. Orlando, Florida | Substantiality The economic effect of an allocation is substantial if there is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received by the Partners from the partnership, independent of tax consequences. In short, an allocation lacks substantiality if the allocation has favorable tax consequences q to one p partner without corresponding p g detrimental tax consequences to the other Partners and no overall change on the Partners ' capital accounts. If the only effect of an allocation is to reduce taxes without substantially affecting the Partners ' pre-tax distributive shares, then the economic effect is not substantial. irc sect . 704(b): Allocations to Partners Webinar 18. Orlando, Florida | Substantiality (Cont.)

10 Even if the general rule is satisfied, the economic effect is not substantial in the following cases: (1) Shifting tax consequences (2) Transitory Allocations (3) After-tax effect irc sect . 704(b): Allocations to Partners Webinar 19. Orlando, Florida | Shifting Tax Allocations Occurs if there is a strong likelihood that: (1) The net increases and decreases that will be recorded in the Partners ' respective p p capital p accounts for such taxable y year will not differ substantially from the net increases and decreases that would be recorded in the Partners ' capital accounts if the Allocations were not contained; and (2) The total tax liability of the Partners will be less than if the Allocations were not contained in the p partnership p agreement g (taking into account the tax consequences that result from the interaction of the allocation with the partner 's tax attributes even if unrelated to the partnership). irc sect . 704(b): Allocations to Partners Webinar 20.