Payments for Services and Property Use to Partners

1


Payments for Services and Property Use to
Partners

• Four Options
• - 707(a)(1) Treated as payments between
  unrelated parties. Services no continuous part
  of integral part of partnerships functions.
• - 704 Treated as allocation of income to
  partner.
• - 707(c) Treated as guaranteed payment to
  partner unrelated to partnership income. Treated
  as unrelated party payment for purposes of 61,
  162 and 263. Here services part of integral part
  of partnerships functions.
• - 707(a)(2)(A) Disguised 707(a)(1) payment
  unrelated parties treatment.
• Significance of different options Can impact
  capitalization of payment, character of income
  and timing recognition.

2


Disguised 707(a)(1) payments

• Factors
• Risk as to amount.
• Transitory partnership status.
• Allocation close in time to services.
• Primary purpose of partnership status is tax
  avoidance.
• Partnership interest relatively small in relation
  to size of allocation.

3


Problem 218 1

• Services within 707(a)(1) not in capacity as
  partner. Services by partner which are ongoing
  and within normal scope of partnership usually
  outside scope of 707(a)(1) and are governed by
  707(c) or 704. Often no substantive difference.
  Armstrong case questionable law on conferring
  employee statue on partners very difficult,
  almost always treated as independent contractors.
• Statutory benefits that come with employee
  status
• - Section 79 group health insurance
• - Section 105 and 106 health insurance and
  medical reimbursement plans
• - Section 119 meals and lodging exclusion
• - Section 132 excludable fringe benefits
• Do not count on these for partner.

4


Problem 218 2
Facts AB partnership in real estate
development. AB paid partner B 5k for legal
services in dispute regarding title to purchased
land. - 5k income to B under 707(a)(1)
services not integral part of partnership
operations. - 5k capitalized by partnership
and added to basis of land. See Rev. Rule 81-301.

5


Problem 224 1

• Facts A, cash basis taxpayer, partner of ABCD
  partnership, with 10k basis in partnership
  interest. A owns depreciable property basis
  2k, FMV 15k, fair rental value 1k per year.
  Partnership uses As property and has income of
  10k per year.
• A lease to partnership for 1k per year for three
  years. Per 707(a)(1), A has 1k income per year
  and partnership has 1k rental expense. If rent
  not paid in any year and not included in A
  income, no deduction for partnership per 267(a)
  and (e). Matching required.
• Payments made 1/31 after close of year. No
  deduction to partnership until A includes.
  267(a) and (e).

6


Problem 224 1
(c) Partner A allocated 1k net income per year
before allocation to all partners. 707(a)(2)(A)
requires treatment as payment to non-partner if
such under all facts and circumstances. Here
question is risk of income to pay special
allocation. If no real risk (likely here),
707(a)(2)(A) would trigger 707(a)(1) and result
would be same as in (a) as payment to none
partner. If net income risky, then
allocation under 704. First 1k to A and then
balance of 9k each year between partners.
What if front loaded 3k in year 1? If under
707(a), A has 3k income in year 1 and partnership
would deduct 3k over three year period. If 704
allocation because of risk of income sufficiency,
A allocated 3k of partnership 3k income in year 1
and partners just divide remaining 7k balance.
704 has effect of accelerating entity deduction
for payment.
7


Problem 224 2
Facts Architect partner (25) takes 40k
special gross income allocation from partnership
rather than 40k fee for services to partnership.
707(a)(2)(A) would require 707(a) treatment
payment to non-partner because - Fixed in
amount and no risk of not having sufficient gross
income - Partnership interest relatively
small in relation to allocation. - Allocation
close in time to services - Not unreasonable
to conclude the deal was structured for tax
avoidance reasons. To preclude capitalization of
architects fee.
8


Problem 232 1

• Facts AB partnership unstable earnings
  current yr 12k ordinary income, 8k capital gain
  A and B equal partners A renders continuous
  services, related to partnership function, not
  capital related.
• A paid 15k per year unrelated to partnership
  income. Per 707(c), A has 15k guaranteed
  payment. Ordinary income to A and 15k 162
  deduction to partnership which reduced ordinary
  income to loss of 3k. No impact on capital gain.
• Services of A relate to land improvement? Per
  Gaines case, still guaranteed payment under
  707(c), taxable in full to A when partnership
  accounts for transaction at partnership level.
  Fully taxable to A even though partnership must
  capitalize expenditure.

9


Problem 232 1

• Facts AB partnership unstable earnings
  current yr 12k ordinary income, 8k capital gain
  A and B equal partners A renders continuous
  services, related to partnership function, not
  capital related.
• Deal is A gets 15k or 50 of profits, whichever
  greater. 50 of AB 20k profits is 10k, meaning
  only 5k (excess of 15k over 10k) is guaranteed
  payment per Rev. Rule 69-180. Thus, 5k taxed to
  A per 707(c) and deducted by partnership,
  reducing ordinary income to 7k. Since 10k of
  remaining 15k partnership profits (20k 5k) go
  to A, A allocated 2/3 remaining 7k ordinary
  income and 3/3 8k capital gain. B gets other 1/3
  of each.
• What result if A rights for guaranteed return on
  capital, not services? Same results.

10


Problem 232 2
Facts G, cash basis taxpayer, 1/3 partner of
FGH, accrual method. G entitled to 10k
guaranteed payment for services in year 1,
payable in year 3. G basis zero. In year 2,
partnership sells asset for cost and distributes
5k to each partner. - G required to recognize
10k income in year 1 because that is year of
partnership deduction, per 707(c), Gaines case
and Reg. 1.707-1(c). If G basis increase, 5k in
year 2 return of capital. If no basis increase,
just unrelated receivable, then 5k distribution
in excess of basis taxable. Issue unresolved,
but Gaines suggested in dicta basis increase.
11


Problem 238 3
Rev. Rule 69-180 Payment of guaranteed payment
or of income, whichever greater. Could it be
707(a)(1) payment? Yes, if not for continuous
services related to partnership. Then, likely
result is entire portion paid to A (the higher of
two) would be treated under 707(a)(1) ordinary
income to partner and deductible by partnership.
12


Problem 238 4

• Facts Partner, cash basis, renders 10k services
  to accrual partnership which has 75k ordinary
  income and 25k capital gain. Partnership makes
  no payment to P in year 1, but desires to deduct
  accrual where appropriate .
• Partnership allocates first 10k profits to P
  under 704. P has 10k income on allocation 7.5k
  ordinary and 2.5k capital gain. Partnership
  balance of income reduced accordingly.
• 707(a)(1) applies to 10k to unrelated party. P
  has 10k income when received. Per 267(a) and
  (e), no deduction to partnership until P book
  income. Hence, no deduction in year 1 for
  partnership.
• 707(c) applies as guaranteed payment.
  Partnership gets deduction in year of accrual.
  Per Reg. 707-1(c), P has 10k income in year 1,
  year of deduction, even though not paid. Gaines
  case

13


Problem 232 4
Facts Partner, cash basis, renders 10k services
to accrual partnership which has 75k ordinary
income and 25k capital gain. Partnership makes
no payment to P in year 1, but desires to deduct
accrual where appropriate . (d) 10k treated
under 707(a)(2)(a) as 707(a)(1) payment. Same as
(b). Income to P only when received and only
then deductible by partnership per 267(a) and (e).