basis calculations for pass-through entities: challenges...
TRANSCRIPT
Basis Calculations for Pass-Through Entities: Challenges for Tax Preparers Tackling Complex Calculation Issues for S Corporations, Partnerships and LLCs
TUESDAY, JANUARY 8, 2013, 1:00-2:50 pm Eastern
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Frank Gariepy, CPA, Partner
Meredith Menden, CPA, MBT, Senior Manager
Stock Basis Calculations for
Pass-Through Entities
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IRS CIRCULAR 230 NOTICE
Any tax advice expressed in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or agency. In addition, if any such tax advice is made available to any person or party other than the party to whom the advice was originally directed, then such advice, under IRS Circular 230, is to be considered as being delivered to support the promotion or marketing (by a person other than Eide Bailly LLP) of the transaction or matter discussed or referenced. Thus, each taxpayer should seek specific tax advice based on the taxpayer’s particular circumstances from an independent tax advisor.
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S Corporations
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Background
• S Corporation basis is “simple”
• Increases
• Amounts earned
• Amounts contributed
• Decreases
• Amounts deducted
• Amounts distributed
• Cannot go negative
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From the beginning…
• Initial Stock Basis
• Cash paid for shares
• Net Value of Property Contributed to the Corporation
(FMV or NTV depending on transaction)
• Taxable value of shares received for services
provided
• Carried over from shares received as gift
• Stepped-up for shares inherited
• Any combination of the above
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Increases to Stock Basis
• Capital Contributions (property or cash)
• Ordinary Income
• Investment Income
• Gains
• Excess of deductions for depletion
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Decreases to Stock Basis
• Distributions (property or cash)
• Business Deductions
• Non-deductible Expenses
• Contributions
• 179 Deduction
• Losses
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Who Cares?
• Why and when does basis matter
• the company had losses
• the company made distributions
• there was an ownership change in the company.
• Basis is a piggy bank
• Excess distributions are taxable
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Order of Basis Adjustments
IRC Sec. 1367(a)
• Order is very important
• First: stock basis is increased for income items
• Second: it is decreased for distributions
• Third: it is decreased for nondeductible, noncapital expenses
• Fourth: it is decreased for items of loss and deduction
• Note: If Basis is Positive Before Distributions but would be zeroed out by deduction items, the excess loss is suspended rather than the excess distributions taxable
• Election to Reduce Basis by Loss or Deduction Items before Nondeductible Expenses [Reg. 1.1367-1(g)]
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Example – [Reg. 1.1367-1(g)]
• Sophia owns all of the shares of Princess, Inc.,
an S corporation that incorporated and elected
S status on January 1, 2012. The corporation
uses a September 30 year-end. Sophia's stock
basis on January 1 is $500,000
• The corporation passes through a non-
separately stated loss from business activities
of $550,000 and $10,000 of nondeductible
meals & entertainment
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Example 1 – [Reg. 1.1367-1(g)]
• Under the ordering rules, the $10,000
nondeductible amount reduces basis before it is
reduced by items of loss and deduction
Beginning Basis $500,000
Less: Nondeductible M&E ($10,000)
Basis before loss $490,000
Less: Loss (limited) ($490,000)
Ending Basis $0
Loss Carried Forward ($60,000)
Loss Utilized on 1040 ($490,000)
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Example 2 – [Reg. 1.1367-1(g)]
• If election made to reverse the ordering rules,
the $10,000 nondeductible amount reduces
basis AFTER it is reduced by items of loss and
deduction
Beginning Basis $500,000
Less: Loss (limited) ($500,000)
Basis before n/d items $0
Carryforward Nondeductible M&E ($10,000)
Loss Carried Forward ($50,000)
Loss Utilized on 1040 ($500,000)
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[Reg. 1.1367-1(g)]
• The election to reduce basis by loss or
deduction items before nondeductible expenses
results in a higher deductible loss
• The nondeductible item however carries over to
future years and will reduce basis when there is
sufficient basis to absorb it
• If the election is not made, the nondeductible
items do not carry over, even if basis is reduced
to zero in the current year
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When to Calculate Basis?
• Normally calculated at the end of the
corporation’s taxable year. [Reg. 1.1367-1(d)]
• Exceptions –
• Disposal of entire shareholder interest
• Disposal of substantial interest
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Example Timing Rules
• Sophia owns all of the shares of Princess, Inc., an S corporation that incorporated and elected S status on January 1, 2012. The corporation uses a September 30 year-end. Sophia's stock basis on January 1 is $500,000
• The corporation passes through a nonseparately stated loss from business activities of $550,000. The corporation made no distributions to Sophia during the year. At September 30th Sophia's basis is adjusted to $0 with a $50,000 loss carry over
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Example Timing Rules
• Sophia contributes an additional $50,000 to the
company on October 1, 2012. Can she take the
full $550,000 loss on her personal 2012 income
tax return
• No - Those increases in basis are considered in
determining basis at the end of the
corporation's next fiscal year, the corporate
year-end not the shareholder year-end governs
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Per-Share, Per-Day
• Pass-through items are generally allocated per-
share, per-day [IRC Sec. 1377(a)(1)]
• Each item is divided by the number of days in
the tax year, then that amount is allocated
equally among the shareholders who held
shares on each day – [IRC Sec. 1377(a)(1)]
• Simplified method: the percentage of stock
owned is multiplied by the percentage of the
year that it is owned – [1120S Instructions]
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Per-Share, Per-Day Example
• The stock of Twins Corporation, a calendar year
S Corporation is held by Leo and Juliet, who
each own 50% on January 1
• Leo sells all of his stock to Juliet for $350,000
on March 31
• The corporation's income for the year ending
December 31 is $400,000
• Leo had basis of $150,000 in his stock at the
beginning of the year
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Per-Share, Per-Day
• Simplified Method, ordinary gain of $400,000
• Leo is allocated $50,000
• Juliet is allocated $350,000
% of
Stock
x % of
the
Year
= x Pass-through Items
Leo 50% x 25% = 12.5% $50,000
0% x 75% = 0% $0
Juliet 50% x 25% = 12.5% $50,000
100% x 75% = 75% $300,000
Total 100% $400,000
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Per-Share, Per-Day
• Leo’s ending basis is $150,000 + $50,000 =
$200,000
• Gain on sale is $350,000 - $200,000 =
$150,000 capital gain
• Overall income:
• Ordinary Gain: $50,000 x 35% = $17,500
• Capital Gain: $150,000 x 15% = $22,500
• Total: $200,000 = $40,000
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Cut-off Method
• Shareholder’s Entire Interest is Disposed
• Requires “specific accounting election” under
[Reg. 1.1377-1(b)(1)]
• Pass-through items are allocated through cut-
off date and then again from cut-off date until
the end of the year
• Basis is adjusted at cut-off date
• Distributions adjust basis
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Cut-off Method - Example
• Same facts as previous examples
• The corporation had net income for the year of
$400,000, made up of a loss of $100,000
through March 31 and income of $500,000 for
the remainder of the year
• Leo has other income that brings him into the
35% tax bracket
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Cut-off Method - Example
Income
Jan 1 – March 31
Income
Apr 1 – Dec 31
Total
Leo ($50,000) $0 ($50,000)
Juliet ($50,000) $500,000 $450,000
Total ($100,000) $500,000 $400,000
Per-share, per-day Specific Accounting
Leo $50,000 ($50,000)
Juliet $350,000 $450,000
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Cut-off Method - Example
• Leo’s ending basis is $150,000 – $50,000 = $100,000
• Gain on sale is $350,000 - $100,000 = $250,000 capital gain
• Overall income: • Ordinary Loss: ($50,000) = ($17,500)
• Capital Gain: $250,000 = $37,500
• Total: $200,000 = $20,000 tax
• Leo’s tax as compared to per-share per day is $20,000 less
• Juliet’s tax is $35,000 more
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Cut-off Method
• All affected shareholders must consent (actual consent kept in taxpayer records)
• If corporate redemption, all shareholders are affected
• Election impacts pass-through items only
• One tax return is filed
• May require supplemental schedules for basis calculations
• Attach election statement to return (means decision can be deferred until tax return is filed)
• The stock sale agreement should address decision process
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Cut-off Method – Other Options
• Qualifying Disposition of Stock [Reg. 1.1368-1(g)(2)]
• Shareholder disposes of 20% or more of the corporation's issued stock in one or more transactions within any 30-day period during the corporation's tax year (sale or redemption)
• Stock equal to or greater than 25% of the previously outstanding stock is issued to one or more new shareholders within any 30-day period during the corporation's tax year
• All shareholders who held stock must consent
• The first tax year is deemed to end on the date the threshold is met
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Other Stock Basis Issues
• Corporate Owned Life Insurance • Basis reduced by premiums to extent attributable to
“pure” life insurance coverage.
• Portion attributable to increase in CSV is capital expenditure, not a reduction in basis
• Increased by proceeds (tax-exempt income)
• Proceeds do not increase AAA
• Items increasing basis MUST be reported on shareholder’s income tax return
• Contributions of appreciated property reduce basis by FMV, not adjusted basis
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Debt Basis
• Shareholder loans provide debt basis
• Losses can reduce debt basis
• Basis reduction is applied at year-end
• Debt basis is restored before stock basis by
corporate income
• Repayment of reduced-basis loan is taxable
• Capital Gain if debt is evidenced by note
• Ordinary Income if no written note
• Investment income
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Debt Basis - Issues
• Partial Payments
• Gain is recognized
• Computed prorata based on the relationship of the
reduction in basis to face value of the loan
• Example
• Corporation makes payment of $75,000 on reduced
basis debt. Income is calculated as follows:
$125,000 (face amount) - $100,000 (Basis)
$125,000 (face amount)
X $75,000 (repayment) = $15,000 Income
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Debt Basis – Requirements
• Must incur a true economic outlay
• Owed by corporation to shareholder
• Loan made directly by shareholder
• Note not required but recommended
• Over $25,000 debt at year-end is treated as if
evidenced by written note
• Guarantee does not create basis (payments
made by shareholder do create basis)
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Debt Basis – Requirements
• Back-to-Back Loans - Background
• A third-party loans fund to shareholder(s), then the
• Shareholders re-loan to S Corporation
• What if not third party but a related company?
• IRS argues no economic outlay
• Hitchins, 103 TC 711 (1994) supports IRS position
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Debt Basis – Requirements
• Prop. Reg. 1.1366-2(a)(2)
• Preference for any bona fide indebtedness to run
directly from the shareholder to the S corporation.
• Back-to-back loan between a shareholder and two
related S corporations is bona fide indebtedness
• Depends upon all the facts and circumstances
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AICPA Proposed Safe Harbor
1. The debt is evidenced by a written note with an unconditional promise by the corporation to pay the shareholder, on demand or on a specified date, a sum certain
2. The interest rate specified in the instrument meets AFR requirements
3. Interest payment dates are specified in the instrument
4. The instrument is legally enforceable under state law (even transferees would have the right to enforce the terms of the note)
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AICPA Proposed Safe Harbor
5. The corporation would not be an obligor or
co-obligor on the note issued by the
shareholder to the primary lender in a back-
to-back situation (a guarantee or pledge of
corporate assets would not be considered as
making the company an obligor)
6. Interest and principal payments are actually
made pursuant to the agreement
7. Loans are reported appropriately on tax
returns and year-end financial statements
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Debt Basis Strategies
• Offset capital gain with capital losses
• Use to deduct investment interest
• Debt for Stock Swap
• Charitable contribution
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Summary
• Keep careful basis records from day one
• Basis is the responsibility of the shareholder
• Tax preparers should be prepared
• Save K-1s in permanent file in case of basis
questions in the future
• Carefully plan debt transactions and follow the
plan
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Partnership Basis Calculation
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Your instructor
Jacob Wilkinson
- Manager
- National Tax
- Washington, DC
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Calculating Basis in Partnership
Interest
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Why Do We Need to Know Basis
Importance
- Transfer of Interest
• Gain calculation
• Step up under section 743
- Nonliquidating distributions
• Gain on distribution
- Liquidating distributions
• Basis of distributed property
- Deductibility of losses under section 704(d)
- Economic Effect under section 704(b)
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Basis in Partnership Interest
Initial concepts
- Inside Basis
• Basis of partnership assets
- Outside Basis
• Partner’s basis in partnership interest
- Why are they different?
- What is the impact if have a difference?
• Section 743(b) or 734(b) adjustments (optional or
mandatory)
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Basis in Partnership Interest
Single Basis Concept - One single basis even though partners can own
multiple classes of stock
- However, this single basis can have separate holding periods
- IRS Legal Advice – AM2012-001 • Cannot allocate tax items to different interests in
disregarded entity
Rev Rul 84-53 - Partner has a unitary basis
- Use FMV to determine portion sold
- Liabilities complicate the issue
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Basis in Partnership Interest
Calculation of Basis - When do you calculate basis?
• A partner is only required to compute the basis of his partnership interest when the computation is necessary to determine his tax liability.
• Where there has been a sale or exchange of all or a part of a partnership interest or a liquidation of a partner's entire interest in a partnership, the adjusted basis of the partner's interest should be determined as of the date of sale or exchange or liquidation Reg section 1.705-1(a)(1)
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Basis in Partnership Interest
Calculation of Basis
- Ordering Rules under section 705(a)
• Increased by
1. Contributions to the partnership and
purchases of partnership interests
(section 722 and 742)
2. Taxable income of the partnership
3. Income of the partnership exempt from tax
4. The excess of the deductions for depletion
over the basis of the property subject to
depletion
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Basis in Partnership Interest
Calculation of Basis
- Ordering Rules under section 705(a)
• Decreased by 1. Distributions of the partnership (section 733)
a. Money is considered distributed before other property if made simultaneously.
b. Basis adjustments for separate distributions are made in chronological order.
2. Losses of the partnership
3. Depletion
- See Rev Rul 66-84 – comprehensive example of basis calculation and ordering rules
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Basis in Partnership Interest
Contribution of property
- Partner receives basis equal to adjusted basis in
partnership property.
Distribution of property
- Partners basis is decreased by adjusted basis in
partnership property.
Exceptions to general rules for –
- Disguised sales
- Shifting of liabilities could cause gain recognition
- Liquidating distributions
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Basis in Partnership Interest
Calculation of Basis
- Alternative rule under section 705(b)
• Partners basis is equal to their proportionate share of
all assets
- When can you apply this rule
• The partner cannot practicably apply the general rule
set forth in section 705(a)
• Reasonable to conclude that the result produced will
not vary substantially from the result obtainable under
the general rule
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Basis in Partnership Interest
A partners basis cannot be reduced below
zero
- Section 704(d) provides that deductions cannot
be taken to the extent they exceed the partner’s
basis
- Section 731(a)(1) causes gain recognition on any
cash distributions to the extent they exceed the
partner’s basis
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Basis in Partnership Interest
Partner’s Basis and Partner’s Capital
Account
- The adjusted basis of a partner's interest in a
partnership is determined without regard to any
amount shown in the partnership books as the
partner's “capital”, “equity”, or similar account.
Reg. section 1.705-1(a)(1)
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Basis in Partnership Interest
Partner’s Basis and Partner’s Capital
Account
- Generally, basis will equal the sum of –
• Tax basis capital account, and
• Partner’s share of liabilities.
- Partners can have negative or deficit capital
accounts
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Basis in Partnership Interest
Treatment of liabilities – Section 752
- Increase in a partner's share of partnership
liabilities are treated as cash contributions by the
partner
- Decrease in a partner's share of partnership
liabilities are treated as cash distributions to the
partner
- A liability to which property is subject shall, to the
extent of the fair market value of such property,
be considered as a liability of the owner of the
property.
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Basis in Partnership Interest
Section 704(b) vs. Tax Basis
- Initial value is fair market value for contributed
property under section 704(b)
- On distribution of property, the value of the
property must be “booked up” to reflect FMV with
a corresponding adjustment to partners 704(b)
capital accounts
- Book ups can be made when other significant
transactions occur. See Reg. section 1.704-
1(b)(2)(iv)(f)
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Basis in Partnership Interest
Other issues
- A partner's note evidencing its obligation to make
a future contribution to the partnership has no
basis
- Rev. Rul 96-11 – basis adjustment on charitable
contribution of partnership property
- Section 1411 triggered on the difference between
inside and outside basis.
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Francis J. Gariepy, CPA
Partner, Eide Bailly National Tax Office
Meredith Menden, CPA, MBT, Senior Manager
Partnership and LLC
At Risk Basis
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IRS CIRCULAR 230 NOTICE
Any tax advice expressed in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties imposed on the taxpayer by any governmental taxing authority or agency. In addition, if any such tax advice is made available to any person or party other than the party to whom the advice was originally directed, then such advice, under IRS Circular 230, is to be considered as being delivered to support the promotion or marketing (by a person other than Eide Bailly LLP) of the transaction or matter discussed or referenced. Thus, each taxpayer should seek specific tax advice based on the taxpayer’s particular circumstances from an independent tax advisor.
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Subjects to be covered
• At Risk Basis and Tax Basis
• At Risk Basis
• Debt Allocation Issues
• Proposed Reg & Tax Cases Affecting At Risk
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At Risk and Tax Basis
• Book capital accounts for the relative economic rights of
a partner
• Tax basis tracks the individual partner’s after tax
investment in the partnership
• At risk basis reflects the partners economic risk of loss
by use of the liabilities to finance tax basis losses
• Partnership level debt provides tax basis and at risk
basis for partners to deduct losses prior to repayment of
the debt or contribution of capital
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At Risk Basis
At Risk Basis – IRC Sec 465 • Partners and LLC members allocated losses are limited to the
capital contributed and amounts they may be obligated to
personally repay or has pledged as security for debt
• Recourse and non-recourse debt can provide basis for
deduction of tax losses in excess of capital for tax purposes
• At risk amounts generally do not include non-recourse debts
• Allocation of “at risk” debt amounts
• Complicated rules using a “constructive liquidation”
approach
• Generally recourse debts allocated by loss ratio and non-
recourse debt allocated by profit ratio
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At Risk Basis
• The roll of debt in computing basis • Debt reflects the economic at risk amounts of a partner’s
interest in a partnership
• Debt supports the allocations and deductions of operating
losses for tax and at risk purposes
• Deficit capital accounts rare without debt
• Entity level debt for tax and at risk basis is a major difference
between partnerships and S Corporations in computing outside
basis
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At Risk Basis
Compliance - Form 6198
• Required form if there are current amounts not at risk
• Non-recourse loans used to finance the activity
• Exception for QNR financing
• Cash, property or borrowed amounts protected against losses
with a guarantee or other type stop-loss arrangement
• Loans that would qualify as recourse or QNR except for the
lender being another partner/LLC member or 10% related
member (IRC Sec 465(b)(3)(C))
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At Risk Basis
Compliance - Form 6198
• Increases and decreases to at risk amounts
• Amounts similar to tax basis increases and decreases
• FMV of pledged property – property not used in activity used to
borrow amounts provided to activity
• Cash or adjusted basis of contributed property
• Increase in non-recourse debt or a change from recourse debt
to non-recourse debt can cause a decrease
• Change in QNR debt to recourse due to guarantee can be a
significant decrease
• Deficit basis amounts subject to at risk loss recapture
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At Risk Basis – Debt Allocation
• Allocation of Recourse Debt Reg 1.752-2 • Follows a “constructive liquidation” computations in which
assets are valued at zero and sold for the amount of debt.
• The partner bears the economic risk of loss in this test to the
extent he is obligated to pay the creditor or make a contribution
to the partnership to satisfy the liability
• In practice this allocation most often follows the loss ratio of the
partner
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At Risk Basis – Debt Allocation
• Allocation of Nonrecourse Debt Reg 1.752-3 • Partnership minimum gain, the excess of a nonrecourse liability
over the 704(b) book value
• Partner’s 704(c) gain if property is disposed for the amount of
the associated debt
• Remaining amounts allocated by profit ratio
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At Risk Basis – Debt Allocation
• Partner at risk basis accounting affected by type
of entity
• General partnership (GP)
• All partners have unlimited liability for all partnership debts
and would be considered as recourse debts and at risk
• Limited partnership (LP)
• The general partner would have unlimited liability but the
limited partners do obtain at risk basis on QNR debt as the
associated real property is considered pledged for the debt
(IRC Reg. 1.465-27(b)(4))
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At Risk Basis – Debt Allocation
• Partner at risk basis accounting affected by type
of partner – cont’d
• Limited Liability Company (LLC)
• Generally all debts are non-recourse and members not at
risk with the exception of direct member loans to the LLC.
Member guaranteed loans and debt that qualifies as QNR
• Limited Liability Partnership (LLP)
• Partner is not liable for the debts of the LLP. Allocation rules
will be similar to LLC
• Limited Liability Limited Partnership (LLLP)
• Similar debt allocations rules with Limited Partnerships with
the general partner having unlimited liability
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At Risk – Debt Allocation
Contrast with S Corporations • Debt within S Corps does not provide at risk or tax basis for
deducting losses by the shareholder
• Shareholder direct loans provide basis
• Very limited tax cases of shareholder guaranteed intercompany
debt providing at risk basis for losses
• No QNR debt allocation within an S corporation will provide at
risk basis for loss deduction
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Example – Tax Basis and At Risk
• Basis comparisons with debt allocations
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Example – Tax Basis and At Risk
• Basis comparisons with disproportional debt
allocations
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Debt Allocation Issues
• Multi-Tiered Partnerships • Reg 1.752-4(a) An upper-tier partnership's share of the liabilities
of a lower-tier partnership (other than any liability of the lower-
tier partnership that is owed to the upper-tier partnership) is
treated as a liability of the upper-tier partnership for purposes of
applying section 752 and the regulations thereunder to the
partners of the upper-tier partnership
• Pass-through “recourse” debt can change to “non-recourse”
debt on second tier LLC
• Debt Guaranteed by an upper tier LLC does not become
recourse debt to the member
• Debt Allocable to a DE is allocable to the extent of the DE value
per Reg 1.752-2(k) rather than look through to the owner of the
DE
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Debt Allocation Issues
• Shifting of “At Risk” Amounts • Non-recourse debt and QNR can become “recourse” debt to the
guarantor partner/member and shift the related allocations of
expenses to the guarantor
• Debt refinancing in which a new guarantor executes a
guarantee can cause a debt shift and recapture of prior at risk
losses
• Drafting guarantees by the appropriate members can insure
allocations do not shift to a single guarantor
• Aggregation of activities IRC Sec 465(c)(2)(B)
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Debt Allocation Issues
Debt Guarantees
• Recourse debt
Minimal effect on at risk amounts for a partner since he
steps into the shoes of the creditor upon payment and has a
right to collect from the partnership or other partners
• Non-recourse debt
Risk of loss can substantially shift to the guarantor,
especially if when there is a waiver of subrogation or
recourse against the partnership
• De minimus exceptions
Reg 1.752-2(d) states a guarantor with a 10 percent or less
interest in the partnership is not considered to bear the
economic risk when they guarantee debt
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Proposed Reg and Tax Cases
Proposed Regulations • Prop Reg 1.465-6(d) states a guarantor does not receive “At
Risk” basis until the taxpayer/guarantor pays on the guarantee
and has no right to reimbursement
• Prop. Reg. 1.465-6(d) is the Service’s position per the IRS Audit
Guide on Partnerships
• This is similar to what an S Corp shareholder would face with a
debt guaranteed by a shareholder
• T.D. 9607 12/21/2012 IRS has retroactively removed the
deminimus rule in the partnership Regs of 1.704-1 (those
owning less than 10%)
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Proposed Reg and Tax Cases
Tax Cases – Government Position • 1983 Tax Court Decision, (Brand v. Commissioner 81 T.C. 821)
held partners were not at risk for the partnership loans they
guaranteed since they were entitled to reimbursement from the
primary obligor
• Subsequent cases uphold the shift in at risk amounts to the
guarantor, (Melvin v Commissioner 88 T.C. 63 (1987), looks at
who will ultimately be obligated to pay the partnership debt
obligations if the partnership is unable
• A limited partner or LLC member are not considered at risk for
partnership recourse debt and the existence of a DRO provision
may not change this under Sec 465, (Hubert Enterprises T.C.
Memo 2008-46, supplementing, 125 T.C. 72 (2005)
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Proposed Reg and Tax Cases
Tax Cases – Guarantee Increases At Risk Basis Abramson, Edwin D.,et al, (1986) 86 TC 360
Gefen (1986) 87 TC 1471
Bennion, Sam H., (1987) 88 TC 684
• Tax Court permitted increased basis when • Guarantee is absolute and unconditional
• There is no right of subrogation, reimbursement from the
entity or other owners
• Guarantor bears the ultimate risk of responsibility for the
debt similar to the hypothetical transaction in Reg 1.752-2
where all of the assets are worthless and the payment of
the liabilities is determined by who bears the economic
risk
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Proposed Reg and Tax Cases
Partnership Law vs. Limited Liability Companies • State law applicable to partners may be different for LLC
members in the way liabilities are allocated
• LLC liability will generally be non-recourse with the exception of
QNR debt
• S Corp owner or LLC Member guaranteeing debt may have a
legal right under state law for reimbursement upon paying the
guaranteed debt….this takes away the “absolute and
unconditional” nature of the guarantee
• Check your state law with a knowledgeable attorney and or
consider changes to your operating agreement to take into
consideration the effect of a guarantee and will the allocations of
income and losses resulting from the shift still represent
“substantial economic effect” under IRC 704(d)
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Summary
• Partnership basis follows 4 separate basis
methods (704(b) ->Tax ->At Risk ->Passive)
• Be aware of outside basis compared to inside
basis
• Review debt obligations annually for
guarantees
• Review operating agreements for possible
changes to avoid un-intended allocations
• Check with tax attorneys on your state law for
LLC members
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Frank Gariepy, CPA
Partner
303.459.6706
Meredith Menden, CPA, MBT
Senior Manager
507.386.6232
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