New Proposed Treasury Regulations for Partnership Varying Interests Rule

By: Tyler B. Korn, Esq.

The Korn Law Firm, P.L. / Tel (239) 354-4300

The Internal Revenue Service has issued proposed Treasury Regulations that would provide guidance for determining how a partner’s distributive share of partnership items should take into account the varying interests of the partners in any year in which there is a change in a partner’s interest in the partnership.

In general, a partner separately takes into account his distributive share of partnership items of income, gain, loss, deduction, or credit. Each partner reports his distributive share of the partnership income, deductions and other items (including guaranteed salary and interest payments) for a partnership tax year on his return for his tax year within or with which the partnership tax year ends.

Under Section 706(d) of the Internal Revenue Code (the “Code”), generally speaking, if there is a change in a partner’s interest in the partnership during the partnership’s tax year, each partner’s distributive share of any partnership item of income, gain, loss, deduction or credit for such tax year is determined by using any method prescribed by Treasury Regulations which takes into account the varying interests of the partners in the partnership during the year. This is referred to as the “varying interests rule.”

Proposed Treasury Regulations Section 1.706-4 would contain numerous rules including the following:

1. If a partner’s interest changes during the partnership’s tax year, the partnership would have to determine the partner’s distributive share using the interim closing method. However, the partnership by agreement of the partners could use the proration method.

2. A partnership generally would have to take into account any variation in the partners’ interests in the partnership during the tax year by determining the distributive share of partnership items under Section 702(a) of the Code for each segment of that tax year using an interim closing of the books method and by allocating those items among the partners in accordance with their respective partnership interests during that segment.

3. For each partner whose interest changes in the tax year, the partnership would have to maintain segments to account for such changes. The partnership would have to determine the items for each segment of the tax year created by the variation event for a partner in accordance with the partnership’s method of accounting used for its entire tax year. For purposes of the Proposed Treasury Regulations’ interim closing and proration methods, a special accounting rule would have to be used to account for certain items.

4. A partnership using the proration method would have to allocate extraordinary items (as defined in the Proposed Treasury Regulations) among the partners in proportion to their interests at the beginning of the day on which they are taken into account.

5. A partnership using the interim closing method could use either a calendar day convention or a semi-monthly convention. A partnership using the proration method could use only the calendar day convention.

6. The varying interests rule would not preclude changes in the allocations among contemporaneous partners resulting from amendments to the partnership agreement made no later than the due date of the partnership return for the tax year (excluding extensions).

7. Service partnerships could allocate items relating to the provision of services among the partners whose interests vary during the year using any reasonable method to account for such changes.

8. A deemed disposition of the partner’s interest under Treasury Regulations Section 1.1502-76(b)(2)(vi) (relating to corporate partners that become or cease to be members of a consolidated group), Treasury Regulations Section 1.1502-76(b)(2)(vi) (relating to the termination of the S election of an S corporation partner), or Treasury Regulations Section 1.1502-76(b)(2)(vi) (regarding an election to terminate the tax year of an S corporation partner), would be treated as a disposition of the partner’s entire interest in the partnership.

If you have any questions regarding the foregoing, please feel free to call our office.

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