Tax News

CCH (cch.taxgroup.com) reports:

The IRS has issued final regulations addressing the substantiality of allocations to partners that are look-through entities or members of a consolidated group. The rules also provide additional guidance on the effect of other provisions upon the tax treatment of partners with respect to their distributive shares, and revise the existing rules for determining the partners' interests in the partnership. The regulations apply to partnership tax years beginning on or after May 16, 2008.
Background
In general, a partner's distributive share of income, gain, loss, deduction or credit is determined by the partnership agreement. Code Sec. 704(b), however, requires that the partnership allocations either have substantial economic effect or be in accordance with the partner's interest in the partnership.
Final Regulations
The final regulations provide that the interaction of a partnership allocation with the tax attributes of owners of look-through entities must be taken into account when testing the substantiality of an allocation to a partner that is a look-through entity. For this purpose, look-through entities include partnerships, S corporations, trusts, estates, certain controlled foreign corporations (CFC) and entities disregarded for federal tax purposes, such as subchapter S subsidiaries, disregarded entities under Reg. §§301.7701-1
through 301.7701-3, and qualified real estate investment trust subsidiaries. The final regulations limit the application of the CFC look-through rule to cases in which U.S. shareholders of the CFC in aggregate own, directly or indirectly, at least 10 percent of the capital or profits interests of the partnership. In addition, the final regulations clarify that a CFC is treated as a look-through entity, but only with respect to allocations of items of income, gain, loss or deduction that (1) enter into the computation of a U.S. shareholder's inclusion under Code Sec. 951(a) with respect to the CFC, (2) enter into any person's income attributable to a U.S. shareholder's inclusion under Code Sec. 951(a) with respect to the CFC, or (3) would enter into such computations if such items were allocated to the CFC.
In the case of an allocation to a partner that is a member of a consolidated group, the interaction of the partnership allocation with the tax attributes of the consolidated group and with the tax attributes of another member with respect to a separate return year must be taken into account when testing the allocation's substantiality (Reg. §1.704-1(b)(2)(iii)(d)). When applying the substantiality test to a partner that is a look-through entity, the tax consequences from the interaction of the allocation with the tax attributes of an owner (or beneficiary in the case of a trust or estate) of an interest in such partner must also be taken into account.
The final regulations add a de minimis rule under which the tax attributes of any partner, including a look-through entity, that owns less than 10 percent of the capital and profits of a partnership and that is allocated less than 10 percent of each partnership item need not be taken into account. The regulations further clarify that the partners' interests in the partnership, determined without regard to the allocation or allocations being tested, is the baseline for comparison when testing the substantiality of an allocation, whether under the after-tax test or the shifting or transitory allocation test. Thus, the final regulations removed the parenthetical clauses added to Reg. §1.704-1(b)(2)(iii)(a) by the proposed regulations.
The final regulations also provide that references in Reg. §1.704-1(b)(2)(iii)
to an allocation or allocations not contained in the partnership agreement mean that the allocation or allocations is determined in accordance with the partners' interests in the partnership (within the meaning of Reg. §1.704-1(b)(3)), disregarding the allocation or allocations being tested. Finally, the regulations remove the per capita presumption in Reg. §1.704-1(b)(3)(i).
T.D. 9398, 2008FED ¶47,034
Other References:
Code Sec. 704
CCH Reference - 2008FED ¶25,121
Tax Research Consultant
CCH Reference - TRC PART: 21,200