[Federal Register Volume 74, Number 70 (Tuesday, April 14, 2009)]
[Proposed Rules]
[Pages 17119-17128]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-8438]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-144689-04]
RIN 1545-BD71
Determination of Distributive Share When a Partner's Interest
Changes
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations regarding the
determination of partners' distributive shares of partnership items of
income, gain, loss, deduction and credit when a partner's interests
varies during a partnership taxable year. Also, the proposed
regulations modify the existing regulations regarding the required
taxable year of a partnership. These proposed regulations affect
partnerships and their partners.
DATES: Written or electronic comments and requests for a public hearing
must be received by July 13, 2009.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-144689-04), Room
5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station,
Washington DC 20044. Submissions may be hand-delivered Monday through
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
144689-04), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue, NW., Washington, DC; or sent electronically via the Federal
eRulemaking Portal at www.regulations.gov (IRS REG-144689-04).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Laura Fields or Jonathan Cornwell at (202) 622-3050, concerning
submissions of comments and the hearing, Richard Hurst at (202) 622-
7180 (not toll-free numbers) or Richard.A.Hurst@irscounsel.treas.gov.
SUPPLEMENTARY INFORMATION:
Background
These proposed regulations contain amendments to the Income Tax
Regulations (26 CFR part 1) under section 706 of the Internal Revenue
Code (Code). These amendments are proposed to conform the Income Tax
Regulations for certain of the provisions of section 1246 of the
Taxpayer Relief Act of 1997, Public Law 105-34 (111 Stat. 788 (1997))
(the 1997 Act) and section 72 of the Deficit Reduction Act
[[Page 17120]]
of 1984, Public Law 98-369 (98 Stat. 494 (1984)) (the 1984 Act).
Also, under section 706(d)(1), the Treasury Secretary may provide
in regulations various methods for determining a partner's distributive
share of partnership items of income, gain, loss, deduction and credit
that takes into account the varying interests of the partners for any
taxable year of the partnership in which there is a change in the
interest of a partner. Pursuant to that grant of regulatory authority,
the proposed regulations provide methods for determining a partner's
distributive share of partnership items to 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. Also, the proposed
regulations provide that a deemed disposition of a partner's entire
interest under other sections of the regulations is a deemed
disposition of a partner's entire interest for the purpose of section
706(d).
Finally, the proposed regulations amend the rules applicable to the
determination of the taxable year of a partnership in those instances
in which partnership interests are held by ``disregarded foreign
partners'' (as that term is defined in Sec. 1.706-1(b)(6)(i)).
1. Varying Interest Rule
a. In General
Section 702(a) of the Code provides that the partner in determining
the partner's income tax shall take into account separately the
partner's distributive share of partnership items of income, gain,
loss, deduction, or credit.
Section 706(a) provides that, in computing the taxable income of a
partner for a taxable year, the inclusions required by sections 702 and
707(c) with respect to a partnership shall be based on the income,
gain, loss, deduction, or credit of the partnership for any taxable
year of the partnership ending within or with the taxable year of the
partner.
Section 706(c)(1) provides that, except in the case of a
termination of a partnership and except as provided in section
706(c)(2), the taxable year of a partnership shall not close as the
result of the death of a partner, the entry of a new partner, the
liquidation of a partner's interest in the partnership, or the sale or
exchange of a partner's interest in the partnership. Under section
706(c)(2)(A), the taxable year of a partnership shall close with
respect to a partner whose entire interest terminates (whether by
reason of death, liquidation, or otherwise). Under section
706(c)(2)(B), the taxable year of a partnership shall not close (other
than at the end of a partnership's taxable year as determined under
section 706(b)(1)) with respect to a partner who sells or exchanges
less than his entire interest in the partnership or with respect to a
partner whose interest is reduced (whether by entry of a new partner,
partial liquidation of a partner's interest, gift, or otherwise).
Section 706(d)(1) provides that, except as required by sections
706(d)(2) and (d)(3), if there is a change in a partner's interest in
the partnership during the partnership's taxable year, each partner's
distributive share of any partnership item of income, gain, loss,
deduction or credit for such taxable year is determined by the use of
any method prescribed by the Secretary by regulations which takes into
account the varying interests of the partners in the partnership during
such taxable year (the varying interests rule). Section 706(d)(1) was
added by the 1984 Act, in part, to clarify that the varying interests
rule applies to the disposition of a partner's entire interest in the
partnership as well as the disposition of less than a partner's entire
interest, and to authorize the Secretary to prescribe methods for
determining a partner's distributive share of partnership items when
there is a change in the partners' interests during the taxable year of
the partnership.
The existing regulations under section 706 have not been revised to
reflect the changes made to that section by the 1984 Act. Section
1.706-1(c)(2)(ii) provides that in the case of a disposition of a
partner's entire interest in a partnership the partner's distributive
share of partnership items for the taxable year of the partnership in
which the disposition occurs may be determined by a closing of the
partnership's books as of the date of disposition (interim closing
method). Alternatively, the partners by agreement may determine the
departing partner's distributive share by taking his pro rata part of
the amount of partnership items that such partner would have included
in his taxable income had he remained a partner until the end of the
partnership taxable year (proration method). Section 1.706-1(c)(2)(ii).
The proration may be based on the portion of the taxable year that has
elapsed prior to the disposition or may be determined under any other
method that is reasonable. Moreover, the transferee of such departing
partner's interest shall include in his taxable income as his
distributive share of partnership items with respect to the acquired
interest the pro rata part (determined by the method used by the
transferor partner) of the amount of such items that would have been
included had he been a partner from the beginning of the partnership's
taxable year. The existing regulations, however, do not specifically
provide for the use of these methods when there has been a disposition
of less a partner's entire interest in the partnership.
In Rev. Rul. 77-310 (1977-2 CB 217) (see Sec.
601.601(d)(2)(ii)(b)), the IRS provided an example of an acceptable
method for allocating a partnership loss for the partnership's taxable
year among the partners where their profit and loss sharing percentages
were changed substantially one month before the end of the taxable year
as a result of capital contributions of several existing partners. The
ruling provided that an acceptable method, under the facts of the
ruling, was to allocate the partnership's loss among the partners based
on their differing profit and loss sharing percentages and the periods
during the year each partner's differing percentage interests existed.
See also Rev. Rul. 77-311 (1977-2 CB 218), (applying the same method to
a partnership's distributive share of a loss from a lower-tier
partnership). See Sec. 601.601(d)(2)(ii)(b).
Finally, the existing regulations under section 706 have not been
revised to reflect the change to that section by the 1997 Act requiring
that the taxable year of the partnership shall close with respect to a
partner whose entire interest in the partnership terminates by reason
of death. In that regard, Sec. 1.706-1(c)(3) provides that, when a
partner dies, the partnership taxable year shall not close with respect
to such partner prior to the end of the partnership's taxable year.
b. Change in Partnership Allocations Among Contemporaneous Partners
Section 761(c) provides that a partnership agreement includes any
modifications of the partnership agreement made prior to, or at, the
time prescribed by law for the filing of the partnership return for the
taxable year (not including extensions). In Lipke v. Commissioner, 81
T.C. 689 (1983), the Tax Court held that section 706(c)(2)(B) (as in
effect prior to the 1984 Act) prohibited retroactive allocations of
partnership losses where the allocations resulted from additional
capital contributions made by both new and existing partners. However,
the Tax Court held that the prohibition on retroactive allocations
under section 706(c)(2)(B) did not apply to changes in the allocations
among partners who were members of the partnership for the entire year
(contemporaneous partners)
[[Page 17121]]
if the changes in the allocations did not result from capital
contributions. Lipke v. Commissioner, supra, at 696 (1983).
As previously discussed, the 1984 Act amended section 706, in part, to
clarify that the varying interests rule applies to any change in a
partner's interest, whether in connection with a complete disposition
of the partner's interest or otherwise. To that end, Congress in the
1984 Act replaced the varying interests rule in section 706(c)(2)(B)
with the rule that now appears in Section 706(d)(1). The legislative
history pertaining to this amendment reflects Congress's intention that
the new rule of section 706(d)(1) be comparable to the pre-1984 law
without overruling the longstanding rule of section 761(c).
The committee wishes to make clear that the varying interests
rule is not intended to override the longstanding rule of section
761(c) with respect to interest shifts among partners who are
members of the partnership for the entire taxable year, provided
such shifts are not, in substance, attributable to the influx of new
capital from such partners. See Lipke v. Commissioner, 81 T.C. 689
(1983).
S. Prt. 98-169, Vol. I, 98th Cong., 2d Sess. 218-19 (1984); see also H.
Rep. No. 432, Pt. 2, 98th Cong., 2d Sess. 1212-13 (1984) (containing
similar language).
c. Conventions
Section 1.706-1(c)(2)(ii) provides that, in determining the
distributive share of partnership items under section 702(a) with
respect to a partner whose entire interest in the partnership
terminates, a partnership may use the interim closing method or
alternatively, the partners may by agreement choose to use the
proration method. Under the proration method, the partnership's income
and losses may be prorated based on the portion of the taxable year
that has elapsed prior to the date upon which the partners' interests
varied, or ``under any other method that is reasonable.'' These other
reasonable methods have become known as conventions.
Staff of J. Comm. On Taxation, 98th Cong., General Explanation of
the Revenue Provisions of the Deficit Reduction Act of 1984, 222 (Comm.
Print 1984), provides,
[I]n any case in which there is a disposition of less than an
entire interest in the partnership by a partner (including the entry
of a new partner), the partners may elect to determine the varying
interests of the partners by using one or more conventions that
treat any change in any partner's interest in the partnership during
a particular month as occurring on one or more specified days in the
month. The actual method for applying a convention is to be provided
by Treasury regulations. The regulations may deny the use of any
convention when the occurrence of significant, discrete events
(e.g., a large, unusual gain or loss) would mean that use of the
convention could result in significant tax avoidance.
* * * Congress intended that the regulations providing for these
conventions will be effective on a prospective basis only. Until
these regulations are proposed, and for a reasonable transition
period thereafter, it is expected that Treasury will permit any
reasonable convention to be used. This may include a method under
which any partner entering during a month is treated as entering on
the first day of the month, a method under which partners entering
during the first 15 days of a month are treated as entering on the
first day of the month and partners entering after the 15th of the
month are treated as entering on the 16th day of the month, or any
other method that is not abusive under the relevant facts and
circumstances. As a general rule, use of a convention is not
permitted when the occurrence of significant, discrete events (e.g.,
a large, unusual gain or loss) would result in significant tax
avoidance if the convention is used.
On December 13, 1984, the IRS issued a news release (IR-84-129)
(http://www.irs.gov/puv/irs-drop/ir-84-129.pdf) announcing that
partnerships using the interim closing method were permitted to use a
semi-monthly convention. Under a semi-monthly convention, partners
entering during the first 15 days of the month are treated as entering
on the first day of the month, and partners entering after the 15th day
of the month (but before the end of the month) are treated as entering
on the 16th day of the month (except to the extent that section
706(c)(2)(A) applied). The news release provided that, until
regulations were issued, partnerships that use the proration method
were required to use a daily convention.
d. Deemed Dispositions
Section 1.1502-76(b)(2)(i) provides that the federal income tax
returns for the years that end and begin with a corporation becoming
(or ceasing to be) a member (as defined in Sec. 1.1502-1(b)) of a
consolidated group (as defined in Sec. 1.1502-1(h)) are separate tax
years for all Federal income tax purposes. The periods ending and
beginning with the corporation's change in status are different tax
years, and the corporation's items of income, gain, loss, deduction and
credit must be allocated between such separate tax years. Under Sec.
1.1502-76(b)(2)(vi), if the corporation is a partner in a partnership,
the corporation is treated for purposes of determining the year to
which the partnership's items are allocated as selling the
corporation's entire interest in the partnership immediately before the
corporation's change in status.
Section 1.1362-3(a) provides that, if an S election (as defined in
section 1362(a)) terminates under section 1362(d) on a date other than
the first day of the taxable year of the S corporation (as defined in
section 1361(a)), the portion of the year ending as of the close of the
day prior to the termination is treated as a short taxable year for
which the corporation is an S corporation (S short year) and the
portion of the S termination year beginning on the day of the
termination is effective is treated as a short taxable year for which
the corporation is a C corporation (as defined in section 1362(a)(2))
(C short year). Under Sec. 1.1362-3(a), the corporation's items of
income, gain, loss, deduction and credit must be allocated between the
S short year and C short year using the pro rata allocation approach
stated in section 1362(e)(2) unless an election is made to allocate the
items using its normal accounting method or in certain other instances
described in sections 1362(e)(3), 1362(e)(6)(C) or 1362(e)(6)(D). Under
Sec. 1.1362-3(c)(1), for purposes of section 706(c) only, the
termination of the S election of a corporation that is a partner in a
partnership is treated as a sale or exchange of the corporation's
entire interest in the partnership on the last day of the S short year
if (i) the pro rata allocation rules do not apply and (ii) the taxable
year of the partnership ends with or within the C short year.
Under section 1377(a)(2), if a shareholder terminates the
shareholder's entire interest in an S corporation and all affected
shareholders (as defined in section 1377(a)(2)(B)) and the corporation
agree, the S corporation may elect under section 1377(a)(2)
(terminating election) to apply the pro rata allocation method (as
defined in section 1377(a)(1)) as if the S corporation's taxable year
consisted of two separate taxable years, the first of which ends at the
close of the day on which the shareholder's entire interest in the S
corporation is terminated. (See Sec. 1.1377-1(b)(1) for certain
exceptions to the preceding rule.) Under Sec. 1.1377(b)(3)(iv), a
terminating election by an S corporation that is a partner in a
partnership is treated as a sale or exchange of the corporation's
entire interest in the partnership for purposes of section 706(c) if
the taxable year of the partnership ends after the shareholder's
interest is terminated and within the taxable year of the S
corporation.
2. Taxable Years of Partnerships
A partnership must determine its taxable year under section
706(b)(1)(B)
[[Page 17122]]
unless the partnership establishes to the satisfaction of the Secretary
a business purpose for a different year. In general, the required
taxable year of a partnership is determined by reference to the taxable
year of its partners. If partners owning a majority interest in a
partnership have the same taxable year, the partnership is required to
have the same taxable year as the majority interest owners (majority
interest taxable year). If a taxable year for the partnership cannot be
determined under the majority interest taxable year rule, the taxable
year of the partnership shall be the taxable year of all of its
principal partners (principal partner taxable year). Finally, if there
is not taxable year described under the majority interest taxable year
rule or principal partner taxable year rule, then the partnership is
required under the regulations to have the taxable year that results in
the least aggregate deferral of income. Section 1.706-1(b)(2)(C).
Under Sec. 1.706-1(b)(6)(i), the interest held by a disregarded
foreign partner is not taken into account in determining the taxable
year of the partnership under the foregoing rules. A foreign partner is
a disregarded foreign partner unless such partner is allocated gross
income that was effectively connected with the conduct of a trade or
business of the partnership within the U.S. and taxation of such income
is not otherwise precluded under any U.S. income tax treaty. The
interest of a disregarded foreign partner is taken into account in
determining the taxable year of the partnership, however, if the
partners that are not disregarded foreign partners (regarded partners)
hold a minority interest in the partnership (minority interest rule).
Section 1.706-1(b)(6)(iii). Regarded partners hold a minority interest
for this purpose if each regarded partner holds less than a 10-percent
interest in capital or profits of the partnership, and the regarded
partners in the aggregate hold less than a 20-percent interest in the
capital or profits of the partnership.
Explanation of Provisions
1. Varying Interests Rule
a. In General
The proposed regulations amend Sec. 1.706-1(c) to reflect the
change made to section 706(c)(2)(A) in the 1997 Act which requires that
the taxable year of the partnership close with respect to a partner who
dies. The proposed regulations do not change the provisions in Sec.
1.706-1(c)(3)(iv) that the sale or exchange of a partnership interest
does not include any transfer of a partnership interest which occurs at
death as a result of inheritance or any testamentary disposition or in
Sec. 1.706-1(c)(5) that the transfer of a partnership interest by gift
does not close the partnership taxable year with respect to the donor.
Also, the proposed regulations add Sec. 1.706-4 to provide for the
application of the varying interests rule in all cases in which a
partner's interest changes during the taxable year, whether by reason
of a disposition of the partner's entire interest in the partnership or
a disposition of less than the partner's entire interest in the
partnership.
b. Methods and Conventions
Proposed Sec. 1.706-4(a) provides that, if a partner's interest
changes during the partnership's taxable year, the partnership shall
determine the partner's distributive share using the interim closing
method. However, the partnership by agreement of the partners may use
the proration method. For each partnership taxable year in which a
partner's interest varies, the proposed regulations provide that the
partnership must use the same method to take into account all changes
occurring within that year.
Proposed Sec. 1.706-4(c) generally provides that a partnership
shall take into account any variation in the partners' interests in the
partnership during the taxable year by determining the distributive
share of partnership items under section 702(a) for each segment of
that taxable 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. Proposed Sec.
1.706-4(c)(1) and (2) incorporate the principles of the former Sec.
1.706-1(c)(2)(ii) (as finalized in TD 6175).
Proposed Sec. 1.706-4(d) provides that by agreement among the
partners a partnership may use a proration method, rather than the
interim closing method, to take into account any variation in a
partner's interest in the partnership during the taxable year. Under
this method, except for extraordinary items (as defined in Sec. 1.706-
4(d)(3)), the partnership allocates the distributive share of
partnership items under section 702(a) among the partners in accordance
with their pro rata shares of these same items for the entire taxable
year. In determining a partner's pro rata share of partnership items,
the partnership shall take into account that partner's interest in such
items during each segment of the taxable year. Proposed Sec. 1.706-
4(d)(1) and (2) incorporate the principles of the former Sec. 1.706-
2(c)(2)(ii) (as finalized in TD 6175).
For purposes of accounting for the partners' varying interests in
the partnership, proposed Sec. 1.706-4 requires that for each partner
whose interest changes in the taxable year the partnership shall
maintain segments to account for such changes. A segment is specific
portion of a partnership's taxable year. The first segment of a taxable
year for a partner that incurs a change will begin on the partnership's
first day of its taxable year and end as of the close of business
immediately preceding the date of the change as determined under the
applicable convention (discussed in this preamble) used by the
partnership and its partners. The next segment will begin on the day
prescribed by the applicable convention and end on the earlier of the
close of the day immediately preceding the date of the subsequent
change as determined by the applicable convention, or the end of the
partnership's taxable year. Proposed Sec. 1.706-4(a)(2) provides that
the partnership shall determine the items for each segment of the
taxable year created by the variation event for a partner in accordance
with the partnership's method of accounting used for its entire taxable
year. Each segment is treated as a separate period.
For purposes of the interim closing method in Sec. 1.706-4(c) and
the proration method in Sec. 1.706-4(d), the proposed regulations
provide a special accounting rule that must be used to account for
certain items. For example, for an interim closing method, the
partnership may compute a net capital loss for a segment even though
the partnership has net capital gain for the complete taxable year.
Also, any limitation applicable to the partnership year as a whole (for
example, the limitation under section 179) must be apportioned among
the segments using any reasonable method provided that the method may
not exceed any limitation applicable to the partnership as a whole. See
proposed Sec. Sec. 1.706-4(a)(2)(i) and (ii).
In addition, proposed Sec. 1.706-4(d)(3) requires a partnership
using the proration method to allocate extraordinary items among the
partners in proportion to their interests at the beginning of the day
on which they are taken into account. For this purpose, an
extraordinary item is (i) any item from the disposition or abandonment
(other than in the ordinary course of business) of a capital asset as
defined in section 1221 (determined without the application of any
other rules of law); (ii) any item from the disposition or abandonment
of property used in a trade or business (other than in the ordinary
course of business) as defined
[[Page 17123]]
in section 1231(b) (determined without the application of any holding
period requirement); (iii) any item from the disposition or abandonment
of an asset described in sections 1221(1), (3), (4), or (5), if
substantially all the assets in the same category from the same trade
or business are disposed of or abandoned in one transaction (or series
of related transactions); (iv) any item from assets disposed of in an
applicable asset acquisition under section 1060(c); (v) any section
481(a) adjustment; (vi) any item from the discharge or retirement of
indebtedness (for example, if a debtor partnership transfers a capital
or profits interest in such partnership to a creditor in satisfaction
of its recourse or nonrecourse indebtedness, any discharge of
indebtedness income recognized under section 108(e)(8) must be
allocated among the persons who were partners in the partnership
immediately before the discharge); (vii) any item from the settlement
of a tort or similar third-party liability; (viii) any credit, to the
extent it arises from activities or items that are not ratably
allocated (for example, the rehabilitation credit under section 47,
which is based on placement in service); and (ix) any item which, in
the opinion of the Commissioner, would, if ratably allocated, result in
a substantial distortion of income in any consolidated return or
separate return in which the item is included. The IRS and the Treasury
Department request comments concerning whether any items should be
added to or removed from the definition of extraordinary items.
Under proposed Sec. 1.706-4(e), a partnership using the interim
closing method may use either a calendar day convention or a semi-
monthly convention. A partnership using the proration method may use
only the calendar day convention. The calendar day convention requires
that, with respect to a partner whose interest terminates, the
partnership's taxable year closes as of the close of the day on which
the change occurs. Section 1.706-4(e)(1). The semi-monthly convention
requires that any variation in a partner's interest occurring during
the first through 15th day of the calendar month is deemed to occur at
the beginning of the first day of the month, and any variation in a
partner's interest occurring during the 16th through the last day of
the month is deemed to occur at the beginning of the 16th day of that
month. Section 1.706-4(e)(2).
A partnership must use the same method and convention for all
variations in the partners' interests during the taxable year of the
partnership. For example, a partnership could not use the proration
method and interim closing method in the same taxable year.
Additionally, a partnership using the interim closing method could not
use the calendar day convention to account for a variation in one
partner's interest during the partnership's taxable year while using a
monthly convention to account for that partner's, or a different
partner's, variation in an interest during the partnership's taxable
year. Comments are requested with regard to the possible expansion of
this rule to include other conventions or other methods.
The IRS and the Treasury Department are aware that some publicly
traded partnerships (as defined in section 7704) are using conventions
other than a monthly or semi-monthly convention and are using these
conventions with the proration method. Thus, the IRS and the Treasury
Department are requesting comments concerning the use of conventions
other than monthly or semi-monthly convention. The proposed regulations
regarding the use of conventions will not apply to existing publicly
traded partnerships.
c. Change in Partnership Allocations Among Contemporaneous Partners
Proposed Sec. 1.706-4(b)(1) provides that the varying interests
rule will 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 taxable year
(excluding extensions). This exception applies only to allocations that
are valid under section 704(b) and the regulations promulgated in
association with that section. Moreover, consistent with the Tax
Court's decision in Lipke, this exception to the varying interests rule
will not apply to any changes in interests of the partners attributable
to contributions of money or other property to the partnership. The
proposed regulations further provide that this exception will not apply
to changes in the interests of the partners as a result of
distributions of capital from the partnership to a partner.
d. Safe Harbors for Service Partnerships and Publicly Traded
Partnerships
Proposed Sec. 1.706-4(b)(2) provides that service partnerships (as
defined in that section) may 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 even though
such method is not described in paragraph (a) of the proposed
regulations and the partnership does not use the methods or conventions
described in paragraphs (c) and (d), and paragraph (e) of the proposed
regulations, respectively. However, the allocations must be valid under
section 704(b).
Proposed Sec. 1.706-4(b)(3) provides that publicly traded
partnerships (as defined in section 7704(b)) may treat all transfers of
its publicly traded units (as described in Sec. 1.7704-1(b)(1)) during
a calendar month as occurring on the first day of the following month
under a consistent method adopted by the partnership or may use the
semi-monthly convention described in Sec. 1.706-4(e)(2). Block
transfers of publicly traded partnership (PTP) units (as described in
Sec. 1.7704-1(e)(2)) will not qualify for this safe harbor.
e. Deemed Dispositions
The proposed regulations amend Sec. 1.706-1(c) to provide that a
deemed disposition of a partner's entire interest in the partnership
pursuant to Sec. Sec. 1.1502-76(b)(2)(vi), 1.1362-3(c)(1), and 1.1377-
1(b)(3)(iv) shall be treated as a disposition of the partner's entire
interest for purposes of section 706. The IRS and Treasury Department
request comments concerning the relationship of Sec. 1.1502-
76(b)(2)(vi)(B) and the proposed regulations regarding the deemed
disposition of partnership interests.
2. Taxable Years of Partnerships
The proposed regulations amend the minority interest rule in Sec.
1.706-1(b)(6)(iii) to provide that regarded partners have a minority
interest only if each regarded partner has less than a 10-percent
interest in capital and profits, and the regarded partners collectively
have less than a 20-percent interest in partnership capital and
profits. This modification means that the interests of foreign partners
will be taken into account in determining the taxable year of the
partnership only if the regarded partners have interests below the
stated thresholds in partnership capital and profits, rather than the
current rule which requires only an interest below the threshold in
either capital or profits. For example, under the current regulations,
the taxable year of disregarded foreign partners would not be ignored
in determining the taxable year of the partnership if the regarded
partners had aggregate capital interests of less than 20-percent but
profits interests of more than 20-percent. By contrast, under the
proposed regulations, in that example, the taxable year of the
disregarded foreign partners
[[Page 17124]]
would not be applicable in determining the taxable year of the
partnership.
Additional Requests for Comments
The IRS and the Treasury Department are also requesting comments
relating to any other outstanding issues arising under section 706(d).
Specifically, the IRS and the Treasury Department are seeking comments
with regard to issues that arise concerning allocable cash basis items
and/or tiered partnerships.
Section 706(d)(2)(A) provides a special rule for determining a
partner's distributive share of an allocable cash basis item. Section
706(d)(2) effectively requires a cash method partnership to use an
economic accrual method solely for the purpose of allocating certain
items. Under the statute, a partner's distributive share of any
allocable cash basis item is determined by assigning a pro rata share
of any allocable cash basis item to each day within a specified period
to which it is attributable and then allocating each day's portion in
an amount equivalent to each partner's interest in the partnership on
that day. A list of allocable cash basis items is found in section
706(d)(2)(B). The IRS and the Treasury Department are seeking comments
as to whether that list should be expanded (to include, for example,
items such as property insurance), as well as on any other issue with
regard to allocating cash basis items.
Section 706(d)(3) provides that if during any taxable year of the
partnership there is a change in any partner's interest in the
partnership (upper-tier partnership), and such partnership is a partner
in another partnership (lower-tier partnership), then (except to the
extent provided by regulations) each partner's distributive share of
any item of the upper-tier partnership attributable to the lower-tier
partnership shall be determined by first assigning the appropriate
portion of each such item to the appropriate days during which the
upper-tier partnership is a partner in the lower-tier partnership, and
then allocating the portion assigned to any such day among the partners
in proportion to their interests in the upper-tier partnership at the
close of such day. Thus, the daily allocation method, used for cash
basis items, is applicable to all items of the lower-tier partnership
if there is a change in the partnership interests in the upper-tier
partnership. The IRS and the Treasury Department are seeking comments
on this and any other issue related to tiered partnerships and
determining a partner's varying interests.
Proposed Effective Date
In accord with the legislative history to section 706(d), the
proposed regulations provide a reasonable transition period for
taxpayers in the effective date provisions of this proposed regulation.
Thus, the proposed amendments to Sec. Sec. 1.706-1 (with the exception
of the change to Sec. 1.706-1(b)(6)(iii)), 1.706-4, and 1.706-5 are
proposed to apply to partnership taxable years that begin after the
date the final regulations are published in the Federal Register, but
not before taxable years beginning after December 31, 2009.
The proposed amendment to Sec. 1.706-1(b)(6)(iii) generally is
applicable to the first taxable year of a partnership that begins on or
after the date final regulations are published in the Federal Register,
subject to two special rules. First, under the current regulations,
partnerships formed prior to September 23, 2002 (``existing
partnerships'') generally are exempt from the rules of Sec. 1.706-
1(b)(6) unless they have voluntarily elected to apply them or unless
they have undergone a technical termination under section 708(b)(1)(B).
The proposed regulation retains this special rule, such that an
existing partnership will not be subject to the modified minority
interest rule in proposed Sec. 1.706-1(b)(6)(iii) unless there has
been such an election or technical termination. Second, because the
proposed regulation would modify Sec. 1.706-1(b)(6)(iii) but otherwise
leave the rules of Sec. 1.706-1(b)(6) unchanged, it is appropriate to
exempt other partnerships from the modified minority interest rule if
they are already subject to Sec. 1.706-1(b)(6) and the minority
interest rule of the current regulations (``interim period
partnerships''). Thus, interim period partnerships will be exempt from
the modified minority interest rule of proposed Sec. 1.706-
1(b)(6)(iii) unless they voluntarily elect to be subject to this rule
or undergo a technical termination. Accordingly, the proposed amendment
to Sec. 1.706-1(b)(6)(iii) would apply to the first taxable year of a
partnership that begins on or after the date final regulations are
published in the Federal Register, subject to these special rules for
existing partnerships and interim period partnerships.
The proposed amendments in Sec. Sec. 1.706-4(c)(2) and (d)(2) are
proposed to apply for the taxable year of a partnership other than an
existing publicly traded partnership that begin after the date the
final regulations are published in the Federal Register, but not before
taxable years beginning after December 31, 2009.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It has also
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) does not apply to these regulations, and because
the regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, this regulation has
been submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Request for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) or electronic comments that are submitted timely
to the IRS. The IRS and the Treasury Department specifically request
comments on the clarity of the proposed rules and how they can be made
easier to understand. All comments will be available for public
inspection and copying.
A public hearing will be scheduled if requested in writing by any
person that timely submits written comments. If a public hearing is
scheduled, notice of the date, time, and place for the pubic hearing
will be published in the Federal Register.
Drafting Information
The principal authors of these proposed regulations are Laura
Fields and Jonathan Cornwell, Office of the Associate Chief Counsel
(Passthroughs and Special Industries). However, other personnel from
the IRS and the Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
a new entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *.
[[Page 17125]]
Section 1.706-2 also issued under 26 U.S.C. 706(d). * * *
Par. 2. Section 1.706-0 is added to read as follows:
Sec. 1.706-0 Table of contents.
This section lists the captions contained in the regulations under
section 706.
Sec. 1.706-1 Taxable years of partner and partnership.
(a) Year in which partnership income is includible.
(b) Taxable year.
(1) Partnership treated as taxpayer.
(2) Partnership's taxable year.
(i) Required taxable year.
(ii) Exceptions.
(3) Least aggregate deferral.
(i) Taxable year that results in the least aggregate deferral of
income.
(ii) Determination of the taxable year of a partner or
partnership that uses a 52-53 week taxable year.
(iii) Special de minimis rule.
(iv) Examples.
(4) Measurement of partner's profits and capital interest.
(i) In general.
(ii) Profits interest.
(A) In general.
(B) Percentage share of partnership net income.
(C) Distributive share.
(iii) Capital interest.
(5) Taxable year of a partnership with tax-exempt partners.
(i) Certain tax-exempt partners disregarded.
(ii) Example.
(iii) Effective date.
(6) Certain foreign partners disregarded.
(i) Interests of disregarded foreign partners not taken into
account.
(ii) Definition of foreign partner.
(iii) Minority interest rule.
(iv) Example.
(v) Effective date.
(A) Generally.
(B) Voluntary change in taxable year.
(C) Subsequent sale or exchange of interests.
(D) Transition rule.
(7) Adoption of taxable year.
(8) Change in taxable year.
(i) Partnerships.
(A) Approval required.
(B) Short period tax return.
(C) Change in required taxable year.
(ii) Partners.
(9) Retention of taxable year.
(10) Procedures for obtaining approval or making a section 444
election.
(11) Effect on partner elections under section 444.
(i) Election taken into account.
(ii) Effective date.
(c) Closing of partnership year.
(1) General rule.
(2) Disposition of entire interest
(i) In general.
(ii) Example.
(iii) Deemed dispositions.
(3) Disposition of less than entire interest.
(4) Determination of distributive shares.
(5) Transfer of interest by gift.
(d) Effective/applicability date.
Sec. 1.706-2 Certain cash basis items prorated over period to which
attributable. [Reserved]
Sec. 1.706-3 Items attributable to interest in lower-tier partnership
prorated over entire taxable year. [Reserved]
Sec. 1.706-4 Determination of distributive share when a partner's
interest varies.
(a) General rule.
(1) Methods.
(2) Segments.
(i) General rule.
(ii) Other provisions.
(b) Exceptions.
(1) Permissible changes among contemporaneous partners.
(2) Safe harbor for certain service partnerships.
(3) Safe harbor for publicly traded units of publicly traded
partnerships.
(c) Interim closing method.
(1) In general.
(2) Conventions.
(3) Example.
(d) Proration method.
(1) In general.
(2) Conventions.
(3) Extraordinary items.
(4) Example.
(e) Conventions.
(1) Calendar day convention.
(2) Semi-monthly convention.
(f) Effective/applicability date.
Sec. 1.706-5 Taxable year determination.
(a) General rule.
(b) Effective/applicability date.
Par. 3. Section 1.706-1 is amended as follows:
1. The language ``capital or profits'' in the first sentence in
paragraph (b)(6)(iii) is removed and the language ``capital and
profits'' is added in its place.
2. Paragraph (b)(6)(v)(A) is revised.
3. The last sentence of paragraph (b)(6)(v)(B) is removed and four
new sentences are added in its place.
4. Paragraph (b)(6)(v)(C) is revised.
5. Add a new sentence at the end of paragraph (b)(6)(v)(D).
6. Paragraph (c)(2) is revised.
7. Paragraph (c)(3) is removed.
8. Paragraph (c)(4) is redesignated as (c)(3) and the last sentence
of newly designated paragraph (c)(3) is removed.
9. New paragraph (c)(4) is added.
10. Paragraph (d) is revised.
The additions and revisions read as follows:
Sec. 1.706-1 Taxable years of partner and partnership.
* * * * *
(b) * * *
(6) * * *
(v) * * * (A) Generally. The provisions of this paragraph (b)(6)
(other than paragraph (b)(6)(iii) of this section) are applicable for
the first taxable year of a partnership other than an existing
partnership that begins on or after July 23, 2002. The provisions of
paragraph (b)(6)(iii) of this section are applicable for the first
taxable year of a partnership other than an existing partnership or an
interim period partnership that begins on or after the date these
regulations become effective. For this purpose, an existing partnership
is a partnership that was formed prior to September 23, 2002, and an
interim period partnership is a partnership that was formed on or after
September 23, 2002, and prior to the date these regulations become
effective.
(B) * * * An existing partnership that makes such a change prior to
the date these regulations become effective will cease to be exempted
from the requirements of paragraph (b)(6) (other than paragraph
(b)(6)(iii)) of this section. An existing partnership that makes such a
change on or after the date these regulations become effective will
cease to be exempted from the requirements of paragraph (b)(6) of this
section. An interim period partnership may change its taxable year to a
year determined in accordance with paragraph (b)(6)(iii) of this
section. An interim period partnership that makes such a change will
cease to be exempted from the requirements of paragraph (b)(6)(iii) of
this section.
(C) Subsequent sale or exchange of interests. If an existing
partnership or an interim period partnership terminates under section
708(b)(1)(B), the resulting partnership is not an existing partnership
or an interim period partnership for purposes of paragraph (b)(6)(v)(A)
of this section.
(D) * * * If, in the first taxable year beginning on or after the
date these regulations become effective, an interim period partnership
voluntarily changes its taxable year to a year determined in accordance
with paragraph (b)(6)(iii) of this section, then the partners of that
partnership may apply the provisions of Sec. 1.702-3T to take into
account all items of income, gain, loss, deduction, and credit
attributable to the partnership year of change ratably over a four-year
period.
* * * * *
(c) * * *
(2) Disposition of entire interest--(i) In general. A partnership
taxable year shall close with respect to a partner who sells or
exchanges his entire interest in the partnership, with respect to a
partner whose entire interest in the partnership is liquidated and with
respect to a partner who dies. In the case of a death or liquidation,
or sale or
[[Page 17126]]
exchange of a partner's entire interest in the partnership, the partner
shall include in his taxable income for his taxable year within or with
which the partner's membership in the partnership ends, the partner's
distributive share of items described in section 702(a), and any
guaranteed payments under section 707(c), for the partner's partnership
taxable year ending with the date of such termination. If the decedent
partner's estate or other successor sells or exchanges its entire
interest in the partnership, or if its entire interest is liquidated,
the partnership taxable year with respect to the estate or other
successor in interest shall close on the date of such sale or exchange,
or the date of the completion of the liquidation. The sale or exchange
of a partnership interest does not, for the purpose of this rule,
include any transfer of a partnership interest which occurs at death as
a result of inheritance or any testamentary disposition.
(ii) Example. H is a member of a partnership having a taxable
year ending December 31. Both H and his wife W are on a calendar
year and file joint returns. H dies on March 31, 2010.
Administration of the estate is completed and the estate, including
the partnership interest, is distributed to W as legatee on November
30, 2010. Such distribution by the estate is not a sale or exchange
of H's partnership interest. The taxable year of the partnership
will close with respect to H on March 31, 2010, and H will include
in his final return for his final taxable year (January 1 through
March 31, 2010) his distributive share of partnership items for that
period under the rules of Sec. 1.706-4. W will include in her
return for the taxable year ending December 31, 2010, her
distributive share of partnership items for the period of April 1
through December 31, 2010, under the rules of Sec. 1.706-4.
(iii) Deemed dispositions. A deemed disposition of the partner's
interest pursuant to Sec. Sec. 1.1502-76(b)(2)(vi) (relating to
corporate partners that become or cease to be members of a consolidated
group within the meaning of Sec. 1.1502-1(h)), 1.1362-3(c)(1)
(relating to the termination of the subchapter S election of an S
corporation partner), and 1.1377-1(b)(3)(iv) (regarding an election to
terminate the taxable year of an S corporation partner), shall be
treated as a disposition of the partner's entire interest in the
partnership.
* * * * *
(4) Determination of distributive shares. See Sec. 1.706-4 for
rules regarding the methods to be used in determining the distributive
shares of items described in section 702(a) for partners whose
interests in the partnership vary as a result of a disposition of a
partner's entire interest in a partnership as described in paragraph
(c)(2) of this section or as a result of a disposition of less than an
entire interest as described in paragraph (c)(3) of this section during
the partnership's taxable year.
* * * * *
(d) Effective/applicability date. The rules for paragraphs (a) and
(b) of this section are applicable for partnership taxable years ending
on or after May 17, 2002, except for paragraph (b)(6)(iii) of this
section which applies to partnership taxable years beginning the day
after final regulations are published in the Federal Register. The
rules for paragraph (c)(1) of this section apply for partnership
taxable years beginning after December 31, 1953. All other paragraphs
under paragraph (c) of this section apply for partnership taxable years
that begin after the date the final regulations are published in the
Federal Register, but not before taxable years beginning after December
31, 2009.
Par. 4. Section 1.706-2 is added and reserved to read as follows:
Sec. 1.706-2 Certain cash basis items prorated over period to which
attributable. [Reserved]
Par. 5. Section 1.706-3 is added and reserved to read as follows:
Sec. 1.706-3 Items attributable to interest in lower-tier partnership
prorated over entire taxable year. [Reserved]
Par. 6. Section 1.706-4 is added to read as follows:
Sec. 1.706-4 Determination of distributive share when a partner's
interest varies.
(a) General rule--(1) Methods. Except as provided in paragraph (b)
of this section, if a partner's interest in a partnership varies during
the taxable year as a result of a disposition of an entire interest in
a partnership as described in Sec. 1.706-1(c)(2) or as a result of the
disposition of less than the entire interest in a partnership or with
respect to a partner whose interest in a partnership is reduced as
described in Sec. 1.706-1(c)(3), the partnership shall determine the
partner's distributive share of partnership items by using the interim
closing method (described in paragraph (c) of this section).
Alternatively, a partnership may, by agreement of the partners, use the
proration method (described in paragraph (d) of this section). The
partnership and all of its partners shall use the same method (interim
closing or proration) and, if applicable, the same convention
(described in paragraph (e) of this section) for all variations in the
partners' interests occurring within each partnership taxable year.
(2) Segments--(i) General rule. For purposes of accounting for a
variation in a partner's interest within a taxable year of the
partnership as a result of dispositions or reductions of interests as
described in Sec. 1.706-1(c)(2) or (c)(3), the partnership shall
maintain segments, which are specific periods of the partnership's
taxable year. The first segment to account for a change in a partner's
interest shall commence with the beginning of the taxable year of the
partnership and end at the close of the day specified by the convention
used by the partnership to account for such change. Any additional
segment shall commence with the day specified by the convention used by
the partnership to account for a previous change in the partner's
interest and shall end as a result of an additional change in the
partner's interest at the close of the day specified by the convention
used by the partnership to account for such change, provided, however,
that the last segment of the taxable year of the partnership shall end
no later than the close of the day of the partnership's taxable year.
The partnership shall determine the items of income, gain, loss,
deduction and credit of the partnership for each segment in accordance
with the method of accounting that it uses for the partnership's entire
taxable year. In general, a partnership using the interim closing
method shall treat each segment as though the segment were a separate
distributive share period. For example, a partnership using the interim
closing method may compute a net capital loss for a segment of a
taxable year even though the partnership has a net capital gain for the
entire taxable year.
(ii) Other provisions. Any limitation applicable to the partnership
year as a whole (for example, the limitation under section 179,
relating to elections to expense certain depreciable business assets)
must be in connection with the interim closing method apportioned among
the segments by the partnership using any reasonable method, provided,
however, that the amounts apportioned among segments shall not exceed
the limitation applicable to the partnership as a whole.
(b) Exceptions--(1) Permissible changes among contemporaneous
partners. The general rule of paragraph (a) of this section, with
respect to the varying interests of a partner described in Sec. 1.706-
1(c)(3), will not preclude changes in the allocations of the
distributive share of items described in section 702(a) among
contemporaneous partners for the entire partnership taxable year,
provided that--
(i) Any variation in a partner's interest is not attributable to a
contribution of money or property by a partner to the capital of the
partnership or a
[[Page 17127]]
distribution of money or property by the partnership to a partner that
is a return of capital; and
(ii) The allocations resulting from the modification satisfy the
provisions of section 704(b) and the regulations promulgated in
association with that section.
(2) Safe harbor for certain service partnerships. Notwithstanding
paragraph (a) of this section, with respect to any taxable year in
which there is a change in any partner's interest in a service
partnership (as defined below in this subsection), the partnership and
such partner may choose to determine the partner's distributive share
of partnership income, gain, loss, deduction and credit using any
reasonable method to account for the varying interests of the partners
in the partnership during the taxable year provided that the
allocations are valid under section 704(b). A service partnership is a
partnership in which substantially all the activities involve the
performance of services in the fields of health, law, engineering,
architecture, accounting, actuarial science, or consulting.
(3) Safe harbor for publicly traded units of publicly traded
partnerships. Notwithstanding paragraph (a) of this section, a publicly
traded partnership (PTP) (as defined in section 7704(b)) using either
the interim closing of the books method in paragraph (c) of this
section or the proration method in paragraph (d) of this section may
treat all transfers of its publicly traded units (as described in Sec.
1.7704-1(b)(1)) during a calendar month as occurring for purposes of
determining partner status on the first day of the following month
under a consistent method adopted by the partnership or may use the
semi-monthly convention described in paragraph (e)(2) of this section.
For example, PRS, a PTP, uses the proration method in paragraph (d) of
this section. PRS adopts a method treating all transfers of its
publicly traded units as occurring on the first day of the month
following the transfer. If on May 5, A, a partner in PRS, sells a unit
in PRS to B, and on May 12 B sells that unit to C, who holds the
interest beyond May 31, PRS may allocate all items with respect to that
unit for the month of May to A, and may allocate all partnership items
with respect to that unit for the month of June to C. B will not be
considered a partner and will receive no allocation of partnership
items. Block transfers of PTP units (as described in Sec. 1.7704-
1(e)(2)) will not qualify for this safe harbor.
(c) Interim closing method--(1) In general. A partnership shall
take into account any variation in a partner's interest in the
partnership as described in Sec. 1.706-1(c)(2) or (c)(3) during the
partnership's taxable year by determining the distributive share of
partnership items under section 702(a) for each segment of that taxable
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.
(2) Conventions. A partnership using the interim closing method may
use either the calendar day convention provided in paragraph (e)(1) of
this section or the semi-monthly convention provided in paragraph
(e)(2) of this section to determine when the segments within that
taxable year end.
(3) Example. PRS is a partnership that was formed in 2004. It
has three partners, P,R, and S, who each own a one-third interest in
the partnership. PRS owns and operates a skiing enterprise and under
section 706(b)(1)(C), has adopted a calendar year end of June 30th.
Each partner is an individual who is on the calendar year. On
December 31, 2010, S sold her entire interest in PRS to Y. PRS, for
its fiscal year ending June 30, 2011, earned $150,000 of income, and
under an interim closing of the books on December 31, 2010, $90,000
of income was earned for the period beginning after December 31,
2010, and $60,000 of income was earned before January 1, 2011. The
partnership has no specific provision in the partnership agreement
relating to which section 706 method to use with regard to varying
interests of the partnership. Thus, pursuant to Sec. 1.706-4(a)(1),
PRS will be required to use the interim closing of the books method
to account for the varying interests of S and Y in the partnership.
As a result, S is allocated one-third of the income earned prior to
January 1, 2011, or $20,000. Y is allocated $30,000 which is one-
third of the income earned after December 31, 2010. Since S sold her
entire interest in PRS, the partnership taxable year closes with
respect to her pursuant to Sec. 1.706-1(c)(2)(i). Thus, she must
include her share of PRS's income on her 2010 federal income tax
return.
(d) Proration method--(1) In general. Except as provided in
paragraph (d)(3) of this section, a partnership may, by agreement of
the partners, take into account any variation in a partner's interest
in the partnership described in Sec. 1.706-1(c)(2) or (c)(3) during
the partnership's taxable year by allocating the distributive share of
partnership items under section 702(a) among the partners according to
their pro rata shares of such items for the entire taxable year. In
determining a partner's pro rata share of partnership items, the
partnership shall take into account that partner's interest in such
items during each segment. For purposes of this paragraph (d), specific
items that are aggregated by the partnership at the end of the year
(other than extraordinary items as defined in paragraph (d)(3) of this
section) shall be disregarded, and the aggregate of the items shall be
considered to be the partnership item for the year.
(2) Conventions. A partnership using the proration method shall use
the calendar day convention described in paragraph (e)(1) of this
section.
(3) Extraordinary items. A partnership must allocate extraordinary
items among the partners in proportion to their interests at the
beginning of the calendar day of the day on which they are taken into
account. For purposes of this paragraph (d), an extraordinary item is--
(i) Any item from the disposition or abandonment of a capital asset
(other than in the ordinary course of business) as defined in section
1221 (determined without the application of any other rules of law);
(ii) Any item from the disposition or abandonment of property used
in a trade or business (other than in the ordinary course of business)
as defined in section 1231(b) (determined without the application of
any holding period requirement);
(iii) Any item from the disposition or abandonment of an asset
described in section 1221(1), (3), (4), or (5), if substantially all
the assets in the same category from the same trade or business are
disposed of or abandoned in one transaction (or series of related
transactions);
(iv) Any item from assets disposed of in an applicable asset
acquisition under section 1060(c);
(v) Any section 481(a) adjustment;
(vi) Any item from the discharge or retirement of indebtedness (for
example, if a debtor partnership transfers a capital or profits
interest in such partnership to a creditor in satisfaction of its
recourse or nonrecourse indebtedness, any discharge of indebtedness
income recognized under section 108(e)(8) must be allocated among the
persons who were partners in the partnership immediately before the
discharge);
(vii) Any item from the settlement of a tort or similar third-party
liability or payment of a judgment;
(viii) Any credit, to the extent it arises from activities or items
that are not ratably allocated (for example, the rehabilitation credit
under section 47, which is based on placement in service); or
(ix) Any item which, in the opinion of the Commissioner, would, if
ratably allocated, result in a substantial distortion of income in any
return in which the item is included.
[[Page 17128]]
(4) Example. PRS is a partnership that was formed in 2004. It
has three partners, P, R, and S, who each own a one-third interest
in the partnership. PRS owns and operates a skiing enterprise, and
under section 706(b)(1)(C), has adopted a calendar year end of June
30th. Each partner is an individual who is on the calendar year. On
December 31, 2010, S sold her entire interest in PRS to Y. PRS, for
its fiscal year ending June 30, 2010, earned $150,000 of income. The
partnership has a specific provision in the partnership agreement
agreeing to use the proration method when accounting for varying
interests in the partnership. (See Sec. 1.706-4(a)(1)). Using the
proration method, $75,000 of income is included in the first segment
of the year that begins July 1, 2010 and ends December 31, 2010, and
$75,000 is included in the second segment of the year that begins
January 1, 2011 and ends June 30, 2011. For the first segment, S's
distributive share of partnership income is one-third of $75,000, or
$25,000. For the second segment, Y's distributive share of
partnership income is one-third of $75,000, or $25,000. Because S
sold her entire interest in PRS, the partnership taxable year closes
with respect to her pursuant to Sec. 1.706-1(c)(2)(i). Thus, she
must include her distributive share of PRS's income, or $25,000, on
her 2010 Federal income tax return.
(e) Conventions--(1) Calendar day convention. Under the calendar
day convention, the first segment of the partnership's taxable year
commences with the beginning of the partnership's taxable year and ends
at the close of any day on which the variation occurs in the partner's
interest in the partnership. Any additional segment shall commence with
the beginning of the day following a prior variation in a partner's
interest and end on the earlier of the close of the day on which an
additional variation occurs in the partner's interest or the close of
the partnership's taxable year, as applicable.
(2) Semi-monthly convention. Under the semi-monthly convention, the
first segment of the partnership's taxable year commences with the
beginning of the partnership's taxable year, and with respect to a
partner's variation in interest occurring on the first through the 15th
day of a calendar month, is deemed to close at the end of the last day
of the immediately preceding calendar month, and with respect to any
variation in interest occurring on the 16th through the last day of a
calendar month, is deemed to close at the end of the 15th calendar day
of that month. Any additional segment of the partnership taxable year
shall commence with beginning of the first day, or 16th day of the
month of the last segment, as the case may be, as determined for a
prior change and shall close at the earlier of the close of the
partnership's taxable year, or with respect to a partner's variation in
interest occurring on the first through 15th day of a calendar month,
is deemed to close at the end of the last day of the immediately
preceding calendar month, and with respect to any variation in interest
occurring on the 16th through the last day of a calendar month, is
deemed to close at the end of the 15th calendar day of that month.
(f) Effective/applicability date. Except with respect to paragraphs
(c)(2) and (d)(2) of this section, this section is applicable for
partnership taxable years that begin the day after the date final
regulations are published in the Federal Register, but not before
taxable years beginning after December 31, 2009. The rules of
paragraphs (c)(2) and (d)(2) of this section are applicable for the
taxable year of partnerships other than existing publicly traded
partnerships that begin after the date the final regulations are
published in the Federal Register, but not before taxable years
beginning after December 31, 2009. For purposes of the immediately
preceding sentence, an existing publicly traded partnership is a
partnership described in section 7704(b) of the Internal Revenue Code
that was formed on a date before these proposed regulations are
published in the Federal Register. However, existing publicly traded
partnerships may rely on the provisions of this section.
Par. 7. Section 1.706-5 is added to read as follows:
Sec. 1.706-5 Taxable year determination.
(a) In general. For purposes of Sec. 1.706-4, the taxable year of
a partnership shall be determined without regard to section
706(c)(2)(A) and the regulations promulgated under that Internal
Revenue Code section.
(b) Effective/applicability date. This section is applicable for
partnership taxable years that begin the day after the date final
regulations are published in the Federal Register, but not before
taxable years beginning after December 31, 2009.
Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E9-8438 Filed 4-13-09; 8:45 am]
BILLING CODE 4830-01-P