[Federal Register Volume 77, Number 249 (Friday, December 28, 2012)]
[Rules and Regulations]
[Pages 76380-76382]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-31155]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9607]
RIN 1545-BJ37


Partner's Distributive Share

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations regarding the 
application of the substantiality de minimis rule. In the interest of 
sound tax administration, this rule is being made inapplicable. These 
final regulations affect partnerships and their partners.

DATES: Effective Date: The final regulations are effective on December 
28, 2012.
    Applicability Date: The final regulations under Sec.  1.704-
1(b)(2)(iii)(e)(1) are applicable for partnership taxable years 
beginning after May 19, 2008 and beginning before December 28, 2012. 
The final regulations under Sec.  1.704-1(b)(2)(iii)(e)(2)(i) are 
applicable beginning on or after December 28, 2012, and the final 
regulations under Sec.  1.704-1(b)(2)(iii)(e)(2)(ii) are applicable for 
partnership taxable years beginning on or after December 28, 2012.

FOR FURTHER INFORMATION CONTACT: Rebecca Kahanel, at (202) 622-3050 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    These final regulations contain amendments to the Income Tax 
Regulations (26 CFR Part 1) under section 704 of the Internal Revenue 
Code (Code). On October 25, 2011, the Treasury Department and the IRS 
published a notice of proposed rulemaking (REG-109564-10) (the proposed 
regulations) in the Federal Register to remove the de minimis rule in 
Sec.  1.704-1(b)(2)(iii)(e) (the de minimis partner rule). The proposed 
regulations provide that the final regulations are effective on the 
date they are published in the Federal Register.
    The Treasury Department and the IRS did not hold a public hearing 
because there were no requests to speak at a hearing. However, the 
Treasury Department and the IRS received comments in response to the 
proposed regulations.

Explanation of Provisions and Summary of Comments

    After consideration of the comments, the final regulations adopt 
the proposed regulations as modified by this Treasury decision. The 
comments are discussed in this preamble.

1. Elimination of the Current De Minimis Partner Rule

    Commenters generally agreed that the current de minimis partner 
rule is too broad, is easily abused, and/or is inconsistent with sound 
tax policy. The Treasury Department and the IRS agree with these 
commenters that the current de minimis partner rule should no longer be 
applicable.

2. Alternative Approaches

    The preamble to the proposed regulations requests comments on ``how 
to reduce the burden of complying with the substantial economic effect 
rules, with respect to look-through partners, without diminishing the 
safeguards the rules provide.'' In response to this request, some of 
the commenters requested that future guidance in regulations amend the 
current de minimis partner rule, and other commenters suggested 
alternative approaches for de minimis partners and look-through 
partners. These alternative approaches are discussed in Part 2.a 
through 2.e of this preamble.
a. Modification of Current De Minimis Partner Rule
    A commenter suggested amending the current de minimis partner rule 
by providing that the de minimis partner rule applies only if: (i) de 
minimis partners own less than a specified aggregate percentage (for 
example, 25 percent, 50 percent, or 80 percent) of the partnership; and 
(ii) the partnership has at least two non-de minimis partners.
b. Reasonable Assumptions Approach
    One commenter suggested adopting a ``reasonable assumptions rule'' 
for de minimis partners and indirect partners. This commenter noted 
that a partnership must know the tax attributes of its partners in 
order to determine whether a partnership's allocations are substantial. 
However, this commenter also explained that many partnerships are 
comprised of partners that are passthrough entities and it is difficult 
for these partnerships to obtain information about the tax attributes 
of their ultimate partners. Thus, this commenter recommended that the 
Treasury Department and the IRS permit a partnership to make reasonable 
assumptions about: (1) The tax attributes of any partner that owns 
(directly, indirectly, and through attribution) not more than a 5 
percent interest in the capital or profits of the partnership (each, a 
de minimis partner); and (2) the identity and tax attributes of any 
person that owns an interest in the partnership indirectly

[[Page 76381]]

through one or more ``look-through entities'' (within the meaning of 
Sec.  1.704-1(b)(2)(iii)(d)(2)) other than disregarded entities (each, 
an indirect partner). Under this approach, if a partnership makes 
reasonable inquiries regarding the tax attributes of all de minimis 
partners and indirect partners but is unable to obtain the necessary 
information, then the partnership would be permitted to make reasonable 
assumptions about the tax attributes of those partners, but only if, in 
the aggregate, those de minimis partners and indirect partners do not 
own more than a 30 percent interest in the profits and capital of the 
partnership.
    This commenter further explained that, provided the partnership's 
assumptions are reasonable, allocations that would be substantial on 
the basis of those reasonable assumptions would be respected even if 
those assumptions later are determined to have been incorrect. 
According to this commenter, whether a partnership's assumptions are 
reasonable should be determined based on all of the facts and 
circumstances. This commenter provided several examples of reasonable 
and unreasonable assumptions (for example, if a partner is identifiable 
(by its name or otherwise) as a charitable organization or educational 
institution, it would be unreasonable for a partnership to assume that 
the partner is a fully taxable individual or corporation).
    Similarly, another commenter suggested that the IRS establish 
``reasonable presumptions'' as to the tax attributes of the owners of 
certain look-through entity partners. According to this commenter, 
these presumptions should be limited to situations in which the 
partnership does not know or have reason to know of the tax attributes 
of the owner of the look-through entity partner.
c. Safe Harbor Presumptions
    Another commenter recommended that the Treasury Department and the 
IRS establish safe harbor presumptions for the tax attributes of de 
minimis partners that do not qualify for the de minimis partner rule 
and partners that own, directly or indirectly, through a look-through 
entity, less than 10 percent of the capital and profits of the 
partnership and are allocated less than 10 percent of each partnership 
item. The commenter proposed several safe harbor presumptions regarding 
the relevant tax attributes of such a partner based on the type of 
partner (for example, if the partner is a nonresident alien) and the 
type of income the partnership earns (for example, if the partnership 
earns effectively connected income).
d. Deemed Satisfaction of Section 704(b) in Limited Situations
    Another commenter suggested amending the section 704(b) regulations 
to provide that in a limited number of situations, the partnership 
would be deemed to satisfy the partnership allocation regulations. 
According to this commenter, deemed satisfaction would apply to 
partnerships that qualify, for the current tax year and all prior tax 
years, as pro rata partnerships, de minimis service partnerships, or de 
minimis partnerships with de minimis partners. A partnership would be 
considered a pro rata partnership if all contributions to the 
partnership are cash; all items of partnership income, gain, loss, 
deduction, and credit are allocated pro rata based on the partners' 
relative contributions; all partnership liabilities are shared pro rata 
based on the partners' relative contributions; and all partnership 
distributions are made pro rata based on the partners' relative 
contributions. A partnership would qualify as a de minimis service 
partnership if the partnership has gross receipts of $5 million or less 
in each taxable year, 95 percent of the partnership's gross receipts is 
derived from services, and all partners are individuals who materially 
participate in the services of the partnership within the meaning of 
section 469(h). A partnership would be considered a de minimis 
partnership with de minimis partners if the aggregate fair market value 
(net of partnership liabilities) or tax basis of partnership property 
is $5 million or less at all times during the partnership taxable year, 
the partnership has gross receipts of $5 million or less in each 
taxable year, and no partner is allocated more than 10 percent of any 
partnership item.
e. Other Alternative Approaches
    Commenters offered other alternative approaches, including lowering 
the de minimis percentage interest threshold and the income allocation 
threshold; providing a limitation or threshold on the amount of net 
taxable income that is reasonably expected to be earned by the 
partnership or allocated to the de minimis partner each year; 
prohibiting reliance on the de minimis partner rule if the partnership 
knows (or has reason to know) of the relevant tax attributes of the de 
minimis partner and such attributes would cause the allocations not to 
have substantial economic effect; or promulgating separate de minimis 
partner rules for large and small partnerships.
    The Treasury Department and the IRS believe that the alternative 
approaches to reduce the burden of complying with the substantial 
economic effect rules described in Part 2.a through 2.e of this 
preamble require further consideration due to the issues raised by the 
complexity of the substantiality rules. Although commenters suggested 
that removal of the de minimis rule without providing other 
administrative relief would result in undue burden, the Treasury 
Department and the IRS have determined that tax administration is best 
served by providing in the final regulations that the current de 
minimis rule will no longer be applicable. The Treasury Department and 
the IRS may address alternative approaches in future guidance, and will 
consider the comments on alternative approaches at that time.

3. Effective/Applicability Date

    Whether an allocation is considered to be substantial is generally 
determined at the time the allocation becomes part of the partnership 
agreement. The final regulations provide that the de minimis partner 
rule does not apply to allocations that become part of the partnership 
agreement on or after December 28, 2012.
    With respect to existing allocations, one commenter suggested that 
the de minimis partner rule was sufficiently flawed that it should be 
promptly removed, and that it should not continue to apply to 
allocations that became part of the partnership agreement prior to its 
removal. The Treasury Department and the IRS agree with this comment. 
Accordingly, these final regulations are effective, and therefore the 
de minimis partner rule of Sec.  1.704-1(b)(2)(iii)(e) is no longer 
applicable, for all partnership taxable years beginning on or after 
December 28, 2012, regardless of when the allocation became part of the 
partnership agreement. Thus, the substantiality of all partnership 
allocations, regardless of when they became part of the partnership 
agreement, must be retested without the benefit of the de minimis 
partner rule. For allocations in existing partnership agreements, the 
retest has to be as of the first day of the first partnership taxable 
year beginning on or after December 28, 2012.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory

[[Page 76382]]

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, these regulations have been submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business, and no comments were received.

Drafting Information

    The principal author of these final regulations is Michala Irons, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the Treasury Department and 
the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.704-1(b)(2)(iii)(e) is revised to read as follows:


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (2) * * *
    (iii) * * *
    (e) De minimis rule--(1) Partnership taxable years beginning after 
May 19, 2008 and beginning before December 28, 2012. Except as provided 
in paragraph (b)(2)(iii)(e)(2) of this section, for purposes of 
applying this paragraph (b)(2)(iii), for partnership taxable years 
beginning after May 19, 2008 and beginning before December 28, 2012, 
the tax attributes of de minimis partners need not be taken into 
account. For purposes of this paragraph (b)(2)(iii)(e)(1), a de minimis 
partner is any partner, including a look-through entity that owns, 
directly or indirectly, less than 10 percent of the capital and profits 
of a partnership, and who is allocated less than 10 percent of each 
partnership item of income, gain, loss, deduction, and credit. See 
paragraph (b)(2)(iii)(d)(6) of this section for the definition of 
indirect ownership.
    (2) Nonapplicability of de minimis rule. (i) Allocations that 
become part of the partnership agreement on or after December 28, 2012. 
Paragraph (b)(2)(iii)(e)(1) of this section does not apply to 
allocations that become part of the partnership agreement on or after 
December 28, 2012.
    (ii) Retest for allocations that become part of the partnership 
agreement prior to December 28, 2012. If the de minimis partner rule of 
paragraph (b)(2)(iii)(e)(1) of this section was relied upon in testing 
the substantiality of allocations that became part of the partnership 
agreement before December 28, 2012, such allocations must be retested 
on the first day of the first partnership taxable year beginning on or 
after December 28, 2012, without regard to paragraph (b)(2)(iii)(e)(1) 
of this section.

Steven T. Miller
Deputy Commissioner for Services and Enforcement.
    Approved: December 19, 2012.
 Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-31155 Filed 12-21-12; 4:15 pm]
BILLING CODE 4830-01-P