Editor: Kevin D. Anderson, CPA, J.D.
Partners & Partnerships
On Dec. 16, 2013, the IRS issued proposed regulations under Sec. 752 (REG-136984-12) on partnership recourse liabilities and the special rules for related persons. The proposed regulations address issues that are either ambiguous or not covered under the current regulations. In particular, the proposed regulations provide guidance as to when and to what extent a partner is treated as bearing the economic risk of loss for a partnership liability when multiple partners bear the economic risk of loss for the same partnership liability (overlapping economic risk of loss). In addition, the proposed regulations provide guidance for when a partner has an obligation to pay a liability or makes a nonrecourse loan to the partnership (and no other partner bears the economic risk of loss for that liability) and that partner is related to another partner in the partnership.
Background
Under Sec. 752(a), any increase in a partner's share of a partnership's liabilities, or any increase in a partner's individual liabilities by reason of the assumption by that partner of partnership liabilities, is considered a contribution of money by that partner to the partnership. In turn, under Sec. 752(b), any decrease in a partner's share of the partnership's liabilities, or any decrease in a partner's individual liabilities by reason of the partnership's assumption of those individual liabilities, is considered a distribution of money to the partner by the partnership. Regs. Sec. 1.752-1 separates partnership liabilities into two categories: recourse and nonrecourse. A liability is recourse to the extent that a partner or a related person bears the economic risk of loss for that liability under Regs. Sec. 1.752-2 and nonrecourse to the extent that no partner or related person bears the economic risk of loss for that liability under Regs. Sec. 1.752-2.
Overlapping Risk of Loss
Under the current regulations, there is uncertainty about how partners should share a partnership liability when overlapping economic risk of loss exists. For example, two partners might bear the economic risk of loss for the same partnership liability if they both guarantee that liability. The proposed regulations address the overlapping economic risk of loss by adopting a rule contained in Temp. Regs. Sec. 1.752-1T(d)(3)(i) that preceded the existing final regulations under Sec. 752. Under the proposed regulations, where there is overlapping economic risk of loss for a partnership liability, each partner is deemed to bear the economic risk of loss in the ratio of the partner's economic risk of loss over the sum of the economic risks of loss borne by all the partners, as shown in this exhibit.
Tiered Partnerships
Overlapping economic risk of loss may also result from a tiered partnership structure.
Under Regs. Sec. 1.752-2(i), if a partnership (the upper-tier partnership) owns (directly or indirectly through one or more partnerships) an interest in another partnership (the lower-tier partnership), the liabilities of the lower-tier partnership are allocated to the upper-tier partnership in an amount equal to the sum of (1) the amount of the economic risk of loss that the upper-tier partnership bears for the liabilities and (2) any other amount of the liabilities for which partners of the upper-tier partnership bear the economic risk of loss.
Prop. Regs. Sec. 1.752-2(i)(2) provides that rule number (2) above does not apply if the upper-tier partner is also a partner in the lower-tier partnership. In that case, the liabilities would be allocated directly to the upper-tier partner on the partner's Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc. , from the lower-tier partnership and not through the upper-tier partnership.
Related-Party Rules
Constructive ownership of stock: Under Regs. Sec. 1.752-4(b)(1), a person is related to a partner if the person and the partner bear a relationship to each other that is specified in Sec. 267(b) or Sec. 707(b)(1), except for the following: "80 percent or more" is substituted for "more than 50 percent" each place it appears in those sections; a person's family is determined by excluding brothers and sisters; and Secs. 267(e)(1) and 267(f)(1)(A), containing related-person rules for passthrough entities and controlled groups, are disregarded.
The constructive-ownership-of-stock rules under Sec. 267(c)(1) provide that stock owned, directly or indirectly, by or for a partnership is considered as being owned proportionately by or for its partners. For example, if a partnership owns all of the stock in a corporation, a partner that owns 80% or more of the interests in the partnership is considered to be related to the corporation under Regs. Sec. 1.752-4(b)(1). Under the current regulations, if the corporation bears the economic risk of loss for a partnership liability, the 80% partner would be allocated the entire liability because of his or her relationship to the corporation. The proposed regulations provide that Sec. 267(c)(1) would not apply under this fact pattern so that the 80% partner would not be treated as related to the corporation.
Person related to multiple partners: Under Regs. Sec. 1.752-4(b)(2)(i), if a person is related to more than one partner in a partnership, the related-party rules are applied by treating the person as related only to the partner with whom there is the highest percentage of related ownership (greatest-percentage rule). In cases when two or more partners have the same percentage of related ownership and no other partner has a greater percentage, the liability is allocated equally among these partners.
Under the proposed regulations, the greatest-percentage rule is removed so that if a person bearing the economic risk of loss is related to more than one partner, those partners share the liability equally.
Related-partner exception to related-party rules: Under Regs. Sec. 1.752-4(b)(2)(iii), persons owning interests directly or indirectly in the same partnership are not treated as related persons for purposes of determining the economic risk of loss borne by each of them for the partnership's liabilities (related-partner exception). The Tax Court in IPO II , 122 T.C. 295 (2004), held that under this rule the related-party exception should be turned off for all purposes between related partners in determining who bears the economic risk of loss for a partnership liability. The IRS believes that under the court's interpretation, the related-party exception could be read to improperly turn off attribution of economic risk of loss between related partners even when none of the related partners directly bears the economic risk of loss.
Therefore, under the proposed regulations, the related-partner exception would apply only where a partner bears the economic risk of loss for a partnership liability.
Conclusion
The proposed regulations provide clarity on a number of unresolved issues pertaining to the allocation of partnership liabilities under Sec. 752, including overlapping risk of loss, allocations in tiered partnerships, and related-party issues.
EditorNotes
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or kdanderson@bdo.com.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.
