Document Type

Article

Publication Date

2004

Abstract

If a partnership makes a payment to a partner for services rendered in the latter's capacity as a partner or for the use of capital, to the extent that the payment is determined without regard to partnership income, it is characterized by the Internal Revenue Code as a "guaranteed payment" and is treated differently from other partnership distributions.' In addition, if a partnership makes a payment in liquidation of a retiring or deceased partner's interest in the partnership, part of that payment may be characterized as a guaranteed payment by section 736(a)(2). We will discuss in Part VI of this article the circumstances when a liquidating payment is treated as a "guaranteed payment." While section 707(c) and 736(a) refer to a "payment," there is no reason that it must be made in cash, and the leading treatises on partnership taxation agree that guaranteed payments can be made in kind.2 As used in this article, a "liquidating" distribution or payment refers to a partnership distribution or payment made pursuant to the liquidation of a partner's interest in the partnership. All other partnership distributions or payments are sometimes referred to as "operating" distributions or payments. An unresolved question is whether a guaranteed payment of property in kind will cause the partnership that made the payment to recognize gain or loss if the property is appreciated or depreciated. Even if the answer to that question were affirmative, and the authors have concluded otherwise, no deduction would be allowed for a loss recognized on a payment to a person owning, directly or indirectly, more than a 50 % interest in the profits or capital of the partnership.3 In this article, the authors will focus on the question of the partnership's recognition of gain or loss, and will not examine questions of deductibility for a recognized loss. Two allied unresolved questions, which are discussed in this article, are: (1) how is a partner's basis in property that was received as a guaranteed payment to be determined, and (2) regardless of whether the guaranteed payment is made in cash or in kind, what effect does the payment have on the partner's outside basis in his partnership interest. The McKee treatise concludes that the proper treatment of guaranteed payments made in kind is that the partnership will recognize gain or loss for the amount of appreciation or depreciation of the property, and that the partner will have a basis in the property equal to its fair market value.4 While the Willis treatise does not discuss the question of gain or loss recognition, the treatise does consider the basis question in the context of a guaranteed payment made as part of the liquidation of a partner's interest. The Willis treatise concludes that although granting the partner a basis equal to the property's fair market value is the logical and desirable treatment, the statutory authority for that treatment is weak.5 The Willis treatise does not resolve that issue. The Lind casebook states that the partnership will recognize gain or loss, but does not discuss the basis issue.6 In this article, the authors contend that no gain or loss is recognized, and nevertheless, the partner takes a basis in the distributed property equal to its fair market value. The authors also contend that a guaranteed payment does not affect the partner's outside basis in his partnership interest except to the extent that any deduction allowed to the partnership for making the payment is allocated to the partner as his share of a partnership loss. There is no case, regulation or ruling expressly addressing those issues. One possible explanation for this dearth of authority is that guaranteed payments are rarely made in kind except for liquidating payments, and many of those are made in cash. Nevertheless, especially since liquidating distributions are sometimes made with property in kind, the issue is worthy of exploration. The issue may yet be raised by the Service. The question of the effect of a guaranteed payment, whether made in cash or in kind, on the partner's outside basis in his partnership interest will arise frequently. Before examining the question of gain or loss recognition, it is useful to set forth the history and role of section 707(a) and (c). Other Code provisions come into play, especially when considering the basis that a partner will acquire in the distributed property and the effect that the payment will have on the partner's outside basis, but section 707 is at the epicenter of this subject.


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