Global Tax Insights
New IRS Regulations on Allocating Debt to Partners and LLC MembersNovember 07, 2016
Are you in a partnership? There are new regulations that might impact your investments in partnerships and limited liability companies (LLCs).
The IRS released new regulations (temporary and final) regarding Section 752 of the Internal Revenue Code on October 5th, 2016. The regulations explain how to allocate partnership debt among partners for purposes of calculating the basis of their partnership interests. Below are some of the most important changes included under the new Section 752 regulations that could affect your partnership and LLC investments.
Under the final Section 752 rules:
- A partner’s share of partnership liabilities is added to the partner’s ‘outside basis,’ in other words, their basis for deducting losses and receiving tax-free distributions. This gives the partner more leeway when it comes to deducting partnership losses, and it is easier for a partner to gain tax-free partnership distributions under this rule.
- A reduction in the partner’s share of partnership liabilities, on the other hand, is treated as a deemed cash distribution that reduces the partner’s ‘outside basis’. This results in phantom taxable income to the partner.
New ‘temporary’ regulations
‘Temporary’ regulations have the same authority as final regulations, except that they can be amended before being issued as officially ‘final’.
Under the temporary regulations:
- Defining a payment obligation: Defining the extent to which a partner or related person has a ‘payment obligation,’ with respect to a recourse liability (debt for which the borrower is personally responsible), is now based on the facts and circumstances at the time of the determination.
- “Bottom-dollar” guarantees no longer recognized as recourse: To allocate recourse liabilities among partners under the Sec. 752 rules, partners do not recognize a “bottom-dollar payment obligation”. This means “exculpatory liabilities” (debts secured by all partnership property) are recognized as nonrecourse debts instead. These new regulations are effective for liabilities incurred on or after October 5, 2016 (certain exceptions allowed)
Under the new guidance, partners that executed bottom-dollar guarantees in the past may benefit from a transition rule allowing them to continue to apply the old rules.
Non-recourse liabilities- important changes
The Sec. 752 Regulations have always required partnerships to allocate “non-recourse liabilities” (secured loans that are secured by a pledge of collateral, usually property; borrower not personally liable) among all partners involved. Under the current law, there is a three tier method used. The last tier applies to something called “excess nonrecourse liabilities” which are allocated according to the partners’ percentage shares of partnership profits.
A new regulation follows that the partnership agreement can specify the partners’ percentage interests in partnership profits to calculate excess non-recourse liabilities. The percentages must be reasonably consistent with legal distributions of some other significant item of partnership income or gain (“significant item method” of allocating this value).
The temporary and final changes are extremely complex. Consult your tax advisor for full guidance on how the modified Sec. 752 rules will affect your LLC or partnership. We can help—contact us today.