c. Transactions between partners and partnerships Present Law Present law provides that, in general, no gain or loss is recognized by a partnership or its partners when property is contributed to the partnership in exchange for a partnership interest. Gain or loss generally is recognized, by contrast, when property is sold. In cases where there is a transfer of money or other property by a partner to a partnership, and a transfer of property or money by the partnership to a partner that, when viewed together, are properly characterized as a sale or exchange, then the transfers are generally treated as such, and the transferor of the property is treated as recognizing gain (or loss, if any). It is not completely clear whether present law treats certain types of transactions as nontaxable contributions to a partnership, or as a sale or exchange between the contributor and the partnership. For example, when a person contributes appreciated property, subject to debt, to a partnership in exchange for a partnership interest, and the partnership then uses the proceeds of sales of other partnership interests to pay off the debt encumbering the appreciated property, it is not completely clear that the transaction is equivalent to a transfer of money or other property to the contributing partner. Possible Proposal Where encumbered property is contributed to a partnership and proceeds of sales of partnership interests are used to pay the debt encumbering the property, the person who contributed the property could be treated as receiving a transfer of money or other property from the partnership in a taxable sale or exchange. Arguments for the proposal Pros and Cons 1. A person such as a corporation that improves its economic position by exchanging debt-encumbered property for an interest in a partnership that promptly pays off the debt with funds contributed by new partners, should be treated for tax purposes as it is treated for financial and economic purposes: as having gained in the transaction. 2. The proposal would treat similarly transactions that are essentially equivalent to each other in substance and differ only in form. Arguments against the proposal 1. It is inappropriate to raise a tax law obstacle to having taxpayers such as corporations remove liabilities from their books so that stock prices reflect more accurately the true value of the corporation's business. 2. Making contributions of property to partnerships less attractive from a tax standpoint, e.g., in the case of corporate contributors, takes away one of the means of fending off hostile corporate takeovers, and merely perpetuates the recent wave of takeovers (which has been criticized as not contributing to healthy growth of the economy). d. Partnership-level income computation Present Law Under present law, a partnership is not subject to tax at the partnership level, but rather, each partner's share of separately calculated items and of overall income and loss of the partnership is subject to tax at the partner's level. The partnership agreement may provide for special allocations of items of income, gain, loss, deduction or credit to particular partners, provided the allocation satisfies standards (set forth in Treasury regulations) requiring that special allocations have substantial economic effect. A partnership can thus pass through net income or losses to its partners, or can pass through deductions or other tax benefits to particular partners, and taxable income to other partners. A partner's share of partnership income is generally determined without regard to whether he receives any corresponding cash distributions. Present law provides several limitations on the deductibility of losses and on other tax benefits passed through partnerships (e.g., the passive loss rule, the at-risk rule, and partnership tax rules limiting partners' losses to their basis in their partnership interests). Under the passive loss rule, activities of limited partnerships are treated as passive activities; except as provided in regulations (which have not been issued), income or loss passed through from limited partnerships is treated as passive. Income from limited partnership activities can consequently be treated as passive and can offset losses that would otherwise be deferred until disposition, under the passive loss rule. Such income-producing limited partnerships have been referred to and publicly marketed as so-called passive income generators. Possible Proposal Limited partnerships could be treated as entities that do not pass through tax losses, deductions or credits to limited partners. Net income of the entity would be subject to only one level of tax (at the partner level). Income of the entity would be treated as portfolio (rather than passive) income under the passive loss rule in the hands of the owners of the entity. Alternatively, this proposal could be applied to a narrower class of partnerships (e.g., publicly offered or publicly traded limited partnerships). Arguments for the proposal Pros and Cons 1. Limited partnerships that pass through net income can be used to avoid the passive loss limitations, which the Congress just adopted to stop tax shelters and regain public confidence in the fairness of the tax system. 2. Treating publicly offered limited partnerships as subject to one level of tax on distributed net income creates a more level playing field in comparison to other business entities not taxed as corporations. 3. The proposal would prevent erosion of the corporate tax base and solve some of the issues relating to master limited partnerships by making it more likely that at least one level of tax is collected on the income of all types of business entities. Arguments against the proposal 1. Owners of interests in such entities could still receive tax-free cash distributions, where the entity operates at a tax loss and has no net income that would be taxable to owners. 2. The proposal removes much of the flexibility that the partnership tax provisions were designed to have, and consequently denies limited partnerships the ability to have their tax treatment parallel the complexities of the economic arrangements of the partners. 3. The proposal is not needed because regulatory authority is already provided to treat net income from limited partnerships as portfolio income under the passive loss rule. 11. Depreciation Provisions a. Determine recovery period of property by reference to 125 percent of lease or other contract term Present Law In general, under the Accelerated Cost Recovery System ("ACRS"), property is assigned among recovery classes on the basis of midpoint lives under the prior law Asset Depreciation Range ("ADR") system, as in effect on January 1, 1986. ADR midpoint lives were derived from data on how long taxpayers who provided information held the assets. The Treasury Department is authorized to prescribe new ADR midpoints based on an asset's anticipated "useful" life (rather than "service" life). Under the alternative depreciation system used for property for which which less generous depreciation is provided, the recovery periods used are also based on ADR midpoint lives. Property that is leased to or used by a tax-exempt person ("tax-exempt use property") is subject to the alternative depreciation system; however, the recovery period used is not less than 125 percent of the lease term if that period is longer than the depreciation period otherwise applicable. ACRS deductions are allowed only to the owner of property for Federal income tax purposes. Although the determination of ownership is inherently factual, general principles were developed in court cases, revenue rulings, and revenue procedures. These principles focus on the economic substance of a transaction, not its form. Thus, in a purported lease or similar arrangement, the person claiming ownership must show that he has sufficient economic indicia of ownership. To give taxpayers guidance in structuring leveraged leases (i.e., leases in which the property is financed by a nonrecourse loan from a third party) of equipment, the Internal Revenue Service ("IRS") issued revenue procedures (the "guidelines"). If the requirements of the guidelines were met, the IRS generally issued an advance letter ruling that the transaction was a lease and the lessor would be treated as the owner for Federal income tax purposes. Under the guidelines, the lessor must demonstrate that a remaining useful life of at least 20 percent of the originally estimated useful life of the property is the reasonable estimate of what the remaining useful life of the property will be at the end of the lease term. Possible Proposal For purposes of ACRS and all cases to which the alternative depreciation system applies, determine the recovery period of property by reference to the longer of 125% of a lease (or other contract) |