Procedure when personal and partnership accounts are on different bases.-A partner may have been accustomed to keep his personal accounts on a cash basis, while his firm's accounts are on an accrual basis. In such a case he may continue to keep his personal accounts as before if it is not practicable for him to change to an accrual basis, but in reporting his share of firm profits or losses he must include the entire amount of profit or loss accrued to or incurred by him on the firm's books for the fiscal or calendar year. It is immaterial how or when he receives his share, and whether or not the firm's books include many accrued items.

Dissolution of or changes in partnership.

REGULATION. When a partner retires from a partnership, or it is dissolved, he realizes a gain or loss measured by the difference between the price received for his interest and the cost to him or (if acquired prior thereto) the fair market value as of March 1, 1913, of his interest in the partnership, including in such cost or value the amount of his share in any undistributed partnership net income earned since February 28, 1913, on which the income tax has been paid. If, however, the partnership distributes its assets in kind and not in cash, the partner realizes no gain or loss until he disposes of the property received on distribution. . . . . (Art. 1570.)

....

Upon the dissolution of or a change in a partnership and a distribution of assets in kind it is not probable that any taxable gain or profit would immediately arise. In a distribution upon the basis of book values there is no gain or loss, because it will be assumed that the partners in their individual returns will have accounted for all gains, profits or income which were shown on the books of partnership. When the accounts of the partnership in dissolution are continued a partner may await the result of the transactions for the entire taxable year before taking up in his accounts any gain or loss.

The foregoing regulation refers to the cases where a partner realizes in cash or its equivalent some amount greater or less than is shown in his capital account in the firm's books. The books may show that the book value of a partner's one

half interest in the firm is $50,000. Goodwill is not carried

as an asset.

If the goodwill is valued at $40,000 and sold to the continuing partner or someone else for that amount the retiring partner will receive in cash $70,000. If the goodwill of the business on March 1, 1913, was worth $40,000 the retiring partner will not realize any taxable gain. If the fair market value of the goodwill on March 1, 1913, was $25,000 the retiring partner must report a realized profit of $7,500. If the business was started after March 1, 1913, his taxable profit is $20,000.

As above stated, usually no taxable income arises when distribution is made in kind, but when a distribution in kind involves assets the equivalent of cash the transaction may be deemed to be a realization. A partnership may have purchased United States Steel stock at $50 per share and it may be selling at $100 per share when the partnership is dissolved. If the dissolution of a partnership constitutes a closed transaction it would seem that the stock would have to be distributed to the partners at $100 per share. Certainly it would have to be so valued in the case of an incoming partner.

On the other hand, an individual partner is presumed to have the same privileges as any other individual and if the stock can be distributed in kind it may be quite in order to postpone any return of the appreciation in value until there has been an actual realization.

As the regulations now stand it is not likely that a tax would be assessed on any distribution in kind by a partnership.

Regulation. . . . . appreciation in value of property is not even an accrual of income to a taxpayer prior to the realization of such appreciation through conversion of the property. . . . . (Art. 23.)

Distributions to partners other than in cash.-A partner should return for taxation the exact amount credited to his capital account in the books of the firm at the end of its fiscal year, after deducting tax-exempt interest, etc. Any payments

to a partner charged against his capital account are, of course, not returnable because such payments merely represent distributions of capital or of income already reported and taxed.

The same principle applies to partnership distributions other than in cash. For instance, a firm may own property or securities which it wishes to divide among the partners. The amount at which such items appear on the firm's books as assets determines the book value of the partner's interests therein, and when distribution is made the items should be entered at book valuation.

A firm may carry 1,000 shares of stock at $1,000, representing its cost. If there are two equal partners, there is merged in the capital account of each a credit of $500. The stock may be worth $10,000, but, if distributed direct to the partners when there is no change in partnership interests, the charge to each still should be $500. If charged to the partners at market value, the current profit and loss account would be credited with $9,000, and each partner's account would receive an additional credit of $4,500, upon which he would be taxed, although the shares of stock were not sold.

If the partners kept personal books by the accrual method it would not be improper to carry the stock at its market value if they desired to do so; but this would subject them to tax sooner than would otherwise be necessary.

Partnerships Must File Returns

The 1918 law for the first time requires annual income tax returns from all partnerships. 10 For details, see page 86.

19

Partnerships Composed of Corporations

It has been held that a partnership composed of corporations should be classed as a partnership rather than as a corporation for income tax purposes. In the case referred to,

20

[Former Procedure] Formerly returns from partnerships were required only when requested by the Commissioner.

Haiku Sugar Company et al. v. Johnstone, 249 Fed. 103 (Circuit

Court of Appeals, Ninth Circuit, April 1, 1918).

the laws of Hawaii permitted corporations to become members of a partnership. In many of our states the corporation laws would not permit a corporation to become a general partner. In other states the position is not so clear. The subject is not of enough general interest to warrant a full discussion in these pages, but it may be said that unless the charter of a corporation expressly prohibits its entering into partnership relations with other corporations or with individuals, it may do so, subject to the further possible restriction that the corporation laws of the state may inhibit such relationship.

Limited Partnerships

The Treasury draws a distinction between different types of limited partnerships, regarding one type as corporations and the other type as partnerships for income tax purposes.21

Limited partnerships may or may not be partnerships.REGULATION. So-called limited partnerships of the type authorized by the statutes of New York and most of the States are partnerships and not corporations within the meaning of the statute. Such limited partnerships, which can not limit the liability of the general partners, although the special partners enjoy limited liability so long as they observe the statutory conditions, which are dissolved by the death or attempted transfer of the interest of a general partner, and which can not take real estate or sue in the partnership name, are so like common law partnerships as to render impracticable any differentiation in their treatment for tax purposes. Michigan and Illinois limited partnerships are partnerships. A California special partnership is a partnership. (Art. 1505.)

LIMITED PARTNERSHIP AS CORPORATION.—

REGULATION. On the other hand, limited partnerships of the type of partnerships with limited liability or partnership associations authorized by the statutes of Pennsylvania and of a few other States are only nominally partnerships. Such so-called limited partnerships, offering opportunity for limiting the liability of all the members, providing for the transferability of partnership shares, and capable of holding real estate and bringing suit in the common name,

re

"[Former Procedure] All limited partnerships were formerly considered corporations. (Reg. 33, 1918, Art. 62.)

more truly corporations than partnerships and must make returns of income and pay the tax as corporations. The income received by the members out of the earnings of such limited partnerships will be treated in their personal returns in the same manner as distributions on the stock of corporations. In all doubtful cases limited partnerships will be treated as corporations unless they submit satisfactory proof that they are not in effect so organized. A Michigan partnership association is a corporation. Such a corporation may or may not be a personal service corporation. 22 (Art. 1506.)

24

"Pennsylvania" type of limited partnerships.-Limited partnerships of the Pennsylvania type mentioned above are such as are organized under the act of June 2, 1874.23 The limited or special partnerships, created by the acts of March 21, 1836, April 6, 1870,25 and June 15, 1871,26 are not covered. The matter is discussed in an opinion from the AttorneyGeneral's department." In general, so far as article 1506 applies to limited partnerships created under the act of June 2, 1874, it seems to be sound. Such a limited partnership is a quasi-corporation,28 having many of the characteristics of a corporation. The limited partnerships of 1836, 1870 and 1871 are quite different and are not within the ruling in Coal Company v. Rogers, nor should they be within article 1506.

In the circumstances it would be better to designate limited partnerships, which must be treated throughout as corporations, as being of the "corporation type" rather than the "Pennsylvania type." It should be noted that article 1506 as amended November 6, 1919, provides that, “a Michigan partnership association is a corporation." The article as originally issued declared that Virginia partnership associations also are corporations.

22This is an amendment of Reg. 45, Art. 1506 (April 17, 1919, edition), issued as T. D. 2943 (November 6, 1919). The previous regulation held that Virginia partnership associations were corporations.

23P. L. 271.

24P. L. 143.

25P. L. 56.

26 P. L. 389.

5 District Reports 288.

2Coal Co. v. Rogers, 108 Pa. 147.