The ABA Tax Section has submitted comments to the IRS on Partnership Equity for Services (12/29/05) (41 pages). Here is the Executive Summary:
In Notice 2000-29 (the “Notice”), the IRS and the Treasury requested public comment on “the tax consequences to the recipient of the partnership interest as well as to the partnership upon the exercise of a partnership option or conversion of a debt or preferred interest in that partnership.” Comments of individual members of the Section of Taxation’s Partnerships and LLCs, Real Estate and Employee Benefits committees were submitted to the Treasury in response to the Notice dated January 30, 2002. REG-103580-023 requested further comments to be submitted to the Treasury, both on the proposed regulations promulgated pursuant to such document (the “NonCompensatory Proposed Regulations”) and on other issues. Comments of individual members of the Section of Taxation’s Partnerships and LLCs, Real Estate and Employee Benefits committees were submitted to the Treasury in response to the NonCompensatory Proposed Regulations dated October 9, 2003. By REG 105346-03, the Treasury and the Service promulgated proposed regulations regarding the transfer of interests in partnerships in connection with the performance of services for the transferring partnership (the “Proposed Regulations”). In conjunction with the Proposed Regulations, the Treasury and the Service issued Notice 2005-43, which contained a proposed revenue procedure that is proposed to be finalized simultaneously with the Proposed Regulations (the “Proposed Rev Proc” and, collectively with the Proposed Regulations, the “Proposals”). These comments address certain issues raised by the Proposals.
We applaud the Treasury and the Service for the Proposals, which we believe take substantial steps forward in clarifying the issues related to transfers of partnership interests in connection with the performance of services (“Compensatory Interests”). For the significant reasons set out in the Original Comments, we particularly support the position taken in the Proposals regarding the application of section 721 to the grant of Compensatory Interests. However, we recommend, when the Proposed Regulations are promulgated as final regulations (the “Final Regulations”) and the Proposed Rev Proc is issued in final form (the “Final Rev Proc” and, collectively with the Final Regulations, the “Final Authorities”), the Treasury and the Service reconsider several portions of the Proposals to make them more administrable and consistent with other areas of federal tax law. In addition, these comments discuss the application of the Proposals to partnerships in respect of which capital is not a material income producing factor (as described in section 736) (“Service Partnerships”) and point out some of the unique realities of Service Partnerships.
Generally, these comments seek to make the contribution of services by service providers (“SPs”) in exchange for Compensatory Interests consistent with other contributions to partnerships. In this regard, we recommend that the Treasury and the Service reconsider the requirement that the capital account of SPs and the income recognized by SPs on the receipt of a Compensatory Interest must be equal. In the event that they must be equal on receipt, we recommend that a mechanism be available to ensure that, while the requirements of section 83 are met on receipt, the flexibility of subchapter K in allowing partners to obtain the benefit of their bargain be similarly met by adjusting capital accounts to reflect the partners’ economic deal. We also address the interaction of the Proposals with the recently finalized regulations under section 752.
In an effort to ensure consistency with the receipt of other property for services, we recommend that the forfeiture allocations contained in Prop. Treas. Reg. § 1.704-1(b)(4)(xii)(c) (the “Forfeiture Allocations”) be eliminated. Similarly, we recommend that the regulations under section 83 be clarified to provide that a recipient of unvested property for which a section 83(b) election is made only faces disallowance of a deduction as to the income recognized by the SP upon the receipt of the Compensatory Interest (the “Grant Income”), and not any income recognized by the SP after such receipt.
As section 83 can apply to transfers of property to a SP by one party while services are being provided to another party, we make several recommendations to attempt to arrive at consistency where a SP provides services to one partnership and receives a Compensatory Interest in another, related partnership. These recommendations focus on an attempt to find consistency with similar compensatory transfers of property.
In attempting to make the Proposals more administrable, we focused on the election allowed under the Proposed Rev Proc (the “LV Election”). We recommend that the method of, and requirements for, making the LV Election be reconsidered, as well as the consequences of certain events that would terminate the LV Election under the Proposed Rev Proc. We also ask the Treasury and the Service to consider the interaction of the LV Election with disregarded entities.
Finally, in looking at Service Partnerships, our conclusion is primarily that the Final Authorities should reserve the treatment of the Service Partnerships for further study. Service Partnerships have a unique potential for double taxation of the partners, all of whom are SPs and many of whom may be receiving Compensatory Interests annually, monthly, quarterly, etc. To the extent the Final Authorities do address Service Partnerships, we make a few specific recommendations to attempt to eliminate some of the potential traps for the unwary.
