Reproduced with permission from Daily Tax Report 148 DTR G-8, (Aug. 3, 2015). Copyright 2015 by The Bureau of National Affairs, Inc. (800-372-1033) <http://www.bna.com>
July 31 — Internal Revenue Service final rules on determining a partner's distributive shares allow partnerships greater flexibility in how they account for variations.
The final rules (T.D. 9728), issued July 31, say that the partnership may select a new method each time a variation occurs, moving back and forth between the interim closing method and the proration method when accounting for changes, such as when a new partner joins, or a partner sells a partnership interest.
“In rules the IRS proposed in 2009, no matter how many variations occurred during the taxable year, whether it was two or 10, the partner had to use the same method to account for every one of those changes,” Michael J. Grace, counsel with Whiteford Taylor & Preston LLP, told Bloomberg BNA July 31.
He said most partnerships will like the idea that they are no longer locked into one particular method of accounting.
Proposed rules (REG-109370-10, RIN 1545-BJ34) were also released July 31, dealing with the determination of a partner's distributive share of allocable cash-basis items, and items attributable to an interest in a lower-tier partnership taxable year when there are partner interest changes. However, they drew far less attention, as practitioners focused on important changes in the final rules.
Michael J. Greenwald, a partner with Friedman LLP, said the final rule is sensitive to the needs of different sized partnerships. “Some partnerships don't maintain monthly books and don't have the ability to do interim closings, but may have a situation where that is necessary,” he told Bloomberg BNA July 31. “In general they would prefer to use prorations so the ability to do both is very helpful to those kinds of partnerships.”
The final rules also include a small-item exception for extraordinary items, Greenwald and Grace said.
If the total of all extraordinary items in a class of extraordinary items is less than 5 percent of gross income and certain other tests are met, they can be treated separately from other extraordinary items, Greenwald said. The new rules include examples for handling that situation.
Extraordinary items include payment of a tort liability or judgment and selling or abandoning a particular asset.
Extraordinary items were a significant issue with 2014 tax year returns, as partnerships attempted to deal with tax code Section 481(a) adjustments (adjustments for changes in accounting methods) in relation to the tangible property regulations, Greenwald said.
Previously all 481(a) adjustments were extraordinary items, but it appears that under the new rules they won't all be treated that way. It will just be those that are initiated after a variation occurs, he said.
Grace pointed to another positive aspect in the final rules—a flow chart, or decision tree, that will help users allocate items. He said this step-by-step road map will make it easier for a broad range of users to understand them.
However, on the extraordinary items, Grace said the requirement that the partnership allocate extraordinary items among partners in proportion to their interests in that item at the time of the day on which the item occurred, is “taking a step backward from the 2009 regulations and will prove difficult to comply with.” The 2009 rules allowed partnerships to allocate items at the beginning of the calendar day.
“Partnerships transactions involve multiple steps, and practitioners are always trying to figure out the order we want them to occur, but it's very rare that anyone is sitting around saying ‘we want to make sure step B occurs at 2 p.m.,'” he said.
Proposed Rule De Minimis Exception
That issue of timing occurs under both the final and the proposed rules, Grace said. The final rules adopt, with changes, the 2009 rules, whereas the proposed rules are entirely new guidance under certain subsections of Section 706.
The proposed rules interpret Section 706(d)(2) and 706(d)(3), Grace said. The proposed rules deal with the topic of allocating cash-basis items. They cover it from a general perspective for all partnerships and apply special rules for an upper-tier partnership owning an interest in a lower-tier partnership.
The upper-tier/lower-tier part of the rules includes a de minimis exception that isn't in the tax code, making it appear to be a rule of administrative convenience that practitioners will welcome, Grace said. There are also several examples that coordinate with partnership special basis adjustments, under Section 734(b) and 743(b).
The final and proposed rules are set to appear in the Federal Register Aug. 3.