1. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Payments for Services and Property Use to Partners Four Options: - 707(a)(1): Treated as payments between unrelated parties. Services no continuous part of integral part of partnership’s functions. - 704: Treated as allocation of income to partner. - 707(c): Treated as guaranteed payment to partner unrelated to partnership income. Treated as unrelated party payment for purposes of 61, 162 and 263. Here services part of integral part of partnership’s functions. - 707(a)(2)(A): Disguised 707(a)(1) payment – unrelated parties treatment. Significance of different options: Can impact capitalization of payment, character of income and timing recognition.

2. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Disguised 707(a)(1) payments Factors: 1.Risk as to amount. 2.Transitory partnership status. 3.Allocation close in time to services. 4.Primary purpose of partnership status is tax avoidance. 5.Partnership interest relatively small in relation to size of allocation.

3. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 230 – 1 (a)Services within 707(a)(1) – not in capacity as partner. Services by partner which are ongoing and within normal scope of partnership usually outside scope of 707(a)(1) and are governed by 707(c) or 704. Often no substantive difference. Armstrong case questionable law on conferring employee statue on partners – very difficult, almost always treated as independent contractors. (b)Statutory benefits that come with employee status: - Section 79 group health insurance - Section 105 and 106 health insurance and medical reimbursement plans - Section 119 meals and lodging exclusion - Section 132 excludable fringe benefits Do not count on these for partner.

4. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 230 – 2 Facts: AB partnership in real estate development. AB paid partner B 5k for legal services in dispute regarding title to purchased land. - 5k income to B under 707(a)(1); services not integral part of partnership operations. - 5k capitalized by partnership and added to basis of land. See Rev. Rule 81-301.

5. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 236 – 1 Facts: A, cash basis taxpayer, partner of ABCD partnership, with 10k basis in partnership interest. A owns depreciable property – basis 2k, FMV 15k, fair rental value 1k per year. Partnership uses A’s property and has income of 10k per year. (a)A lease to partnership for 1k per year for three years. Per 707(a)(1), A has 1k income per year and partnership has 1k rental expense. If rent not paid in any year and not included in A income, no deduction for partnership per 267(a) and (e). Matching required. (b)Payments made 1/31 after close of year. No deduction to partnership until A includes. 267(a) and (e).

6. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 236 – 1 (c) Partner A allocated 1k net income per year before allocation to all partners. 707(a)(2)(A) requires treatment as payment to non-partner if such under all facts and circumstances. Here question is risk of income to pay special allocation. If no real risk (likely here), 707(a)(2)(A) would trigger 707(a)(1) and result would be same as in (a) as payment to none partner. If net income risky, then allocation under 704. First 1k to A and then balance of 9k each year between partners. What if front loaded 3k in year 1? If under 707(a), A has 3k income in year 1 and partnership would deduct 3k over three year period. If 704 allocation because of risk of income sufficiency, A allocated 3k of partnership 3k income in year 1 and partners just divide remaining 7k balance. 704 has effect of accelerating entity deduction for payment.

7. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 236 – 2 Facts: Architect partner (25%) takes 40k special gross income allocation from partnership rather than 40k fee for services to partnership. 707(a)(2)(A) would require 707(a) treatment – payment to non- partner because: - Fixed in amount and no risk of not having sufficient gross income - Partnership interest relatively small in relation to allocation. - Allocation close in time to services - Not unreasonable to conclude the deal was structured for tax avoidance reasons. To preclude capitalization of architect’s fee.

8. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 1 Facts: AB partnership – unstable earnings; current yr 12k ordinary income, 8k capital gain; A and B equal partners; A renders continuous services, related to partnership function, not capital related. (a)A paid 15k per year unrelated to partnership income. Per 707(c), A has 15k guaranteed payment. Ordinary income to A and 15k 162 deduction to partnership which reduced ordinary income to loss of 3k. No impact on capital gain. (b)Services of A relate to land improvement? Per Gaines case, still guaranteed payment under 707(c), taxable in full to A when partnership accounts for transaction at partnership level. Fully taxable to A even though partnership must capitalize expenditure.

9. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 1 Facts: AB partnership – unstable earnings; current yr 12k ordinary income, 8k capital gain; A and B equal partners; A renders continuous services, related to partnership function, not capital related. (c)Deal is A gets 15k or 50% of profits, whichever greater. 50% of AB 20k profits is 10k, meaning only 5k (excess of 15k over 10k) is guaranteed payment per Rev. Rule 69-180. Thus, 5k taxed to A per 707(c) and deducted by partnership, reducing ordinary income to 7k. Since 10k of remaining 15k partnership profits (20k – 5k) go to A, A allocated 2/3 remaining 7k ordinary income and 3/3 8k capital gain. B gets other 1/3 of each. (d)What result if A rights for guaranteed return on capital, not services? Same results.

10. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 2 Facts: G, cash basis taxpayer, 1/3 partner of FGH, accrual method. G entitled to 10k guaranteed payment for services in year 1, payable in year 3. G basis zero. In year 2, partnership sells asset for cost and distributes 5k to each partner. - G required to recognize 10k income in year 1 because that is year of partnership deduction, per 707(c), Gaines case and Reg. 1.707-1(c). If G basis increase, 5k in year 2 return of capital. If no basis increase, just unrelated receivable, then 5k distribution in excess of basis taxable. Issue unresolved, but Gaines suggested in dicta basis increase.

11. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 3 Rev. Rule 69-180: Payment of guaranteed payment or % of income, whichever greater. Could it be 707(a)(1) payment? Yes, if not for continuous services related to partnership. Then, likely result is entire portion paid to A (the higher of two) would be treated under 707(a)(1) – ordinary income to partner and deductible by partnership.

12. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 4 Facts: Partner, cash basis, renders 10k services to accrual partnership which has 75k ordinary income and 25k capital gain. Partnership makes no payment to P in year 1, but desires to deduct accrual where appropriate. (a)Partnership allocates first 10k profits to P under 704. P has 10k income on allocation – 7.5k ordinary and 2.5k capital gain. Partnership balance of income reduced accordingly. (b)707(a)(1) applies to 10k – to unrelated party. P has 10k income when received. Per 267(a) and (e), no deduction to partnership until P book income. Hence, no deduction in year 1 for partnership. (c)707(c) applies as guaranteed payment. Partnership gets deduction in year of accrual. Per Reg. 707-1(c), P has 10k income in year 1, year of deduction, even though not paid. Gaines case

13. Corporate & Partner Tax Instructor: Dwight Drake ```````````````````````````````````````````` ```````````````````````````````````````` Problem 246 – 4 Facts: Partner, cash basis, renders 10k services to accrual partnership which has 75k ordinary income and 25k capital gain. Partnership makes no payment to P in year 1, but desires to deduct accrual where appropriate. (d) 10k treated under 707(a)(2)(a) as 707(a)(1) payment. Same as (b). Income to P only when received and only then deductible by partnership per 267(a) and (e).