Publication 541 (Rev. January 2016) P541
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Department of the Treasury Internal Revenue Service Publication 541 (Rev. January 2016) Contents Cat. No. 15071D Reminder . . . . . . . . . . . . . . . . . . . . 1 Partnerships Introduction . . . . . . . . . . . . . . . . . . 1 Forming a Partnership . . . . . . . . . . . . 2 Terminating a Partnership ......... 3 Exclusion From Partnership Rules . . . . 4 Partnership Return (Form 1065) . . . . . . 4 Partnership Distributions . . . . . . . . . . 4 Transactions Between Partnership and Partners . . . . . . . . . . . . . . . 7 Basis of Partner's Interest ......... 9 Disposition of Partner's Interest . . . . . 11 Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) . . . . . . . . . . . . . . . . 13 Index . . . . . . . . . . . . . . . . . . . . . 15 Reminder Photographs of missing children. The Inter nal Revenue Service is a proud partner with the National Center for Missing and Exploited Chil dren. Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1800THELOST (18008435678) if you recognize a child. Introduction This publication provides supplemental federal income tax information for partnerships and partners. It supplements the information provi ded in the Instructions for Form 1065, U. S. Re turn of Partnership Income, and the Partner's In structions for Schedule K1 (Form 1065). Generally, a partnership doesn't pay tax on its income but “passes through” any profits or los ses to its partners. Partners must include part nership items on their tax returns. For a discussion of business expenses a partnership can deduct, see Publication 535, Business Expenses. Members of oil and gas partnerships should read about the deduction for depletion in chapter 9 of that publication. Certain partnerships must have a tax mat ters partner (TMP) who is also a general part ner. For information on the rules for designating a TMP, see Designation of Tax Matters Partner (TMP) in the Form 1065 instructions and sec tion 301.6231(a)(7)1 of the regulations. Get forms and other information faster and easier at: • IRS.gov (English) • IRS.gov/Spanish (Español) • IRS.gov/Chinese (中文) Dec 15, 2015 • IRS.gov/Korean (한국어) • IRS.gov/Russian (Pусский) • IRS.gov/Vietnamese (TiếngViệt) Many rules in this publication do not apply to partnerships that file Form CAUTION 1065-B, U.S. Return of Income for Electing Large Partnerships. For the rules that apply to these partnerships, see the Instructions for Form 1065-B. However, the partners of electing large partnerships can use the rules in this publication except as otherwise noted. ! Withholding on foreign partner or firm. If a partnership acquires a U.S. real property inter est from a foreign person or firm, the partner ship may have to withhold tax on the amount it pays for the property (including cash, the fair market value of other property, and any as sumed liability). If a partnership has income ef fectively connected with a trade or business in the United States, it must withhold on the in come allocable to its foreign partners. A part nership may have to withhold tax on a foreign partner's distributive share of fixed or determi nable income not effectively connected with a U.S. trade or business. A partnership that fails to withhold may be held liable for the tax, appli cable penalties, and interest. For more information, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities. Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions. You can write to: Internal Revenue Service Tax Forms and Publications 1111 Constitution Ave. NW, IR6526 Washington, DC 20224 We respond to many letters by telephone. Therefore, it would be helpful if you would in clude your daytime phone number, including the area code, in your correspondence. You can send us comments from www.irs.gov/formspubs. Click on “More Infor mation” and then on “Give us feedback.” Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products. Tax questions. If you have a tax question, go to IRS.gov and click on the Help & Resour ces tab for more information. We cannot an swer tax questions at the address listed above. Ordering forms and publications. Visit www.irs.gov/formspubs to download forms and publications, or write to one of the addresses shown under How To Get Tax Help in the back of this publication. Online payment agreements. Make a payment using one of several safe and conven ient electronic payment options available on IRS.gov. Select the Payments tab on the front page of IRS.gov for more information. Deter mine if you are eligible and submit an Online Payment Agreement Application if you owe more tax than you can pay today. Useful Items You may want to see: Publication 334 Tax Guide for Small Business 505 Tax Withholding and Estimated Tax 535 Business Expenses 537 Installment Sales 538 Accounting Periods and Methods 544 Sales and Other Dispositions of Assets 551 Basis of Assets 925 Passive Activity and AtRisk Rules 946 How To Depreciate Property See How To Get Tax Help near the end of this publication for information about getting publi cations and forms. Forming a Partnership The following sections contain general informa tion about partnerships. Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a part nership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. However, a joint undertaking merely to share expenses is not a partnership. For example, coownership of property maintained and rented or leased is not a partnership unless the coowners provide services to the tenants. The rules you must use to determine whether an organization is classified as a part nership changed for organizations formed after 1996. Organizations formed after 1996. An organi zation formed after 1996 is classified as a part nership for federal tax purposes if it has two or more members and it is none of the following. An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. An organization formed under a state law that refers to it as a jointstock company or jointstock association. An insurance company. Certain banks. An organization wholly owned by a state, local, or foreign government. An organization specifically required to be taxed as a corporation by the Internal Rev enue Code (for example, certain publicly traded partnerships). Certain foreign organizations identified in section 301.77012(b)(8) of the regula tions. A taxexempt organization. A real estate investment trust. Page 2 An organization classified as a trust under section 301.77014 of the regulations or otherwise subject to special treatment un der the Internal Revenue Code. Any other organization that elects to be classified as a corporation by filing Form 8832. For more information, see the instructions for Form 8832. Limited liability company. A limited liabil ity company (LLC) is an entity formed under state law by filing articles of organization as an LLC. Unlike a partnership, none of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regula tions section 301.77013. See Form 8832 and section 301.77013 of the regulations for more details. A domestic LLC with at least two members that doesn't file Form 8832 is classified as a partnership for federal income tax purposes. TIP Organizations formed before 1997. An or ganization formed before 1997 and classified as a partnership under the old rules will gener ally continue to be classified as a partnership as long as the organization has at least two mem bers and doesn't elect to be classified as a cor poration by filing Form 8832. Community property. Spouses who own a qualified entity (defined below) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partner ship tax returns. They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. A change in reporting posi tion will be treated for federal tax purposes as a conversion of the entity. A qualified entity is a business entity that meets all the following requirements. The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a pos session of the United States. No person other than one or both spouses would be considered an owner for federal tax purposes. The business entity is not treated as a cor poration. For more information about community property, see Publication 555, Community Property. Publication 555 discusses the com munity property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Family Partnership Members of a family can be partners. However, family members (or any other person) will be recognized as partners only if one of the follow ing requirements is met. If capital is a material incomeproducing factor, they acquired their capital interest in a bona fide transaction (even if by gift or Publication 541 (January 2016) purchase from another family member), actually own the partnership interest, and actually control the interest. If capital is not a material incomeproduc ing factor, they joined together in good faith to conduct a business. They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. Capital is material. Capital is a material in comeproducing factor if a substantial part of the gross income of the business comes from the use of capital. Capital is ordinarily an in comeproducing factor if the operation of the business requires substantial inventories or in vestments in plants, machinery, or equipment. Capital is not material. In general, capital is not a material incomeproducing factor if the in come of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. Capital interest. A capital interest in a partner ship is an interest in its assets that is distributa ble to the owner of the interest in either of the following situations. The owner withdraws from the partnership. The partnership liquidates. The mere right to share in earnings and prof its is not a capital interest in the partnership. Gift of capital interest. If a family member (or any other person) receives a gift of a capital in terest in a partnership in which capital is a ma terial incomeproducing factor, the donee's dis tributive share of partnership income is subject to both of the following restrictions. It must be figured by reducing the partner ship income by reasonable compensation for services the donor renders to the part nership. The donee's distributive share of partner ship income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. Purchase. For purposes of determining a partner's distributive share, an interest pur chased by one family member from another family member is considered a gift from the seller. The fair market value of the purchased interest is considered donated capital. For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). Example. A father sold 50% of his business to his son. The resulting partnership had a profit of $60,000. Capital is a material incomepro ducing factor. The father performed services worth $24,000, which is reasonable compensa tion, and the son performed no services. The $24,000 must be allocated to the father as com pensation. Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. The son's share of partnership profit cannot be more than $18,000. Publication 541 (January 2016) Business owned and operated by spouses. If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal part nership agreement. If so, they should report in come or loss from the business on Form 1065. They should not report the income on a Sched ule C (Form 1040) in the name of one spouse as a sole proprietor. However, the spouses can elect not to treat the joint venture as a partner ship by making a Qualified Joint Venture Elec tion. Qualified Joint Venture Election. A "qualified joint venture," whose only members are spou ses filing a joint return, can elect not to be treated as a partnership for federal tax purpo ses. A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partner ship; both spouses materially participate in the trade or business (see Passive Activity Limita tions in the Instructions for Form 1065 for a defi nition of material participation); and the busi ness is coowned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax pur poses and therefore doesn't have a Form 1065 filing requirement. All items of income, gain, de duction, loss, and credit are divided between the spouses based on their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). For purposes of determining net earnings from selfemployment, each spouse's share of in come or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (that is, based on their respective interests in the venture). If the spouses do not make the election to treat their respective interests in the joint ven ture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K1 (Form 1065) to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of selfemployment income on a separate Schedule SE (Form 1040), SelfEmployment Tax. This generally doesn't increase the total tax on the return, but it does give each spouse credit for social security earnings on which re tirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation. For more information on qualified joint ven tures, go to IRS.gov, enter “Election for Quali fied Joint Ventures” in the search box and se lect the link reading “Election for Husband and Wife Unincorporated Businesses.” Partnership Agreement The partnership agreement includes the original agreement and any modifications. The modifi cations must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. The agreement or mod ifications can be oral or written. Partners can modify the partnership agree ment for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. This filing date doesn't include any extension of time. If the partnership agreement or any modifi cation is silent on any matter, the provisions of local law are treated as part of the agreement. Terminating a Partnership A partnership terminates when one of the fol lowing events takes place. 1. All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its part ners in a partnership. 2. At least 50% of the total interest in partner ship capital and profits is sold or ex changed within a 12month period, includ ing a sale or exchange to another partner. Unlike other partnerships, an electing large partnership doesn't terminate on the sale or ex change of 50% or more of the partnership inter ests within a 12month period. See section 1.7081(b) of the regulations for more information on the termination of a part nership. For special rules that apply to a merger, consolidation, or division of a partner ship, see sections 1.7081(c) and 1.7081(d) of the regulations. Date of termination. The partnership's tax year ends on the date of termination. For the event described in (1) above, the date of termi nation is the date the partnership completes the winding up of its affairs. For the event described in (2) above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or ex changes in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. Short period return. If a partnership is termi nated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the begin ning of the tax year through the date of termina tion. The return is due the 15th day of the 4th month (or for tax years beginning after 2015, the 15th day of the 3rd month) following the date of termination. See Partnership Return (Form 1065), later, for information about filing Form 1065. Conversion of partnership into limited lia bility company (LLC). The conversion of a partnership into an LLC classified as a partner ship for federal tax purposes doesn't terminate the partnership. The conversion is not a sale, exchange, or liquidation of any partnership in terest; the partnership's tax year doesn't close; and the LLC can continue to use the partnership's taxpayer identification number. Page 3 However, the conversion may change some of the partners' bases in their partnership inter ests if the partnership has recourse liabilities that become nonrecourse liabilities. Because the partners share recourse and nonrecourse li abilities differently, their bases must be adjus ted to reflect the new sharing ratios. If a de crease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. The same rules apply if an LLC classified as a partnership is converted into a partnership. IRS e-file (Electronic Filing) extraction, or use of property meet all the fol lowing requirements. They own the property as coowners, ei ther in fee or under lease or other form of contract granting exclusive operating rights. They reserve the right separately to take in kind or dispose of their shares of any prop erty produced, extracted, or used. They don't jointly sell services or the prop erty produced or extracted. Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in ex cess of the minimum needs of the industry, and in no event for more than one year. However, this exclusion doesn't apply to an un incorporated organization one of whose princi pal purposes is cycling, manufacturing, or pro cessing for persons who are not members of the organization. Certain partnerships with more than 100 partners are required to file Form 1065, Sched ules K1, and related forms and schedules elec tronically (e-file). Other partnerships generally have the option to file electronically. For details about IRS e-file, see the Form 1065 instruc tions. Exclusion From Partnership Rules Certain partnerships that do not actively con duct a business can choose to be completely or partially excluded from being treated as partner ships for federal income tax purposes. All the partners must agree to make the choice, and the partners must be able to figure their own taxable income without figuring the partner ship's income. However, the partners are not exempt from the rule that limits a partner's dis tributive share of partnership loss to the adjus ted basis of the partner's partnership interest. Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. Investing partnership. An investing partner ship can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following re quirements. They own the property as coowners. They reserve the right separately to take or dispose of their shares of any property ac quired or retained. They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. Each separate participant can delegate au thority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. Operating agreement partnership. An oper ating agreement partnership group can be ex cluded if the participants in the joint production, Page 4 Electing the exclusion. An eligible organiza tion that wishes to be excluded from the part nership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. This filing date includes any extension of time. See Regulations section 1.7612(b) for the pro cedures to follow. Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an infor mation return on Form 1065 showing its in come, deductions, and other required informa tion. The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. The return must be signed by a general partner. If a limited liability company is treated as a part nership, it must file Form 1065 and one of its members must sign the return. A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expen ses treated as deductions or credits for federal income tax purposes. See the Instructions for Form 1065 for more information about who must file Form 1065. Partnership Distributions Partnership distributions include the following. A withdrawal by a partner in anticipation of the current year's earnings. A distribution of the current year's or prior years' earnings not needed for working capital. A complete or partial liquidation of a part ner's interest. A distribution to all partners in a complete liquidation of the partnership. A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is re ceived. Money or property withdrawn by a part ner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. Effect on partner's basis. A partner's adjus ted basis in his or her partnership interest is de creased (but not below zero) by the money and adjusted basis of property distributed to the partner. See Adjusted Basis under Basis of Partner's Interest, later. Effect on partnership. A partnership gener ally doesn't recognize any gain or loss because of distributions it makes to partners. The part nership may be able to elect to adjust the basis of its undistributed property. Certain distributions treated as a sale or exchange. When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. Unrealized receivables or substantially ap preciated inventory items distributed in ex change for any part of the partner's interest in other partnership property, including money. Other property (including money) distrib uted in exchange for any part of a partner's interest in unrealized receivables or sub stantially appreciated inventory items. See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. This treatment doesn't apply to the following distributions. A distribution of property to the partner who contributed the property to the part nership. Payments made to a retiring partner or successor in interest of a deceased part ner that are the partner's distributive share of partnership income or guaranteed pay ments. Substantially appreciated inventory items. Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the part nership's adjusted basis for the property. How ever, if a principal purpose for acquiring inven tory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. Partner's Gain or Loss A partner generally recognizes gain on a part nership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. Any gain recognized is generally treated as capital gain from the sale of the part nership interest on the date of the distribution. If Publication 541 (January 2016) partnership property (other than marketable se curities treated as money) is distributed to a partner, he or she generally doesn't recognize any gain until the sale or other disposition of the property. For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. Example. The adjusted basis of Jo's part nership interest is $14,000. She receives a dis tribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. Because the cash received doesn't exceed the basis of her partnership interest, Jo doesn't recognize any gain on the distribution. Any gain on the land will be recognized when she sells or otherwise disposes of it. The distri bution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. Marketable securities treated as money. Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. This treatment, however, doesn't generally ap ply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. The amount treated as money is the securi ty's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: 1. The partner's distributive share of the gain that would be recognized had the partner ship sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over 2. The partner's distributive share of the gain that would be recognized had the partner ship sold all such securities it still held af ter the distribution at the fair market value in (1). For more information, including the defini tion of marketable securities, see section 731(c) of the Internal Revenue Code. Loss on distribution. A partner doesn't recog nize loss on a partnership distribution unless all the following requirements are met. The adjusted basis of the partner's interest in the partnership exceeds the distribution. The partner's entire interest in the partner ship is liquidated. The distribution is in money, unrealized re ceivables, or inventory items. There are exceptions to these general rules. See the following discussions. Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. Distribution of partner's debt. If a partner ship acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under Publication 541 (January 2016) the rules discussed in Partner's Basis for Distributed Property, later). The partner is treated as having satisfied the debt for its fair market value. If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distrib uted, the partner may have to include the ex cess amount in income as canceled debt. Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its ad justed issue price. Net precontribution gain. A partner generally must recognize gain on the distribution of prop erty (other than money) if the partner contrib uted appreciated property to the partnership during the 7year period before the distribution. The gain recognized is the lesser of the fol lowing amounts. 1. The excess of: a. The fair market value of the property received in the distribution, over b. The adjusted basis of the partner's in terest in the partnership immediately before the distribution, reduced (but not below zero) by any money re ceived in the distribution. 2. The “net precontribution gain” of the part ner. This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribu tion, and held by the partnership immedi ately before the distribution, were distrib uted to another partner, other than a partner who owns more than 50% of the partnership. For information about the dis tribution of contributed property to another partner, see Contribution of Property, un der Transactions Between Partnership and Partners, later. The character of the gain is determined by reference to the character of the net precontri bution gain. This gain is in addition to any gain the partner must recognize if the money distrib uted is more than his or her basis in the partner ship. For these rules, the term “money” includes marketable securities treated as money, as dis cussed earlier under Marketable securities treated as money. Effect on basis. The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. Other than for purposes of deter mining the gain, the increase is treated as oc curring immediately before the distribution. See Basis of Partner's Interest, later. The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. Exceptions. Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in de termining the amount of the excess distribution or the partner's net precontribution gain. For this purpose, the partner's previously contributed property doesn't include a contributed interest in an entity to the extent its value is due to prop erty contributed to the entity after the interest was contributed to the partnership. Recognition of gain under this rule also doesn't apply to a distribution of unrealized re ceivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier under Certain distributions treated as a sale or exchange. Partner's Basis for Distributed Property Unless there is a complete liquidation of a part ner's interest, the basis of property (other than money) distributed to the partner by a partner ship is its adjusted basis to the partnership im mediately before the distribution. However, the basis of the property to the partner cannot be more than the adjusted basis of his or her inter est in the partnership reduced by any money re ceived in the same transaction. Example 1. The adjusted basis of Emily's partnership interest is $30,000. She receives a distribution of property that has an adjusted ba sis of $20,000 to the partnership and $4,000 in cash. Her basis for the property is $20,000. Example 2. The adjusted basis of Steve's partnership interest is $10,000. He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). Complete liquidation of partner's interest. The basis of property received in complete liqui dation of a partner's interest is the adjusted ba sis of the partner's interest in the partnership re duced by any money distributed to the partner in the same transaction. Partner's holding period. A partner's holding period for property distributed to the partner in cludes the period the property was held by the partnership. If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. Basis divided among properties. If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distrib uted to the partner. For property distributed af ter August 5, 1997, allocate the basis using the following rules. 1. Allocate the basis first to unrealized re ceivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjus ted basis in the item immediately before the distribution. If the total of these as signed bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. 2. Allocate any remaining basis to properties other than unrealized receivables and in ventory items by assigning a basis to each property equal to the partnership's Page 5 adjusted basis in the property immediately before the distribution. If the allocable ba sis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. If the total of these assigned bases exceeds the allocable ba sis, decrease the assigned bases by the amount of the excess. Allocating a basis increase. Allocate any basis increase required in rule (2) above first to properties with unrealized appreciation to the extent of the unrealized appreciation. If the ba sis increase is less than the total unrealized ap preciation, allocate it among those properties in proportion to their respective amounts of unre alized appreciation. Allocate any remaining ba sis increase among all the properties in propor tion to their respective fair market values. Example. Eun's basis in her partnership in terest is $55,000. In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unreal ized receivables. Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. Property B has an ad justed basis to the partnership of $10,000 and a fair market value of $10,000. To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). She first allocates $35,000 to property A (its unrealized appreciation). The remaining $5,000 is alloca ted between the properties based on their fair market values. $4,000 ($40,000/$50,000) is al located to property A and $1,000 ($10,000/$50,000) is allocated to property B. Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). Allocating a basis decrease. Use the fol lowing rules to allocate any basis decrease re quired in rule (1) or rule (2), earlier. 1. Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. 2. Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). Example. Armando's basis in his partner ship interest is $20,000. In a distribution in liqui dation of his entire interest, he receives proper ties C and D, neither of which is inventory or unrealized receivables. Property C has an ad justed basis to the partnership of $15,000 and a fair market value of $15,000. Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. To figure his basis in each property, Ar mando first assigns bases of $15,000 to prop erty C and $15,000 to property D (their adjusted bases to the partnership). This leaves a $10,000 basis decrease (the $30,000 total of Page 6 the assigned bases minus the $20,000 alloca ble basis). He allocates the entire $10,000 to property D (its unrealized depreciation). Arman do's basis in property C is $15,000 and his ba sis in property D is $5,000 ($15,000 − $10,000). Distributions before August 6, 1997. For property distributed before August 6, 1997, allo cate the basis using the following rules. 1. Allocate the basis first to unrealized re ceivables and inventory items included in the distribution to the extent of the partner ship's adjusted basis in those items. If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. 2. Allocate any remaining basis to other dis tributed properties in proportion to their adjusted bases to the partnership. Partner's interest more than partnership basis. If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inven tory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the part nership interest. Special adjustment to basis. A partner who acquired any part of his or her partnership inter est in a sale or exchange or upon the death of another partner may be able to choose a spe cial basis adjustment for property distributed by the partnership. To choose the special adjust ment, the partner must have received the distri bution within 2 years after acquiring the partner ship interest. Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership inter est. If a partner chooses this special basis ad justment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjust ment to basis. However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to de preciation, depletion, or amortization. If the choice doesn't have to be made for the distribu tion year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. A partner choosing this special basis adjust ment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. Example. Chin Ho purchased a 25% inter est in X partnership for $17,000 cash. At the time of the purchase, the partnership owned in ventory having a basis to the partnership of $14,000 and a fair market value of $16,000. Thus, $4,000 of the $17,000 he paid was attrib utable to his share of inventory with a basis to the partnership of $3,500. Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, in ventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. The value of the inventory received was 25% of the value of all partnership inventory. (It is immaterial whether the inventory he received was on hand when he acquired his interest.) Since the partnership from which Chin Ho withdrew didn't make the optional adjustment to basis, he chose to adjust the basis of the inven tory received. His share of the partnership's ba sis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of part nership gain or loss on disposition. The total to be allocated among the proper ties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 spe cial adjustment). The remaining $11,500 is allo cated to his new basis for the other property he received. Mandatory adjustment. A partner doesn't always have a choice of making this special ad justment to basis. The special adjustment to ba sis must be made for a distribution of property (whether or not within 2 years after the partner ship interest was acquired) if all the following conditions existed when the partner received the partnership interest. The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the part nership. If there had been a liquidation of the part ner's interest immediately after it was ac quired, an allocation of the basis of that in terest under the general rules (discussed earlier under Basis divided among properties.) would have decreased the basis of property that couldn't be depreciated, de pleted, or amortized and increased the ba sis of property that could be. The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. Required statement. Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjust ment is mandatory, the partnership must pro vide a statement to the partner. The statement must provide information necessary for the part ner to figure the special basis adjustment. Publication 541 (January 2016) Marketable securities. A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding dis cussions, is increased by any gain recognized by treating the securities as money. See Marketable securities treated as money under Part ner's Gain or Loss, earlier. The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appre ciation before the basis increase. Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. These transactions include the following. 1. Performing services for, or transferring property to, a partnership if: a. There is a related allocation and distri bution to a partner; and b. The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the ca pacity of a partner. 2. Transferring money or other property to a partnership if: a. There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and b. The transfers together are properly characterized as a sale or exchange of property. Payments by accrual basis partnership to cash basis partner. A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. However, this rule doesn't apply to guaranteed payments made to a partner, which are generally deducti ble when accrued. Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. This treatment is for purposes of determining gross income and deductible business expen ses only. For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Guaranteed pay ments are not subject to income tax withhold ing. The partnership generally deducts guaran teed payments on line 10 of Form 1065 as a business expense. They are also listed on Schedules K and K1 of the partnership return. The individual partner reports guaranteed Publication 541 (January 2016) payments on Schedule E (Form 1040) as ordi nary income, along with his or her distributive share of the partnership's other ordinary in come. Guaranteed payments made to partners for organizing the partnership or syndicating inter ests in the partnership are capital expenses. Generally, organizational and syndication ex penses are not deductible by the partnership. However, a partnership can elect to deduct a portion of its organizational expenses and am ortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). Organizational ex penses (if the election is not made) and syndi cation expenses paid to partners must be repor ted on the partners' Schedule K1 as guaranteed payments. Minimum payment. If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income be fore taking into account the guaranteed pay ment. Example. Under a partnership agreement, Divya is to receive 30% of the partnership in come, but not less than $8,000. The partnership has net income of $20,000. Divya's share, with out regard to the minimum guarantee, is $6,000 (30% × $20,000). The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. Selfemployed health insurance premiums. Premiums for health insurance paid by a part nership on behalf of a partner, for services as a partner, are treated as guaranteed payments. The partnership can deduct the payments as a business expense, and the partner must include them in gross income. However, if the partner ship accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. A partner who qualifies can deduct 100% of the health insurance premiums paid by the part nership on his or her behalf as an adjustment to income. The partner cannot deduct the premi ums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. For more infor mation on the selfemployed health insurance deduction, see chapter 6 in Publication 535. Including payments in partner's income. Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. Example 1. Under the terms of a partner ship agreement, Erica is entitled to a fixed an nual payment of $10,000 without regard to the income of the partnership. Her distributive share of the partnership income is 10%. The partnership has $50,000 of ordinary income af ter deducting the guaranteed payment. She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her indi vidual income tax return for her tax year in which the partnership's tax year ends. Example 2. Lamont is a calendar year tax payer who is a partner in a partnership. The partnership uses a fiscal year that ended Janu ary 31, 2015. Lamont received guaranteed pay ments from the partnership from February 1, 2014, until December 31, 2014. He must in clude these guaranteed payments in income for 2015 and report them on his 2015 income tax return. Payments resulting in loss. If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. The partner sep arately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain per sons. Losses. Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indi rect interest in the capital or profits of the part nership is more than 50%. If the sale or exchange is between two part nerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduc tion of a loss is allowed. The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. Gains. Gains are treated as ordinary income in a sale or exchange of property directly or indi rectly between a person and a partnership, or between two partnerships, if both of the follow ing tests are met. More than 50% of the capital or profits in terest in the partnership(s) is directly or in directly owned by the same person(s). The property in the hands of the transferee immediately after the transfer is not a capi tal asset. Property that is not a capital Page 7 asset includes accounts receivable, inven tory, stockintrade, and depreciable or real property used in a trade or business. More than 50% ownership. To determine if there is more than 50% ownership in partner ship capital or profits, the following rules apply. 1. An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned propor tionately by, or for, its shareholders, part ners, or beneficiaries. 2. An individual is considered to own the in terest directly or indirectly owned by, or for, the individual's family. For this rule, “family” includes only brothers, sisters, halfbrothers, halfsisters, spouses, an cestors, and lineal descendants. 3. If a person is considered to own an inter est using rule (1), that person (the “con structive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. However, if a person is con sidered to own an interest using rule (2), that person is not treated as actually own ing that interest in reapplying rule (2) to make another person the constructive owner. Example. Individuals A and B and Trust T are equal partners in Partnership ABT. A's hus band, AH, is the sole beneficiary of Trust T. Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. As a result, A is a morethan50% partner. This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. More information. For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Pub. 544. Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is con tributed to the partnership in exchange for a partnership interest. This applies whether a partnership is being formed or is already oper ating. The partnership's holding period for the property includes the partner's holding period. The contribution of limited partnership inter ests in one partnership for limited partnership interests in another partnership qualifies as a taxfree contribution of property to the second partnership if the transaction is made for busi ness purposes. The exchange is not subject to the rules explained later under Disposition of Partner's Interest. Disguised sales. A contribution of money or other property to the partnership followed by a distribution of different property from the part nership to the partner is treated not as a contri Page 8 bution and distribution, but as a sale of prop erty, if both of the following tests are met. The distribution wouldn't have been made but for the contribution. The partner's right to the distribution doesn't depend on the success of partner ship operations. All facts and circumstances are considered in determining if the contribution and distribu tion are more properly characterized as a sale. However, if the contribution and distribution oc cur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. Form 8275 required. A partner must at tach Form 8275, Disclosure Statement, (or other statement) to his or her return if the part ner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other con sideration to the partner. For exceptions to this requirement, see section 1.7073(c)(2) of the regulations. A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (be fore or after the distribution), the partner trans fers money or other consideration to the part nership. Form 8275 must include the following infor mation. A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. A description of the transferred property or money, including its value. A description of any relevant facts in deter mining if the transfers are properly viewed as a disguised sale. See section 1.7073(b)(2) of the regulations for a de scription of the facts and circumstances considered in determining if the transfers are a disguised sale. Contribution to partnership treated as in vestment company. Gain is recognized when property is contributed (in exchange for an in terest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. A partnership is generally treated as an in vestment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. These items include money, stocks and other equity inter ests in a corporation, and interests in regulated investment companies and real estate invest ment trusts. For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. Contribution to foreign partnership. A do mestic partnership that contributed property af ter August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. 1. Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partner ship. 2. The fair market value of the property con tributed to the foreign partnership, when added to other contributions of property made to the partnership during the pre ceding 12month period, is greater than $100,000. The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. See the form instructions for more infor mation. Basis of contributed property. If a partner contributes property to a partnership, the part nership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. Allocations to account for builtin gain or loss. The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. The partnership must allocate among the partners any income, de duction, gain, or loss on the property in a man ner that will account for the difference. This rule also applies to contributions of accounts paya ble and other accrued but unpaid items of a cash basis partner. The partnership can use different allocation methods for different items of contributed prop erty. A single reasonable method must be con sistently applied to each item, and the overall method or combination of methods must be reasonable. See section 1.7043 of the regula tions for allocation methods generally consid ered reasonable. If the partnership sells contributed property and recognizes gain or loss, builtin gain or loss is allocated to the contributing partner. If con tributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account builtin gain or loss on the property. However, the total de preciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. Example. Areta and Sofia formed an equal partnership. Areta contributed $10,000 in cash to the partnership and Sofia contributed depre ciable property with a fair market value of $10,000 and an adjusted basis of $4,000. The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. In effect, Areta purchased an undivided onehalf interest in the depreciable property with her contribution of $10,000. Assuming that Publication 541 (January 2016) the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. To simplify this example, the depreciation de ductions are determined without regard to any firstyear depreciation conventions. However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. The entire $400 must be allocated to Areta. Distribution of contributed property to an other partner. If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. This amount is the difference between the property's basis and its fair market value at the time of contribution. The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. Appropri ate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the prop erty distributed to reflect the recognized gain or loss. Disposition of certain contributed property. The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. 1. Unrealized receivables. If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is or dinary income or loss. Unrealized receiva bles are defined later under Payments for Unrealized Receivables and Inventory Items. When reading the definition, substi tute “partner” for “partnership.” 2. Inventory items. If the property was an inventory item in the hands of the contribu ting partner, any gain or loss on its dispo sition by the partnership within 5 years af ter the contribution is ordinary income or loss. Inventory items are defined later un der Payments for Unrealized Receivables and Inventory Items. 3. Capital loss property. If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contri bution is a capital loss. The capital loss is limited to the amount by which the part ner's adjusted basis for the property ex ceeded the property's fair market value im mediately before the contribution. 4. Substituted basis property. If the dispo sition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis Publication 541 (January 2016) property (other than certain corporate stock) resulting from the transaction. Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. Capital interest. A capital interest is an inter est that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were dis tributed in a complete liquidation of the partner ship. This determination generally is made at the time of receipt of the partnership interest. The fair market value of such an interest re ceived by a partner as compensation for serv ices must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. The fair market value of an interest in part nership capital transferred to a partner as pay ment for services to the partnership is a guaran teed payment, discussed earlier under Guaranteed Payments. Profits interest. A profits interest is a partner ship interest other than a capital interest. If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. However, this doesn't apply in the following sit uations. The profits interest relates to a substan tially certain and predictable stream of in come from partnership assets, such as in come from highquality debt securities or a highquality net lease. Within 2 years of receipt, the partner dispo ses of the profits interest. The profits interest is a limited partnership interest in a publicly traded partnership. A profits interest transferred as compensa tion for services is not subject to the rules for re stricted property that apply to capital interests. Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the part ner contributed. If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. Any increase in a partner's individual liabilities be cause of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. nership, the partner's basis must be determined using the basis rules described in Publication 551. Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). TIP The basis of an interest in a partnership is in creased or decreased by certain items. Increases. A partner's basis is increased by the following items. The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership lia bilities. The partner's distributive share of taxable and nontaxable partnership income. The partner's distributive share of the ex cess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. Decreases. The partner's basis is decreased (but never below zero) by the following items. The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partner ship. The partner's distributive share of the part nership losses (including capital losses). The partner's distributive share of nonde ductible partnership expenses that are not capital expenditures. This includes the partner's share of any section 179 expen ses, even if the partner cannot deduct the entire amount on his or her individual in come tax return. The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. Partner's liabilities assumed by partnership. If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability as sumed by the other partners. This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. The other partners' as sumption of the liability is treated as a contribu tion by them of money to the partnership. See Effect of Partnership Liabilities, later. Example 1. Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. The partnership assumed payment of the mortgage. The basis of Ivan's interest is: Interest acquired by gift, etc. If a partner ac quires an interest in a partnership by gift, inheri tance, or under any circumstance other than by a contribution of money or property to the part Page 9 Adjusted basis of contributed property . . . . . . Minus: Part of mortgage assumed by other partners (80% × $4,000) . . . . . . . . . . . . . Basis of Ivan's partnership interest $8,000 . . 3,200 . . . . . . . . $4,800 Example 2. If, in Example 1, the contrib uted property had a $12,000 mortgage, the ba sis of Ivan's partnership interest would be zero. The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or ex change of a partnership interest. However, this gain wouldn't increase the basis of his partner ship interest. Book value of partner's interest. The adjus ted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. Example. Enzo contributes to his partner ship property that has an adjusted basis of $400 and a fair market value of $1,000. His partner contributes $1,000 cash. While each partner has increased his capital account by $1,000, which will be reflected in the partnership books, the adjusted basis of Enzo's interest is only $400 and the adjusted basis of his partner's in terest is $1,000. When determined. The adjusted basis of a partner's partnership interest is ordinarily deter mined at the end of the partnership's tax year. However, if there has been a sale or exchange of all or part of the partner's interest or a liquida tion of his or her entire interest in a partnership, the adjusted basis is determined on the date of sale, exchange, or liquidation. Alternative rule for figuring adjusted basis. In certain cases, the adjusted basis of a part nership interest can be figured by using the partner's share of the adjusted basis of partner ship property that would be distributed if the partnership terminated. This alternative rule can be used in either of the following situations. The circumstances are such that the part ner cannot practicably apply the general basis rules. It is, in the opinion of the IRS, reasonable to conclude that the result produced will not vary substantially from the result under the general basis rules. Adjustments may be necessary in figuring the adjusted basis of a partnership interest un der the alternative rule. For example, adjust ments would be required to include in the part ner's share of the adjusted basis of partnership property any significant discrepancies that re sulted from contributed property, transfers of partnership interests, or distributions of property to the partners. Page 10 Effect of Partnership Liabilities A partner's basis in a partnership interest in cludes the partner's share of a partnership liability only if, and to the extent that, the liability: 1. Creates or increases the partnership's ba sis in any of its assets, 2. Gives rise to a current deduction to the partnership, or 3. Is a nondeductible, noncapital expense of the partnership. The term “assets” in (1) includes capitalized items allocable to future periods, such as or ganization expenses. A partner's share of accrued but unpaid ex penses or accounts payable of a cash basis partnership are not included in the adjusted ba sis of the partner's interest in the partnership. Partner's basis increased. If a partner's share of partnership liabilities increases, or a partner's individual liabilities increase because he or she assumes partnership liabilities, this in crease is treated as a contribution of money by the partner to the partnership. Partner's basis decreased. If a partner's share of partnership liabilities decreases, or a partner's individual liabilities decrease because the partnership assumes his or her individual li abilities, this decrease is treated as a distribu tion of money to the partner by the partnership. Assumption of liability. Generally, a partner or related person is considered to assume a partnership liability only to the extent that: 1. He or she is personally liable for it, 2. The creditor knows that the liability was assumed by the partner or related person, 3. The creditor can demand payment from the partner or related person, and 4. No other partner or person related to an other partner will bear the economic risk of loss on that liability immediately after the assumption. Related person. Related persons, for these purposes, includes all the following. An individual and his or her spouse, ances tors, and lineal descendants. An individual and a corporation if the indi vidual directly or indirectly owns 80% or more in value of the outstanding stock of the corporation. Two corporations that are members of the same controlled group. A grantor and a fiduciary of any trust. Fiduciaries of two separate trusts if the same person is a grantor of both trusts. A fiduciary and a beneficiary of the same trust. A fiduciary and a beneficiary of two sepa rate trusts if the same person is a grantor of both trusts. A fiduciary of a trust and a corporation if the trust or the grantor of the trust directly or indirectly owns 80% or more in value of the outstanding stock of the corporation. A person and a taxexempt educational or charitable organization controlled directly or indirectly by the person or by members of the person's family. A corporation and a partnership if the same persons own 80% or more in value of the outstanding stock of the corporation and 80% or more of the capital or profits in terest in the partnership. Two S corporations or an S corporation and a C corporation if the same persons own 80% or more in value of the outstand ing stock of each corporation. An executor and a beneficiary of an estate. A partnership and a person owning, di rectly or indirectly, 80% or more of the cap ital or profits interest in the partnership. Two partnerships if the same persons di rectly or indirectly own 80% or more of the capital or profits interests. Property subject to a liability. If property contributed to a partnership by a partner or dis tributed by the partnership to a partner is sub ject to a liability, the transferee is treated as having assumed the liability to the extent it doesn't exceed the fair market value of the property. Partner's share of recourse liabilities. A partnership liability is a recourse liability to the extent that any partner or a related person, de fined earlier under Related person, has an eco nomic risk of loss for that liability. A partner's share of a recourse liability equals his or her economic risk of loss for that liability. A partner has an economic risk of loss if that partner or a related person would be obligated (whether by agreement or law) to make a net payment to the creditor or a contribution to the partnership with respect to the liability if the partnership were constructively liquidated. A partner who is the creditor for a liability that would otherwise be a nonrecourse liability of the partnership has an economic risk of loss in that liability. Constructive liquidation. Generally, in a constructive liquidation, the following events are treated as occurring at the same time. All partnership liabilities become payable in full. All of the partnership's assets have a value of zero, except for property contributed to secure a liability. All property is disposed of by the partner ship in a fully taxable transaction for no consideration except relief from liabilities for which the creditor's right to reimburse ment is limited solely to one or more assets of the partnership. All items of income, gain, loss, or deduc tion are allocated to the partners. The partnership liquidates. Example. Juan and Teresa form a cash ba sis general partnership with cash contributions of $20,000 each. Under the partnership agree ment, they share all partnership profits and los ses equally. The partnership borrows $60,000 and purchases depreciable business equip ment. This debt is included in the partners' ba sis in the partnership because incurring it cre ates an additional $60,000 of basis in the partnership's depreciable property. Publication 541 (January 2016) If neither partner has an economic risk of loss in the liability, it is a nonrecourse liability. Each partner's basis would include his or her share of the liability, $30,000. If Teresa is required to pay the creditor if the partnership defaults, she has an economic risk of loss in the liability. Her basis in the partner ship would be $80,000 ($20,000 + $60,000), while Juan's basis would be $20,000. Limited partner. A limited partner gener ally has no obligation to contribute additional capital to the partnership and therefore doesn't have an economic risk of loss in partnership re course liabilities. Thus, absent some other fac tor, such as the guarantee of a partnership lia bility by the limited partner or the limited partner making the loan to the partnership, a limited partner generally doesn't have a share of part nership recourse liabilities. Partner's share of nonrecourse liabilities. A partnership liability is a nonrecourse liability if no partner or related person has an economic risk of loss for that liability. A partner's share of nonrecourse liabilities is generally proportionate to his or her share of partnership profits. How ever, this rule may not apply if the partnership has taken deductions attributable to nonre course liabilities or the partnership holds prop erty that was contributed by a partner. More information. For more information on the effect of partnership liabilities, including rules for limited partners and examples, see sections 1.7521 through 1.7525 of the regula tions. Disposition of Partner's Interest The following discussions explain the treatment of gain or loss from the disposition of an interest in a partnership. Abandoned or worthless partnership inter est. A loss incurred from the abandonment or worthlessness of a partnership interest is an or dinary loss only if both of the following tests are met. The transaction is not a sale or exchange. The partner has not received an actual or deemed distribution from the partnership. If the partner receives even a de minimis actual or deemed distribution, the entire loss generally is a capital loss. However, see Payments for Unrealized Receivables and Inventory Items, later. For information on how to report an aban donment loss, see the Instructions for Form 4797. See Revenue Ruling 9380 for more in formation on determining if a loss incurred on the abandonment or worthlessness of a part nership interest is a capital or an ordinary loss. Partnership election to adjust basis of part nership property. Generally, a partnership's basis in its assets is not affected by a transfer of an interest in the partnership, whether by sale or exchange or because of the death of a part ner. However, the partnership can elect to Publication 541 (January 2016) make an optional adjustment to basis in the year of transfer. Sale, Exchange, or Other Transfer The sale or exchange of a partner's interest in a partnership usually results in capital gain or loss. However, see Payments for Unrealized Receivables and Inventory Items, later, for cer tain exceptions. Gain or loss is the difference between the amount realized and the adjusted basis of the partner's interest in the partnership. If the selling partner is relieved of any partner ship liabilities, that partner must include the lia bility relief as part of the amount realized for his or her interest. Example 1. Kumar became a limited part ner in the ABC Partnership by contributing $10,000 in cash on the formation of the partner ship. The adjusted basis of his partnership in terest at the end of the current year is $20,000, which includes his $15,000 share of partnership liabilities. The partnership has no unrealized re ceivables or inventory items. Kumar sells his in terest in the partnership for $10,000 in cash. He had been paid his share of the partnership in come for the tax year. Kumar realizes $25,000 from the sale of his partnership interest ($10,000 cash payment + $15,000 liability relief). He reports $5,000 ($25,000 realized − $20,000 basis) as a capital gain. Example 2. The facts are the same as in Example 1, except that Kumar withdraws from the partnership when the adjusted basis of his interest in the partnership is zero. He is consid ered to have received a distribution of $15,000, his relief of liability. He reports a capital gain of $15,000. Exchange of partnership interests. An ex change of partnership interests generally doesn't qualify as a nontaxable exchange of likekind property. This applies regardless of whether they are general or limited partnership interests or interests in the same or different partnerships. However, under certain circum stances, such an exchange may be treated as a taxfree contribution of property to a partner ship. See Contribution of Property under Transactions Between Partnership and Partners, ear lier. An interest in a partnership that has a valid election in effect under section 761(a) of the In ternal Revenue Code to be excluded from the partnership rules of the Code is treated as an interest in each of the partnership assets and not as a partnership interest. See Exclusion From Partnership Rules, earlier. Installment reporting for sale of partnership interest. A partner who sells a partnership in terest at a gain may be able to report the sale on the installment method. For requirements and other information on installment sales, see Publication 537. Part of the gain from the installment sale may be allocable to unrealized receivables or inventory items. See Payments for Unrealized Receivables and Inventory Items, later. The gain allocable to unrealized receivables and in ventory items must be reported in the year of sale. The gain allocable to the other assets can be reported under the installment method. Payments for Unrealized Receivables and Inventory Items If a partner receives money or property in ex change for any part of a partnership interest, the amount due to his or her share of the partner ship's unrealized receivables or inventory items results in ordinary income or loss. This amount is treated as if it were received for the sale or exchange of property that is not a capital asset. This treatment applies to the unrealized re ceivables part of payments to a retiring partner or successor in interest of a deceased partner only if that part is not treated as paid in ex change for partnership property. See Liquidation at Partner's Retirement or Death, later. Unrealized receivables. Unrealized receiva bles include any rights to payment not already included in income for the following items. Goods delivered or to be delivered to the extent the payment would be treated as re ceived for property other than a capital as set. Services rendered or to be rendered. These rights must have arisen under a con tract or agreement that existed at the time of sale or distribution, even though the partnership may not be able to enforce payment until a later date. For example, unrealized receivables in clude accounts receivable of a cash method partnership and rights to payment for work or goods begun but incomplete at the time of the sale or distribution of the partner's share. The basis for any unrealized receivables in cludes all costs or expenses for the receivables that were paid or accrued but not previously taken into account under the partnership's method of accounting. Other items treated as unrealized receivables. Unrealized receivables include potential gain that would be ordinary income if the follow ing partnership property were sold at its fair market value on the date of the payment. Mining property for which exploration ex penses were deducted. Stock in a Domestic International Sales Corporation (DISC). Certain farm land for which expenses for soil and water conservation or land clear ing were deducted. Franchises, trademarks, or trade names. Oil, gas, or geothermal property for which intangible drilling and development costs were deducted. Stock of certain controlled foreign corpora tions. Market discount bonds and shortterm obli gations. Property subject to recapture of deprecia tion under sections 1245 and 1250 of the Internal Revenue Code. Depreciation re capture is discussed in chapter 3 of Publi cation 544. Page 11 Determining gain or loss. The income or loss realized by a partner upon the sale or ex change of its interest in unrealized receivables and inventory items, discussed below, is the amount that would have been allocated to the partner if the partnership had sold all of its prop erty for cash at fair market value, in a fully taxa ble transaction, immediately prior to the part ner's transfer of interest in the partnership. Any gain or loss recognized that is attributable to the unrealized receivables and inventory items will be ordinary gain or loss. Example. You are a partner in ABC Part nership. The adjusted basis of your partnership interest at the end of the current year is zero. Your share of potential ordinary income from partnership depreciable property is $5,000. The partnership has no other unrealized receivables or inventory items. You sell your interest in the partnership for $10,000 in cash and you report the entire amount as a gain since your adjusted basis in the partnership is zero. You report as ordinary income your $5,000 share of potential ordinary income from the partnership's depreci able property. The remaining $5,000 gain is a capital gain. Inventory items. Inventory items are not limi ted to stockintrade of the partnership. They also include the following property. Property that would properly be included in the partnership's inventory if on hand at the end of the tax year or that is held primarily for sale to customers in the normal course of business. Property that, if sold or exchanged by the partnership, wouldn't be a capital asset or section 1231 property (real or depreciable business property held more than one year). For example, accounts receivable acquired for services or from the sale of in ventory and unrealized receivables are in ventory items. Property held by the partnership that would be considered inventory if held by the part ner selling the partnership interest or re ceiving the distribution. Notification required of partner. If a partner exchanges a partnership interest attributable to unrealized receivables or inventory for money or property, he or she must notify the partner ship in writing. This must be done within 30 days of the transaction or, if earlier, by January 15 of the calendar year following the calendar year of the exchange. A partner may be subject to a $50 penalty for each failure to notify the partnership about such a transaction, unless the failure was due to reasonable cause and not willful neglect. Information return required of partnership. When a partnership is notified of an exchange of partnership interests involving unrealized re ceivables or inventory items, the partnership must file Form 8308, Report of a Sale or Ex change of Certain Partnership Interests. Form 8308 is filed with Form 1065 for the tax year that includes the last day of the calendar year in which the exchange took place. If notified of an exchange after filing Form 1065, the partner ship must file Form 8308 separately, within 30 days of the notification. Page 12 On Form 8308, the partnership provides its telephone number and states the date of the ex change and the names, addresses, and tax payer identification numbers of the partnership filing the return and the transferee and trans feror in the exchange. The partnership must provide a copy of Form 8308 (or a written state ment with the same information) to each trans feree and transferor by the later of January 31 following the end of the calendar year or 30 days after it receives notice of the exchange. The partnership may be subject to a penalty for each failure to timely file Form 8308 and a penalty for each failure to furnish a copy of Form 8308 to a transferor or transferee, unless the failure is due to reasonable cause and not willful neglect. If the failure is intentional, a higher penalty may be imposed. See Internal Revenue Code sections 6722, 6723, and 6724 for details. Statement required of partner. If a partner sells or exchanges any part of an interest in a partnership having unrealized receivables or in ventory, he or she must file a statement with his or her tax return for the year in which the sale or exchange occurs. The statement must contain the following information. The date of the sale or exchange. The amount of any gain or loss attributable to the unrealized receivables or inventory. The amount of any gain or loss attributable to capital gain or loss on the sale of the partnership interest. Partner's disposition of distributed unreal ized receivables or inventory items. In gen eral, any gain or loss on a sale or exchange of unrealized receivables or inventory items a part ner received in a distribution is an ordinary gain or loss. For this purpose, inventory items do not include real or depreciable business property, even if they are not held more than 1 year. Example. Oscar, a distributee partner, re ceived his share of accounts receivable when his law firm dissolved. The partnership used the cash method of accounting, so the receivables had a basis of zero. If Oscar later collects the receivables or sells them, the amount he re ceives will be ordinary income. Exception for inventory items held more than 5 years. If a distributee partner sells in ventory items held for more than 5 years after the distribution, the type of gain or loss depends on how they are being used on the date sold. The gain or loss is capital gain or loss if the property is a capital asset in the partner's hands at the time sold. Example. Marucia receives, through disso lution of her partnership, inventory that has a basis of $19,000. Within 5 years, she sells the inventory for $24,000. The $5,000 gain is taxed as ordinary income. If she had held the inven tory for more than 5 years, her gain would have been capital gain, provided the inventory was a capital asset in her hands at the time of sale. Substituted basis property. If a distribu tee partner disposes of unrealized receivables or inventory items in a nonrecognition transac tion, ordinary gain or loss treatment applies to a later disposition of any substituted basis prop erty resulting from the transaction. Liquidation at Partner's Retirement or Death Payments made by the partnership to a retiring partner or successor in interest of a deceased partner in return for the partner's entire interest in the partnership may have to be allocated be tween payments in liquidation of the partner's interest in partnership property and other pay ments. The partnership's payments include an assumption of the partner's share of partnership liabilities treated as a distribution of money. For income tax purposes, a retiring partner or successor in interest of a deceased partner is treated as a partner until his or her interest in the partnership has been completely liquidated. Liquidating payments. Payments made in liq uidation of the interest of a retiring or deceased partner in exchange for his or her interest in partnership property are considered a distribu tion, not a distributive share or guaranteed pay ment that could give rise to a deduction (or its equivalent) for the partnership. Unrealized receivables and goodwill. Payments made for the retiring or deceased partner's share of the partnership's unrealized receivables or goodwill are not treated as made in exchange for partnership property if both of the following tests are met. Capital is not a material incomeproducing factor for the partnership. Whether capital is a material incomeproducing factor is ex plained in the discussion under Family Partnership near the beginning of this pub lication. The retiring or deceased partner was a general partner in the partnership. However, this rule doesn't apply to payments for goodwill to the extent that the partnership agreement provides for a reasonable payment to a retiring partner for goodwill. Unrealized receivables includes, to the ex tent not previously includible in income under the method of accounting used by the partner ship, any rights (contractual or otherwise) to payment for (1) goods delivered, or to be deliv ered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capi tal asset, or (2) services rendered, or to be ren dered. Partners' valuation. Generally, the part ners' valuation of a partner's interest in partner ship property in an arm'slength agreement will be treated as correct. If the valuation reflects only the partner's net interest in the property (to tal assets less liabilities), it must be adjusted so that both the value of, and the basis for, the partner's interest include the partner's share of partnership liabilities. Gain or loss on distribution. Upon the re ceipt of the distribution, the retiring partner or successor in interest of a deceased partner will recognize gain only to the extent that any money (and marketable securities treated as money) distributed is more than the partner's Publication 541 (January 2016) adjusted basis in the partnership. The partner will recognize a loss only if the distribution is in money, unrealized receivables, and inventory items. No loss is recognized if any other prop erty is received. See Partner's Gain or Loss un der Partnership Distributions, earlier. Other payments. Payments made by the part nership to a retiring partner or successor in in terest of a deceased partner that are not made in exchange for an interest in partnership prop erty are treated as distributive shares of part nership income or guaranteed payments. This rule applies regardless of the time over which the payments are to be made. It applies to pay ments made for the partner's share of unreal ized receivables and goodwill not treated as a distribution. If the amount is based on partnership in come, the payment is taxable as a distributive share of partnership income. The payment re tains the same character when reported by the recipient that it would have had if reported by the partnership. If the amount is not based on partnership in come, it is treated as a guaranteed payment. The recipient reports guaranteed payments as ordinary income. For additional information on guaranteed payments, see Transactions Between Partnership and Partners, earlier. These payments are included in income by the recipient for his or her tax year that includes the end of the partnership tax year for which the payments are a distributive share or in which the partnership is entitled to deduct them as guaranteed payments. Former partners who continue to make guar anteed periodic payments to satisfy the partner ship's liability to a retired partner after the part nership is terminated can deduct the payments as a business expense in the year paid. Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) TEFRA (Tax Equity and Fiscal Responsibility Act of 1982) is the common acronym used for a set of consolidated examination, processing, and judicial procedures which determine the tax treatment of partnership items at the partner ship level for partnerships and limited liability companies (LLCs) that file as partnerships. TE FRA created the unified partnership audit and litigation procedures of Internal Revenue Code sections 6221 through 6234 (TEFRA partner ship procedures). Partnership item. Any item more appro priately determinable at the partnership level. If an item is determined to be a partnership item, all TEFRA rules and procedures apply. Prior to the enactment of TEFRA, no con solidated proceeding existed for the tax treat ment of partnership items at the entity level. As a result, examination, processing, and judicial proceedings for partnerships were conducted at the partner level which required that each part ner dealt separately with the IRS and the courts. Publication 541 (January 2016) TEFRA procedures were designed to streamline examinations of partnerships by re quiring that partnership issues be handled in a single, unified partnershiplevel proceeding in stead of multiple proceedings at the partner level. TEFRA also created the Tax Matters Part ner or “TMP” which is the main contact between the IRS, the partnership, and its partners during an examination of a partnership. It is important to note that partners other than the TMP are also entitled to participate during the examina tion process and appellate conferences. For the purposes of these instructions, the consolidated audit proceedings of Internal Rev enue Code sections 6221 through 6234 will be referred to as “TEFRA proceedings.” In addi tion, partnerships and LLCs that are subject to the consolidated audit proceedings of Internal Revenue Code sections 6221 through 6234 will be referred to as “TEFRA partnerships” and those partnerships and LLCs that are not sub ject to the consolidated audit proceedings will be referred to as “nonTEFRA partnerships.” Small Partnerships and the Small Partnership Exception The term “partnership” means any partnership required to file a partnership return pursuant to Internal Revenue Code section 6031. Partner ships whose tax years begin after September 3, 1982 are TEFRA partnerships unless they meet the definition of a small partnership found in In ternal Revenue Code section 6231(a)(1)(B)(i). This is also commonly referred to as the “Small Partnership Exception.” To meet the definition of a small partnership, the partnership must pass two tests. 1. The partnership must have 10 or fewer partners at all times during the tax year. For purposes of the Small Partnership Ex ception, a married couple filing jointly and their estates are treated as one partner. 2. All partners must be U.S. persons, resi dent aliens, C corporations, or estates of deceased partners. For purposes of the Small Partnership Exception, a C corpora tion is any corporation that is not an S cor poration. Therefore, a partnership is subject to TE FRA procedures if during the tax year any part ner is: Another partnership; An S corporation which files Form 1120–S; An LLC which files a Form 1065, U.S. Re turn of Partnership Income; An LLC electing S corporation status; A single member LLC, commonly referred to as a “Disregarded Entity” for federal tax purposes; A trust, including a grantor trust; A nominee; or A nonresident alien individual. Small Partnership TEFRA Election A partnership that meets the definition of a small partnership may elect to be a TEFRA partnership by filing Form 8893, Election of Partnership Level Tax Treatment. Once a valid TEFRA election is filed, the small partnership is a TEFRA partnership for the year of the election and all subsequent tax years unless the election is revoked with the consent of the IRS. Form 8894, Request to Revoke Partnership Level Tax Treatment Election, is used by small partner ships to revoke a prior TEFRA election. If its TE FRA election is revoked, the small partnership remains subject to TEFRA for all tax years that the TEFRA election was in effect including the year that the election was first filed. Note. If a partnership doesn't qualify as a small partnership for the tax year shown on a TEFRA election revocation, the revocation can not be made and will not be accepted by the IRS. Role of Tax Matters Partner (TMP) in TEFRA Proceedings Pursuant to Internal Revenue Code section 6231(a)(7) and Regulations section 301.6231(a)(7)1, the TMP is a general partner designated by the partnership to represent the partners during the TEFRA proceedings. The TMP has special rights and the authority to rep resent the partners during the TEFRA proceed ings. The TMP and the TMP's authorized repre sentative are the only ones that can extend the Internal Revenue Code section 6229 period of limitations for making assessments. The TMP usually selects the forum for litigation of the partnershiplevel tax dispute: Appeals; U.S. Tax Court; District Court, in the district of the part nership's principal place of business; or U.S. Court of Federal Claims. Notice partners and notice groups (defined below) are also allowed to file protests to go to Appeals or petitions to go to court. TMPs are designated separately for each tax year. If a partnership is subject to TEFRA procedures, it can designate a partner as the TMP for the tax year for which the return is be ing filed by completing the Designation of Tax Matters Partner section of Form 1065. Note. Since the TMP is a position created by statute, if the partnership or LLC is nonTE FRA, it cannot have a TMP. The TMP can be designated by the partner ship on the partnership return or at any time af ter the filing of the partnership return by filing a statement with the IRS Service Center where the partnership return was orginally filed. If the TEFRA partnership is unable or unwilling to designate a TMP, a TMP can be identified by using the Largest Profits Interest Rule. The TMP can also be designated by the IRS or Tax Court. Note. Special rules exist for LLCs designat ing a TMP. See Regulations section 301.6231(a)(7)2 for more information. Page 13 A partner may be designated as the TMP of a partnership for a tax year only if that partner: 1. Was a general partner or managing mem ber in the partnership or LLC at some time during the tax year for which designation is made; or 2. Is a general partner or managing member in the partnership or LLC as of the time the designation is made. For TEFRA purposes, a partner is defined under Internal Revenue Code sections 761 and 6231(a)(2)(B). State law determines whether the partner is a general or limited partner and whether an LLC member is the managing mem ber. Under the Uniform Limited Partnership Act (as adopted by most states), a general partner must have a capital account or contribute serv ices to the partnership, but need not have an al location of profit and loss for each year. Note. If a U.S. person or entity is eligible to be the TMP, a nonU.S. person or entity cannot be designated TMP without the consent of the IRS. How To Sign Documents on Behalf of the Partnership The following are examples of how a tax matters partner (TMP) should sign documents on behalf of the partnership. The manner in which the TMP signs depends on whether the TMP is an entity or an individual. If the TMP is an entity, the individual signs in his or her authority to act on behalf of that entity. Designated Tax Matters Partner (TMP) Signature as Tax Matters Partner (TMP) Example Individual Individual's signature John Smith, TMP S corporation Corporate name followed by the signature and title of the corporate officer authorized to sign ABC Inc., TMP, by John Smith, Vice President C corporation Corporate name followed by the signature and title of the corporate officer authorized to sign ABC Inc., TMP, by John Smith, Vice President Subsidiary of an affiliated group of corporations filing a consolidated tax return Subsidiary corporation's name as TMP, followed by the ABCMIlwaukee Incorporated, TMP, by John Smith, signature and title of the officer of the subsidiary corporation President authorized to sign Trust (grantor trust) Trust name, followed by the signature and title of the person Smith Family Trust, TMP, by Joan Smith, Trustee authorized to sign on behalf of the trust Limited Liability Company (LLC) without regard to filing status LLC name followed by the signature of LLC manager and title of the manager LMN LLC, TMP, by John Smith, Manager Partnership (including limited liability partnerships) whether or not subject to TEFRA Partnership name followed by the signature of the person who has authority under state law to sign for the partnership (usually, a general partner) RST Partnership, TMP, by John Smith, General Partner Notice group. A notice group is a group of partners in the aggregate having a 5% or more interest in the profits of a partnership that re quests and designates one of their members to receive notices. The designated member of the notice group is treated as a notice partner. Note. The Internal Revenue Code section 6229 period of limitations for making assess ments extends, but cannot shorten, the Internal Revenue Code section 6501 statute. It is the partners' periods of assessment that are exten ded by this provision. Notice partner. In partnerships with 100 partners or fewer, all partners are notice part ners. In a partnership having more than 100 partners, all partners owning at least a 1% inter est are notice partners. A notice partner is enti tled to receive notice of the beginning and con clusion of the TEFRA partnership proceedings. Affected item. A special nonpartnership item that is affected by a partnership item. Statute of Limitations and TEFRA Administrative adjustment requests are also known as requests for administrative adjust ment (RAAs). AARs are amended returns filed either by the TMP on behalf of the entire part nership (partnershiplevel AAR) or by a partner (partnerlevel AAR) requesting an administra tive adjustment to correct a partnership item re ported on the partner's income tax return. Part nershiplevel AARs are filed on Form 1065X, Amended Return or Administrative Adjustment Request (AAR), unless the partnership files electronically. Partnershiplevel AARs filed electronically and partnerlevel AARs are filed using Form 8082, Notice of Inconsistent Treat ment or Administrative Adjustment Request. For more information on filing AARs, see the In structions for Forms 1065X and 8082. There is only one statute of limitations for tax payers and it is under Internal Revenue Code section 6501. This code section states that the period for assessing any tax shall not expire be fore three years after the later of: 1. The date the taxpayer's return was filed, or 2. The last day for filing the return deter mined without regard to extensions. TEFRA created Internal Revenue Code sec tion 6229 which states that the period for as sessing any tax attributable to partnership items (or related affected items, defined below) for a partnership shall not expire before three years after the later of: 1. The date the partnership return was filed, or 2. The last day for filing the partnership re turn determined without regard to exten sions. Page 14 Amended Returns and Administrative Adjustment Requests (AARs) Note. A passthrough entity that is a partner in a TEFRA partnership cannot file an AAR. For example, if a partner in a TEFRA partnership is itself a partnership, the passthrough entity that is a partner cannot file an AAR for partnership items originating from the TEFRA partnership. How To Get Tax Help Go online, use a smart phone, call, or walk in to an office near you. Whether it's help with a tax issue, preparing your tax return or picking up a free publication or form, get the help you need the way you want it. Internet. IRS.gov and IRS2Go are ready when you are — every day, ev ery night, 24 hours a day, 7 days a week. Apply for an Employer Identification Num ber (EIN). Go to IRS.gov and enter Apply for an EIN in the search box. Request an Electronic Filing PIN by going to IRS.gov and entering Electronic Filing PIN in the search box. Check the status of your amended return. Go to IRS.gov and enter Where's My Amended Return in the search box. Download forms, instructions, and publica tions, including some accessible versions. Order free transcripts of your tax returns or tax account using the Order a Transcript tool on IRS.gov or IRS2Go. Tax return and tax account transcripts are generally avail able for the current year and past three years. Locate the nearest Taxpayer Assistance Center using the Office Locator tool on IRS.gov or IRS2Go. Stop by most busi ness days for facetoface tax help, no ap pointment necessary — just walk in. An employee can explain IRS letters, request adjustments to your tax account, or help you set up a payment plan. Before you visit, check the Office Locator for the ad dress, phone number, hours of operation, and the services provided. If you have an Publication 541 (January 2016) ongoing tax account problem or a special need, such as a disability, you can request an appointment. Call the local number lis ted in the Office Locator, or look in the phone book under United States Government, Internal Revenue Service. Research your tax questions at www.irs.gov/uac/Tax-Law-Questions. Search publications and instructions by topic or keyword. Read the Internal Revenue Code, regula tions, or other official guidance. Read Internal Revenue Bulletins. Sign up to receive local and national tax news by email. Phone. You can call the IRS, or you can carry it in your pocket with the IRS2Go app on your smart phone or tablet. Download the free IRS2Go mobile app from the iTunes app store or from Google Play. Use it to watch the IRS YouTube channel, get IRS news as soon as it's re leased to the public, order transcripts of your tax returns or tax account, check your refund status, subscribe to filing season updates or daily tax tips, and follow the IRS Twitter news feed, @IRSnews, to get the latest federal tax news, including informa tion about tax law changes and important IRS programs. Index Call the Amended Return Hotline, 18664642050, to check the status of your amended return. Call to order forms, instructions and publications, 1800TAXFORM (18008293676) to order currentyear forms, instructions and publications, and prioryear forms and instructions (limited to 5 years). You should receive your order within 10 business days. Walkin. You can find a selection of forms, publications, and services — inperson, facetoface. Products. You can walk in to some post of fices, libraries, and IRS offices to pick up certain forms, instructions, and publica tions. Some IRS offices, libraries, and city and county government offices have a col lection of products available to photocopy from reproducible proofs. Mail. You can send your order for forms, instructions, and publications to the address below. You should re ceive a response within 10 business days after your request is received. The Taxpayer Advocate Service. The Tax payer Advocate Service (TAS) is your voice at the IRS. The TAS's job is to ensure that every taxpayer is treated fairly, and that you know and understand your rights. The TAS offers free help to guide you through the oftenconfusing process of resolving tax problems that you haven't been able to solve on your own. Re member, the worst thing you can do is nothing at all. As a taxpayer, you have rights that the IRS must abide by in its dealings with you. The TAS online tax toolkit at www.TaxpayerAdvocate.irs.gov can help you understand these rights. If you think the TAS might be able to help you, call your local advocate, whose number is in your phone book and on our website at www.irs.gov/advocate. You can also call our tollfree number at 18777774778. The TAS also handles largescale or sys temic problems that affect many taxpayers. If you know of one of these broad issues, please report it to us through our Systemic Advocacy Management System at www.irs.gov/sams. Internal Revenue Service 1201 N. Mitsubishi Motorway Bloomington, IL 617056613 To help us develop a more useful index, please let us know if you have ideas for index entries. See “Comments and Suggestions” in the “Introduction” for the ways you can reach us. A Administrative adjustment requests 14 Allocations: Builtin gain or loss 8 Installment sale 11 Amended returns 14 Assistance (See Tax help) B Builtin gain or loss 8 C Capital interest 3, 9 C corporation, TEFRA 13 Comments on publication 2 Contribution: Basis of property 8 Builtin gain or loss 8 Distribution of property 9 Net precontribution gain 5 Property 8 Services 9 D Definition, partnership 2 Determining ownership 8 Distributions: Gain or loss 4 Partner's debt 5 Partnership 4 Publication 541 (January 2016) Distributive share: Adjusted basis 9 Guaranteed payments 7 E efile 4 Electronic filing 4 F Family partnership 2 Form: 8275 8 8308 12 8832 2 8865 8 G Guaranteed payments 7 H How to sign documents on behalf of the partnership 14 I Insurance, selfemployed health 7 Inventory items, substantially appreciated 4 Basis adjustments 9 Book value 10 Liquidation of 5, 12 Liability: Mandatory basis Assumption of 10 adjustment 6 Partner's assumed by Sale, exchange, transfer 11 partnership 9 Special basis adjustment 6 Partnership's 10 Transactions with partnership 7 Limited liability company 2 Partnership: Liquidation: Abandoned or worthless Constructive 10 interest 11 Partner's interest 5 Agreement 3 Partner's retirement or death 12 Basis, contributed property 8 Losses: Capital interest 3 Sales or exchanges 7 Defined 2 Exclusion from rules 4 Family 2 M Forming 2 Marketable securities 5 Liabilities 10 Terminating 3 Transactions with partner 7 N Partnership item, TEFRA 13 Notice group, TEFRA 14 Precontribution gain 5 Notice partner, TEFRA 14 Profits interest 9 Publications (See Tax help) L P Partner's: Basis: Distributed property 5 Partnership interest 9 Interest: Acquired by gift 9 Alternative rule, adjusted basis 10 Basis 9 R Related person 10 S Selfemployed health insurance 7 Short period return 3 Page 15 Small partnership exception to TEFRA 13 Statute of Limitations and TEFRA 14 Substantially appreciated inventory items 4 Suggestions for publication 2 Page 16 T Tax help 14 Tax matters partner 13 Tax withholding, foreign person or firm 2 TEFRA 13 Terminating a partnership 3 TTY/TDD information 14 U Uniform Limited Partnership ACT (ULPA) 14 Unrealized receivables 11 Publication 541 (January 2016)
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