Daily Tax Update - August 21, 2007


IRS PROPOSES RULES REGARDING PARTNER'S DISTRIBUTIVE SHARE: Today the Internal Revenue Service issued proposed regulations concerning the application of Code sections 704(c)(1)(B) and 737 to distributions of property after two partnerships engage in an assets-over merger.  The proposed regulations implement the principles of Revenue Ruling 2004-43.

  • Section 704(c)(1)(B) provides that a partner that contributes section 704(c) property to a partnership must recognize gain or loss on the distribution of such property to another partner within 7 years of its contribution to the partnership in an amount equal to the gain or loss that would have been allocated to such partner under section 704(c) if the distributed property had been sold by the partnership to the distributee partner for its fair market value at the time of the distribution.  Section 737(a) provides that a partner that contributes section 704(c) property to the partnership and then receives a distribution of property (other than money) within 7 years of its contribution must recognize gain in an amount equal to the lesser of (1) the excess (if any) of (A) the fair market value of  property (other than money) received in the distribution over (B) the adjusted  basis of the partner's interest in the partnership immediately before the distribution reduced (but not below zero) by the amount of money received in the distribution, or (2) the net precontribution gain of the partner.
  • Revenue Ruling 2004-43 held that sections 704(c)(1)(B) and 737(b) apply to newly created section 704(c) gain or loss in property contributed by the transferor partnership to the transferee partnership in an assets-over partnership merger, but not to reverse section 704(c) gain or loss resulting from a revaluation of property of the transferee partnership.  This ruling was criticized as inconsistent with the existing regulations, so the IRS withdrew it and issued a Notice (Notice 2005-15) warning taxpayers that it intended to amend the regulations to provide the same result as Rev. Rul. 2004-43.
  • The proposed regulations under Reg. § 1.704-4(c)(4) and Reg. § 1.737-2(b) implement that intent and provide that in an assets-over merger, sections 704(c)(1)(B) and 737 do not apply to the transfer by a partnership (the transferor partnership) of all of its assets and liabilities to another partnership (the transferee partnership), followed by a distribution of the interests in the transferee partnership in liquidation of the transferor partnership as part of the same plan or arrangement.  However, the proposed rules provide that section 704(c)(1)(B) applies to a subsequent distribution by the transferee partnership of section 704(c) property contributed in the assets-over merger by the transferor partnership to the transferee partnership.  The proposed regulations also provide that section 737 applies when a partner of the transferor partnership receives a subsequent distribution of property (other than money) from the transferee partnership.
  • As promised in Notice 2005-15, the regulations will be effective for any distributions of property after January 19, 2005, if such property was contributed in an assets-over merger after May 3, 2004.  Provisions relating to a change in the regulations in Reg. § 1.704-4 and Reg. § 1.737-1 from the previous five-year rule to the seven-year rule (for accounting for section 704(c) gain or loss with respect to distributions) will be effective August 22, 2007.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.comAaron P. Nocjar - anocjar@steptoe.com 

TAXPAYER ADVOCACY PANEL RELEASES ANNUAL REPORT:  On August 17th, the Taxpayer Advocacy Panel released its annual report.

  • The panel recommended that the IRS eliminate the private debt collection program.  "The IRS should abandon all plans to outsource any taxpayer debts and restrict collection activities to properly trained and proficient IRS personnel," the report stated. "Debt collection is a core function of IRS, and appropriate staffing should be assigned to this function to achieve collection objectives."
  • The panel also recommended that the IRS license return preparers according to level and area of expertise.  "The licensing of paid tax return preparers will benefit the taxpayers, tax preparers, and the IRS by reducing fraudulent and inaccurate returns, raising the professionalism of preparers, and enabling the IRS to ensure the qualifications of the people who are paid to prepare tax returns," the report said.

TRANSFER PRICING DOCUMENTATION DEADLINE ON SEPTEMBER 15, 2007 FOR CALENDAR YEAR TAXPAYERS:  To avoid penalties, taxpayers should have appropriate documentation of their transfer pricing methodologies and results by the time they file their tax returns.  For calendar year taxpayers, this means that the documentation must be completed by September 15.  IRS agents have been instructed to look critically at this documentation, so companies may want to reconsider the standards they have used in the past for determining whether their documentation is rigorous and specific enough.  Steptoe's transfer pricing group is available and particularly well-situated to assist with that work.  Click here for more information


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