[Federal Register Volume 76, Number 206 (Tuesday, October 25, 2011)]
[Proposed Rules]
[Pages 66012-66013]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-27575]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-109564-10]
RIN 1545-BJ37


Partner's Distributive Share

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations removing Sec.  
1.704-1(b)(2)(iii)(e) (the de minimis partner rule) because the rule 
may have resulted in unintended tax consequences. The proposed 
regulations affect partnerships and their partners.

DATES: Written or electronic comments and requests for a public hearing 
must be received by January 23, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-109564-10), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
109564-10), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW, Washington, DC; or sent electronically, via the Federal 
eRulemaking Portal at http://www.regulations.gov (IRS REG-109564-10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Michala Irons, at (202) 622-3050; concerning submission of comments, or 
requests for a public hearing, Richard Hurst, at (202) 622-2949 (TDD 
Telephone) (not toll free numbers) and his e-mail address is 
[email protected].

SUPPLEMENTARY INFORMATION:

Background

    Subchapter K is intended to permit taxpayers to conduct joint 
business activities through a flexible economic arrangement without 
incurring an entity-level tax. To achieve this goal of a flexible 
economic arrangement, partners are generally permitted to decide among 
themselves how a partnership's items will be allocated. Section 704(a) 
of the Internal Revenue Code provides that a partner's distributive 
share of income, gain, loss, deduction, or credit shall, except as 
otherwise provided, be determined by the partnership agreement.
    Section 704(b) places a significant limitation on the general 
flexibility of section 704(a). Specifically, section 704(b) provides 
that a partner's distributive share of income, gain, loss, deduction, 
or credit (or item thereof) shall be determined in accordance with the 
partner's interest in the partnership (determined by taking into 
account all facts and circumstances) if the allocation to a partner 
under the partnership agreement of income, gain, loss, deduction, or 
credit (or item thereof) does not have substantial economic effect. 
Thus, the statute provides that partnership allocations either must 
have substantial economic effect or must be in accordance with the 
partners' interests in the partnership.
    Section 1.704-1(b)(2)(i) provides that the determination of whether 
an allocation of income, gain, loss, or deduction to a partner has 
substantial economic effect involves a two-part analysis that is made 
as of the end of the partnership taxable year to which the allocation 
relates. First, the allocation must have economic effect within the 
meaning of Sec.  1.704-1(b)(2)(ii). Second, the economic effect of the 
allocation must be substantial within the meaning of Sec.  1.704-
1(b)(2)(iii).
    For an allocation to have economic effect, it must be consistent 
with the underlying economic arrangement of the partners. This means 
that, in the event that there is an economic benefit or burden that 
corresponds to the allocation, the partner to whom the allocation is 
made must receive such economic benefit or bear such economic burden. 
See Sec.  1.704-1(b)(2)(ii). Generally, an allocation of income, gain, 
loss, or deduction (or item thereof) to a partner will have economic 
effect if, and only if, throughout the full term of the partnership, 
the partnership agreement provides: (1) for the determination and 
maintenance of the partners' capital accounts in accordance with Sec.  
1.704-1(b)(2)(iv); (2) for liquidating distributions to the partners to 
be made in accordance with the positive capital account balances of the 
partners; and (3) for each partner to be unconditionally obligated to 
restore the deficit balance in the partner's capital account following 
the liquidation of the partner's partnership interest. In lieu of 
satisfying the third criterion, the partnership may satisfy the 
qualified income offset rules set forth in Sec.  1.704-1(b)(2)(ii)(d).
    Section 1.704-1(b)(2)(iii)(a) provides as a general rule that the 
economic effect of an allocation (or allocations) is substantial if 
there is a reasonable possibility that the allocation (or allocations) 
will affect substantially the dollar amounts to be received by the 
partners from the partnership, independent of tax consequences. This 
section further provides that, even if the allocation affects 
substantially the dollar amounts, the economic effect of the allocation 
(or allocations) is not substantial if, at the time the allocation (or 
allocations) becomes part of the partnership agreement: (1) The after-
tax economic consequences of at least one partner may, in present value 
terms, be enhanced compared to such consequences if the allocation (or 
allocations) were not contained in the partnership agreement, and (2) 
there is a strong likelihood that the after-tax economic consequences 
of no partner will, in present value terms, be substantially diminished 
compared to such consequences if the allocation (or allocations) were 
not contained in the partnership agreement.

[[Page 66013]]

Explanation of Provisions

Removal of De Minimis Partner Rule in Sec.  1.704-1(b)(2)(iii)(e)

    The de minimis partner rule in Sec.  1.704-1(b)(2)(iii)(e) (TD 
9398, 73 FR 28699-01) was promulgated on May 19, 2008, as part of final 
regulations with respect to partners that are look-through entities. 
The de minimis partner rule provides that for purposes of applying the 
substantiality rules, the tax attributes of de minimis partners need 
not be taken into account and defines a de minimis partner as any 
partner, including a look-through entity that owns, directly or 
indirectly, less than 10 percent of the capital and profits of a 
partnership, and who is allocated less than 10 percent of each 
partnership item of income, gain, loss, deduction, and credit. The 
intent of the de minimis partner rule was to allow partnerships to 
avoid the complexity of testing the substantiality of insignificant 
allocations to partners owning very small interests in the partnership. 
It was not intended to allow partnerships to entirely avoid the 
application of the substantiality regulations if the partnership is 
owned by partners each of whom owns less than 10 percent of the capital 
or profits, and who are allocated less than 10 percent of each 
partnership item of income, gain, loss, deduction, and credit. The IRS 
and the Treasury Department have determined that the de minimis partner 
rule should be removed in order to prevent unintended tax consequences. 
The IRS and the Treasury Department request comments on how to reduce 
the burden of complying with the substantial economic effect rules, 
with respect to look-through partners, without diminishing the 
safeguards the rules provide.

Proposed Effective Date

    These regulations are proposed to be effective the date final 
regulations are published in the Federal Register.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that Sec.  553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to Sec.  7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking has been submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Requests for a Public Hearing

    Before the proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and the Treasury Department request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying. A public hearing may be scheduled if requested in writing by 
any person that timely submits written or electronic comments. If a 
public hearing is scheduled, notice of the date, time, and place for 
the public hearing will be published in the Federal Register.

Drafting Information

    The principal author of these regulations is Michala Irons, Office 
of the Associate Chief Counsel (Passthroughs and Special Industries). 
However, other personnel from the IRS and the Treasury Department 
participated in its development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR Part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. In Sec.  1.704-1 paragraph (b)(2)(iii)(e) is removed.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-27575 Filed 10-24-11; 8:45 am]
BILLING CODE 4830-01-P