United States: New Regulations Change Allocation Of Partnership Liabilities

On October 4, 2016, the Treasury Department and Internal Revenue Service (IRS) issued revised regulations governing how recourse partnership liabilities are allocated among partners.  These temporary regulations, which are binding on taxpayers immediately, relate to so-called "bottom-dollar payment obligations" (BDPOs).  Generally, if a partner guarantees a recourse partnership liability, the liability will be allocated to that partner and will increase his basis in his partnership interest—thereby increasing the amount of money or property the partner may receive in distributions from the partnership, or the amount of partnership losses that he can be allocated, without incurring income tax.  Under the new regulations, certain guarantees, indemnities and similar arrangements (collectively, "guarantees") classified as BDPOs will be disregarded for purposes of characterizing partnership liabilities as recourse obligations and instead such liabilities will be treated as nonrecourse obligations and allocated amongst the partners accordingly.  Although the "bottom-dollar" moniker implies that only guarantees of the last dollars of a recourse partnership obligation will be disregarded, the temporary regulations sweep much more broadly.  The new rules generally do not apply to obligations in place before October 5, 2016 unless they are modified.  Partners and partnerships planning to enter into or modify guarantees should ascertain whether and how the new rules affect their intended structures.

  1. Changes in the Rules

A partnership's liabilities are allocated among its partners for purposes of determining each partner's tax basis in his partnership interest, and accordingly the amount of money or other property that each partner can receive as a distribution from the partnership or the amount of partnership losses that can be allocated to each partner without incurring income tax.  The new rules were intended to curb perceived abuses—in particular, the use of guarantees lacking significant non-tax, commercial purposes to characterize obligations as recourse liabilities and thereby artificially increase the guaranteeing partner's basis in the partnership. 

Generally, a recourse partnership liability would be allocated to the partner who, if the partnership were liquidated and the obligation became due and payable, would be obligated to make a payment or a contribution to the partnership with respect to that liability.  Formerly, all statutory and contractual obligations relating to a partnership liability were taken into account, including guarantees relating to less than all of the partnership liability, such as a tranche-based or "horizontal slice" guaranty.  If, for example, Partner A guaranteed the first $500 of a $1,000 recourse partnership liability, and Partner B guaranteed the second $500, the liability would be allocated 50/50 to Partners A and B. 

Under the new rules, because Partner B's guaranty does not extend to any portion of the first dollar of the liability, it will be disregarded, and the second $500 of the $1,000 liability will be allocated among the partners as if it were a non-recourse liability.  The new rules presumptively disregard BDPOs, subject to limited exceptions.  They also require disclosure on the partnership's information return of any BDPO as well as the partnership's position as to whether (and why) that BDPO should be respected under the rules. 

  1. Bottom-Dollar Payment Obligation

BDPOs are not limited to guarantees of the last dollar of an obligation.  A BDPO is any payment obligation on which the obligor-partner would not be liable up to the full amount of his obligation if, and to the extent that, any amount of the partnership's liability were unsatisfied.  Separate prongs of the BDPO definition address indemnities and arrangements involving tiered partnerships, intermediaries, senior and subordinate liabilities and other structures that convert what would otherwise be a single liability into multiple liabilities.

In the simple example above, Partner B's guaranty is a BDPO because, if the partnership were to satisfy its recourse obligation in part, Partner B would not necessarily be required to make good on any portion of his guaranty.  If the partnership failed to satisfy half (or less than half) of its $1,000 liability, for example, Partner A—not Partner B—would be liable for the balance.  Alternatively, suppose that Partner B guarantees the full $1,000 of the partnership liability, and instead of guaranteeing a portion of that liability directly, Partner A agrees to indemnify Partner B for the first $500 that Partner B pays out on his guaranty.  Partner B's guaranty is again a BDPO because Partner B is liable only to the extent that any amount beyond $500 of the partnership liability is not satisfied; Partner A is on the hook for the first $500, albeit indirectly.

As these examples illustrate, the BDPO definition generally captures payment obligations with respect to horizontal slices of a partnership liability.  A guaranty of any slice that does not include a portion of the first dollar of the partnership's obligation is a BDPO.  However, a guaranty will not qualify as a BDPO merely because it does not extend to the full amount of the partnership liability, and vertical-slice guarantees (covering a fixed percentage of every dollar of the partnership liability) are generally not BDPOs.  Moreover, where partners are co-obligors on a guaranty or indemnity for which they are jointly and severally liable, their proportionate rights of contribution do not cause the guaranty to become a BDPO.

  1. Effective Date

By their terms, the temporary regulations apply only to recourse liabilities incurred by a partnership, and guarantees undertaken with respect to recourse partnership liabilities, on or after October 5, 2016.  Liabilities incurred and guarantees undertaken pursuant to a binding contract executed before that date are excepted.  The regulations do not explicitly address modifications of partnership liabilities, but the preamble states that such modifications and refinancings of pre-existing obligations that are subject to guarantees trigger application of the new rules.  A partnership can elect to apply the new rules to all pre-existing obligations.

The application of the BDPO rules to modifications and refinancings is tempered by a transition rule.  A partnership may choose to disapply the BDPO rules with respect to any partner (a "Transition Partner") whose share of partnership recourse obligations determined under prior law exceeded such partner's basis in his partnership interest on October 5, 2016 to the extent of such excess.  A partnership may apply this grandfathering treatment to a Transition Partner for up to seven years from the effective date of the temporary regulations.

  1. Effect on Taxpayers

Because the new rules define BDPOs broadly, they reach obligations that represent standard practice in some industries.  Consequently, partners and partnerships that anticipate relying on guarantees to characterize partnership obligations as recourse liabilities or modifying any partnership liability subject to an existing guaranty, should determine:

  • Whether any proposed modification would result in application of the BDPO rules to a pre-existing guaranty;
  • Whether any guaranty would be a BDPO;
  • Whether any BDPO would qualify for an exception to the presumptive disregard of BDPOs;  and
  • The partnership's reporting obligations with respect to any such BDPO.

Given the immediate effect of the new regulations, such determinations should be made before any new recourse partnership liabilities are incurred or new partner guarantees undertaken, and before any existing recourse partnership liability subject to a guarantee is modified.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.