Allocating liabilities among related partners: determining the impact of IPO II.

• Author: Harris, Deanna Walton

In 2004, the Tax Court released its decision in IPO II, 122 T.C. 295 (2004). Five years later, IPO II's impact on the allocation of liabilities among related partners has not been fully explored. This item is intended to make the reader aware of IPO II's potential impact on allocating partnership liabilities under Sec. 752 and, given the decision, the unique considerations that must be taken into account in reaching a desired liability allocation among related partners.

Allocation of Liabilities

Although a full discussion of the allocation of partnership liabilities is beyond the scope of this item, some background is necessary to understand the issue addressed in IPO II. In relevant part, Sec. 752 treats an increase or decrease in a partner's share of partnership liabilities as a contribution or distribution, respectively, of money by the partner to the partnership or vice versa. Because the deemed contributions and distributions affect a partner's basis in its partnership interests, a partner's share of partnership liabilities is relevant in determining the amount of partnership losses the partner may include on its tax return, the amount of gain or loss recognized if the interest is sold, and the partner's basis in property distributed by the partnership (or, if the distributed property is cash, whether the partner recognizes gain on the distribution).

The Sec. 752 regulations provide rules for determining a partner's share of the partnership's liabilities and make the "economic risk of loss" concept essential to the allocation of partnership liabilities. A partnership liability is recourse to the extent that one or more partners (or a related person) bear the economic risk of loss for the liability. In contrast, a liability is nonrecourse if no partner (or related person) bears the economic risk of loss for the liability. Under these rules, because members of a limited liability company (LLC) are not obligated to pay the debts of the LLC, debt incurred by an LLC is generally nonrecourse for purposes of Sec. 752, unless a member bears the economic risk of loss for such liability by contract (i.e., a guarantee) or the member (or related person) is the lender.

Regs. Sec. 1.752-2 allocates a partnership recourse liability to a partner if and to the extent the partner--or a related person--bears the economic risk of loss. Regs. Sec. 1.752-4 generally treats a person as related to a partner if, among other things, the person and the partner are:

* An individual and a corporation, and the individual owns more than 80% of the corporation's value; or

* Two corporations that are members of the same controlled group of corporations, which generally means that the same person holds, directly or indirectly, at least 80% of the vote or value of both corporations.

If a person is related to more than one partner, the person is treated as related only to one partner--the partner with whom there is the highest percentage of related ownership. If...