Tax benefits for partners in "trading" partnerships.

• Author: Torella, Lawrence

Partners in a trading partnership can receive substantial tax benefits due to the treatment of the partnership as generating neither passive nor portfolio items for income tax purposes.

Generally, a partner who does not materially participate in a partnership's trade or business activity is considered to be passive with respect to the activity, thereby potentially limiting his ability to deduct losses from the activity. However, a partnership engaged in trading securities is not a passive activity for its partners, according to Temp. Regs. Sec. 1.469-1T(e)(6).

Further, the distributive share of income and deductions of a trading partnership is not treated as portfolio income and deductions as it would be for a partner in an investment partnership. Trader status is determined at the partnership level with the benefits of the trading activity passed out to the individual partners, even if they are limited partners and without regard to their participation in the activity.

The tax benefits for an individual partner of a trading partnership (in contrast to a partner in a passive or investment partnership) include:

* No passive loss limitations: Partners can fully deduct their share of the partnership's operating expenses (such as rent, salaries, office expenses and professional and management fees), without regard to the passive loss limitations.

* Above-the-line deduction of operating expenses: The distributive share of the partnership's operating deductions is deductible when computing adjusted gross income (AGI), rather than as a miscellaneous itemized deduction. Thus, partners in a trading partnership are not subject to the following limitations on operating deductions:

1. Miscellaneous itemized deductions are deductible only to the extent they exceed 2% of AGI; and

2. Certain itemized deductions are deductible only to the extent they exceed 3% of the excess of AGI over a threshold amount.

The above-the-line deduction also causes a reduction in AGI, which may permit a greater deduction for medical expenses, as well as miscellaneous and overall itemized deductions.

* Elimination of AMT issues: A partner in an investment partnership cannot deduct any of his share of the partnership's operating expenses against the alternative minimum tax (AMT) because the deductions are treated as miscellaneous itemized deductions, not deductible when computing the AMT. Since a partner in a trading partnership deducts these expenses as trade or business...