Impact of off-code amendment to consolidated return rules.

• Author: Zarzar, Robert
• Position: Partnerships and consolidated groups

Late last year, Congress enacted an off-Code technical change that deals directly with partnerships and consolidated groups. The provision, which applies retroactively, will likely affect a limited number of taxpayers; however, those affected should pay close attention, as the tax ramifications are important.

Background

Under general partnership rules, partners can receive distributions of property tax-free. Further, when a partner receives a property distribution in complete redemption of his interest, the property takes a substituted basis equal to the recipient's basis in his partnership interest.

These rules previously presented planning opportunities for corporate partners with a low basis in their partnership interests. If the partnership were to distribute "hard assets" in a complete redemption, the corporate partner would take a stepped-down basis in those assets. However, if the partnership first contributed these same assets to a corporation (Newco) and then distributed the Newco stock in redemption of the corporate partner's interest, the partner would suffer a basis step-down only in the Newco stock, preserving a high basis in the assets within Newco. The partner then could liquidate Newco tax-free, making the step-down in the basis of the stock inconsequential.

Congressional Response

In response, Congress enacted Sec. 732(f), which applies to distributions of stock to corporate partners made by a partnership after July 14, 1999. Basically, that provision mandates a further reduction to the basis of a corporation's assets if the stock of that corporation is distributed by a partnership to a corporate partner. As originally enacted, the reduction only applied if, after the distribution, the corporate partner controlled the distributed corporation, with control measured at the time of the distribution or at any time after the distribution.

Concerns arose over operation of the new statute. The term "control" generally meant direct, actual ownership of stock reflecting 80% vote and value. Since neither the Code nor the consolidated return rules contained an attribution rule, indirect stock ownership through an affiliated corporation would not result in control for Sec. 732(f) purposes. As a result, partnerships sought to circumvent Sec. 732(f) and avoid reducing the basis of the assets inside a distributed corporation.

Example: Partners A and B are members of the same consolidated group. A owns 40% of Partnership X, and B owns 40%...