Final partnership anti-abuse regulations.

• Author: Crnkovich, Robert J.

The IRS has released final partnership anti-abuse regulations under Sec. 701 in an attempt to clarify Prop. Regs. Sec. 1.701-2. The final regulations are generally effective as of May 12, 1994 (when the proposed regulations were originally issued), although one provision is effective as of Dec. 29, 1994.

The wording of the final regulation will continue to create uncertainty for many partnership transactions. The anti-abuse rule in Regs. Sec. 1.701-2(b) states:

[I]f a partnership is formed or availed of in connection with a transaction a principal purpose of which is to reduce substantially the present value of the partners' aggregate federal tax liability in a manner that is inconsistent with the intent of subchapter K, the Commissioner can recast the transaction for federal tax purposes, as appropriate to achieve tax results that are consistent with the intent of subchapter K, in light of the applicable statutory and regulatory provisions and the pertinent facts and circumstances.

The IRS has further defined "the intent of subchapter K." Regs. Sec. 1.701-2(a) states that implicit in the intent of subchapter K are the following: (1) the partnership is bona fide and entered into for a substantial business purpose; (2) the form of each partnership transaction must be respected under substance over form principles; and (3) the tax consequences under subchapter K to each partner of partnership operations and of transactions between the partner and the partnership must accurately reflect the partners' economic agreement and clearly reflect the partner's income (with certain limited exceptions for p o visions adopted with administrative convenience or other policy objectives).

In describing the intent of subchapter K, the proposed regulation had provided that the provisions of subchapter K were not intended to permit taxpayers "to use the existence of the partnerships to avoid the purposes of other provisions of the Internal Revenue Code."

Although apparently intended to address aggregate entity issues, because of the confusion created by this clause, it was removed from the general anti-abuse rule; in its place, Regs. See. 1.701-2(e) was added to address inappropriate treatment of a partnership as an entity. Generally, Regs. Sec. 1.701-2(e) provides that in applying particular sections of the Code...