Foreign and tax-exempt partners' tax years.

• Author: Pimenta, Antonio D.

Treasury issued Sec. 706 final regulations (TD 9009) on the tax year of a partnership with foreign and tax-exempt partners. Under the regulations, a partnership's tax year will be determined without regard to the tax year of its foreign and tax-exempt partners, under certain circumstances. The regulations also provide relief for certain foreign partnerships in existence, and transitional rules for those who elect to conform to the new rules.

Permissible Tax Years

Under Sec. 706(a), in computing a partner's taxable income for a tax year, the partner must include its share of any partnership income, gain, loss, deduction or credit for the partnership's tax year that ends within or with the partner's tax year.

According to Sec. 706(b)(1)(B), unless a partnership establishes a business purpose for a different tax year, it cannot have a tax year other than (1) the majority-interest tax year; (2) if no majority-interest tax year exists, the tax year of all principal partners; or (3) if no tax year is described in (1) or (2), the calendar year, unless regulations prescribe another period. Under Regs. Sec. 1.706-1(b)(2), if neither Sec. 706(b)(1)(B)(i) nor (ii) apply, the partnership's tax year will be the tax year that results in the least aggregate deferral of partnership income.

For tax-exempt partners, the 1988 proposed regulations have been finalized without substantive change. The proposed and final regulations provide that in determining a partnership's current tax year, a tax-exempt partner under Sec. 501(a) would be disregarded if such partner were not subject to tax on any income attributable to its investment in the partnership during the partnership's tax year immediately preceding the current year.

The regulation's apparent purpose is to prevent taxable partners from obtaining a deferral not otherwise available without adverse consequences to tax-exempt partners.

The treatment of foreign partners was addressed in 2001 proposed regulations, which generally provided that a foreign partner not subject to U.S. taxation on a net basis on partnership earned income is disregarded for Sec. 706(b) purposes. A foreign partner will be deemed subject to U.S. taxation on a net basis, only if it is allocated partnership gross income that is U.S. effectively connected income (ECI) (i.e., effectively connected with a U.S. trade or business). A foreign partner claiming benefits under a U.S. income tax treaty is disregarded, unless it is allocated any...