IRS issues partnership anti-abuse rule regs.

• Author: Nevius, Alistair M.

The IRS and Treasury issued final regulations on June 8 to provide that the Sec. 704(c) anti-abuse rule takes into account the tax liabilities of both partners and certain owners of partners (T.D. 9485). The regulations also provide that partnerships cannot use an allocation method to achieve tax results that are inconsistent with the intent of the partnership rules in the Internal Revenue Code.

The final regulations adopt without any changes proposed regulations that were issued in 2008 (REG-100798-06). (For more on the proposed regulations, see Tax Trends, "IRS Issues New Rules on Allocation of Partnership Items," 39 The Tax Adviser 540 (August 2008).) The regulations respond to a recommendation by the Joint Committee on Taxation in the wake of the Enron scandal that the anti-abuse rule of Regs. Sec. 1.704-3(a)(10) be strengthened with respect to "partnership allocations for property contributed to a partnership, especially in the case of partners that are members of the same consolidated group, to ensure that the allocation rules are not used to obtain unwarranted tax benefits" (Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations (JCS-3-03) (February 2003), p. 29).

Under the anti-abuse rule, a method (or combination of methods) for allocating contributed partnership property is not reasonable if the contribution of property and the corresponding allocation of tax items with respect to the property are made with a view to shifting the tax consequences of built-in gain or loss among the partners in a way that substantially reduces the present value of the partners' aggregate tax liability. According to the IRS, a substantial reduction in the present value of an indirect partner's tax liability must be considered when analyzing the reasonableness of an allocation method because allowing a partnership to adopt a method under which the tax advantages accrue to an indirect partner rather than a direct partner would be inconsistent with the purposes of Sec. 704(c).

Therefore, the regulations amend Regs. Sec. 1.704-3(a)(10) to provide that, for purposes of applying the anti-abuse rule, the tax effect of an allocation method (or combination of methods) on both direct and indirect partners is considered. An indirect partner is defined as any direct or indirect owner of a partnership, S corporation, or controlled foreign corporation...