Payments to partners: proposed regs: disguised payments for services.

• Author: Josephs, Stuart R.
• Position: Fed Tax

Proposed regulations (REG-115452 14), published in the Federal Register July 23 (corrected Aug. 19), provide guidance to partnerships and their partners regarding when an arrangement will be treated as a disguised payment for services under IRC Sec. 707(a)(2)(A).

The notice of proposed rulemaking also provides notice of proposed modifications to Rev. Procs. 93-27 and 2001-43 relating to the issuance of interests in partnership profits to service providers.

Whether an arrangement constitutes a payment for services, in whole or in part, depends on the facts and circumstances. The proposed regulations include six non-exclusive factors that may indicate an arrangement is a disguised payment for services. The first five factors generally track the facts and circumstances identified as relevant in Sec. 707(a)(2)(A)'s legislative history. The proposed regulations add a sixth factor not specifically identified by Congress.

The first factor, the existence of significant entrepreneurial risk, is accorded more weight than the other factors. Arrangements that lack significant entrepreneurial risk are treated as disguised payments for services.

The weight given to each of the other five factors depends on the particular case. The absence of a particular factor, other than significant entrepreneurial risk, is not necessarily indicative of whether an arrangement is treated as a payment for services.

The Six Factors

1. The arrangement lacks significant entrepreneurial risk. Whether an arrangement lacks significant entrepreneurial risk is based on the service provider's entrepreneurial risk relative to the partnership's overall entrepreneurial risk. The following sub-factors provide facts and circumstances that create a presumption that an arrangement lacks significant entrepreneurial risk and will be treated as a disguised payment for services--unless other facts and circumstances establish the presence of significant entrepreneurial risk by clear and convincing evidence:

   * Capped allocations of partnership income if the cap is reasonably expected to apply in most years;

   * An allocation for one or more years under which the service provider's share of income is reasonably certain;

   * An allocation of gross income;

   * An allocation (under a formula or otherwise) that is predominantly fixed in amount, is reasonably determinable under all the facts and circumstances, or is designed to assure that sufficient net profits are highly likely to be available to make...