Structuring partnership payments to a retiring partner.

• Author: Bakale, Anthony

Sec. 736 classifies payments made by an ongoing partnership to liquidate the interest of a retiring or a deceased partner's successor-in-interest. The purpose underlying the passage of Sec. 736 was to eliminate the prior uncertainties in the taxation of partner retirements.

These-uncertainties arose because payments made to a retiring or a deceased partner's successor were often a combination of payments for the partner's share of partnership property and payments that represent the partner's share of continuing partnership income. Sec. 736 clarifies this situation by classifying payments for the partner's share of partnership property under Sec. 736(b) and classifying income payments under Sec. 736(a). The Sec. 736 liquidation rules apply only when the retiring or deceased partner, or the successor to the deceased partner, receives a distribution or distributions in complete liquidation of the partner's interest in the continuing partnership.

Sec. 736(b) payments are payments made to the retiring or deceased partner's successor in exchange for the retiring partner's interest in partnership property. It is useful to think of these payments as being made in lieu of distributing to the partner or the successor a proportionate share of each partnership asset. Sec. 736(a) payments include all payments not classified as Sec. 736(b) payments, such as:

1. Payments for the distributee partner's share of partnership unrealized receivables, to the extent the receivables do not have basis to the partnership and if the payments are reclassified as Sec. 736(a) payments under Sec. 736(b)(2)(A).

2. Payments for goodwill not provided for in the partnership agreement, to the extent goodwill does not have any basis to the partnership and if the payments are reclassified as Sec. 736(a) payments under Sec. 736(b)(2)(A).

3. Payments for the distributee partner's share of partnership unrealized receivables and goodwill generally will not be reclassified as Sec. 736(a) payments if the distributee partner is a limited partner or if capital is a material income-producing item in the partnership.

   Sec. 736(a) rules will not apply when a partner is a limited partner or when capital is a material income-producing factor for the partnership. Rather, all payments are treated as payments in exchange for partnership property (Sec. 736(b)). Therefore, the importance of Sec. 736 relates mainly to service-oriented partnerships (such as general partnerships in the practice of...