Transactions Between Partnerships and Their Partners

• Pages: 173-188
• Author: James R. Repetti,William H. Lyons,Charlene D. Luke

173

Chapter Nine

TRANSACTIONS BETWEEN

PARTNERSHIPS AND THEIR PARTNERS

A. Introduction

Partnerships can make payments to a partner in three ways: (1)

payments to a partner in a non-partner capaci ty (described in

§ 707(a)), (2) payments that are called “guaranteed payments”

(described in § 707(c)), and (3) payments of a partner’s distributive

share of partnership income.

Section 707(a) treats payments in the first category—payments

made to a partner who acts in a non-partner capacity—as though the

partner is an outsider. Section 707(a) provide s, subject to exceptions

to be noted later, that:

If a partner engages in a transaction with a par tnership

other than in his capacity as a member of such partnership,

the transaction shall . . . be considere d as occurring

between the partnership and one who is not a partner.

For example, if a partnership buys property from a partner, the

partnership’s basis and the amou nt of the partner’s gain on the sale

will be calculated exactly as if the partner were an unrelated person.

Section 707(c) deals with the second ca tegory—“guaranteed

payments” made by partnerships to partners “for services or the use

of capital.” Unlike § 707(a) payments, § 707(c) states that guaranteed

payments are “considered as” made to non-partners “only” in

determining whether the payments are includable in the partne rs’

gross incomes and whether the payments are deductible as bus iness

expenses under § 162(a). Although, the statute’s use of the word

“only” suggests that guaranteed payments will for all other purposes

be treated as payments to partners, guaranteed payments do not

decrease the recipient’s outside basis or capital account.

1

For other

purposes, however, including the timing of income inclusion and any

deduction, guaranteed payments are treated as made to partners.

As an illustration of the difference between § 707(a) payments

and § 707(c) guaranteed payments, consider a case in which partner

Jean receives $10,000 cash for services performed for the JK

partnership. If the partnership had paid an o utsider for these

services, it wou ld have de ducted the $10,000 as an ordinary and

necessary business expense under § 162(a). The payment, being a flat

1

Reg. § 1.704–1(b)(2)(iv)(o).

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Transactions Between Partnerships

and Their Partners

Ch. 9

fee fo r services rather than a share o f the partnership’s income, is

probably either a § 707(a) payment or a § 707(c) guaranteed

payment, but without more information we cannot tell which. (Even

if we had more information, we might not be able to tell; the

distinction, as we shall see, is fuzzy.) What difference does it make?

In either case, the partnership can deduct the payment, and Jean

must include it in income.

One difference between treating the paymen t to Jean as a

§ 707(c) guaranteed payment and treating it as a § 707(a) payment

involves the timing of her income and the partnership’s deduction. If

the payment is a guaranteed payment, Jean will include it in her

income for her taxable year “within or with” which the partnership’s

taxable year ends.

2

This is the same timing rule that governs the

inclusion of a partner’s distributive share. Suppose that the

partnership, which uses a calendar year and an accrual method of

accounting, accrues the payment in 2022. Jean, a cash -method

taxpayer, does not actually receive the payment until 2023. The

“within or with” rule of § 706(a) requires that Jean include the

$10,000 in her 2022 inc ome because the partnership accrued the

payment in 2022 and the partnership 2022 year e nds with Jean’s

2022 taxable year. Therefore, the timing of a partner’s income from

a guaranteed payment will depend upon the partnership’s method of

accounting, rather than upon the partner’s method.

If Jean’s $10,000 payment is a § 707(a) payment (one made to

her in a non-partner capacity), the timing of her income will depend

upon her accounting method, just as if she had received the payment

from an unrelated third party. In the example, she would have

income in 2023, the year she receives the payment. If § 707(a) were

the whole story, the partnership would deduct the payment in 2022

under its accrual method. Section 267(a)(2) will, however, delay the

partnership’s deduction until the payment is includible in Jean’s

income in 2023. Altho ugh § 707(a) generally treats Jean as a no n-

partner, she and the partnership are “related” under § 267(b), which

is outside Subchapter K.

3

“Qualified business income,” which is eligible for the 20% § 199A

deduction, does not include “any guaranteed payment described in

§ 707(c) paid to a par tner for services rendered with respect to the

trade or business.”

4

As a result, the recipient of a § 707(c) payment

for services is prevented from increasing her § 199A eligible items by

that payment. Similarly, the regulations state that payments for

2

§ 706(a).

3

See § 267(e).

4

§ 199A(c)(4)(B); Reg. § 1.199A–3(b)(2)(ii)(I). Nevertheless, the partnership’s

deduction of the guaranteed payment will reduce qualified business income if allocable

to the partnership’s trade or business. Id.