Page 139 - The TEFRA Partnership Audit Rules Repeal:

ALI CLE Live Video Webcast / “The TEFRA Partnership Audit Rules Repeal: Partnership and Partner Impacts” June 7, 2016, Jerald David August and Terence Floyd Cuff
The imputed underpayment of the partnership is determined without decreasing the $100 of rental income by the $70 of depreciation and interest deductions. The adjustment is a $70 increase in income. Assume that the highest rate of Federal income tax applicable to individuals or corporations in 2024 is 39.6 percent. The product of $70 and 39.6 percent is $27.72, the amount of the imputed underpayment. However, the partnership may implement procedures for modifying the imputed underpayment as so determined.
Any adjustment which reallocates the distributive share of any item or items from one partner to another, is taken into account in computing the imputed underpayment by disregarding any corresponding decrease in any item of income or gain, and any corresponding increase in any item of deduction, loss or credit. This controversial aspect of the new provisions may inspire many partnership structures to “elect-out” on an annual basis. Perhaps the Internal Revenue Service will like this new rule, as it will increase tax revenues by authorizing the “double-counting” of partnership income.
Consider this example:
Example 1. Newton and Manning, two United States individuals, form in 2018 the Newton-Manning Sports Production LLC (“NMSP”) as a New York LLC. Newton contributes sports memorabilia, production rights and instruction materials having a fair market value of $1,200x and a tax basis of $1x or a nominal amount. Manning contributes $1,200x in cash. The NMSP LLC agreement acknowledges their agreement to be 50-50 partners although Newton thinks he should have at least 50.1% of the venture but they agree nonetheless. Their book capital accounts are $1,200x each.
In 2019 the NMSP LLC sold the media production rights (which were contributed by Newton’s contribution) for $2,000x in cash. NMSP LLC uses the proceeds to grow the business. Assume the production rights qualify for capital asset treatment and with tacking. The partnership, which did not elect-out for 2019, ignored Section 704(c) and allocated the long term capital gain of $1,500x (the production rights were contributed with a cost basis of $500x and FMV of $1,000x) equally between Manning and Newton ($750x each). Under Section 704(c), the partnership should have allocated Manning the first $500x of the long term capital gain. The partnership then should have allocated Manning and Newton $500x each of the remaining gain of $1000x.
In April of the following year, 2020, Manning and Newton each pay $150x of tax ($750x x 20%). In year 2021 the IRS audits NMSP for the
© Terence Floyd Cuff and Jerald David August, 2016
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