Page 2 - Tax Controversy Corner: Consider the Constructive Partnership Rules Before reorganizing to Elect Out of the BBA

TAX CONTROVERSY CORNER

Sec. 6221 so that most partnership audits are governed in January 2018, Treasury again stated that the IRS
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8
by the BBA. Treasury explained as follows: would carefully examine elections out to determine if
two or more partnerships are actually constructive or
The centralized partnership audit regime is designed de facto partnerships with each other, but declined
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to improve upon both the TEFRA rules and the to provide any additional guidance as to how this
deficiency procedures by providing for a centralized would be done, referring instead to “existing judicial
audit proceeding with respect to the partnership and doctrines and bodies of law” which govern whether a
mandating centralized assessment and collection of partnership exists. 13
tax, penalties, and interest from the partnership. It
follows then that rules designed to limit the number Is There a Constructive Partnership
of partnerships that can elect out of the new regime
is consistent with this objective. 10 Between Entities That Would Not
Otherwise Be Eligible to Elect Out?
Some partnerships may attempt to meet the eligibility
requirements by changing their ownership structure to Since this is an issue of concern for Treasury, before tak-
reach the 100 or fewer thresholds or by removing partners ing steps to restructure, practitioners should review the
who are not eligible. For example, a partnership with 150 judicial doctrines for determining whether a constructive
partners might reorganize to form two separate partner- partnership exists.
ships with less than 100 partners each. Federal law controls the classification of an entity for
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federal tax purposes. The Code defines a partnership as
“a syndicate, group, pool, joint venture or other unincor-
porated organization through or by means of which any
Tax professionals have expressed business, financial operation, or venture is carried on, and
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concern that assessment and which is not a corporation or a trust or estate.” As this
definition does not provide much guidance, the courts and
collection of tax at the partnership
the IRS look to the facts and circumstances to determine
level is inconsistent with the whether a partnership exists. As stated by the Supreme
ve
vel l
is i inconcoo
ev
is
p
. ulberts
long-standing rules of taxation nstastang-ngonon andinin ules of taxxati Court in W.O. Culbertson:
and
pas
ssthhrohroououg
ssth
of passthrough entities, and
of
of pas ntities, an The question is not whether the services or capital
s or capit
e qu
n is n t hether he servic
p
ay h
ay h
ctable and
may have unpredictable and contributed by a partner are of sufficient importance
hav
havve uve uunnp
a
byapartn rare o ufficien
ontrib
mport n
incongruous consequences. to meet some objective standard … but whether,
considering all the facts – the agreement, the conduct
of the parties in execution of its provisions, the rela-
tionship of the parties, their respective abilities and
Will Treasury Police Elections Out? capital contributions, the actual control of income
and the purposes for which It is used, and any other
Treasury has expressed concern that partnerships may facts throwing light on their true intent – the parties
try to avoid the BBA by restructuring to meet the elec- in good faith and acting with a business purpose
tion out requirements. In the Preamble to Proposed intended to join together in the present conduct of
Regulations issued in June 2017, Treasury stated that the enterprise. 16
“the IRS intends to carefully scrutinize whether two
or more partnerships that have elected out should be The substance of a transaction, and not the form, con-
recast under existing judicial doctrines and general trols the result, and thus, a joint venture may be treated
federal tax principles as having formed one or more like a partnership even though the parties have not formed
constructive or de facto partnerships for federal income an entity, and an entity formed as a partnership may be
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tax purposes.” Treasury received numerous comments disregarded if the parties did not intend to create a joint
in response to this remark, including requests for venture. The focus of the W.O. Culbertson test is “‘not …
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guidance as to how the IRS would determine whether objective’; it is the parties’ ‘true intent.’” Over the years,
separate entities would be treated as a single partner- courts have looked to the following factors in determining
ship. In the Preamble to the Final Regulations issued that intent, including:
60 JOURNAL OF PASSTHROUGH ENTITIES MAY–JUNE 2018