Page 3 - Tax Controversy Corner: Consider the Constructive Partnership Rules Before reorganizing to Elect Out of the BBA

(1) The contributions, if any, which each party has made a partnership because there was no profit sharing, but the
to the venture; Tax Court found that there was a sufficient profit motive
(2) The agreement of the parties and their conduct in and business activity for the venture to be treated as a
executing its terms; partnership for tax purposes. 24
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(3) Whether business was conducted in the joint names Another example is Bergford, where the taxpayers were
of the parties; investors in a computer-leasing tax shelter managed by an
(4) Whether each party was a principal and coproprietor, independent third party and they argued that they were not
sharing a mutual proprietary interest in the net profits partners in a partnership but mere co-owners of property
and having an obligation to share losses, or whether leased to third parties. Even though the taxpayers could not
one party was the agent or employee of the other, separately buy or finance computer equipment, the Tax Court
receiving for his services contingent compensation determined that the taxpayers had an “intent to join together
in the form of a percentage of income…;
(5) Whether the parties exercised mutual control over and
assumed mutual responsibilities for the enterprise;
(6) The parties’ control over income and capital and the For partnerships considering
right of each to make withdrawals; restructuring in order to meet the
(7) Whether separate books of account were maintained election out eligibility requirements,
for the venture; and
(8) Whether the parties filed Federal partnership returns the election to be treated as a small
or otherwise represented to [the IRS] or to persons business corporation may be a
with whom they dealt that they were joint venturers. 18 useful analogy.
In addition, courts have focused on whether the partners
of a purported partnership had meaningful downside risk
and upside potential in the venture. 19
The IRS and taxpayers have been on both sides of these in a transaction in order to share profits and losses,” and had
issues, depending on the tax benefits to the parties based thus formed a partnership. 26
depenndin
es, d
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on the existence of a partnership. For example, in Russian
nd
Recovery Fund Ltd., the Federal Circuit reviewed a series Federal Circuy FunyFunoveryoveryRecoReco nd LtdLtdtd ,dtd.,dd 20 we a s Does Rev. Rul. 94-43 Matter?es . Rul 9 3 atte ?
Do
plex ttransaact
of complex transactions that generated a large loss from a
of c comp hat generatedd a large lo s fromm a
For partnerships considering restructuring in order to g in o departn
porte
purp ed paartneersh rest, and f und that t e ity F hips co si ering structuri
purported partnership interest, and found that the entity
m et the
tion outel gibilit
at issue, which existed for only two weeks and lacked eco- meet the election out eligibility requirements, the elec-
nts thee
equirem
is
whic
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ssue,
e ted
nly two w ks and acked ec
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bt
nomic substance, was not a true partnership but merely tion to be treated as a small business corporation may
27
device for selling contributed property to the other pur- be a useful analogy. In Rev. Ruls. 77-220 and 94-43, 28
21
ported partner. Similarly, in Gabriel, the Tax Court found the IRS interpreted former Code Sec. 1372(a), which
29
that taxpayers who participated in a program that invested allowed certain businesses to elect to be treated as small
in forward contracts and held their interests through a business corporations. At the time of issuance of Rev.
joint account were not partners in a partnership since the Rul. 77-770, to be eligible for S status, the business
only joint activity was to pay management fees and the could not, among other things, have more than 10
investors had no role in the operation of the program. The shareholders. In Rev. Rul. 77-220, the IRS considered
Tax Court found that the taxpayers were “merely passive the case of 30 unrelated individuals who entered into
copurchasers of an interest in the … program,” and not the joint operation of a single business, but divided the
partners in a partnership. 22 business into three equal groups of 10 individuals and
The IRS also has argued that a partnership exists de- each group formed a separate corporation. The three
spite the taxpayers’ claims to the contrary. For example, corporations then formed a partnership for the joint
23
in Madison Gas and Electric Co., the issue was whether operation of the business. The IRS found that the three
three electric utilities were partners in a nuclear power corporations should be treated as a single corporation
plant. The utilities agreed in advance to contribute pro for purposes of making the election because the prin-
rata shares for the construction and operation of the cipal purpose of setting up the separate corporations
plant, and to take a share of the power generated by the was to make the election. Looking past the form of
plant in proportion to their respective ownership interests. the entities, the IRS found that, in fact, there was one
One of the utilities argued that the utilities did not form corporation with 30 shareholders, and the election
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