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limitation that precluded the deduction
of the deferred compensation in 2012,
not any purported failure to satisfy the
economic performance requirement.
Hoops further argued that, if not
allowable as a deduction, then the de-
ferred compensation liability was not
a liability for purposes of determining
gain under Sec. 1001 because it was not
included in basis and it did not give rise
to a deduction.
The court also rejected this argu-
ment, stating that because Hoops had an
obligation to pay the deferred compen-
sation, the buyer’s assumption in con-
nection with the 2012 sale discharged
Hoops from its obligation. Thus, Hoops
was required under Sec. 1001 to take were comfortable with the underlying Adviser 828 (December 2019)). While
into account the amount of the deferred partnership economics, they were likely this type of restructuring potentially
compensation liability in computing its largely indifferent regarding the clas- alters the partnership economics, most
gain from the sale. sification, as both categories of income partners will prefer to receive a distribu-
This case is a great example of a situ- were taxed at ordinary income rates and, tive share of partnership income, as it
ation in which an exception to a general if the partner actively participated in the can qualify as QBI and will allow the
rule can lead to a trap for the unwary. business, both categories of income were partner to claim the Sec. 199A deduc-
In cases where deferred compensation subject to self-employment tax. tion if he or she otherwise qualifies.
is involved in a sale of assets, such as in However, this changed with the pas- However, for certain partners, the
Hoops, it is advisable (barring a change sage of the law known as the Tax Cuts presumed preference for receiving a
in the rules) that the seller entity con- and Jobs Act (TCJA), P.L. 115-97. The distributive share of income (including
tinue to exist so that when the deferred TCJA added Sec. 199A, which allows a a priority profit allocation) may need
compensation is paid by the buyer and qualified business income (QBI) deduc- further evaluation to determine how it
included in the employee’s income, the tion for individual and trust taxpayers coordinates with various international
seller can claim a deduction. Based on a that receive passthrough-entity income. tax provisions. Ultimately, the specific
clear reading of the statute, if the seller is For partnerships (including limited circumstances of each partner will deter-
in existence at that time, it should be en- liability companies treated as partner- mine which type of partnership income
titled to the deduction for the payment ships for federal income taxes), the QBI provides the most favorable income
of the deferred compensation under the deduction applies to a distributive share tax result.
Sec. 404(a)(5) timing rule. of partnership income but does not
From Samantha Smudz, CPA, J.D., apply to partnership income paid out US trade or business
Cleveland; Chelsie Nelson, J.D., Chi- as a guaranteed payment for services requirement
cago; and Kevin Ko, CPA, Chicago rendered to the partnership’s trade or For Sec. 199A purposes, QBI includes
IMAGE BY TOMEKBUDUJEDOMEK/GETTY IMAGES Guaranteed payments vs. distinction between these two forms of items are effectively connected with
business (Sec. 199A(c)(4)(B)). Sec.
qualified items of income, gain, deduc-
tion, and loss, i.e., to the extent these
199A now presents a clear, important
Partners & Partnerships
the conduct of a U.S. trade or business
partnership income.
Because of this disparate treatment,
(within the meaning of Sec. 864(c)) and
distributive share of income
are includible or allowed in determining
many partnerships have restructured
Historically, the income tax treatment of
taxable income for the tax year (Sec.
their operating agreements to convert
a distributive share of partnership ordi-
199A(c)(3)(A)). This determination is
guaranteed payments into priority profit
nary income did not differ significantly
made by substituting “qualified trade
allocations (see Parikh et al., “Trade
Guaranteed Payments for Net Profits to
or business (within the meaning of Sec.
from that of partnership guaranteed
payments. Assuming that partners
August 2022 19
www.thetaxadviser.com Gain From QBI Deduction,” 50 The Tax 199A)” for “nonresident alien individual