Page 89 - TaxAdviser_2022

PARTNERS & PARTNERSHIPS

for an S Corporation; or Form 8865, but disagreed, noting that partners must that should be allocable solely to the
only if the entity for which the form is report income whether they receive the fourth partner. The court rejected this
being filed has items of international tax proceeds or not. The Tax Court sided argument because the partnership had
relevance (generally foreign activities or with the IRS and held that the income originally allocated the debt to all part-
foreign partners). was taxable even though the taxpayer ners. This case is another instance where
To promote compliance with adop- did not receive any of the proceeds taxpayers were not allowed to change the
tion of Schedules K-2 and K-3 by from the sale. substance of a transaction once they had
affected passthrough entities and their elected a specific form.
partners and shareholders, Treasury and Cancellation-of-indebtedness
the IRS have provided certain penalty income Certain disallowed deductions
relief for tax years that begin in 2021. If In another case, Hohl,19 three individu- In Chief Counsel Advice (CCA)
the filer establishes to the satisfaction als were partners in a partnership from 202050015, the IRS Chief Counsel’s
of the IRS that it made a good-faith which they reported guaranteed pay- Office addressed the issue of whether
effort to comply with the new report- ments. A fourth partner regularly put certain insurance premiums paid by
ing requirements on Schedule K-2 money into the partnership, which the a partnership were deductible. In this
and K-3, certain penalties will not be partnership and the partners generally situation, the partnership paid for an
imposed for incorrect or incomplete treated as loans. The year the partner- insurance policy to reimburse partners
reporting.17 ship ceased operation, the partners in the event of an adjustment upon
treated the fourth partner’s loans as audit to a deduction claimed for a
Partner’s income contributions of capital, and the other charitable contribution. The policy
Partnerships are not subject to federal partners were not required to repay would reimburse the partners for any
income tax under Sec. 701. After items their respective shares of the loans. The difference between the tax benefits they
of income and expense are determined partners did not report any income claimed and the tax benefits they are
at the partnership level, each partner is related to the change from loans to entitled to receive, regardless of any
required to take into account separately capital contribution. trade or business activity of the part-
in the partner’s return a distributive The IRS agent determined the nership. The Chief Counsel’s Office de-
share, whether or not distributed, of change from a loan to a capital termined that the cost of the insurance
each class or item of partnership in- contribution created cancellation-of- policy was not deductible because the
come, gain, loss, deduction, or credit indebtedness income to the partners. premiums were not sufficiently related
under Sec. 702. This determination was made because to the partnership’s trade or business to
the funds originally provided by the support a deduction under Sec. 162(a)
Income included on partner’s fourth partner were loans to the part- and were not sufficiently related to the
return nership, which were allocated among partnership’s income-producing activi-
Sec. 702 requires partners to report the partners. Since none of the partners ties under Sec. 212.
income on their tax returns when the were insolvent, the cancellation of those In a Tax Court case, Estate of
partnership earns the revenue even if loans resulted in income to the partners. Morgan,20 the taxpayer had several busi-
the partner does not receive the pro- The Tax Court held in favor of the nesses prior to the years in question.
ceeds. In Dodd,18 the taxpayer was a IRS, noting that the taxpayers’ argument However, the businesses had gone into
partner in a partnership that reported a that the loans were not in fact loans in receivership. Afterward, the taxpayer
gain on the sale of partnership property. the first place, but instead represented attempted to find a new business and
The partner’s share was reported on her capital contributions, failed because the deducted the expenses incurred in
Schedule K-1, and she reported that partnership had reported the advances as searching for a new business. The
amount on her individual tax return but liabilities for each operating year before IRS disallowed the deductions for the
did not pay the tax on the gain. the year of termination. It did not matter expenses related to searching for a new
The taxpayer argued that the pro- that the partners did not include their trade or business. The Tax Court agreed
ceeds of the sale went to the bank to share of the liabilities in their capital ac- with the IRS that the taxpayer was not
pay off several loans and that she got count. Alternatively, the taxpayers argued carrying on a trade or business through
no benefit from these funds. The IRS that the loans were recourse liabilities his search for a new trade or business

17. Notice 2021-39. 19. Hohl, T.C. Memo. 2021-5.
18. Dodd, T.C. Memo. 2021-118. 20. Estate of Morgan, T.C. Memo. 2021-104.

42 February 2022 The Tax Adviser