Individual Seeks Effective Date Correction Under Partnership Regs

October 11, 2019

To:
Holly Porter, ACC P&SI

Cc:
Tax Analysts, Clifford Warren, Robert Crnkovich

From:
Monte Jackel

Subject:
Apparent Error in DRO effective date

I read a story this morning in Tax Notes Today Federal by Eric Yauch, Partners Beware Changes to Deficit Restoration Obligation Rules, October 11, 2019. Other than the story mistakenly noting “February 9, 2019” instead of “October 9, 2019”, the story highlights the confusion that has been created by the manner in which the effective date of the DRO rules are drafted in the effective date text. As drafted, the final regulations state that the effective date is for taxable years beginning on or after October 9, 2019, the date of publication of the regulations in the Federal Register.

This textual effective date is inconsistent with the final regulation preamble which references the date the obligation is incurred or assumed, and is also inconsistent with the effective date of the section 752 payment obligation rules issued as part of the same treasury decision. The textual effective date is also inconsistent with the preamble and proposed effective date regulation text of those regulations proposed in October, 2016.

This should be clarified as soon as possible as it has raised issues in the tax community about the validity of partnership allocations that both precede and follow the stated effective date. For example, do allocations in prior taxable years have to be corrected if inconsistent with the new rules if those years are still open for statute of limitations purposes? If partnership agreements need to be amended, is the section 761(c) date to amend the partnership agreement still applicable? Is an additional grace period allowed to correct for the new rules if necessary?

The initial set of final regulations under regulation section 1.704-1 were effective for taxable years beginning on or after May 1, 1986 (or for allocations of nonrecourse debt, for taxable years beginning on or after January 1, 1987). This effective date matches the capital account restatement rule of regulation section 1.704-1(b)(2)(iv)(r). Section 704(b) itself was amended to apply to taxable years beginning after December 31, 1975, which is why there is transition language in regulation section 1.704-1(b)(1)(ii)(a) to deal with the gap period between the amendment of the statute and the effective date of the regulations. The effective date of taxable years beginning on or after May 19, 2008 in those regulations references the partner look-through rule regulations that were added to the section 704(b) regulations at that time. It was logical to have an effective date there that was divorced of any payment obligation issuance or assumption because the 2008 regulations were focusing on who the partner is to test for substantial economic effect. The later change to the section 704(b) regulations was to incorporate the non-compensatory option provisions and the effective date of those changes was for options issued on or after February 5, 2013. The effective date of that change was tied to the issuance of the options, which would have a dramatic impact on capital accounts as it affected obligations of the partnership and related corrective allocations. Making the effective date for taxable years beginning on or after February 2, 2013 would create the same set of concerns that some practitioners are already making to the final DRO effective date for options issued prior to that date.

I urge you to correct this apparent error as soon as possible, or to clarify how the rules would apply for prior periods of the partnership and whether there would be a grace period to amend partnership agreements to comply with the new rules.

Set forth below is the pertinent language from the final and proposed regulations.

Monte A. Jackel
Silver Spring, MD
Oct. 11, 2019

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1. Final Regulation Preamble Effective Date Of DROs and Payment Obligations

Except as provided in Section 1.D. of the Summary of Comments and Explanations of Revisions in this preamble relating to bottom dollar payments obligations, these final regulations apply to liabilities incurred or assumed by a partnership and to payment obligations imposed or undertaken with respect to a partnership liability on or after October 9, 2019, other than liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken pursuant to a written binding contract in effect prior to that date.

2. Final Regulation text

DRO effective date

(a) * * * Furthermore, the last sentence of paragraph (b)(2)(ii)(b)(3) of this section and paragraphs (b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section apply to partnership taxable years ending on or after October 9, 2019. However, taxpayers may apply the last sentence of paragraph (b)(2)(ii)(b)(3) of this section and paragraphs (b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section for partnership taxable years ending on or after October 5, 2016. For partnership taxable years ending before October 9, 2019, see §1.704-1 as contained in 26 CFR part 1 revised as of April 1, 2019.

Payment Obligation Effective Date

(l) Applicability dates. (1) Paragraphs (a) and (h)(3) of this section apply to liabilities incurred or assumed by a partnership on or after October 11, 2006, other than liabilities incurred or assumed by a partnership pursuant to a written binding contract in effect prior to that date. The rules applicable to liabilities incurred or assumed (or pursuant to a written binding contract in effect) prior to October 11, 2006, are contained in §1.752-2 in effect prior to October 11, 2006, (see 26 CFR part 1 revised as of April 1, 2006). Paragraphs (b)(6), (j)(3) and (4), and (k) of this section apply to liabilities incurred or assumed by a partnership and to payment obligations imposed or undertaken with respect to a partnership liability on or after October 9, 2019, other than liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken pursuant to a written binding contract in effect prior to that date. However, taxpayers may apply paragraphs (b)(6), (j)(3) and (4), and (k) of this section to all of their liabilities as of the beginning of the first taxable year of the partnership ending on or after October 5, 2016. The rules applicable to liabilities incurred or assumed (or pursuant to a written binding contract in effect) prior to October 9, 2019, are contained in §1.752-2 in effect prior to October 9, 2019, (see 26 CFR part 1 revised as of April 1, 2019).

Proposed Applicability Dates

Preamble Proposed Effective Date for DROs and Payment Obligations

The amendments to § 1.704-1 are proposed to apply on or after the date these regulations are published as final regulations in the Federal Register. The amendments to § 1.752-2 are proposed to apply to liabilities incurred or assumed by a partnership and to payment obligations imposed or undertaken with respect to a partnership liability on or after the date these regulations are published as final regulations in the Federal Register. Partnerships and their partners may rely on these proposed regulations prior to the date they are published as final regulations in the Federal Register. However, the rules in § 1.752-2(k) still apply to disregarded entities until the proposed regulations are published as final regulations in the Federal Register.

Proposed Regulation text effective date for DROs

(a) * * * Furthermore, the last sentence of paragraph (b)(2)(ii)(b)(3 of this section and paragraphs (b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section apply on or after the date these regulations are published as final regulations in the Federal Register. However, taxpayers may rely on the last sentence of paragraph (b)(2)(ii)(b)(3) of this section and paragraphs (b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section on or after October 5, 2016 and before the date these regulations are published as final regulations in the Federal Register.

Proposed Regulation text effective date for payment obligations

(k) Effective/applicability dates. (1) Paragraph (h)(3) of this section applies to liabilities incurred or assumed by a partnership on or after October 11, 2006, other than liabilities incurred or assumed by a partnership pursuant to a written binding contract in effect prior to that date. The rules applicable to liabilities incurred or assumed (or pursuant to a written binding contract in effect) prior to October 11, 2006, are contained in § 1.752-2 in effect prior to October 11, 2006, (see 26 CFR part 1 revised as of April 1, 2006). The last sentence of paragraphs (a), (b)(6), and (f) of this section and paragraphs (j)(3) and (4) of this section apply to liabilities incurred or assumed by a partnership and to payment obligations imposed or undertaken with respect to a partnership liability on or after the date these regulations are published as final regulations in the Federal Register, other than liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken pursuant to a written binding contract in effect prior to that date. Taxpayers may rely on these regulations for the period between October 5, 2016 and the date these regulations are published as final regulations in the Federal Register.