Rev. Rul. 83-155

ISSUE

Are payments to a retired partner or the spouse of a deceased partner made pursuant to a partnership agreement by a corporation that succeeded the partnership deductible by the corporation as ordinary and necessary business expenses under section 162(a) of the Internal Revenue Code under the circumstances described below?

FACTS

The taxpayer is a corporation that formerly conducted its business as a partnership. Pursuant to section 351 of the Code, the partnership transferred all of its assets and liabilities to the taxpayer, a newly formed corporation. The liabilities assumed by the new corporation did not exceed the basis of the assets transferred by the partnership. Prior to the section 351 transfer, the partnership had been making payments, pursuant to the partnership agreement, to a retired partner. These payments qualified as guaranteed payments under section 736(a)(2) and were deducted by the partnership under section 162(a). The partnership reported its income under the cash receipts and disbursements method of accounting. Subsequent to the section 351 transfer, the taxpayer continued to make the guaranteed payments to the retired partner and deducted the amount of the guaranteed payments under section 162(a) as ordinary and necessary business expenses. The taxpayer elected to report its income under the cash receipts and disbursements method of accounting.

LAW AND ANALYSIS

Section 162(a) of the Code provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 351 (a) of the Code provides that no gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control of the corporation.

Section 736(a)(2) of the Code provides that payments made in liquidation of the interest of a retiring partner or a deceased partner shall be considered as a guaranteed payment described in section 707(c) if the amount thereof is determined without regard to the income of the partnership.

Section 707(c) of the Code provides that, to the extent determined without regard to the income of the partnership, payments to a partner for services or for the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61 (a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses).

In Rev. Rul. 80-198, 1980-2 C.B. 113, an individual transferred all the assets and liabilities of a sole proprietorship, which included accounts payable and accounts receivable, to a new corporation in exchange for all the corporate stock. The revenue ruling holds that the transfer qualifies as an exchange within the meaning of section 351(a) of the Code and that the transferee corporation will report in its income the accounts receivable as collected and will be allowed deductions under section 162 of the Code for the payments it makes to satisfy the accounts payable. In reaching these holdings the revenue ruling makes reference to the specific congressional intent of section 351(a) to facilitate the incorporation of an ongoing business by making the incorporation tax free. This intent would be equally frustrated if either the transferor were taxed on the transfer of the accounts receivable, or the transferee were not allowed a deduction for payment of the accounts payable.

The present case is analogous to the situation in Rev. Rul. 80-198. The taxpayer is making the same payments that the partnership was making. The payments have been deductible by the partnership had the partnership continued in existence. The congressional intent to facilitate necessary business readjustments would be frustrated by not according to the transferee the right to deduct expenses of the ongoing business which, if not assumed by the transferee, would have been deductible by the transferor.

HOLDING

Payments to a retired partner or spouse made pursuant to a partnership agreement by a corporation that succeeded the partnership are deductible by the corporation as ordinary and necessary business expenses under section 162(a) of the Code.