The IRS has issued proposed regulations relating to disguised payments for services under Code Sec. 707(a)(2)(A). The proposed regulations provide guidance to partnerships and their partners regarding when an arrangement will be treated as a disguised payment for services. In addition, the IRS proposes conforming modifications to the regulations governing guaranteed payments under Code Sec. 707(c) and notice of proposed modifications to Rev. Proc. 93-27, 1993-2 CB 343, and Rev. Proc. 2001-43, 2001-2 CB 191. The proposed regulations would be effective on the date the final regulations are published in the Federal Register and would apply to any arrangement entered into or modified on or after the publication of the final regulations.
General Rules Regarding Disguised Payments for Services
Proposed Reg. §1.707-2(b) provides that an arrangement will be treated as a disguised payment for services if (i) a service provider, either in a partner capacity or in anticipation of being a partner, performs services (directly or through its delegate) to or for the benefit of the partnership; (ii) there is a related direct or indirect allocation and distribution to the service provider; and (iii) the performance of the services and the allocation and distribution when viewed together, are properly characterized as a transaction occurring between the partnership and a person acting other than in that person’s capacity as a partner.
The proposed regulations provide a mechanism for determining whether or not an arrangement is treated as a disguised payment for services under Code Sec. 707(a)(2)(A). An arrangement that is treated as a disguised payment for services under the proposed regulations will be treated as a payment for services for all purposes of the Code. Thus, the partnership must treat the payments as payments to a nonpartner in determining the remaining partners’ shares of taxable income or loss, and, where appropriate, the partnership must capitalize the payments or otherwise treat them in a manner consistent with the recharacterization.
The proposed regulations apply to a service provider who purports to be a partner even if applying the regulations causes the service provider to be treated as a person who is not a partner. Moreover, the proposed regulations may apply even if their application results in a determination that no partnership exists.
Whether an arrangement constitutes a payment for services depends on all of the facts and circumstances. The proposed regulations include six nonexclusive factors that may indicate an arrangement constitutes a disguised payment for services. One of the six factors, the existence of significant entrepreneurial risk, is given more weight than the other factors, and arrangements that lack significant entrepreneurial risk are treated as disguised payments for services.
The weight given to the five secondary factors depends on the particular case. The absence of any of these factors is not necessarily determinative of whether an arrangement is treated as payment for services. The secondary factors include: (1) that the service provider holds, or is expected to hold, a transitory partnership interest or a partnership interest for only a short duration; (2) that the service provider receives an allocation and distribution in a time frame comparable to the time frame that a nonpartner service provider would typically receive payment; (3) that the service provider became a partner primarily to obtain tax benefits that would not have been available if the services were rendered to the partnership in a third-party capacity; (4) that the value of the service provider’s interest in general and continuing partnership profits is small in relation to the allocation and distribution; and (5) that the arrangement provides for different allocations or distributions with respect to different services received, where the services are provided by a single person or persons that are related under Code Secs. 707(b) and 267(b), and the terms of the differing allocations or distributions are subject to levels of entrepreneurial risk that vary significantly.
Safe Harbor Revenue Procedures
The Treasury and the IRS plan to issue a revenue procedure providing an additional exception to the safe harbor provision of Rev. Proc. 93-27 in conjunction with the publication of these regulations in final form. Rev. Proc. 93-27 provides that in certain circumstances if a person receives a profits interest for the provision of services to or for the benefit of a partnership in a partner capacity or in anticipation of becoming a partner, the IRS will not treat the receipt of such interest as a taxable event for the partner or partnership. Further, Rev. Proc. 2001-43 provides that, for purposes of Rev. Proc. 93-27, if a partnership grants a substantially nonvested profits interest in the partnership to a service provider, the service provider will be treated as receiving the interest on the date of its grant if certain conditions are met.
Written and electronic comments and requests for a public hearing must be received by October 21, 2015. Send submissions to CC:PA:LPD:PR (REG-115452-14), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044. Submission may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-115452-14), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C., or sent electronically, via the federal eRulemaking portal at www.regulations.gov (indicate IRS and REG-115452-14).
Proposed Regulations, NPRM REG-115452-14, 2015FED ¶49,657
Code Sec. 707
CCH Reference – 2015FED ¶25,180AD
CCH Reference – 2015FED ¶25,181AB
CCH Reference – 2015FED ¶25,181AD
CCH Reference – 2015FED ¶25,181HD
CCH Reference – 2015FED ¶25,421D
Tax Research Consultant
CCH Reference – TRC PART: 27,050
CCH Reference – TRC PART: 27,052