Proposed Regulations Address Disguised Payments for Services (NPRM REG-115452-14)

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.

Factors Considered

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.

Comments Requested

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

Other References:

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

 

AUTHOR

Wolters Kluwer Tax and Accounting

Wolters Kluwer Tax and Accounting is a leading provider of software solutions and local expertise that helps tax, accounting, and audit professionals research and navigate complex regulations, comply with legislation, manage their businesses and advise clients with speed, accuracy and efficiency. Wolters Kluwer Tax and Accounting is part of Wolters Kluwer N.V. (AEX: WKL), a global leader in information services and solutions for professionals in the health, tax and accounting, risk and compliance, finance and legal sectors. We help our customers make critical decisions every day by providing expert solutions that combine deep domain knowledge with specialized technology and services. Wolters Kluwer reported 2016 annual revenues of €4.3 billion. The company, headquartered in Alphen aan den Rijn, the Netherlands, serves customers in over 180 countries, maintains operations in over 40 countries and employs 19,000 people worldwide. Wolters Kluwer shares are listed on Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices. Wolters Kluwer has a sponsored Level 1 American Depositary Receipt program. The ADRs are traded on the over-the-counter market in the U.S. (WTKWY).

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