When Partnership becomes a disregarded entity, impact on reporting

[samx99]

I am trying to understand the impact of a 2 Member Partnership becoming a disregarded entity (sole p.) because one owner acquires all interest in the company but I cannot find the answer

The impacts in question are:

1) if the assets, liability are staying with the company then does the balance sheet need to be zeroed out on 1065 final?

2) concern for (q1) is that zeroing out implies distributions. Is there technically distributions to report on K-1 even though the assets and liabilities are staying with the company (at the state level)?

3) does the answer to (1) or (2) change if there is outstanding non-recourse

4) is it a liquidation for reporting purposes, and does this imply distributions?

5) does the final business owner receive a final K-1 reflecting adjustments to capital account, distributions, or other fields on the k-1 as a result of acquiring remaining interest?

6) if distributions are reported merely as a technicality (clarify if they are not) does this constitute a disposition from the partnership to the disregarded entity and thereby requiring special forms

7) if a negative capital account is reflected in any of the various situations, does this result in gains reported on 6198 and gross income?

[Rick19744 · Accepted solution]

A number of things are impacted here and depending on the $$ involved, you may want to consult with a tax professional.  I will provide some direction and comments here:

1. The IRS has a revenue ruling on this matter and I will include a link below (Rev Rul 99-6).  Your facts are situation 1 in the revenue ruling.
2. The answer to your question number 1; the technically correct answer is "yes".  The reason is that the partnership has terminated.
3. The answer to your question number 2; once again "yes" there has been a liquidating distribution of the assets.
4. Your question 3; debt can have significant impact in partnership tax.  Non-recourse debt provides basis and relief of debt is treated the same as a distribution of cash.  This is an area that can cause issues and discussion with a tax professional can be beneficial.
5. Your question 4 was addressed above in response 2 and 3.
6. Your question 5; all partners receive a final K-1 when there is a termination of a partnership.  In addition, the form 1065 will need to be marked as final as well.
7. Your question 6; there could be a requirement to file form 8308.  This is used when there are "hot assets" involved.  These assets include "accounts receivable" for a cash basis partnership, depreciation recapture and inventory.  All ordinary income type items.  This is important as the character of the gain for the selling partner will be impacted.
8. Your question 7; there are significant differences between capital account, basis and at-risk.  Understanding the differences is critical to getting to the correct tax result.
9. As you will see in Rev Rul 99-6 the basis of assets that you have post termination will have a bifurcated basis.
10. You will need to check with the Secretary of State for your state as to any state filing requirements since you no longer have a partnership.

Here is the link to Rev Rul 99-6:

https://www.irs.gov/pub/irs-drop/rr-99-6.pdf

[samx99]

Thanks for the information.

one thing the ruling doesn't seem to cover is when the partnership has recourse or non-recourse outstanding.

a) Would non-recourse translate as income even if if the debt is not forgiven and the company continues?

b) Would recourse translate as income even if if the debt is not forgiven and the company continues?

[Rick19744]

These type of general rulings, as most IRS released commentary, don't get into detail on complicated situations.  As noted in my comment 4, debt (recourse or non-recourse) add another level of complexity.
This area is handled in Section 752 of the code and regulations and the interaction with Section 731.
As noted previously, debt is included in basis (not capital account) and a relief of debt is treated the same as if cash was distributed; reduces basis.
As a result, you need to understand the mechanics, mostly the seller, and the impact on basis and the ultimate gain or loss on sale.
To respond to your specific questions, both a and b could result in a tax implication where income is recognized.  The key is to minimize that impact or at least understand the impact so it is not a surprise.

[samx99]

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I think I understand, maybe, 731 (a) seems to indicates gains is money distributed in excess of adjusted basis. As such, a negative capital account + money on liquidation, if less-then adjusted basis, is not a gain.

so hypothetically in partnership AB, if A(80%) acquires B(20%) , it a liquidation per the ruling 99-6

if:

adjust basis for one partner A  is $250 ( $200 non-rec liabilities  + $50 capital account [cash]),
and adjusted basis for partner B is $200 ($50 non-rec liabilities + $150 capital account [cash]),

then:
A: cash Dist:$160, ending capital account $-110
B: cash Dist:$40, ending capital account $110



in this above case though, this implies there is a liability created on A to pay back the disregarded entity. further, since there is no relief of any debts from A to is creditors, there is also no gain or loss, per se.

731 (a) also seems to indicate that a loss is not recognized either because the loss as show in the example above are not in excess of basis.


the problem I see is that should K-1 instruction indicates the end-year of liabilities should reflect just before disposition, if I understand correctly. if there is no relief of debt, would the K-1 on its own be interpreted as such? it would be really annoying for someone to get a tax bill for a debt deemed as income merely because of a K-1 reporting requirement.

but even in this case, is a 6198 required for that $110 or since there is no actual gain, or it is not required.

or is the example above incorrect somehow?

[samx99]

the answer seems to be here though it is not obvious:
<a rel="nofollow" target="_blank" href="https://www.taxlawforchb.com/2017/09/liquidating-a-partnership-interest-beware-the-effects-of-partne...>

negative capital account seems to indicate capital gains, and that seems to go on the K-1, which also removes the negative capital account entry if their is also a gains entry.