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Proposal to remove de minimis partner rule from substantiality regulations for determining partners’ distributive share under section 704(b)

October 24, 2011 | No. 2011-518


The Treasury Department and IRS today released for publication in the Federal Register proposed regulations (REG-109564-10) to remove the “de minimis partner rule” from the May 2008 final section 704(b) regulations because the rule “may have resulted in unintended tax consequences.”

For an electronic version of the proposed regulations: REG-109564-10

Summary

Regulations finalized in May 2008 addressed rules on determining partners’ distributive shares under section 704(b). The final regulations specifically provided rules for testing the substantiality of an allocation under section 704(b) when the partners are look-though entities or members of a consolidated group. See TaxNewsFlash 2008-225.

Included in the final regulations is a de minimis rule for purposes of determining substantiality. Under this rule, the tax attributes of de minimis partners (generally, any partner—including a look-through entity—that owns less than 10% of the partnership capital and profits, and who is allocated less than 10% of each partnership item) need not be taken into account.

As noted in the preamble to today’s proposed regulations, the intent of the de minimis partner rule was to allow partnerships to avoid the complexity of testing the substantiality of insignificant allocations to partners owning very small interests in the partnership. The de minimis partner rule was not intended to allow partnerships “to entirely avoid the application of the substantiality regulations” if owned by partners each of whom owns less than 10% of the capital or profits, and who are allocated less than 10% of each partnership item of income, gain, loss, deduction, and credit.

Treasury and the IRS therefore have determined that the de minimis partner rule must be removed in order to prevent unintended tax consequences. Comments are requested on how to reduce the burden of complying with the substantial economic effect rules with respect to look-through partners, without diminishing safeguards that the rules provide.

Comments and requests for a public hearing are requested. Requests for a public hearing must be received by a date that is 90 days after the proposed regulations are published in the Federal Register (publication is scheduled for Tuesday, October 25, 2011).

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The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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