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By Suellen Wolfe, J.D., LL.M. *
In 2011, IRS adopted final regs on indebtedness satisfied by receipt of a partnership interest and application of IRC §108(e)(8)(B) to partnerships and their partners. The regs provide guidance on determining discharge or cancellation of indebtedness income incurred by a partnership on the transfer of a partnership interest to a creditor in satisfaction of partnership debt. This article focuses on valuation of the partnership interest transferred.
Under IRC Section 108(e)(8) and new treasury regulations, to determine cancellation of indebtedness income ("COD Income"), if any, of a debtor partnership in a debt-for-equity exchange, the partnership is treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the interest transferred to the creditor. [IRC § 108(e)(8).] If the amount of the indebtedness exceeds the fair market value of the partnership interest transferred, the excess is treated as COD Income. [IRC § 108(e)(8); TD 9557, 76 FR 71255 (Nov 17, 2011), Treas Reg §1.108-8.] This COD Income is required to be included in the distributive shares of the partners in the debtor partnership immediately before the discharge. [IRC § 108(e)(8); TD 9557, 76 FR 71255 (Nov 17, 2011), Treas Reg §1.108-8.] The final regulations do not differentiate between cash or accrual partnerships. [IRC § 108(e)(2) provides that "no income shall be realized from the discharge of indebtedness to the extent that payment of the liability would have given rise to a deduction." Interest paid or accrued is generally deductible under IRC § 163(a).]
The liquidation value method is the acknowledged method to determine the value the transferred interest to the creditor in a debt-for-equity exchange. [Treas Reg § 1.108-8(b)(2)(iii); see also, Notice 2005-43 used for determining whether a partnership interest qualifies as a profits interest under Rev Proc 93-27.] Pursuant to this method, the value of the creditor's newly acquired partnership interest equals the amount of cash the creditor would receive if, immediately after the transfer, the partnership sold all of its assets (including goodwill, going concern value, and any other intangibles) for cash equal to the fair market value of those assets, and then liquidated. [The liquidation value equals the amount of cash that the creditor would receive with respect to the debt-for-equity interest if, immediately after the transfer, the partnership sold all of its assets (including goodwill, going concern value, and any other intangibles associated with the partnership's operations) for cash equal to the fair market value of those assets, and then liquidated. Treas Reg § 1.108-8(b)((2)(iii).] If the liquidation value method is used, the final regulations also observe the value of the partnership interest received is determined by reference to the dollar amount credited to the creditor's capital account which will, in turn, equal the fair market value of the indebtedness exchanged. [Treas Reg §§ 1.704-1(b)(2)(iv)(b) & (d); § 1.108-8(c).]
Apparently, the IRS envisions that the use of the liquidation value method avoids multiple conflicts. . . .
The regulations chronicle a liquidation value safe harbor in order to apply IRC Section 108(e)(8) with certainty. . . .
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If the fair market value of the debt-for-equity interest does not equal the fair market value of the indebtedness exchanged, general tax law principles apply to account for the difference. An analysis of the actual fair market value of the debt and other economic characteristics of the creditor's interest after the exchange are scrutinized. The value partnership interest received by the creditor varies depending on its share of future profits and losses, restrictions on future transfer of the interest, its possession of management rights and its portion of the partnership's capital. If deemed appropriate to a transaction, attention will be given to Section 707(a)(2)(A) relating to the treatment of payments to partners for the transfer of property.
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* Suellen Wolfe is engaged in the private practice of law in Pennsylvania where she is also licensed as a Certified Public Accountant. She received her LL.M. (Taxation) from New York University School of Law. Ms. Wolfe has taught as a visiting professor at law schools throughout the United States. She previously served as Chief Deputy Attorney General, Tax and Finance Section and Chief Deputy Attorney General, Charitable Trusts and Organizations Section of the Office of Attorney General, Commonwealth of Pennsylvania and Counsel to the Pennsylvania Board of Finance & Revenue. Ms. Wolfe is the Update Author of Tax Planning for the Alternative Minimum Tax (Matthew Bender).
Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.
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