EFTA01154591.pdf

Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) [4830-01-p] DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [REG-119305-11] RIN 1545-BK29 Section 707 Regarding Disguised Sales, Generally AGENCY: Internal Revenue Service (IRS), Treasury. ACTION: Notice of proposed rulemaking. SUMMARY: This document contains proposed regulations under section 707 of the Internal Revenue Code (Code) relating to disguised sales of property to or by a partnership and under section 752 relating to the treatment of partnership liabilities. The proposed regulations address certain deficiencies and technical ambiguities in the section 707 regulations and certain issues in determining partners' shares of liabilities under section 752. The proposed regulations affect partnerships and their partners. DATES: Written or electronic comments and requests for a public hearing must be received by April 30, 2014. ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-119305-11), room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-119305-11), Courier's Desk, Internal EFTA01154591  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) Revenue Service, 1111 Constitution Avenue, Washington, DC, or sent electronically, via the Federal eRulemaking Portal site at http://www.regulations.gov (indicate IRS and REG-119305-11). FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Deane M. Burke, (202) 317-5279; concerning submissions of comments and requests for a public hearing, Oluwafunmilayo (Funmi) Taylor, (202) 317-6901 (not toll-free numbers). SUPPLEMENTARY INFORMATION: Paperwork Reduction Act The collection of information related to these proposed regulations under section 707 is reported on Form 8275, Disclosure Statement, and has been reviewed in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) and approved by the Office of Management and Budget under control number 1545-0889. Comments concerning the collection of information and the accuracy of estimated average annual burden and suggestions for reducing this burden should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the burden associated with this collection of information should be received by March 31, 2014. The collection of information in these proposed regulations is in proposed §§1.707-5(a)(3)(ii) and 1.707-5(b)(2)(iii)(B) (regarding the reduction of a liability EFTA01154592  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) presumed to be anticipated) and §1.707-5(a)(7)(ii) (regarding a liability incurred within two years prior to a transfer of property). This information is required by the IRS to ensure that sections 707(a)(2)(B) and 752 of the Code and applicable regulations are properly applied respectively either to transfers between a partner and a partnership or for allocations of partnership liabilities. The respondents will be partners and partnerships. The collection of information in these proposed regulations under section 752 has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collection of information should be received by March 31, 2014. Comments are specifically requested concerning: Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility; The accuracy of the estimated burden associated with the proposed collection of information (see below); How the quality, utility, and clarity of the information to be collected may be enhanced; EFTA01154593  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of service to provide information. The collection of information in this proposed regulation is in §1.752- 2(b)(3)(iii)(C). This information is required to ensure proper allocations of partnership liabilities. This information will be used to determine the extent to which certain partners or related persons bear the economic risk of loss with respect to partnership liabilities. The collection of information is mandatory. The likely reporters are small and large businesses or organizations and trusts. Estimated total annual reporting burden: 8 million hours. The estimated annual burden per respondent varies from 6 minutes to 2 hours, depending on individual circumstances, with an estimated average of 1 hour. Estimated number of respondents: 8 million. Estimated frequency of responses: On occasion. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget. Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by section 6103. EFTA01154594  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) Background This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 707 relating to disguised sales of property to or by a partnership and under section 752 relating to the treatment of partnership liabilities. Section 707(a)(2)(B) of the Code generally provides that, under regulations prescribed by the Secretary, related transfers to and by a partnership that, when viewed together, are more properly characterized as a sale or exchange of property, will be treated either as a transaction between the partnership and one who is not a partner or between two or more partners acting other than in their capacity as partners. The legislative history of section 707(a)(2)(B) indicates Congress adopted the provision to prevent parties from characterizing a sale or exchange of property as a contribution to the partnership followed by a distribution from the partnership, thereby deferring or avoiding tax on the transaction. See H.R. Rep. No. 432, pt. 2, 98th Cong. 2nd Sess. 1216, 1218 (1984). On September 30, 1992, final regulations under section 707(a)(2) (TD 8439, 1992-2 CB 126) relating to disguised sales of property to and by partnerships were published in the Federal Register (57 FR 44974 as corrected on November 30, 1992, by 57 FR 56443) (existing regulations). Since publication of the existing regulations, the IRS and the Treasury Department have become aware of certain issues in interpreting or applying the regulations. On November 26, 2004, a notice of proposed rulemaking under section 707(a)(2)(B) (REG-149519-03, 2004-2 CB 1009) was published in the Federal Register (69 FR 68838) to add rules for disguised sales of partnership interests and to amend the existing regulations by revising, to a limited extent, the rules EFTA01154595  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) relating to disguised sales of property. The IRS and the Treasury Department noted in the preamble to those proposed regulations an awareness of certain deficiencies and technical ambiguities in the existing regulations under §§1.707-3, 1.707-4, and 1.707-5, and requested comments on the scope and content of revisions to the existing regulations, but received none. The notice of proposed rulemaking was subsequently withdrawn on January 21, 2009, in Announcement 2009-4, 2009-1 CB 597. The IRS and the Treasury Department have, however, continued to study these issues, and set forth in the following section is a discussion of those areas in the existing regulations that the IRS and the Treasury Department have identified as requiring clarification or revision and the proposed changes to those areas. In addition, regulations under section 752 address the treatment of partnership recourse and nonrecourse liabilities. The IRS and the Treasury Department believe it is appropriate to reconsider the rules under section 752 regarding the payment obligations that are recognized under §1.752-2(b)(3), the satisfaction of payment obligations under §1.752-2(b)(6), and the methods available for allocating excess nonrecourse liabilities under §1.752-3(a)(3). Also discussed in the following section is an explanation of those areas in the section 752 regulations that the IRS and the Treasury Department have identified as requiring revision and the proposed changes to those areas. Explanation of Provisions 1. Debt-Financed Distributions Section 1.707-3 of the existing regulations generally provides that a transfer of property by a partner to a partnership followed by a transfer of money or other consideration from the partnership to the partner will be treated as a sale of property by EFTA01154596  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) the partner to the partnership if, based on all the facts and circumstances, the transfer of money or other consideration would not have been made but for the transfer of the property and, for non-simultaneous transfers, the subsequent transfer is not dependent on the entrepreneurial risks of the partnership. Notwithstanding this general rule, the existing regulations provide several exceptions. One such exception in §1.707-5(b) of the existing regulations generally provides that a distribution of money to a partner is not taken into account for purposes of §1.707-3 to the extent the distribution is traceable to a partnership borrowing and the amount of the distribution does not exceed the partner's allocable share of the liability incurred to fund the distribution (the "debt-financed distribution exception"). Under a special rule in the existing regulations, if a partnership transfers to more than one partner pursuant to a plan all or a portion of the proceeds of one or more liabilities, the debt-financed distribution exception is applied by treating all of the liabilities incurred pursuant to the plan as one liability. Thus, partners who are allocated shares of multiple liabilities are treated as being allocated a share of a single liability, to which any distributee partner's distribution of debt proceeds relates, rather than a share of each separate liability. To illustrate the application of this rule, the proposed regulations add an example to the existing regulations to demonstrate that if more than one partner receives all or a portion of the debt proceeds of multiple liabilities that are treated as a single liability under the special rule, the debt proceeds will not be treated as consideration in a disguised sale to the extent of the partner's allocable share of the single liability. EFTA01154597  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) In addition, the IRS and the Treasury Department are aware that there is uncertainty as to whether, for purposes of §1.707-5(b)(2), the amount of money transferred to a partner that is traceable to a partnership liability is reduced by any portion of such amount that is also excluded from disguised sale treatment under one or more of the exceptions in §1.707-4 (for example, because the transfer of money is also properly treated as a reasonable guaranteed payment). The IRS and the Treasury Department believe that the treatment of a transfer should first be determined under the debt-financed distribution exception, and any amount not excluded from §1.707-3 under the debt-financed distribution exception should be tested to see if such amount would be excluded from §1.707-3 under a different exception in §1.707-4. This ordering rule ensures that the application of one of the exceptions in §1.707-4 does not minimize the application of the debt-financed distribution exception. 2. Preformation Expenditures Section 1.707-4(d) of the existing regulations provides an additional exception for reimbursements of preformation expenditures to the general rule in §1.707-3. Under §1.707-4(d), transfers to reimburse a partner for certain capital expenditures and costs incurred are not treated as part of a sale of property under §1.707-3 (the "exception for preformation capital expenditures"). The proposed regulations amend the exception for preformation capital expenditures to address three issues. First, the proposed regulations provide how the exception for preformation capital expenditures applies in the case of multiple property transfers. The exception for preformation capital expenditures generally applies only to the extent that "the reimbursed capital expenditures do not exceed 20 percent of the fair EFTA01154598  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) market value of such property at the time of the contribution." This fair market value limitation, however, does not apply if the fair market value of the contributed property does not exceed 120 percent of the partner's adjusted basis in the contributed property at the time of the contribution. The references to "such property" and "contributed property" in §1.707-4(d) are intended to refer to the single property for which the expenditures were made. Accordingly, in the case of multiple property contributions, the proposed regulations provide that the determination of whether the fair market value limitation and the exception to the fair market value limitation apply to reimbursements of capital expenditures is made separately for each property that qualifies for the exception. Second, the proposed regulations clarify the scope of the term "capital expenditures" for purposes of H1.707-4 and 1.707-5. For purposes of §§1.707-4 and 1.707-5, the term "capital expenditures" has the same meaning as the term "capital expenditures" has under the Code and applicable regulations, except that it includes capital expenditures taxpayers elect to deduct, and does not include deductible expenses taxpayers elect to treat as capital expenditures. The IRS and the Treasury Department are aware that taxpayers are uncertain whether the term capital expenditures includes only expenditures that are required to be capitalized under the Code. The purpose of the exception for preformation capital expenditures is to permit a partnership to reimburse a contributing partner for expenditures incurred with respect to contributed property. The IRS and the Treasury Department considered whether a contributing partner's capital expenditures for this purpose should be reduced by the benefit of the tax deduction the contributing partner received prior to contribution of the EFTA01154599  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) property either because the capital expenditure was currently deductible by the contributing partner or recovered through amortization or depreciation deductions. The proposed regulations, however, do not adopt such an approach because the approach would be too burdensome to administer. Finally, the proposed regulations provide a rule coordinating the exception for preformation capital expenditures and the rules regarding liabilities traceable to capital expenditures. Section 1.707-5 provides special rules for disguised sales relating to liabilities assumed or taken subject to by a partnership. Under §1.707-5(a)(1) of the existing regulations, a partnership's assumption of or taking property subject to a qualified liability in connection with a partner's transfer of property to the partnership is treated as a transfer of consideration to the partner only if the property transfer is otherwise treated as part of a sale. A liability constitutes a qualified liability of the partner to the extent the liability meets one of the four definitions of qualified liabilities under §1.707-5(a)(6). One of the enumerated qualified liabilities is a liability that is allocable under the rules of §1.163-8T to capital expenditures with respect to the property transferred to the partnership (the "capital expenditure qualified liability"). The IRS and the Treasury Department are aware that taxpayers are uncertain about whether a partner may qualify under the exception for preformation capital expenditures if those expenditures were funded with a capital expenditure qualified liability. For example, taxpayers are uncertain about whether a partner can finance its capital expenditures through a borrowing that is exempted as a qualified liability and can also be reimbursed for those expenditures without triggering sale treatment. The IRS and the Treasury Department believe that the exception for preformation capital 10 EFTA01154600  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (55 pgs) expenditures applies only to the extent the distribution is in reimbursement of such expenditures. Thus, the proposed regulations provide that to the extent a partner funded a capital expenditure through a borrowing and economic responsibility for that borrowing has shifted to another partner, the exception for preformation capital expenditures should not apply because there is no outlay by the partner to reimburse. 3. Qualified Liabilities in a Trade or Business As previously mentioned, the existing regulations generally exclude qualified liabilities from disguised sale treatment. The legislative history of section 707(a)(2)(B) with respect to liabilities provides that Congress was "concerned with transactions that attempt to disguise a sale of property and not with non-abusive transactions that reflect the various economic contributions of the partners.... For example...the transaction will be treated as a sale or exchange of property...to the extent the partner has received a loan related to the property in anticipation of the transaction and responsibility for repayment of the loan is transferred to the other partners." See H.R. Rep. No. 432, pt. 2, 981h Cong. 2nd Sess. 1216, 1220-1221 (1984). The existing regulations under §1.707-5(a)(6) provide four types of liabilities that are qualified liabilities. In addition to the capital expenditure qualified liabilities discussed previously, the existing regulations include as a qualified liability a liability incurred in the ordinary course of the trade or business in which property transferred to the partnership was used or held, but only if all of the assets that are material to that trade or business are transferred to the partnership ("ordinary course qualified liability"). There is no requirement that these two types of liabilities encumber the transferred property to be treated as qualified liabilities. II EFTA01154601  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) The remaining two types of qualified liabilities are liabilities incurred more than two years before the transfer (or written agreement to transfer), and liabilities incurred within two years of the transfer (or written agreement to transfer) but not in anticipation of the transfer. Liabilities incurred by a partner within two years of the transfer, other than capital expenditure and ordinary course qualified liabilities, are presumed to be incurred in anticipation of the transfer unless the facts and circumstances clearly establish otherwise. With respect to both of these types of qualified liabilities, there is a requirement that the liability encumber the transferred property. The IRS and the Treasury Department believe the requirement that the liability encumber the transferred property is not necessary to carry out the purposes of section 707(a)(2)(B) when a liability was incurred in connection with the conduct of a trade or business, provided the liability was not incurred in anticipation of the transfer and all of the assets material to that trade or business are transferred to the partnership. Accordingly, the proposed regulations add an additional definition of qualified liability to account for this type of liability. As under the existing regulations regarding liabilities other than capital expenditure and ordinary course qualified liabilities, if the partner incurred the liability within two years of the transfer of assets to the partnership, (i) the liability is presumed under §1.707-5(a)(7)(i) to have been incurred in anticipation of the transfer unless the facts and circumstances clearly establish that the liability was not incurred in anticipation of the transfer, and (ii) the treatment of the liability as a qualified liability under the new definition must be disclosed to the IRS under §1.707-8. 4. Anticipated Reduction 12 EFTA01154602  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) Under the existing regulations, for purposes of the rules under section 707, a partner's share of a liability assumed or taken subject to by a partnership is determined by taking into account certain subsequent reductions in the partner's share of the liability. Specifically, a subsequent reduction in a partner's share of a liability is taken into account if (i) at the time that the partnership incurs, assumes, or takes property subject to the liability, it is anticipated that the partner's share of the liability will be subsequently reduced; and (ii) the reduction is part of a plan that has as one of its principal purposes minimizing the extent to which the distribution or assumption of, or taking property subject to, the liability is treated as part of a sale (the "anticipated reduction rule"). The IRS and the Treasury Department are aware that there is uncertainty as to when a reduction is anticipatory because it is generally anticipated that all liabilities will be repaid. Consistent with the overall approach of the existing regulations under section 707, the IRS and the Treasury Department believe that a reduction that is subject to the entrepreneurial risks of partnership operations is not an anticipated reduction, and the proposed regulations adopt this approach. In addition, the proposed regulations provide that if within two years of the partnership incurring, assuming, or taking property subject to the liability, a partner's share of the liability is reduced due to a decrease in the partner's or a related person's net value (as described in Part 8.a of the Explanation of Provisions section of this preamble), then the reduction will be presumed to be anticipated, unless the facts and circumstances clearly establish that the decrease in the net value was not anticipated. Any such reduction must be disclosed in accordance with §1.707-8. 5. Tiered Partnerships 13 EFTA01154603  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) The existing regulations in §1.707-5(e), and §1.707-6(b) by applying rules similar to §1.707-5(e), currently provide only a limited tiered-partnership rule for cases in which a partnership succeeds to a liability of another partnership. Under those rules, if a lower-tier partnership succeeds to a liability of an upper-tier partnership, the liability in the lower-tier partnership retains the same characterization as either a qualified or a nonqualified liability that it had as a liability of the upper-tier partnership. Similarly, if an upper-tier partnership succeeds to a liability of a lower-tier partnership, the liability in the upper-tier partnership retains the same characterization as either a qualified or a nonqualified liability that it had as a liability of the lower-tier partnership that incurred the liability. Moreover, the existing regulations provide that a similar rule applies to other related party transactions involving liabilities to the extent provided by guidance in the Internal Revenue Bulletin. See for example, Rev. Rul. 2000-44, 2000-2 CB 336. The proposed regulations add additional rules regarding tiered partnerships. First, the proposed regulations clarify that the debt-financed distribution exception applies in a tiered partnership setting. Second, the proposed regulations provide rules regarding the characterization of liabilities attributable to a contributed partnership interest. Section 752(d) provides that in the case of a sale or exchange of an interest in a partnership, liabilities shall be treated in the same manner as liabilities in connection with the sale or exchange of property not associated with partnerships. Accordingly, a partner that contributes an interest in a partnership (lower-tier partnership) to another partnership (upper-tier partnership) must take into account its share of liabilities from the lower-tier partnership in applying the rules under §1.707-5. The IRS and the Treasury Department believe it is appropriate to treat the lower-tier partnership as an aggregate 14 EFTA01154604  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) for purposes of determining whether the upper-tier partnership's share of the liabilities of the lower-tier partnership are qualified liabilities. Thus, these proposed regulations provide that a contributing partner's share of liabilities from a lower-tier partnership are treated as qualified liabilities to the extent the liability would be a qualified liability had the liability been assumed or taken subject to by the upper-tier partnership in connection with a transfer of all of the lower-tier partnership's property to the upper-tier partnership by the lower-tier partnership. 6. Treatment of Liabilities in Assets-Over Merger Section 1.752-1(f) provides for netting of increases and decreases in a partner's share of liabilities resulting from a single transaction. Under that rule, increases and decreases in partnership liabilities associated with a merger or consolidation are netted by the partners in the terminating partnership and the resulting partnership to determine the effect of a merger under section 752. The IRS and the Treasury Department believe that similar netting rules should apply with respect to the disguised sale rules and, accordingly, the proposed regulations extend the principles of §1.752-1(f) to determine the effect of the merger under the disguised sale rules. 7. Disguised Sales of Property by a Partnership to a Partner For disguised sales of property by a partnership to a partner, the existing regulations under §1.707-6 provide that rules similar to those in §1.707-5 (for disguised sales of property by a partner to a partnership) apply to determine the extent to which an assumption of or taking property subject to a liability by a partner, in connection with a transfer of property by a partnership, is considered part of a sale. More specifically, the existing regulations provide that if the partner assumes or takes property subject to IS EFTA01154605  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) a liability that is not a qualified liability, the amount treated as consideration transferred to the partnership is the amount that the liability assumed or taken subject to by the partner exceeds the partner's share of that liability immediately before the transfer. Thus, if a transferee partner had a 100 percent share of a liability immediately before a transfer in which the transferee partner assumed the liability, then no sale is treated as occurring between the partnership and the partner with respect to the liability assumption, irrespective of the period of time during which the partnership liability is outstanding and the period of time in which the partnership liability is allocated to the partner. The IRS and the Treasury Department are studying these rules and believe it may be inappropriate to take into account a transferee partner's share of a partnership liability immediately prior to a distribution if the transferee partner did not have economic exposure with respect to the partnership liability for a meaningful period of time before appreciated property is distributed to that partner subject to the liability. Thus, the IRS and the Treasury Department are considering, and request comments on, whether the rules under §1.707-6 should be amended to provide that a transferee partner's share of an assumed liability immediately before a distribution is taken into account for purposes of determining the consideration transferred to the partnership only to the extent of the partner's lowest share of the liability within some meaningful period of time, for example, 12 months. 8. Partner's Share of Partnership Liabilities A. Recourse Liabilities I6 EFTA01154606  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) The existing regulations under section 1.752-2 provide that a partner's share of a recourse partnership liability equals the portion of the liability, if any, for which the partner or related person bears the economic risk of loss. A partner generally bears the economic risk of loss for a partnership liability to the extent the partner, or a related person, would be obligated to make a payment if the partnership's assets were worthless and the liability became due and payable. Subject to an anti-abuse rule and the disregarded entity net value requirement of §1.752-2(k), §1.752-2(b)(6) assumes that all partners and related persons will actually satisfy their payment obligations, irrespective of their actual net worth, unless the facts and circumstances indicate a plan to circumvent or avoid the obligation (the "satisfaction presumption"). Thus, for purposes of allocating partnership liabilities, §1.752-2 adopts an ultimate liability test under a worst-case scenario. Under this test, the regulations would generally allocate an otherwise nonrecourse liability of the partnership to a partner that guarantees the liability even if the lender and the partnership reasonably anticipate that the partnership will be able to satisfy the liability with either partnership profits or capital. The IRS and the Treasury Department have considered whether the approach of the existing regulations under §1.752-2 is appropriate given that, in most cases, a partnership will satisfy its liabilities with partnership profits, the partnership's assets do not become worthless, and the payment obligations of partners or related persons are not called upon. The IRS and the Treasury Department are concerned that some partners or related persons have entered into payment obligations that are not commercial solely to achieve an allocation of a partnership liability to such partner. The IRS and the Treasury Department believe that section 79 of the Tax Reform Act of 1984 17 EFTA01154607  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) (Public Law 98-369), which overruled the decision in Raphan v. United States 3 Cl. Ct. 457 (1983) (holding that a guarantee by a general partner of an otherwise nonrecourse liability of the partnership did not require the partner to be treated as personally liable for that debt), and directed the Treasury Department to prescribe regulations under section 752 relating to the treatment of guarantees and other payment obligations, was intended to ensure that bona fide, commercial payment obligations would be given effect under section 752. Accordingly, the proposed regulations provide a rule that obligations to make a payment with respect to a partnership liability (excluding those imposed by state law) will not be recognized for purposes of section 752 unless certain factors are present. These factors, if satisfied, are intended to establish that the terms of the payment obligation are commercially reasonable and are not designed solely to obtain tax benefits. Specifically, the rule requires a partner or related person to maintain a commercially reasonable net worth during the term of the payment obligation or be subject to commercially reasonable restrictions on asset transfers for inadequate consideration. In addition, the partner or related person must provide commercially reasonable documentation regarding its financial condition and receive arm's length consideration for assuming the payment obligation. The rule also requires that the payment obligation's term must not end prior to the term of the partnership liability and that the primary obligor or any other obligor must not be required to hold money or other liquid assets in an amount that exceeds the reasonable needs of such obligor. The rule would also prevent certain so-called "bottom-dollar" guarantees from being recognized for purposes of section 752. 18 EFTA01154608  Luanalysts DOCUMENT SERVICE Doc 2014 1995 (55 pgs) Moreover, the IRS and the Treasury Department are concerned that some partners or related persons might attempt to use certain structures or arrangements to circumvent the rules included in these proposed regulations with respect to bottom- dollar guarantees. For example, a financial intermediary might artificially convert a single mortgage loan into senior and junior tranches using a wrap-around mortgage or other device with a principal purpose of creating tranches for partners to guarantee that result in exposure tantamount to a bottom-dollar guarantee. Accordingly, the proposed regulations revise the anti-abuse rule under §1.752-2(j) to address the use of intermediaries, tiered partnerships, or similar arrangements to avoid the bottom-dollar guarantee rules. The IRS and the Treasury Department request comments on whether other structures or arrangements might be used to circumvent the rules regarding bottom-dollar guarantees, and whether the final regulations should broaden the anti- abuse rule further to address any such structures or arrangements. The IRS and the Treasury Department also acknowledge that the proposed regulations relating to guarantees and indemnities draw lines that, among other things, preclude recognition of a payment obligation for a portion, rather than 100 percent, of each dollar of a partnership liability to which the payment obligation relates (a so-called vertical slice of the partnership liability) (see §1.752-2(f) Example 12 in the proposed regulations). The IRS and the Treasury Department request comments on whether, and under what circumstances, the final regulations should permit recognition of such a payment obligation. In addition, the IRS and the Treasury Department request comments on whether the special rule under §1.752-2(e) (and related §1.752-2(f) Example 7) should be removed from the final regulations or revised to require that 100 19 EFTA01154609  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) percent of the total interest that will accrue on a partnership nonrecourse liability be guaranteed. As was previously noted, the satisfaction presumption assumes that all partners and related persons will actually satisfy their payment obligations, unless the facts and circumstances indicate a plan to circumvent or avoid the obligation. The satisfaction presumption does not apply, however, to the payment obligations of disregarded entities. Instead, the payment obligation of a disregarded entity for which a partner is treated as bearing the economic risk of loss is taken into account only to the extent of the net value of the disregarded entity, as determined under §1.752-2(k). The preamble to the proposed regulations under §1.752-2(k) requested comments regarding whether the rules for disregarded entities should be extended to the payment obligations of other entities. Some commenters opposed extending the rules to other entities, while other commenters suggested that the anti-abuse rule in §1.752-2(j) could be expanded to cover certain situations involving thinly capitalized entities. One commenter suggested that the anti-abuse rule should apply if a substantially undercapitalized subsidiary of a consolidated group of corporations or a substantially undercapitalized passthrough entity (other than a disregarded entity) is utilized as the partner (or related obligor) for a principal purpose of limiting its owners risk of loss in respect of existing partnership liabilities, and obtaining tax benefits for its owners (or other members of the consolidated group) that would not be available but for the additional tax basis in the partnership interest that results from the satisfaction presumption. Although the final regulations under §1.752-2(k) did not extend the rules for disregarded entities to other entities, the IRS and the Treasury Department indicated that they would continue to 70 EFTA01154610  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) study the issue of extending the net value approach for disregarded entities to other entities. After further consideration, the IRS and the Treasury Department believe that there are circumstances in addition to those involving disregarded entities under which the satisfaction presumption is not appropriate. Thus, the proposed regulations turn off the satisfaction presumption by extending the net value requirement of §1.752-2(k) to all partners or related persons, including grantor trusts, other than individuals and decedent's estates for payment obligations associated with liabilities that are not trade payables. In situations in which the satisfaction presumption is turned off, the proposed regulations provide that the partner's or related person's payment obligation is recognized only to the extent of the partner's or related person's net value as of the allocation date. A partner or related person that is not a disregarded entity is treated as a disregarded entity for purposes of determining net value under §1.752-2(k). The IRS and the Treasury Department request comments on whether it would be clearer if all the net value requirement rules were consolidated in §1.752-2(k). The IRS and the Treasury Department considered further extending the net value requirement of §1.752-2(k) to partners and related persons that are individuals and decedent's estates, but decided not to require such persons to comply with the net value requirement of §1.752-2(k) because of the nature of personal guarantees. However, applying this less restrictive standard to individuals and decedent's estates may disadvantage other entities that enter into partnerships with individuals or decedent's estates. Thus, the IRS and the Treasury Department request comments on whether the final regulations should extend the net value requirement of §1.752-2(k) to 21 EFTA01154611  taxanalysts DOCUMENT SERVICE Doc 2014 1995 (SS pgs) all partners and related persons. The IRS and the Treasury Department also request comments on the application of the net value requirement of §1.752-2(k) to tiered partnerships. Finally, in determining the amount of any obligation of a partner to make a payment to a creditor or a contribution to the partnership with respect to a partnership liability, §1.752-2(b)(1) reduces the partners payment obligation by the amount of any reimbursement that the partner would be entitled to receive from another partner, a person related to another partner, or the partnership. The IRS and the Treasury Department have considered whether a right to be reimbursed for a payment or contribution by an unrelated person (for example, pursuant to an indemnification agreement from a third party) should be taken into account in the same manner and have concluded that any source of reimbursement that effectively eliminates the partner's payment risk should cause a payment obligation to be disregarded. Therefore, the proposed regulations change the rule in §1.752-2(b)(1) to reduce the partner's payment obligation by the amount of any right to reimbursement from any person. B. Nonrecourse Liabilities The existing regulations under § 1.752-3 contain rules for determining a partner's share of a nonrecourse liability of a partnership, including the partner's share of excess