Abstract

In this article, Professor Lee charts two alternative methods for implementing an aggregate solution to the problem of partnership profits share for services. The functional, or judicial, method is to handle (1) the exchange of partner-capacity services for a profit share subject to the risk f the venture with the Culbertson "common law relation of partnership," nonrealization event doctrine, implicitly contemplated by the 1984 legislative history to section 707(a)(2), (2) the classic Diamond transitory partner with a substance-over-form rule or step-transaction rule, and (3) a sale of the partnership interest in circumstances that would result in ordinary income in a sale of a proprietorship by a proprietress with the P.G. Lake "substitution for ordinary income" doctrine, widely applied in analogous cases under the 1939 code. Lee believes that rather than just setting forth standards, regulations should implement structured discretionary justice. Therefore, he recommends that the Service and the Treasury use regulations to legislate a defined "tainted freestanding intangible" approach, inspired in part by United States v. Stafford and in part by Wolfsen Land & Cattle, which would treat the value created by performance of partner-capacity services (or the promise of future partner-capacity services) as a built-in gain freestanding intangible. The transfer of such an intangible to the partnership in return for a profits interest subject to the risks of the venture, says Lee, would fall under section 721's nonrecognition umbrella, as in Stafford. Lee explains that sales by the service partner of her five-year profits share would be tainted as follows. The transferred intangible would carry ordinary income status in the transferee partnership's "hands" for five year under section 724, with mandatory allocations of the built-in tainted gain under section 704{c) to the service partner.

Lee suggests two alternative tax accounting solutions to a year two sale of a profits share. His Alternative A would be to hold the transaction (receipt of the profits share) open for two years under the "indeterminable character" variant of the open transaction doctrine to see whether there will be (1) no sale with the two-year window and resultant nonrecognition and sale thereafter likely at capital gain (just like a proprietress), or (2) a sale in year two resulting in ordinary income because of a transitory partner. His Alternative B would be to apply year two balancing entry notions based upon a reading of Hillsboro.

(The first part of this article appeared in Tax Notes, Mar. 28, 1994, at p. 1733.)

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Article

Publication Information

63 Tax Notes 97-108 (1994)

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