The U.S. Senate and House of Representatives are currently circulating two versions of a bill that is scheduled for a vote as early as March 2004, containing proposed changes to the tax treatment of private partnership transfers of interests and distributions. The changes would result in higher taxes for some partners, lower prices for selling partners, and a greater administrative burden for general partners.
What are the changes? In summary, under the Senate bill, a partnership (including a limited liability company) will be required to adjust the partnership’s tax basis of its investments (the “Inside Basis”) by the difference between the Inside Basis attributable to a selling partner and the purchase price to a newly admitted partner (the “Outside Basis”). The House bill is similar, but does not apply unless the Inside Basis exceeds the stated fair market value of the investments by more than $250,000. As a result, when the partnership sells investments, the taxable gain will be greater because of the reduction in the Inside Basis. This larger gain equates to a higher tax for the partners.
Under current tax law, a private partnership does not adjust the Inside Basis of its investments following a transfer of its interests by a partner (unless the partnership has made a one-time election under section 754 of the Internal Revenue Code to make tax basis adjustments). Therefore, a secondary buyer of a partnership interest essentially stands in the shoes’ of the selling partner for purposes of realizing gains or losses when a partnership sells investments (and makes distributions). Some members of Congress and the Senate believe the current tax law is no longer appropriate. According to the U.S. Joint Committee on Taxation, “the present [tax] law electivity of [private] partnership [tax] basis adjustments upon transfer and distributions leads to anomalous tax results, causes inaccurate income measurement, and gives rise to opportunities for tax sheltering. In particular, the failure to make partnership basis adjustments permits partners to duplicate losses and to transfer losses among partners, creating an inappropriate incentive to use the partnerships as tax shelter vehicles.” (Source: Daily Tax Report 11.13.03)
Translation: A newly admitted partner should not be able to stand in the shoes’ of a former (selling) partner, particularly as it relates to losses when a partnership sells its investments (and makes distributions).
We believe the passage of such a bill would result in (a) significant additional burdens to general partners in the administration, accounting, and valuation of investments, (b) reduced after-tax returns to certain limited partners, (c) the non-recognition in some cases of real economic losses, and (d) reduced capital allocation to asset classes represented by private partnership structures. The bill could adversely impact the private capital formation process, and the prospects for economic growth and job creation.
There is currently little opposition to the bill. If general partners, limited partners, and their respective legal and tax advisors wish to express their disapproval of this bill, they should contact their representatives in Washington, D.C., membership associations with lobbying efforts such as the NVCA, or email NYPPE at firstname.lastname@example.org. We will forward your comments to our representatives in Washington, D.C., and if appropriate, can introduce you to lobby groups that can represent your views. Please remember to include your contact information and comments in your emails to us.
For further information, or to arrange to have private partnership interests transferred or valued, please contact either:
Laurence G. AllenDexter B. Blake III
Managing MemberManaging Director
203-422-5000 x201203-422-5000 x204
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