Tax consequences of liquidating a partnership

This economic risk of loss is present only if any partner or any person related to a partner would be obligated to make a payment to the creditor or a partnership contribution upon a constructive liquidation of the partnership under certain hypothetical circumstances.

Recourse liabilities can provide basis for distributions and can also generate basis for purposes of the at-risk rules.

Family limited partnerships (“FLPs”) and family limited liability companies (“LLCs”) have been a mainstay of estate and related planning for decades.

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There are three different types of liabilities that are allocated: nonrecourse, qualified nonrecourse financing and recourse.

These liabilities are important components of calculating a partner’s basis both for making tax free distributions and also for deducting partnership losses (at-risk).

Liquidating distributions may be accompanied by other retirement payments that do not represent consideration for the withdrawing partner's interest in partnership property, and may be deferred compensation, or other claims against past or future partnership income. Mixing Bowl Transactions-§ § 704(c)(1)(B) and 737 1.

When the withdrawal is a result of death, there may be other collateral income and transfer tax consequences. Contributed Property Distributed to Another Partner-§ 704(c)(1)(B) 2.

For purposes of the Section 752 rules, nonrecourse liabilities are those liabilities of the partnership for which no partner bears the economic risk of loss.

Only the creditor bears the economic risk of loss with respect to a nonrecourse liability.

Thus, for many even wealthy taxpayers, there is no federal estate tax benefit to FLPs because the discounts will not save a tax if none is due.

But there may now be a tax planning negative (for all taxpayers, even wealthier taxpayers paying a federal estate tax).

811-2nd, Partnerships—Current and Liquidating Distributions; Death or Retirement of a Partner, provides a detailed discussion of the tax consequences of distributions by partnerships to partners, including those arising from distributions of a partner's share of the results of partnership operations, and other distributions by the partnership that do not result in termination of the distributee's interest in the partnership even though accompanied by a change in the distributee's and remaining partners' shares of capital or profits and losses, whether in money or property—all called current distributions—and distributions of money or property on the withdrawal of a partner whether on death or withdrawal—called liquidating distributions.


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