Example of nonliquidating distribution
Presumably P and Q will agree to share future profit and loss in these new proportions.But that has no effect on the taxation of the accrued gain in Blackacre of 0; that accrued gain should be shared equally between the partners because it was a return on their investments when their investments were equal.It should not be difficult to figure out how to tax two individuals who contribute equal amounts of cash to start a joint business in which each will own a one-half interest.But it quickly becomes problematic when one if the two partners wants a greater share of early receipts in exchange for a lower share of back-end gains.The way to ensure that the distribution does not inappropriately affect the economics of the venture is to restate the partner‟s capitals accounts immediately prior to the distribution (called an asset “book-up”). That is, because Blackacre is now worth 0, each partner‟s capital account should be increased by his share of the 0 increase from cost of to current value of 0.Thus, the books of the partnership really should be: The books accurately show that P now has a one-third interest in the capital of the partnership while Q‟s interest has grown to two-thirds.Since each partner invested 0, each should be taxed on 0, and for Q is exactly what happened: the only taxable event was the sale of Blackacre, and Q reported a gain of 0 as a result.
The books of the partnership would become: These totals show P with a capital account balance of only , which means that if the partnership were to liquidate immediately, P would be entitled to cash of (and the remaining cash of 7 would go to Q). When coupled with the prior cash distribution to P of 0, that means P‟s total return from the venture would be 3.
The basic paradigm upon which Subchapter K is best described as ; that is, that a partnership should be all but invisible to the taxing system.
In particular, transactions between a partner and the partnership should be tax-free as much as possible, with the taxable events being dealings between the partnership (or the partners) and third-parties.
The partnership tax provisions – Subchapter K of the Internal Revenue Code – work pretty well.
And they have a difficult job to do because they must provide a reasonable mechanism for taxing arrangements between parties that can be far from off-the-rack.
And if the amounts they contribute are unequal, they will have some arrangement to account for that difference which the taxing structure must digest.