REGULATION 12/22/2024
On December 2, 2024, the IRS issued final regulations (TD 10014) under Section 752, providing long-awaited clarity on how to determine a partner’s share of recourse liabilities in partnerships. These regulations address three critical areas:
- Situations where multiple partners share economic risk for a single liability.
- Tiered partnership structures.
- Related parties.
These updates resolve ambiguities in prior rules, particularly around the allocation of economic risk of loss among related parties.
Why These Regulations Matter
The final regulations provide much-needed guidance on how partnerships allocate recourse liabilities, affecting tax basis and debt allocation. These rules apply to liabilities incurred or assumed by partnerships on or after December 2, 2024. Partnerships can also apply these rules retroactively to all liabilities on returns filed on or after this date, provided they consistently apply the rules across all liabilities.
Key provisions include:
- A grandfather rule for pre-existing liabilities under written binding contracts before December 2, 2024.
- Special rules for refinanced debts, preserving the allocation based on the pre-modified liability’s amount and duration.
Actions for Partnerships
Partnerships should evaluate whether to apply the new regulations retroactively to all liabilities or limit application to liabilities incurred after December 2, 2024. Consulting with a tax professional is essential to assess the implications of these changes.
Key Updates in the Final Regulations
1. Allocation of Economic Risk of Loss
The regulations clarify how to allocate liabilities when multiple partners bear economic risk of loss for the same liability:
- A proportionality rule ensures that the total liability is allocated proportionately among partners based on the amount of economic risk they bear.
- Example: If Partner A guarantees $1,000 and Partner B guarantees $500 of a $1,000 liability, the liability is allocated $667 to A and $333 to B.
2. Tiered Partnerships
For tiered partnerships, liabilities are allocated directly to the upper-tier partnership bearing the economic risk of loss.
- Example: In a scenario where both A and B guarantee a liability in a tiered partnership structure, the proportionality rule allocates the liability between A and B at both the lower and upper-tier levels.
3. Special Rules for Related Parties
The regulations refine the treatment of related parties in liability allocation:
- Exclude additional constructive ownership rules for partnerships and subsidiaries when allocating liabilities.
- Clarify that when one partner directly bears the economic risk of loss, they are treated as unrelated to other related partners.
- Introduce the “multiple partner rule”, allocating liabilities among related partners who share economic risk in proportion to their partnership profit interests.
Observations and Considerations
These regulations may result in significant shifts in how liabilities are allocated, especially in partnerships with related partners or complex tiered structures.
- Potential Impact: Some debt may shift away from a partner who bears the primary economic risk to related partners with profit-sharing interests.
- Recommendation: Partnerships should revisit their agreements and evaluate how these rules affect their liability allocations, tax basis, and partner contributions or distributions.
Next Steps
Partnerships must act promptly to understand and implement these new regulations:
- Review current liabilities: Assess existing debt allocations and evaluate potential changes under the new rules.
- Consider retroactive application: Decide whether applying the regulations retroactively provides a tax advantage.
- Seek professional advice: Work with a qualified tax advisor to ensure compliance and optimize liability allocation strategies.
At Chartered Consulting, we specialize in helping partnerships navigate complex tax regulations. Contact us today to discuss how these new rules impact your partnership and ensure you’re prepared for these changes.