Say goodbye to the partnership technical termination rules in 2018 thanks to the Tax Cuts and Jobs Act passed in 2017. This little known provision in the tax code is a step in the right direction when it comes to cutting the unnecessary complexities in the tax code. Here’s exactly how the change will impact partnerships and what we can look forward to in 2018.
Old Rules Explained
Before the passage of the Tax Cuts and Jobs Act in 2017 there were two primary ways a partnership was considered terminated for tax purposes under IRC §708(b)(1):
- A partnership is considered terminated when the operations of the partnership are discontinued and no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership. In layman’s terms a partnership is considered terminated when the business itself ends.
- A partnership shall terminate when 50 percent or more of the total interest in partnership capital and profits is sold or exchanged within a period of 12 consecutive months.
The wording in paragraph 2 is considered a “technical termination” because the business operations don’t necessarily terminate but tax structure itself is considered terminated. The day-to-day operations may continue with no interruption but if 50 percent or more of the total interest in the business changes hands within a 12 month period then the IRS considered that business as no longer existing.
In tax terms, within a split second the business distributes its interest to each of the partners and the new existing partners contribute their interest into an entirely new partnership.
This nuance in the tax code (or nuisance depending on who’m you ask) created unnecessary reporting requirements for partnerships who would be subject to filing two separate partnership returns in a given year.
For partnerships filing tax returns prior to 2017, technical terminations are not intentional but do cause several unintended consequences:
- Tax Reporting: partnerships falling under the rules of technical termination were required to file 2 short year tax returns. This would not only double the reporting requirements but also double the accounting fees for partners.
- Tax Elections: since the partnership is considered “technically terminated” the partnership elections are considered terminated as well. If the partnership failed to make some of the elections going forward they could lose out on several tax benefits.
- Tax Distortions: the simultaneous distribution of partnership assets from the old partnership and contribution of partnership interest into the new partnership creates several tax distortions. Timing differences in reporting income, depreciation calculations and treatment of negative capital accounts all add up to a headache for partners.
Effective for all taxable years beginning after 2017 IRC § 708(b)(1) has been modified by eliminating subsection (B) and ending the possibility of a technical terminations in the future. The repeal of this quirky code section comes as a welcomed change to reduce the unnecessary complexities in the tax code.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer. Photo Credit: https://www.123rf.com/profile_bobaa22