81_FR_69494 81 FR 69301 - Liabilities Recognized as Recourse Partnership Liabilities Under Section 752

81 FR 69301 - Liabilities Recognized as Recourse Partnership Liabilities Under Section 752

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Federal Register Volume 81, Issue 193 (October 5, 2016)

Page Range69301-69309
FR Document2016-23390

This document contains proposed regulations that incorporate the text of related temporary regulations and withdraws a portion of a notice of proposed rulemaking (REG-119305-11) to the extent not adopted by final regulations. This document also contains new proposed regulations addressing when certain obligations to restore a deficit balance in a partner's capital account are disregarded under section 704 of the Internal Revenue Code (Code) and when partnership liabilities are treated as recourse liabilities under section 752. These regulations would affect partnerships and their partners.

Federal Register, Volume 81 Issue 193 (Wednesday, October 5, 2016)
[Federal Register Volume 81, Number 193 (Wednesday, October 5, 2016)]
[Proposed Rules]
[Pages 69301-69309]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2016-23390]



Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / 
Proposed Rules

[[Page 69301]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-122855-15]
RIN 1545-BM83


Liabilities Recognized as Recourse Partnership Liabilities Under 
Section 752

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Partial withdrawal of notice of proposed rulemaking and notice 
of proposed rulemaking, including by cross reference to temporary 
regulations.

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SUMMARY: This document contains proposed regulations that incorporate 
the text of related temporary regulations and withdraws a portion of a 
notice of proposed rulemaking (REG-119305-11) to the extent not adopted 
by final regulations. This document also contains new proposed 
regulations addressing when certain obligations to restore a deficit 
balance in a partner's capital account are disregarded under section 
704 of the Internal Revenue Code (Code) and when partnership 
liabilities are treated as recourse liabilities under section 752. 
These regulations would affect partnerships and their partners.

DATES: The notice of proposed rulemaking under sections 707 and 752 
that was published in the Federal Register on January 30, 2014 (REG-
119305-11, 79 FR 4826), is partially withdrawn as of October 5, 2016. 
Written or electronic comments and requests for a public hearing must 
be received by January 3, 2017.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-122855-15), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
122855-15), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal site at http://www.regulations.gov (indicate IRS and 
REG-122855-15).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Caroline E. Hay or Deane M. Burke, (202) 317-5279; concerning 
submissions of comments and requests for a public hearing, Regina L. 
Johnson, (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: In addition to these proposed regulations, 
the Treasury Department and the IRS are publishing in the Rules and 
Regulations section in this issue of the Federal Register: (1) Final 
regulations under section 707 concerning disguised sales and under 
section 752 regarding the allocation of excess nonrecourse liabilities 
and (2) temporary regulations concerning a partner's share of 
partnership liabilities for purposes of section 707 and the treatment 
of certain payment obligations under section 752.

Paperwork Reduction Act

    The collection of information related to these proposed regulations 
under section 752 is reported on Form 8275, Disclosure Statement, and 
has been reviewed in accordance with the Paperwork Reduction Act (44 
U.S.C. 3507) and approved by the Office of Management and Budget under 
control number 1545-0889. Comments concerning the collection of 
information and the accuracy of estimated average annual burden and 
suggestions for reducing this burden should be sent to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503, with copies to the Internal Revenue Service, IRS Reports 
Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments 
on the burden associated with this collection of information should be 
received by December 5, 2016.
    The collection of information in these proposed regulations is in 
proposed Sec.  1.752-2(b)(3)(ii)(D) (which cross references the 
requirement in Sec.  1.752-2T(b)(3)(ii)(D)). This information is 
required by the IRS to ensure that section 752 of the Code and 
applicable regulations are properly applied for allocations of 
partnership liabilities. The respondents will be partners and 
partnerships.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by section 6103.

Background

1. Overview

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 704, 707, and 752 of the 
Code. On January 30, 2014, the Treasury Department and the IRS 
published a notice of proposed rulemaking in the Federal Register (REG-
119305-11, 79 FR 4826) to amend the then existing regulations under 
section 707 relating to disguised sales of property to or by a 
partnership and under section 752 concerning the treatment of 
partnership liabilities (the 2014 Proposed Regulations). The 2014 
Proposed Regulations provided certain technical rules intended to 
clarify the application of the disguised sale rules under section 707. 
The 2014 Proposed Regulations also contained rules regarding the 
sharing of partnership recourse and nonrecourse liabilities under 
section 752.
    A public hearing on the 2014 Proposed Regulations was not requested 
or held, but the Treasury Department and the IRS received written 
comments. After consideration of, and in response to, the comments on 
the 2014 Proposed Regulations, the Treasury Department and the IRS are 
withdrawing the 2014 Proposed Regulations under Sec.  1.752-2 and 
publishing new proposed regulations under Sec.  1.752-2, as well as 
proposed regulations under section 704. Concurrently in this issue of 
the Federal Register, the Treasury Department and the IRS are also 
publishing final regulations that adopt, as modified, the 2014 Proposed 
Regulations under section 707 and Sec.  1.752-3, and temporary 
regulations under sections 707 and 752.

2. Summary of Applicable Law

    Section 752 separates partnership liabilities into two categories: 
recourse liabilities and nonrecourse liabilities. Section 1.752-1(a)(1) 
provides that a partnership liability is a recourse liability to the 
extent that any partner or related person bears the economic risk of 
loss (EROL) for that liability under Sec.  1.752-2. Section 1.752-
1(a)(2) provides that a partnership liability is a nonrecourse 
liability to the extent that no partner or related person bears the 
EROL for that liability under Sec.  1.752-2.
    A partner generally bears the EROL for a partnership liability if 
the partner or related person has an obligation to make a payment to 
any person within the meaning of Sec.  1.752-2(b). For purposes of 
determining the extent to which a partner or related person has an 
obligation to make a payment, an obligation to restore a deficit 
capital account upon liquidation of the partnership under the section 
704(b) regulations is taken into account. Further, for this purpose, 
Sec.  1.752-2(b)(6)

[[Page 69302]]

of the existing regulations presumes that partners and related persons 
who have payment obligations actually perform those obligations, 
irrespective of their net worth, unless the facts and circumstances 
indicate a plan to circumvent or avoid the obligation (the satisfaction 
presumption). However, the satisfaction presumption is subject to an 
anti-abuse rule in Sec.  1.752-2(j) pursuant to which a payment 
obligation of a partner or related person may be disregarded or treated 
as an obligation of another person if facts and circumstances indicate 
that a principal purpose of the arrangement is to eliminate the 
partner's EROL with respect to that obligation or create the appearance 
of the partner or related person bearing the EROL when the substance is 
otherwise. Under the existing rules, the satisfaction presumption is 
also subject to a disregarded entity net value requirement under Sec.  
1.752-2(k) pursuant to which, for purposes of determining the extent to 
which a partner bears the EROL for a partnership liability, a payment 
obligation of a disregarded entity is taken into account only to the 
extent of the net value of the disregarded entity as of the allocation 
date that is allocated to the partnership liability.

3. 2014 Proposed Regulations

    As discussed in greater detail in the Summary of Comments and 
Explanation of Provisions section of this preamble, Sec.  1.752-2 of 
the 2014 Proposed Regulations generally, among other things, (1) 
provided that a partner's or related person's obligation to make a 
payment with respect to a partnership liability (excluding those 
imposed by state law) would not be recognized for purposes of section 
752 unless each recognition factor was satisfied; (2) applied the list 
of recognition factors to all payment obligations under Sec.  1.752-
2(b), including a partner's obligation to restore a deficit capital 
account upon liquidation of a partnership (deficit restoration 
obligations, or DROs) as provided under the section 704(b) regulations; 
and (3) provided generally that a payment obligation would be 
recognized to the extent of the net value of a partner or related 
person as of the allocation date.
    After consideration of the comments received on the 2014 Proposed 
Regulations, the Treasury Department and the IRS are reconsidering the 
rules under section 752 regarding payment obligations that are 
recognized under Sec.  1.752-2(b)(3), the satisfaction presumption 
under Sec.  1.752-2(b)(6), the anti-abuse rule provided in Sec.  1.752-
2(j), and the net value requirement as provided in Sec.  1.752-2(k). 
Accordingly, the Treasury Department and the IRS are withdrawing Sec.  
1.752-2 of the 2014 Proposed Regulations and publishing these new 
proposed regulations that would amend existing regulations under 
sections 704 and 752. These new provisions, and comments received on 
the 2014 Proposed Regulations that are pertinent to these new 
provisions, are discussed in the Summary of Comments and Explanation of 
Provisions section of the preamble that follows.

4. Final and Temporary Regulations Under Section 707 and Requests for 
Comments

    As previously mentioned, the Treasury Department and the IRS are 
concurrently publishing temporary regulations under section 707 
(concerning disguised sales) (the 707 Temporary Regulations) and 
section 752 (concerning recourse liabilities, in particular bottom 
dollar payment obligations) (the 752 Temporary Regulations), and final 
regulations under section 707 and Sec.  1.752-3. The temporary 
regulations are incorporated by cross reference in these proposed 
regulations. Notably, the 707 Temporary Regulations provide that, for 
disguised sale purposes, partners determine their share of any 
partnership liability in the manner in which excess nonrecourse 
liabilities are allocated under Sec.  1.752-3(a)(3) (with certain 
limitations). Generally, a partner's share of the excess nonrecourse 
liability is determined in accordance with the partner's share of 
partnership profits taking into account all the facts and circumstances 
relating to the economic arrangement of the partners. The Treasury 
Department and the IRS recognize that taxpayers may require further 
guidance regarding reasonable methods for determining a partner's share 
of partnership profits under Sec.  1.752-3(a)(3) for disguised sale 
purposes, especially given that a partner's share may change from year 
to year or differ with respect to different partnership assets and 
believe it may be appropriate to issue administrative guidance for this 
purpose. Accordingly, comments are requested regarding possible safe 
harbors and reasonable methods for determining a partner's share of 
profits, taking into account all of the relevant facts and 
circumstances relating to the economic arrangement of the partners. The 
preamble to the temporary regulations describes the provisions in 
greater detail. In addition, the final regulations under section 707 
also include a request for comments concerning the exception for 
reimbursements of preformation capital expenditures under Sec.  1.707-
4(d), which is described in greater detail in the preamble to the final 
regulations.

Summary of Comments and Explanation of Provisions

1. Rights of Reimbursement

    Section 1.752-2(b)(1) provides that, except as otherwise provided 
in Sec.  1.752-2, a partner bears the EROL for a partnership liability 
to the extent that, if the partnership constructively liquidated, the 
partner or related person would be obligated to make a payment to any 
person (or a contribution to the partnership) because that liability 
becomes due and payable and the partner or related person would not be 
entitled to reimbursement from another partner or a person that is a 
related person to another partner. Section 1.752-2(b)(1) presumes that, 
in the constructive liquidation, the partnership has a value of zero 
with which to pay its liabilities. Under the 2014 Proposed Regulations, 
a partner would not bear the EROL under Sec.  1.752-2(b)(1) if the 
partner or related person is entitled to a reimbursement from ``any 
person.'' Commenters noted that a reimbursement from ``any person'' 
would include a reimbursement from the partnership, which is contrary 
to the intent of the regulations under section 752. A right to be 
reimbursed by the partnership should be disregarded, as Sec.  1.752-
2(b)(1) presumes that the partnership would not be able to pay the 
liability or reimburse the partner. The Treasury Department and the IRS 
agree with the concerns expressed in the comments; therefore, these 
proposed regulations do not include the changes to Sec.  1.752-2(b)(1) 
that were in the 2014 Proposed Regulations.

2. Arrangements Part of a Plan To Circumvent or Avoid an Obligation

    The 2014 Proposed Regulations provided that a partner's or related 
person's obligation to make a payment with respect to a partnership 
liability (excluding those imposed by state law) will not be recognized 
for purposes of section 752 unless: (1) The partner or related person 
is (A) required to maintain a commercially reasonable net worth 
throughout the term of the payment obligation or (B) subject to 
commercially reasonable contractual restrictions on transfers of assets 
for inadequate consideration; (2) the partner or related person is 
required periodically to provide commercially reasonable documentation 
regarding the partner's or related person's financial condition; (3) 
the term of the payment obligation does not end prior to the term

[[Page 69303]]

of the partnership liability; (4) the payment obligation does not 
require that the primary obligor or any other obligor with respect to 
the partnership liability directly or indirectly hold money or other 
liquid assets in an amount that exceeds the reasonable needs of such 
obligor; (5) the partner or related person received arm's length 
consideration for assuming the payment obligation; and (6) the 
obligation is not a bottom dollar guarantee or indemnity (recognition 
factors).
    Commenters expressed concerns with the all-or-nothing approach in 
the 2014 Proposed Regulations. One commenter noted that a partner could 
cause an obligation to deliberately fail one of the recognition factors 
so as to cause a liability to be treated as nonrecourse if such 
characterization potentially would be beneficial to such partner, even 
if that partner did, in fact, bear the EROL. This commenter also noted 
that commercial arrangements rarely satisfy each and every one of the 
recognition factors and commercial practices tend to change over time, 
thereby rendering the recognition factors out of date. This commenter 
recommended that regulations instead provide a nonexclusive list of 
facts and circumstances containing as factors many of the items 
identified in the 2014 Proposed Regulations.
    The Treasury Department and the IRS believe that the concerns 
expressed by the commenters are valid and thus propose to move the list 
of factors to an anti-abuse rule in Sec.  1.752-2(j), other than the 
recognition factors concerning bottom dollar guarantees and 
indemnities, which are addressed in the 752 Temporary Regulations. 
Under the anti-abuse rule, factors are weighed to determine whether a 
payment obligation should be respected. The list of factors in the 
anti-abuse rule in these proposed regulations is nonexclusive, and the 
weight to be given to any particular factor depends on the particular 
case. Furthermore, the presence or absence of any particular factor, in 
itself, is not necessarily indicative of whether or not a payment 
obligation is recognized under Sec.  1.752-2(b).
    In addition to comments addressing the recognition factor approach 
in the 2014 Proposed Regulations, the Treasury Department and the IRS 
received specific comments regarding the individual recognition 
factors. With respect to the first recognition factor regarding 
commercially reasonable net worth or restrictions on transfers, one 
commenter agreed that an obligor should have the wherewithal to make a 
payment to the extent required for the entire duration of its 
obligation, but believed that this concern is alleviated by the anti-
abuse rule in the current regulations under Sec.  1.752-2(j). This 
commenter suggested that the anti-abuse rule in Sec.  1.752-2(j) 
contain additional examples to illustrate abusive or problematic 
situations. Another commenter noted that the 2014 Proposed Regulations 
did not address the consequences if a partner or related person 
breaches its payment obligation under an agreement regarding net worth 
or restrictions on transfers and suggested that the regulations address 
such consequences in an anti-abuse rule (for example, a partner's or 
related person's payment obligation may be disregarded if it is 
determined that the creditor lacked the intent to enforce its rights 
under the agreement).
    With respect to the first two recognition factors, commenters 
expressed concerns with the use of the terms ``commercially 
reasonable'' and ``commercially reasonable documentation.'' One 
commenter believed that these terms are vague and subjective and would 
require partnerships to make difficult judgments as to whether these 
recognition factors have been met prior to allocating any partnership 
liability. Another commenter noted that the ``commercially reasonable 
documentation'' recognition factor did not specify who should receive 
the documentation and that such documentation should be provided to the 
lender.
    Moving the list of factors to an anti-abuse rule should alleviate 
some of the concerns expressed regarding both whether a payment obligor 
has the wherewithal to pay and the use of the term ``commercially 
reasonable.'' The proposed regulations also revise the first two 
factors to provide clarity by limiting the first factor to examine 
solely whether the partner or related person is subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, such as restrictions on transfers for inadequate consideration 
or equity distributions. In addition, the proposed regulations do not 
retain the subjective commercially reasonable net worth factor, but 
instead include a new factor that examines whether the payment 
obligation restricts the creditor from promptly pursuing payment 
following a default on the partnership liability or whether there are 
other arrangements that indicate a plan to delay collection.
    The proposed regulations retain the use of the ``commercially 
reasonable'' standard, however, because different facts may require a 
different standard of whether contractual restrictions and 
documentation are ``commercially reasonable'' with respect to a 
particular industry, and the flexible nature of the term is helpful in 
informing partnerships and their partners that obligations should be 
consistent with what is customary in the marketplace. With respect to 
the second recognition factor regarding documentation, these proposed 
regulations also clarify that the factor examines whether commercially 
reasonable documentation was provided to the party that benefits from 
the payment obligation (for example, the creditor in the case of a 
guarantee or the indemnified party in the case of an indemnification 
arrangement).
    Commenters also noted that certain recognition factors do not take 
into account industry specific practices. One commenter pointed out 
that the requirement that a payment obligation last throughout the full 
term of the partnership's loan is contrary to commercial practice in 
some cases. In particular, the commenter noted that, in the real estate 
industry context, it is common for a construction loan to be guaranteed 
until the property reaches a required level of stabilization. This 
commenter did believe, however, that a payment obligation should be 
disregarded if the guarantor or other obligor has an unrestricted 
unilateral right to terminate the obligation at will, including 
immediately before the obligation becomes due and payable. Commenters 
also noted that the recognition factor that would require arm's length 
consideration is not commercial, as a partner is often willing to enter 
into a guarantee or other payment obligation with respect to a 
partnership liability because the partner will benefit from the 
liability in the obligor's capacity as a partner. The Treasury 
Department and the IRS agree with these recommendations; thus, these 
proposed regulations take into account industry practice with respect 
to terminations of payment obligations and do not include the arm's 
length consideration factor.
    A commenter also expressed concerns regarding the recognition 
factor that examines whether a primary obligor or any other obligor 
with respect to the partnership liability is required to hold assets in 
an amount that exceeds the reasonable needs of the obligor. The 
commenter noted that partnership agreements often include restrictions 
on distributions before certain hurdles are satisfied for a variety of 
reasons, such as to protect the interests of preferred partners or for 
prudent business management. Another commenter agreed with the legal 
theory

[[Page 69304]]

underpinning the recognition factor (to address fact patterns in which 
the taxpayer intended and acted to ensure the partnership maintained 
sufficient collateral to repay the creditor without exposing the 
obligor to meaningful liability) but suggested that commercially 
required or prudent reserves not be considered. Both commenters 
suggested that an example illustrating the restrictions that violate 
this factor would be helpful.
    The commenters' concerns should be largely addressed by making this 
recognition factor one of many examined under the anti-abuse rule that 
looks to whether there is a plan to circumvent or avoid the obligation. 
Under the anti-abuse rule, an obligor's retention of assets for its 
reasonable foreseeable needs (such as for commercial or prudent 
business reasons) generally would not, on its own, indicate that there 
is a plan to circumvent or avoid the obligation.
    Finally, the proposed regulations provide two additional factors 
that indicate when a plan to circumvent or avoid an obligation exists. 
The first provides that, in the case of a guarantee or similar 
arrangement, the terms of the liability would be substantially the same 
had the partner or related person not agreed to provide the guarantee. 
This factor indicates that the guarantee was not required by the 
lender, presumably because the partnership had sufficient assets to 
satisfy its obligation. The second additional factor examines whether 
the creditor or other party benefiting from the obligation received 
executed documents with respect to the payment obligation from the 
partner or related person before, or within a commercially reasonable 
time after, the creation of the obligation.

3. Deficit Restoration Obligations

    The 2014 Proposed Regulations applied the list of recognition 
factors discussed in Section 2 of this Summary of Comments and 
Explanation of Provisions to all payment obligations under Sec.  1.752-
2(b), including a DRO, as provided under the section 704(b) 
regulations. Commenters explained that not all of the recognition 
factors could be satisfied with respect to a DRO. In addition, 
commenters suggested that the regulations under section 704(b) be 
amended to clarify that if a DRO is not given effect under section 752, 
it should not be given effect under section 704(b).
    A DRO is an obligation to the partnership that is imposed by the 
partnership agreement. In contrast, a guarantee or indemnity is a 
contractual obligation outside the partnership agreement. As a result 
of this difference and based on the comments on the 2014 Proposed 
Regulations, the proposed regulations refine the list of factors 
applicable to DROs and clarify the interaction of section 752 with 
section 704 regarding DROs. Under Sec.  1.704-1(b)(2)(ii)(c)(2) of the 
existing regulations, a partner's DRO is not respected if the facts and 
circumstances indicate a plan to circumvent or avoid the partner's DRO. 
These proposed regulations add a list of factors to Sec.  1.704-
1(b)(2)(ii)(c) that are similar to the factors in the proposed anti-
abuse rule under Sec.  1.752-2(j), but specific to DROs, to indicate 
when a plan to circumvent or avoid an obligation exists. Under the 
proposed regulations, the following factors indicate a plan to 
circumvent or avoid an obligation: (1) The partner is not subject to 
commercially reasonable provisions for enforcement and collection of 
the obligation; (2) the partner is not required to provide (either at 
the time the obligation is made or periodically) commercially 
reasonable documentation regarding the partner's financial condition to 
the partnership; (3) the obligation ends or could, by its terms, be 
terminated before the liquidation of the partner's interest in the 
partnership or when the partner's capital account as provided in Sec.  
1.704-1(b)(2)(iv) is negative; and (4) the terms of the obligation are 
not provided to all the partners in the partnership in a timely manner.
    Notwithstanding the proposed factors, the Treasury Department and 
the IRS have concerns with whether and to what extent it is appropriate 
to recognize DROs (and certain partner notes treated as DROs) as 
meaningful payment obligations. Many DROs are triggered only on the 
liquidation of a partnership. However, some partnerships are intended 
to have perpetual life and other partnerships can effectively cease 
operations but not actually liquidate; therefore, a partner's DRO may 
never be required to be satisfied. In addition, some DROs can be 
terminated or significantly reduced in a manner that may not be 
appropriate, and therefore, the DRO similarly may never be triggered. 
The Treasury Department and the IRS request comments on the extent to 
which such DROs should be recognized. In addition, certain partner 
notes are treated as DROs under Sec.  1.704-1(b)(2)(ii)(c)(1) and (3) 
of these proposed regulations. The Treasury Department and the IRS also 
request comments concerning whether these obligations should continue 
to be treated as DROs.

4. Exculpatory Liabilities

    One commenter suggested that the 2014 Proposed Regulations would 
result in more liabilities being characterized as nonrecourse 
liabilities, in particular, so-called, ``exculpatory liabilities,'' and 
urged the Treasury Department and the IRS to provide guidance with 
respect to such liabilities. An exculpatory liability is a liability 
that is recourse to an entity under state law and section 1001, but no 
partner bears the EROL within the meaning of section 752. Thus, the 
liability is treated as nonrecourse for section 752 purposes. The 
Treasury Department and the IRS are studying the treatment of 
exculpatory liabilities under sections 704 and 752 and agree that 
guidance is warranted in this area. However, the treatment of 
exculpatory liabilities is beyond the scope of these proposed 
regulations. The Treasury Department and the IRS seek additional 
comments regarding the proper treatment of an exculpatory liability 
under regulations under section 704(b) and the effect of such a 
liability's classification under section 1001. Further, the Treasury 
Department and the IRS request additional comments addressing the 
allocation of an exculpatory liability among multiple assets and 
possible methods for calculating minimum gain with respect to such 
liability, such as the so-called ``floating lien'' approach (whereby 
all the assets in the entity, including cash, are considered to be 
subject to the exculpatory liability) or a specific allocation 
approach.

5. Net Value

    Section 1.752-2(b)(6) of the existing regulations provides that, 
for purposes of determining the extent to which a partner or related 
person has a payment obligation and the EROL, it is assumed that all 
partners and related persons who have obligations to make payments 
actually perform those obligations, irrespective of their actual net 
worth, unless the facts and circumstances indicate a plan to circumvent 
or avoid the obligation. See Sec.  1.752-2(b)(6), cross referencing 
Sec.  1.752-2(j) and (k). Under the anti-abuse rule in Sec.  1.752-
2(j), a payment obligation is disregarded if there is a plan to 
circumvent or avoid such obligation. Section 1.752-2(k)(1) provides 
that, when determining the extent to which a partner bears the EROL for 
a partnership liability, a payment obligation of a business entity that 
is disregarded as an entity separate from its owner under section 
856(i), section 1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-3 
of the Procedure and Administration Regulations (a

[[Page 69305]]

disregarded entity) is taken into account only to the extent of the net 
value of the disregarded entity as of the allocation date that is 
allocated to the partnership liability. Section 1.752-2(k)(2)(i) 
provides, in part, that net value is the fair market value of all 
assets owned by the disregarded entity that may be subject to 
creditors' claims under local law less all obligations of the 
disregarded entity that do not constitute Sec.  1.752-2(b)(1) payment 
obligations of the disregarded entity.
    The 2014 Proposed Regulations provided that, in determining the 
extent to which a partner or related person other than an individual or 
a decedent's estate bears the EROL for a partnership liability other 
than a trade payable, a payment obligation is recognized only to the 
extent of the net value of the partner or related person that, as of 
the allocation date, is allocated to the liability, as determined under 
Sec.  1.752-2(k). The 2014 Proposed Regulations also provided that the 
partner must provide a statement concerning the net value of the 
payment obligor to the partnership. The preamble to the 2014 Proposed 
Regulations requested comments concerning whether the net value rule 
should also apply to individuals and estates and whether the 
regulations should consolidate these rules under Sec.  1.752-2(k).
    Commenters expressed concerns that an expansion of the net value 
rule would add considerable burden and expense to taxpayers and would 
likely lead to time consuming and costly disputes regarding valuations. 
Another commenter explained that taxpayers have often avoided the net 
value regulations (by not using disregarded entities) or have applied 
the regulations only when the disregarded entity has minimal or no 
assets.
    Commenters suggested that if the net value rule is retained, Sec.  
1.752-2(k) should be extended to all partners and related persons other 
than individuals. One commenter expressed concerns that a partner who 
may be treated as bearing the EROL with respect to a partnership 
liability would have to provide information regarding the net value of 
the payment obligor, which is unnecessarily intrusive. Another 
commenter believed that if the rules requiring net value were extended 
to all partners in partnerships, the attempt to achieve more realistic 
substance would be accompanied by a corresponding increase in the 
potential for manipulation.
    The Treasury Department and the IRS remain concerned with ensuring 
that a partner or related person only be presumed to satisfy its 
payment obligation to the extent that such partner or related person 
would be able to pay on the obligation. After consideration of the 
comments, however, the Treasury Department and the IRS agree that 
expanding the application of the net value rules under Sec.  1.752-2(k) 
may lead to more litigation and may unduly burden taxpayers. 
Furthermore, net value as provided in Sec.  1.752-2(k) may not 
accurately take into account the future earnings of a business entity, 
which normally factor into lending decisions. Therefore, the Treasury 
Department and the IRS propose to remove Sec.  1.752-2(k) and instead 
create a new presumption under the anti-abuse rule in Sec.  1.752-2(j). 
Under the presumption in the proposed regulations, evidence of a plan 
to circumvent or avoid an obligation is deemed to exist if the facts 
and circumstances indicate that there is not a reasonable expectation 
that the payment obligor will have the ability to make the required 
payments if the payment obligation becomes due and payable. A payment 
obligor includes disregarded entities (including grantor trusts). These 
proposed regulations also add an example to illustrate the application 
of the anti-abuse rule when the payment obligor is an underfunded 
entity. Under these proposed regulations, Sec.  1.752-2(b)(6) continues 
to presume that payment obligations with respect to a partnership 
liability will be satisfied unless evidence of a plan to circumvent or 
avoid the obligation exists as determined under Sec.  1.752-2(j). If 
evidence of a plan to circumvent or avoid the obligation exists or is 
deemed to exist, the obligation is not recognized under Sec.  1.752-
2(b) and therefore the partnership liability is treated as a 
nonrecourse liability under Sec.  1.752-1(a)(2).

Proposed Applicability Dates

    The amendments to Sec.  1.704-1 are proposed to apply on or after 
the date these regulations are published as final regulations in the 
Federal Register. The amendments to Sec.  1.752-2 are proposed to apply 
to liabilities incurred or assumed by a partnership and to payment 
obligations imposed or undertaken with respect to a partnership 
liability on or after the date these regulations are published as final 
regulations in the Federal Register. Partnerships and their partners 
may rely on these proposed regulations prior to the date they are 
published as final regulations in the Federal Register. However, the 
rules in Sec.  1.752-2(k) still apply to disregarded entities until the 
proposed regulations are published as final regulations in the Federal 
Register.
    Some commenters were concerned that the 2014 Proposed Regulations 
``delinked'' the regulations under sections 704 and 752 concerning 
DROs, that is, that a DRO may somehow still be recognized under section 
704 despite not meeting the requirements to be recognized as a payment 
obligation under section 752. DROs are subject to the bottom dollar 
payment obligation rules in the 752 Temporary Regulations, but the 
rules in these proposed regulations concerning DROs will not be 
effective prior to the date they are published as final regulations in 
the Federal Register. However, these proposed regulations allow 
partnerships and their partners to rely on the proposed regulations, 
which should address this concern.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. It is hereby certified that the collection of 
information in these regulations will not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that the amount of time necessary to report the 
required information will be minimal in that it requires partnerships 
(including partnerships that may be small entities) to provide 
information they already maintain or can easily obtain to the IRS. 
Moreover, it should take a partnership no more than 2 hours to satisfy 
the information requirement in these regulations. Accordingly, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the 
Code, this notice of proposed rulemaking has been submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The Treasury Department and the IRS request comments on all 
aspects of the proposed regulations. All comments will be available for 
public inspection

[[Page 69306]]

and copying at www.regulations.gov or upon request. A public hearing 
will be scheduled if requested in writing by a person who timely 
submits written comments. If a public hearing is scheduled, notice of 
the date, time, and place of the hearing will be published in the 
Federal Register.

Drafting Information

    The principal authors of these regulations are Caroline E. Hay and 
Deane M. Burke of the Office of the Associate Chief Counsel 
(Passthroughs & Special Industries), IRS. However, other personnel from 
the Treasury Department and the IRS participated in their development.

Withdrawal of Proposed Regulations

    Accordingly, under the authority of 26 U.S.C. 7805, Sec.  1.752-2 
of the notice of proposed rulemaking (REG-119305-11) that was published 
in the Federal Register on January 30, 2014 (79 FR 4826) is withdrawn.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sections 1.707-2 through 1.707-9 also issued under 26 U.S.C. 
707(a)(2)(B).
0
Par. 2. Section 1.704-1 is amended by:
0
1. Adding two sentences to the end of paragraph (b)(1)(ii)(a).
0
2. Adding a sentence to the end of paragraph (b)(2)(ii)(b)(3) 
introductory text.
0
3. Removing the undesignated paragraph following paragraph 
(b)(2)(ii)(b)(3).
0
4. Adding paragraphs (b)(2)(ii)(b)(4) through (7).
0
5. Revising paragraph (b)(2)(ii)(c).
    The additions and revisions read as follows:


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (1) * * *
    (ii) * * *
    (a) * * * Furthermore, the last sentence of paragraph 
(b)(2)(ii)(b)(3) of this section and paragraphs (b)(2)(ii)(b)(4) 
through (7) and (b)(2)(ii)(c) of this section apply on or after the 
date these regulations are published as final regulations in the 
Federal Register. However, taxpayers may rely on the last sentence of 
paragraph (b)(2)(ii)(b)(3) of this section and paragraphs 
(b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section on or 
after October 5, 2016 and before the date these regulations are 
published as final regulations in the Federal Register.
* * * * *
    (2) * * *
    (ii) * * *
    (b) * * *
    (3) * * * Notwithstanding the partnership agreement, an obligation 
to restore a deficit balance in a partner's capital account, including 
an obligation described in paragraph (b)(2)(ii)(c)(1) of this section, 
will not be respected for purposes of this section to the extent the 
obligation is disregarded under paragraph (b)(2)(ii)(c)(4) of this 
section.
    (4) For purposes of paragraphs (b)(2)(ii)(b)(1) through (3) of this 
section, a partnership taxable year shall be determined without regard 
to section 706(c)(2)(A).
    (5) The requirements in paragraphs (b)(2)(ii)(b)(2) and (3) of this 
section are not violated if all or part of the partnership interest of 
one or more partners is purchased (other than in connection with the 
liquidation of the partnership) by the partnership or by one or more 
partners (or one or more persons related, within the meaning of section 
267(b) (without modification by section 267(e)(1)) or section 
707(b)(1), to a partner) pursuant to an agreement negotiated at arm's 
length by persons who at the time such agreement is entered into have 
materially adverse interests and if a principal purpose of such 
purchase and sale is not to avoid the principles of the second sentence 
of paragraph (b)(2)(ii)(a) of this section.
    (6) The requirement in paragraph (b)(2)(ii)(b)(2) of this section 
is not violated if, upon the liquidation of the partnership, the 
capital accounts of the partners are increased or decreased pursuant to 
paragraph (b)(2)(iv)(f) of this section as of the date of such 
liquidation and the partnership makes liquidating distributions within 
the time set out in the requirement in paragraph (b)(2)(ii)(b)(2) of 
this section in the ratios of the partners' positive capital accounts, 
except that it does not distribute reserves reasonably required to 
provide for liabilities (contingent or otherwise) of the partnership 
and installment obligations owed to the partnership, so long as such 
withheld amounts are distributed as soon as practicable and in the 
ratios of the partners' positive capital account balances.
    (7) See examples (1)(i) and (ii), (4)(i), (8)(i), and (16)(i) of 
paragraph (b)(5) of this section for issues concerning paragraph 
(b)(2)(ii)(b) of this section.
    (c) Obligation to restore deficit--(1) Other arrangements treated 
as obligations to restore deficits. If a partner is not expressly 
obligated to restore the deficit balance in such partner's capital 
account, such partner nevertheless will be treated as obligated to 
restore the deficit balance in his capital account (in accordance with 
the requirement in paragraph (b)(2)(ii)(b)(3) of this section and 
subject to paragraph (b)(2)(ii)(c)(2) of this section) to the extent 
of--
    (A) The outstanding principal balance of any promissory note (of 
which such partner is the maker) contributed to the partnership by such 
partner (other than a promissory note that is readily tradable on an 
established securities market), and
    (B) The amount of any unconditional obligation of such partner 
(whether imposed by the partnership agreement or by state or local law) 
to make subsequent contributions to the partnership (other than 
pursuant to a promissory note of which such partner is the maker).
    (2) Satisfaction requirement. For purposes of paragraph 
(b)(2)(ii)(c)(1) of this section, a promissory note or unconditional 
obligation is taken into account only if it is required to be satisfied 
at a time no later than the end of the partnership taxable year in 
which such partner's interest is liquidated (or, if later, within 90 
days after the date of such liquidation). If a promissory note referred 
to in paragraph (b)(2)(ii)(c)(1) of this section is negotiable, a 
partner will be considered required to satisfy such note within the 
time period specified in this paragraph (b)(2)(ii)(c)(2) if the 
partnership agreement provides that, in lieu of actual satisfaction, 
the partnership will retain such note and such partner will contribute 
to the partnership the excess, if any, of the outstanding principal 
balance of such note over its fair market value at the time of 
liquidation. See paragraph (b)(2)(iv)(d)(2) of this section. See 
examples (1)(ix) and (x) of paragraph (b)(5) of this section.
    (3) Related party notes. For purposes of paragraph (b)(2) of this 
section, if a partner contributes a promissory note to the partnership 
during a partnership taxable year beginning after December 29, 1988, 
and the maker of such note is a person related to such partner (within 
the meaning of Sec.  1.752-4(b)(1)), then such promissory note shall be 
treated as

[[Page 69307]]

a promissory note of which such partner is the maker.
    (4) Obligations disregarded--(A) General rule. A partner in no 
event will be considered obligated to restore the deficit balance in 
his capital account to the partnership (in accordance with the 
requirement in paragraph (b)(2)(ii)(b)(3) of this section) to the 
extent such partner's obligation is a bottom dollar payment obligation 
that is not recognized under Sec.  1.752-2(b)(3) or is not legally 
enforceable, or the facts and circumstances otherwise indicate a plan 
to circumvent or avoid such obligation. See paragraphs (b)(2)(ii)(f), 
(b)(2)(ii)(h), and (b)(4)(vi) of this section for other rules regarding 
such obligation. To the extent a partner is not considered obligated to 
restore the deficit balance in the partner's capital account to the 
partnership (in accordance with the requirement in paragraph 
(b)(2)(ii)(b)(3) of this section), the obligation is disregarded and 
paragraph (b)(2) of this section and Sec.  1.752-2 are applied as if 
the obligation did not exist.
    (B) Factors indicating plan to circumvent or avoid obligation. In 
the case of an obligation to restore a deficit balance in a partner's 
capital account upon liquidation of a partnership, paragraphs 
(b)(2)(ii)(c)(4)(B)(i) through (iv) of this section provide a non-
exclusive list of factors that may indicate a plan to circumvent or 
avoid the obligation. For purposes of making determinations under this 
paragraph (b)(2)(ii)(c)(4), the weight to be given to any particular 
factor depends on the particular case and the presence or absence of 
any particular factor is not, in itself, necessarily indicative of 
whether or not the obligation is respected. The following factors are 
taken into consideration for purposes of this paragraph (b)(2):
    (i) The partner is not subject to commercially reasonable 
provisions for enforcement and collection of the obligation.
    (ii) The partner is not required to provide (either at the time the 
obligation is made or periodically) commercially reasonable 
documentation regarding the partner's financial condition to the 
partnership.
    (iii) The obligation ends or could, by its terms, be terminated 
before the liquidation of the partner's interest in the partnership or 
when the partner's capital account as provided in Sec.  1.704-
1(b)(2)(iv) is negative.
    (iv) The terms of the obligation are not provided to all the 
partners in the partnership in a timely manner.
* * * * *
0
Par. 3. Section 1.707-0 is amended by revising the entries for Sec.  
1.707-5(a)(2)(i) and (ii) to read as follows:


Sec.  1.707-0  Table of contents.

* * * * *


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

    (a) * * *
    (2) * * *
    (i) In general.
    (ii) Partner's share of Sec.  1.752-7 liability.
* * * * *
* * * * *
0
Par. 4. Section 1.707-5 is amended by revising paragraph (a)(2) and 
Examples 2, 3, 7, and 8 of paragraph (f) to read as follows:


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

    (a) * * *
    (2) [The text of proposed Sec.  1.707-5(a)(2) is the same as the 
text of Sec.  1.707-5T(a)(2) published elsewhere in this issue of the 
Federal Register].
* * * * *
    (f) * * *

    Example 2. [The text of proposed Sec.  1.707-5(f) Example 2 is 
the same as the text of Sec.  1.707-5T(f) Example 2 published 
elsewhere in this issue of the Federal Register].
    Example 3. [The text of proposed Sec.  1.707-5(f) Example 3 is 
the same as the text of Sec.  1.707-5T(f) Example 3 published 
elsewhere in this issue of the Federal Register].
* * * * *
    Example 7. [The text of proposed Sec.  1.707-5(f) Example 7 is 
the same as the text of Sec.  1.707-5T(f) Example 7 published 
elsewhere in this issue of the Federal Register].
    Example 8. [The text of proposed Sec.  1.707-5(f) Example 8 is 
the same as the text of Sec.  1.707-5T(f) Example 8 published 
elsewhere in this issue of the Federal Register].
* * * * *
0
Par. 5. Section 1.707-9 is amended by adding paragraph (a)(5) to read 
as follows:


Sec.  1.707-9  Effective dates and transitional rules.

    (a) * * *
    (5) [The text of proposed Sec.  1.707-9(a)(5) is the same as the 
text of Sec.  1.707-9T(a)(5) published elsewhere in this issue of the 
Federal Register].
* * * * *
0
Par. 6. Section 1.752-0 is amended by:
0
1. Adding entries for Sec.  1.752-2(b)(3)(i) and (ii), (b)(3)(ii)(A) 
and (B), (b)(3)(ii)(C), (b)(3)(ii)(C)(1) through (3), (b)(3)(ii)(D), 
and (b)(3)(iii).
0
2. Adding entries for Sec.  1.752-2(j)(2)(i) and (ii).
0
3. Adding entries for Sec.  1.752-2(j)(3)(i) through (iii).
0
4. Revising the entries for Sec.  1.752-2(j)(3) and (4).
0
5. Adding an entry for Sec.  1.752-2(k).
    The revisions and additions read as follows:


Sec.  1.752-0  Table of contents.

* * * * *


Sec.  1.752-2  Partner's share of recourse liabilities.

* * * * *
    (b) * * *
    (3) * * *
    (i) In general.
    (ii) Special rules for bottom dollar payment obligations.
    (A) In general.
    (B) Exception.
    (C) Definition of bottom dollar payment obligation.
    (1) In general.
    (2) Exceptions.
    (3) Benefited party defined.
    (D) Disclosure of bottom dollar payment obligations.
    (iii) Special rule for indemnities and reimbursement agreements.
* * * * *
    (j) * * *
    (2) * * *
    (i) In general.
    (ii) Economic risk of loss.
    (3) Plan to circumvent or avoid an obligation.
    (i) General rule.
    (ii) Factors indicating plan to circumvent or avoid an obligation.
    (iii) Deemed plan to circumvent or avoid an obligation.
    (4) Examples.
    (k) Effective/applicability dates.
* * * * *
0
Par. 7. Section 1.752-2 is amended by:
0
1. Revising the last sentence of paragraph (a).
0
2. Revising paragraph (b)(3) and the last sentence of paragraph (b)(6).
0
3. Adding a sentence to the end of paragraph (f) introductory text and 
adding Examples 10 and 11 to paragraph (f).
0
4. Revising paragraphs (j)(2) and (3).
0
5. Adding paragraph (j)(4).
0
6. Removing paragraph (k).
0
7. Redesignating paragraph (l) as paragraph (k) and revising it.
    The revisions and additions read as follows:


Sec.  1.752-2  Partner's share of recourse liabilities.

    (a) * * * The determination of the extent to which a partner bears 
the economic risk of loss for a partnership liability is made under the 
rules in paragraphs (b) through (j) of this section.

[[Page 69308]]

    (b) * * *
    (3) [The text of proposed Sec.  1.752-2(b)(3) is the same as the 
text of Sec.  1.752-2T(b)(3) published elsewhere in this issue of the 
Federal Register].
* * * * *
    (6) * * * See paragraph (j) of this section.
* * * * *
    (f) Examples. * * * Unless otherwise provided, for purposes of the 
following examples, assume that any obligation of a partner or related 
person to make a payment is recognized under paragraph (b)(3) of this 
section.
* * * * *
    Example 10. [The text of proposed Sec.  1.752-2(f) Example 10 is 
the same as the text of Sec.  1.752-2T(f) Example 10 published 
elsewhere in this issue of the Federal Register].
    Example 11. [The text of proposed Sec.  1.752-2(f) Example 11 is 
the same as the text of Sec.  1.752-2T(f) Example 11 published 
elsewhere in this issue of the Federal Register].
* * * * *
    (j) * * *
    (2) [The text of proposed Sec.  1.752-2(j)(2) is the same as the 
text of Sec.  1.752-2T(j)(2) published elsewhere in this issue of the 
Federal Register].
    (3) Plan to circumvent or avoid an obligation--(i) General rule. An 
obligation of a partner or related person to make a payment is not 
recognized under paragraph (b) of this section if the facts and 
circumstances evidence a plan to circumvent or avoid the obligation.
    (ii) Factors indicating plan to circumvent or avoid an obligation. 
In the case of a payment obligation, other than an obligation to 
restore a deficit capital account upon liquidation of a partnership, 
paragraphs (j)(3)(ii)(A) through (G) of this section provide a non-
exclusive list of factors that may indicate a plan to circumvent or 
avoid the payment obligation. The presence or absence of a factor is 
based on all of the facts and circumstances at the time the partner or 
related person makes the payment obligation or if the obligation is 
modified, at the time of the modification. For purposes of making 
determinations under this paragraph (j)(3), the weight to be given to 
any particular factor depends on the particular case and the presence 
or absence of a factor is not necessarily indicative of whether a 
payment obligation is or is not recognized under paragraph (b) of this 
section.
    (A) The partner or related person is not subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, including, for example, restrictions on transfers for 
inadequate consideration or distributions by the partner or related 
person to equity owners in the partner or related person.
    (B) The partner or related person is not required to provide 
(either at the time the payment obligation is made or periodically) 
commercially reasonable documentation regarding the partner's or 
related person's financial condition to the benefited party.
    (C) The term of the payment obligation ends prior to the term of 
the partnership liability, or the partner or related person has a right 
to terminate its payment obligation, if the purpose of limiting the 
duration of the payment obligation is to terminate such payment 
obligation prior to the occurrence of an event or events that increase 
the risk of economic loss to the guarantor or benefited party (for 
example, termination prior to the due date of a balloon payment or a 
right to terminate that can be exercised because the value of loan 
collateral decreases). This factor typically will not be present if the 
termination of the obligation occurs by reason of an event or events 
that decrease the risk of economic loss to the guarantor or benefited 
party (for example, the payment obligation terminates upon the 
completion of a building construction project, upon the leasing of a 
building, or when certain income and asset coverage ratios are 
satisfied for a specified number of quarters).
    (D) There exists a plan or arrangement in which the primary obligor 
or any other obligor (or a person related to the obligor) with respect 
to the partnership liability directly or indirectly holds money or 
other liquid assets in an amount that exceeds the reasonable 
foreseeable needs of such obligor.
    (E) The payment obligation does not permit the creditor to promptly 
pursue payment following a payment default on the partnership 
liability, or other arrangements with respect to the partnership 
liability or payment obligation otherwise indicate a plan to delay 
collection.
    (F) In the case of a guarantee or similar arrangement, the terms of 
the partnership liability would be substantially the same had the 
partner or related person not agreed to provide the guarantee.
    (G) The creditor or other party benefiting from the obligation did 
not receive executed documents with respect to the payment obligation 
from the partner or related person before, or within a commercially 
reasonable period of time after, the creation of the obligation.
    (iii) Deemed plan to circumvent or avoid an obligation. Evidence of 
a plan to circumvent or avoid an obligation is deemed to exist if the 
facts and circumstances indicate that there is not a reasonable 
expectation that the payment obligor will have the ability to make the 
required payments if the payment obligation becomes due and payable. 
For purposes of this section, a payment obligor includes an entity 
disregarded as an entity separate from its owner under section 856(i), 
section 1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-3 of this 
chapter (a disregarded entity), and a trust to which subpart E of part 
I of subchapter J of chapter 1 of the Code applies.
    (4) Examples. The following examples illustrate the principles of 
paragraph (j) of this section.

    Example 1. Gratuitous guarantee. (i) In 2016, A, B, and C form a 
domestic limited liability company (LLC) that is classified as a 
partnership for federal tax purposes. Also in 2016, LLC receives a 
loan from a bank. A, B, and C do not bear the economic risk of loss 
with respect to that partnership liability, and, as a result, the 
liability is treated as nonrecourse under Sec.  1.752-1(a)(2) in 
2016. In 2018, A guarantees the entire amount of the liability. The 
bank did not request the guarantee and the terms of the loan did not 
change as a result of the guarantee. A did not provide any executed 
documents with respect to A's guarantee to the bank. The bank also 
did not require any restrictions on asset transfers by A and no such 
restrictions exist.
    (ii) Under paragraph (j)(3) of this section, A's 2018 guarantee 
(payment obligation) is not recognized under paragraph (b)(3) of 
this section if the facts and circumstances evidence a plan to 
circumvent or avoid the payment obligation. In this case, the 
following factors indicate a plan to circumvent or avoid A's payment 
obligation: (1) The partner is not subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, such as restrictions on transfers for inadequate 
consideration or equity distributions; (2) the partner is not 
required to provide (either at the time the payment obligation is 
made or periodically) commercially reasonable documentation 
regarding the partner's or related person's financial condition to 
the benefited party; (3) in the case of a guarantee or similar 
arrangement, the terms of the liability are the same as they would 
have been without the guarantee; and (4) the creditor did not 
receive executed documents with respect to the payment obligation 
from the partner or related person at the time the obligation was 
created. Absent the existence of other facts or circumstances that 
would weigh in favor of respecting A's guarantee, evidence of a plan 
to circumvent or avoid the obligation exists and, pursuant to 
paragraph (j)(3)(i) of this section, A's guarantee is not recognized 
under paragraph (b) of this section. As a result, LLC's liability 
continues to be treated as nonrecourse.
    Example 2. Underfunded disregarded entity payment obligor. (i) 
In 2016, A forms a wholly owned domestic limited liability

[[Page 69309]]

company, LLC, with a contribution of $100,000. A has no liability 
for LLC's debts, and LLC has no enforceable right to a contribution 
from A. Under Sec.  301.7701-3(b)(1)(ii) of this chapter, LLC is a 
treated for federal tax purposes as a disregarded entity. Also in 
2016, LLC contributes $100,000 to LP, a limited partnership with a 
calendar year taxable year, in exchange for a general partnership 
interest in LP, and B and C each contributes $100,000 to LP in 
exchange for a limited partnership interest in LP. The partnership 
agreement provides that only LLC is required to restore any deficit 
in its capital account. On January 1, 2017, LP borrows $300,000 from 
a bank and uses $600,000 to purchase nondepreciable property. The 
$300,000 is secured by the property and is also a general obligation 
of LP. LP makes payments of only interest on its $300,000 debt 
during 2017. LP has a net taxable loss in 2017, and, under 
Sec. Sec.  1.705-1(a) and 1.752-4(d), LP determines its partners' 
shares of the $300,000 debt at the end of its taxable year, December 
31, 2017. As of that date, LLC holds no assets other than its 
interest in LP.
    (ii) Because LLC is a disregarded entity, A is treated as the 
partner in LP for federal income tax purposes. Only LLC has an 
obligation to make a payment on account of the $300,000 debt if LP 
were to constructively liquidate as described in paragraph (b)(1) of 
this section. Therefore, paragraph (j)(3)(iii) of this section is 
applied to the LLC and not to A. LLC has no assets with which to pay 
if the payment obligation becomes due and payable. As such, evidence 
of a plan to circumvent or avoid the obligation is deemed to exist 
and, pursuant to paragraph (j)(3)(i) of this section, LLC's 
obligation to restore its deficit capital account is not recognized 
under paragraph (b) of this section. As a result, LP's $300,000 debt 
is characterized as nonrecourse under Sec.  1.752-1(a)(2) and is 
allocated among A, B, and C under Sec.  1.752-3.

    (k) Effective/applicability dates. (1) Paragraph (h)(3) of this 
section applies to liabilities incurred or assumed by a partnership on 
or after October 11, 2006, other than liabilities incurred or assumed 
by a partnership pursuant to a written binding contract in effect prior 
to that date. The rules applicable to liabilities incurred or assumed 
(or pursuant to a written binding contract in effect) prior to October 
11, 2006, are contained in Sec.  1.752-2 in effect prior to October 11, 
2006, (see 26 CFR part 1 revised as of April 1, 2006). The last 
sentence of paragraphs (a), (b)(6), and (f) of this section and 
paragraphs (j)(3) and (4) of this section apply to liabilities incurred 
or assumed by a partnership and to payment obligations imposed or 
undertaken with respect to a partnership liability on or after the date 
these regulations are published as final regulations in the Federal 
Register, other than liabilities incurred or assumed by a partnership 
and payment obligations imposed or undertaken pursuant to a written 
binding contract in effect prior to that date. Taxpayers may rely on 
these regulations for the period between October 5, 2016 and the date 
these regulations are published as final regulations in the Federal 
Register.
    (2) [The text of proposed Sec.  1.752-2(k)(2) is the same as the 
text of Sec.  1.752-2T(l)(2) published elsewhere in this issue of the 
Federal Register.]
    (3) [The text of proposed Sec.  1.752-2(k)(3) is the same as the 
text of Sec.  1.752-2T(l)(3) published elsewhere in this issue of the 
Federal Register.]

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-23390 Filed 10-4-16; 8:45 am]
BILLING CODE 4830-01-P



                                                                          Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules                                           69301

                                                     DEPARTMENT OF THE TREASURY                              the Treasury Department and the IRS                   Regulations (26 CFR part 1) under
                                                                                                             are publishing in the Rules and                       sections 704, 707, and 752 of the Code.
                                                     Internal Revenue Service                                Regulations section in this issue of the              On January 30, 2014, the Treasury
                                                                                                             Federal Register: (1) Final regulations               Department and the IRS published a
                                                     26 CFR Part 1                                           under section 707 concerning disguised                notice of proposed rulemaking in the
                                                     [REG–122855–15]                                         sales and under section 752 regarding                 Federal Register (REG–119305–11, 79
                                                                                                             the allocation of excess nonrecourse                  FR 4826) to amend the then existing
                                                     RIN 1545–BM83                                           liabilities and (2) temporary regulations             regulations under section 707 relating to
                                                                                                             concerning a partner’s share of                       disguised sales of property to or by a
                                                     Liabilities Recognized as Recourse                                                                            partnership and under section 752
                                                                                                             partnership liabilities for purposes of
                                                     Partnership Liabilities Under Section                                                                         concerning the treatment of partnership
                                                                                                             section 707 and the treatment of certain
                                                     752                                                                                                           liabilities (the 2014 Proposed
                                                                                                             payment obligations under section 752.
                                                     AGENCY:  Internal Revenue Service (IRS),                                                                      Regulations). The 2014 Proposed
                                                                                                             Paperwork Reduction Act                               Regulations provided certain technical
                                                     Treasury.
                                                     ACTION: Partial withdrawal of notice of                    The collection of information related              rules intended to clarify the application
                                                     proposed rulemaking and notice of                       to these proposed regulations under                   of the disguised sale rules under section
                                                     proposed rulemaking, including by                       section 752 is reported on Form 8275,                 707. The 2014 Proposed Regulations
                                                     cross reference to temporary regulations.               Disclosure Statement, and has been                    also contained rules regarding the
                                                                                                             reviewed in accordance with the                       sharing of partnership recourse and
                                                     SUMMARY:    This document contains                      Paperwork Reduction Act (44 U.S.C.                    nonrecourse liabilities under section
                                                     proposed regulations that incorporate                   3507) and approved by the Office of                   752.
                                                     the text of related temporary regulations               Management and Budget under control                      A public hearing on the 2014
                                                     and withdraws a portion of a notice of                  number 1545–0889. Comments                            Proposed Regulations was not requested
                                                     proposed rulemaking (REG–119305–11)                     concerning the collection of information              or held, but the Treasury Department
                                                     to the extent not adopted by final                      and the accuracy of estimated average                 and the IRS received written comments.
                                                     regulations. This document also                         annual burden and suggestions for                     After consideration of, and in response
                                                     contains new proposed regulations                       reducing this burden should be sent to                to, the comments on the 2014 Proposed
                                                     addressing when certain obligations to                  the Office of Management and Budget,                  Regulations, the Treasury Department
                                                     restore a deficit balance in a partner’s                Attn: Desk Officer for the Department of              and the IRS are withdrawing the 2014
                                                     capital account are disregarded under                   the Treasury, Office of Information and               Proposed Regulations under § 1.752–2
                                                     section 704 of the Internal Revenue                     Regulatory Affairs, Washington, DC                    and publishing new proposed
                                                     Code (Code) and when partnership                        20503, with copies to the Internal                    regulations under § 1.752–2, as well as
                                                     liabilities are treated as recourse                     Revenue Service, IRS Reports Clearance                proposed regulations under section 704.
                                                     liabilities under section 752. These                    Officer, SE:W:CAR:MP:T:T:SP,                          Concurrently in this issue of the Federal
                                                     regulations would affect partnerships                   Washington, DC 20224. Comments on                     Register, the Treasury Department and
                                                     and their partners.                                     the burden associated with this                       the IRS are also publishing final
                                                     DATES: The notice of proposed                           collection of information should be                   regulations that adopt, as modified, the
                                                     rulemaking under sections 707 and 752                   received by December 5, 2016.                         2014 Proposed Regulations under
                                                     that was published in the Federal                          The collection of information in these             section 707 and § 1.752–3, and
                                                     Register on January 30, 2014 (REG–                      proposed regulations is in proposed                   temporary regulations under sections
                                                     119305–11, 79 FR 4826), is partially                    § 1.752–2(b)(3)(ii)(D) (which cross                   707 and 752.
                                                     withdrawn as of October 5, 2016.                        references the requirement in § 1.752–                2. Summary of Applicable Law
                                                     Written or electronic comments and                      2T(b)(3)(ii)(D)). This information is
                                                                                                                                                                      Section 752 separates partnership
                                                     requests for a public hearing must be                   required by the IRS to ensure that
                                                                                                                                                                   liabilities into two categories: recourse
                                                     received by January 3, 2017.                            section 752 of the Code and applicable                liabilities and nonrecourse liabilities.
                                                     ADDRESSES: Send submissions to:                         regulations are properly applied for                  Section 1.752–1(a)(1) provides that a
                                                     CC:PA:LPD:PR (REG–122855–15), Room                      allocations of partnership liabilities.               partnership liability is a recourse
                                                     5203, Internal Revenue Service, P.O.                    The respondents will be partners and                  liability to the extent that any partner or
                                                     Box 7604, Ben Franklin Station,                         partnerships.                                         related person bears the economic risk
                                                     Washington, DC 20044. Submissions                          An agency may not conduct or                       of loss (EROL) for that liability under
                                                     may be hand-delivered Monday through                    sponsor, and a person is not required to              § 1.752–2. Section 1.752–1(a)(2)
                                                     Friday between the hours of 8 a.m. and                  respond to, a collection of information               provides that a partnership liability is a
                                                     4 p.m. to: CC:PA:LPD:PR (REG–122855–                    unless it displays a valid control                    nonrecourse liability to the extent that
                                                     15), Courier’s Desk, Internal Revenue                   number assigned by the Office of                      no partner or related person bears the
                                                     Service, 1111 Constitution Avenue NW.,                  Management and Budget.                                EROL for that liability under § 1.752–2.
                                                     Washington, DC, or sent electronically,                    Books or records relating to a                        A partner generally bears the EROL
                                                     via the Federal eRulemaking Portal site                 collection of information must be                     for a partnership liability if the partner
                                                     at http://www.regulations.gov (indicate                 retained as long as their contents may                or related person has an obligation to
                                                     IRS and REG–122855–15).                                 become material in the administration                 make a payment to any person within
                                                     FOR FURTHER INFORMATION CONTACT:                        of any internal revenue law. Generally,
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                                                                                                                                                                   the meaning of § 1.752–2(b). For
                                                     Concerning the proposed regulations,                    tax returns and tax return information                purposes of determining the extent to
                                                     Caroline E. Hay or Deane M. Burke,                      are confidential, as required by section              which a partner or related person has an
                                                     (202) 317–5279; concerning submissions                  6103.                                                 obligation to make a payment, an
                                                     of comments and requests for a public                   Background                                            obligation to restore a deficit capital
                                                     hearing, Regina L. Johnson, (202) 317–                                                                        account upon liquidation of the
                                                     6901 (not toll-free numbers).                           1. Overview                                           partnership under the section 704(b)
                                                     SUPPLEMENTARY INFORMATION: In                             This document contains proposed                     regulations is taken into account.
                                                     addition to these proposed regulations,                 amendments to the Income Tax                          Further, for this purpose, § 1.752–2(b)(6)


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                                                     69302                Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules

                                                     of the existing regulations presumes that               and the net value requirement as                      expenditures under § 1.707–4(d), which
                                                     partners and related persons who have                   provided in § 1.752–2(k). Accordingly,                is described in greater detail in the
                                                     payment obligations actually perform                    the Treasury Department and the IRS                   preamble to the final regulations.
                                                     those obligations, irrespective of their                are withdrawing § 1.752–2 of the 2014
                                                                                                                                                                   Summary of Comments and
                                                     net worth, unless the facts and                         Proposed Regulations and publishing
                                                                                                             these new proposed regulations that                   Explanation of Provisions
                                                     circumstances indicate a plan to
                                                     circumvent or avoid the obligation (the                 would amend existing regulations under                1. Rights of Reimbursement
                                                     satisfaction presumption). However, the                 sections 704 and 752. These new                          Section 1.752–2(b)(1) provides that,
                                                     satisfaction presumption is subject to an               provisions, and comments received on                  except as otherwise provided in
                                                     anti-abuse rule in § 1.752–2(j) pursuant                the 2014 Proposed Regulations that are                § 1.752–2, a partner bears the EROL for
                                                     to which a payment obligation of a                      pertinent to these new provisions, are
                                                                                                                                                                   a partnership liability to the extent that,
                                                     partner or related person may be                        discussed in the Summary of Comments
                                                                                                                                                                   if the partnership constructively
                                                     disregarded or treated as an obligation                 and Explanation of Provisions section of
                                                                                                                                                                   liquidated, the partner or related person
                                                     of another person if facts and                          the preamble that follows.
                                                                                                                                                                   would be obligated to make a payment
                                                     circumstances indicate that a principal
                                                                                                             4. Final and Temporary Regulations                    to any person (or a contribution to the
                                                     purpose of the arrangement is to
                                                                                                             Under Section 707 and Requests for                    partnership) because that liability
                                                     eliminate the partner’s EROL with
                                                                                                             Comments                                              becomes due and payable and the
                                                     respect to that obligation or create the
                                                                                                                As previously mentioned, the                       partner or related person would not be
                                                     appearance of the partner or related
                                                                                                             Treasury Department and the IRS are                   entitled to reimbursement from another
                                                     person bearing the EROL when the
                                                                                                             concurrently publishing temporary                     partner or a person that is a related
                                                     substance is otherwise. Under the
                                                     existing rules, the satisfaction                        regulations under section 707                         person to another partner. Section
                                                     presumption is also subject to a                        (concerning disguised sales) (the 707                 1.752–2(b)(1) presumes that, in the
                                                     disregarded entity net value                            Temporary Regulations) and section 752                constructive liquidation, the partnership
                                                     requirement under § 1.752–2(k)                          (concerning recourse liabilities, in                  has a value of zero with which to pay
                                                     pursuant to which, for purposes of                      particular bottom dollar payment                      its liabilities. Under the 2014 Proposed
                                                     determining the extent to which a                       obligations) (the 752 Temporary                       Regulations, a partner would not bear
                                                     partner bears the EROL for a partnership                Regulations), and final regulations                   the EROL under § 1.752–2(b)(1) if the
                                                     liability, a payment obligation of a                    under section 707 and § 1.752–3. The                  partner or related person is entitled to
                                                     disregarded entity is taken into account                temporary regulations are incorporated                a reimbursement from ‘‘any person.’’
                                                     only to the extent of the net value of the              by cross reference in these proposed                  Commenters noted that a
                                                     disregarded entity as of the allocation                 regulations. Notably, the 707 Temporary               reimbursement from ‘‘any person’’
                                                     date that is allocated to the partnership               Regulations provide that, for disguised               would include a reimbursement from
                                                     liability.                                              sale purposes, partners determine their               the partnership, which is contrary to the
                                                                                                             share of any partnership liability in the             intent of the regulations under section
                                                     3. 2014 Proposed Regulations                            manner in which excess nonrecourse                    752. A right to be reimbursed by the
                                                        As discussed in greater detail in the                liabilities are allocated under § 1.752–              partnership should be disregarded, as
                                                     Summary of Comments and Explanation                     3(a)(3) (with certain limitations).                   § 1.752–2(b)(1) presumes that the
                                                     of Provisions section of this preamble,                 Generally, a partner’s share of the excess            partnership would not be able to pay the
                                                     § 1.752–2 of the 2014 Proposed                          nonrecourse liability is determined in                liability or reimburse the partner. The
                                                     Regulations generally, among other                      accordance with the partner’s share of                Treasury Department and the IRS agree
                                                     things, (1) provided that a partner’s or                partnership profits taking into account               with the concerns expressed in the
                                                     related person’s obligation to make a                   all the facts and circumstances relating              comments; therefore, these proposed
                                                     payment with respect to a partnership                   to the economic arrangement of the                    regulations do not include the changes
                                                     liability (excluding those imposed by                   partners. The Treasury Department and                 to § 1.752–2(b)(1) that were in the 2014
                                                     state law) would not be recognized for                  the IRS recognize that taxpayers may                  Proposed Regulations.
                                                     purposes of section 752 unless each                     require further guidance regarding
                                                                                                                                                                   2. Arrangements Part of a Plan To
                                                     recognition factor was satisfied; (2)                   reasonable methods for determining a
                                                                                                                                                                   Circumvent or Avoid an Obligation
                                                     applied the list of recognition factors to              partner’s share of partnership profits
                                                     all payment obligations under § 1.752–                  under § 1.752–3(a)(3) for disguised sale                 The 2014 Proposed Regulations
                                                     2(b), including a partner’s obligation to               purposes, especially given that a                     provided that a partner’s or related
                                                     restore a deficit capital account upon                  partner’s share may change from year to               person’s obligation to make a payment
                                                     liquidation of a partnership (deficit                   year or differ with respect to different              with respect to a partnership liability
                                                     restoration obligations, or DROs) as                    partnership assets and believe it may be              (excluding those imposed by state law)
                                                     provided under the section 704(b)                       appropriate to issue administrative                   will not be recognized for purposes of
                                                     regulations; and (3) provided generally                 guidance for this purpose. Accordingly,               section 752 unless: (1) The partner or
                                                     that a payment obligation would be                      comments are requested regarding                      related person is (A) required to
                                                     recognized to the extent of the net value               possible safe harbors and reasonable                  maintain a commercially reasonable net
                                                     of a partner or related person as of the                methods for determining a partner’s                   worth throughout the term of the
                                                     allocation date.                                        share of profits, taking into account all             payment obligation or (B) subject to
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                                                        After consideration of the comments                  of the relevant facts and circumstances               commercially reasonable contractual
                                                     received on the 2014 Proposed                           relating to the economic arrangement of               restrictions on transfers of assets for
                                                     Regulations, the Treasury Department                    the partners. The preamble to the                     inadequate consideration; (2) the
                                                     and the IRS are reconsidering the rules                 temporary regulations describes the                   partner or related person is required
                                                     under section 752 regarding payment                     provisions in greater detail. In addition,            periodically to provide commercially
                                                     obligations that are recognized under                   the final regulations under section 707               reasonable documentation regarding the
                                                     § 1.752–2(b)(3), the satisfaction                       also include a request for comments                   partner’s or related person’s financial
                                                     presumption under § 1.752–2(b)(6), the                  concerning the exception for                          condition; (3) the term of the payment
                                                     anti-abuse rule provided in § 1.752–2(j),               reimbursements of preformation capital                obligation does not end prior to the term


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                                                                          Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules                                           69303

                                                     of the partnership liability; (4) the                   believed that this concern is alleviated              documentation are ‘‘commercially
                                                     payment obligation does not require that                by the anti-abuse rule in the current                 reasonable’’ with respect to a particular
                                                     the primary obligor or any other obligor                regulations under § 1.752–2(j). This                  industry, and the flexible nature of the
                                                     with respect to the partnership liability               commenter suggested that the anti-abuse               term is helpful in informing
                                                     directly or indirectly hold money or                    rule in § 1.752–2(j) contain additional               partnerships and their partners that
                                                     other liquid assets in an amount that                   examples to illustrate abusive or                     obligations should be consistent with
                                                     exceeds the reasonable needs of such                    problematic situations. Another                       what is customary in the marketplace.
                                                     obligor; (5) the partner or related person              commenter noted that the 2014                         With respect to the second recognition
                                                     received arm’s length consideration for                 Proposed Regulations did not address                  factor regarding documentation, these
                                                     assuming the payment obligation; and                    the consequences if a partner or related              proposed regulations also clarify that
                                                     (6) the obligation is not a bottom dollar               person breaches its payment obligation                the factor examines whether
                                                     guarantee or indemnity (recognition                     under an agreement regarding net worth                commercially reasonable documentation
                                                     factors).                                               or restrictions on transfers and                      was provided to the party that benefits
                                                        Commenters expressed concerns with                   suggested that the regulations address                from the payment obligation (for
                                                     the all-or-nothing approach in the 2014                 such consequences in an anti-abuse rule               example, the creditor in the case of a
                                                     Proposed Regulations. One commenter                     (for example, a partner’s or related                  guarantee or the indemnified party in
                                                     noted that a partner could cause an                     person’s payment obligation may be                    the case of an indemnification
                                                     obligation to deliberately fail one of the              disregarded if it is determined that the              arrangement).
                                                     recognition factors so as to cause a                    creditor lacked the intent to enforce its                Commenters also noted that certain
                                                     liability to be treated as nonrecourse if               rights under the agreement).                          recognition factors do not take into
                                                     such characterization potentially would                    With respect to the first two                      account industry specific practices. One
                                                     be beneficial to such partner, even if                  recognition factors, commenters                       commenter pointed out that the
                                                     that partner did, in fact, bear the EROL.               expressed concerns with the use of the                requirement that a payment obligation
                                                     This commenter also noted that                          terms ‘‘commercially reasonable’’ and                 last throughout the full term of the
                                                     commercial arrangements rarely satisfy                  ‘‘commercially reasonable                             partnership’s loan is contrary to
                                                     each and every one of the recognition                   documentation.’’ One commenter                        commercial practice in some cases. In
                                                     factors and commercial practices tend to                believed that these terms are vague and               particular, the commenter noted that, in
                                                     change over time, thereby rendering the                 subjective and would require                          the real estate industry context, it is
                                                     recognition factors out of date. This                   partnerships to make difficult                        common for a construction loan to be
                                                     commenter recommended that                              judgments as to whether these                         guaranteed until the property reaches a
                                                     regulations instead provide a                           recognition factors have been met prior               required level of stabilization. This
                                                     nonexclusive list of facts and                          to allocating any partnership liability.              commenter did believe, however, that a
                                                     circumstances containing as factors                     Another commenter noted that the                      payment obligation should be
                                                     many of the items identified in the 2014                ‘‘commercially reasonable                             disregarded if the guarantor or other
                                                     Proposed Regulations.                                   documentation’’ recognition factor did                obligor has an unrestricted unilateral
                                                        The Treasury Department and the IRS                  not specify who should receive the                    right to terminate the obligation at will,
                                                     believe that the concerns expressed by                  documentation and that such                           including immediately before the
                                                     the commenters are valid and thus                       documentation should be provided to                   obligation becomes due and payable.
                                                     propose to move the list of factors to an               the lender.                                           Commenters also noted that the
                                                     anti-abuse rule in § 1.752–2(j), other                     Moving the list of factors to an anti-             recognition factor that would require
                                                     than the recognition factors concerning                 abuse rule should alleviate some of the               arm’s length consideration is not
                                                     bottom dollar guarantees and                            concerns expressed regarding both                     commercial, as a partner is often willing
                                                     indemnities, which are addressed in the                 whether a payment obligor has the                     to enter into a guarantee or other
                                                     752 Temporary Regulations. Under the                    wherewithal to pay and the use of the                 payment obligation with respect to a
                                                     anti-abuse rule, factors are weighed to                 term ‘‘commercially reasonable.’’ The                 partnership liability because the partner
                                                     determine whether a payment obligation                  proposed regulations also revise the first            will benefit from the liability in the
                                                     should be respected. The list of factors                two factors to provide clarity by limiting            obligor’s capacity as a partner. The
                                                     in the anti-abuse rule in these proposed                the first factor to examine solely                    Treasury Department and the IRS agree
                                                     regulations is nonexclusive, and the                    whether the partner or related person is              with these recommendations; thus,
                                                     weight to be given to any particular                    subject to commercially reasonable                    these proposed regulations take into
                                                     factor depends on the particular case.                  contractual restrictions that protect the             account industry practice with respect
                                                     Furthermore, the presence or absence of                 likelihood of payment, such as                        to terminations of payment obligations
                                                     any particular factor, in itself, is not                restrictions on transfers for inadequate              and do not include the arm’s length
                                                     necessarily indicative of whether or not                consideration or equity distributions. In             consideration factor.
                                                     a payment obligation is recognized                      addition, the proposed regulations do                    A commenter also expressed concerns
                                                     under § 1.752–2(b).                                     not retain the subjective commercially                regarding the recognition factor that
                                                        In addition to comments addressing                   reasonable net worth factor, but instead              examines whether a primary obligor or
                                                     the recognition factor approach in the                  include a new factor that examines                    any other obligor with respect to the
                                                     2014 Proposed Regulations, the                          whether the payment obligation restricts              partnership liability is required to hold
                                                     Treasury Department and the IRS                         the creditor from promptly pursuing                   assets in an amount that exceeds the
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                                                     received specific comments regarding                    payment following a default on the                    reasonable needs of the obligor. The
                                                     the individual recognition factors. With                partnership liability or whether there                commenter noted that partnership
                                                     respect to the first recognition factor                 are other arrangements that indicate a                agreements often include restrictions on
                                                     regarding commercially reasonable net                   plan to delay collection.                             distributions before certain hurdles are
                                                     worth or restrictions on transfers, one                    The proposed regulations retain the                satisfied for a variety of reasons, such as
                                                     commenter agreed that an obligor                        use of the ‘‘commercially reasonable’’                to protect the interests of preferred
                                                     should have the wherewithal to make a                   standard, however, because different                  partners or for prudent business
                                                     payment to the extent required for the                  facts may require a different standard of             management. Another commenter
                                                     entire duration of its obligation, but                  whether contractual restrictions and                  agreed with the legal theory


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                                                     69304                Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules

                                                     underpinning the recognition factor (to                 and based on the comments on the 2014                 4. Exculpatory Liabilities
                                                     address fact patterns in which the                      Proposed Regulations, the proposed                       One commenter suggested that the
                                                     taxpayer intended and acted to ensure                   regulations refine the list of factors                2014 Proposed Regulations would result
                                                     the partnership maintained sufficient                   applicable to DROs and clarify the                    in more liabilities being characterized as
                                                     collateral to repay the creditor without                interaction of section 752 with section               nonrecourse liabilities, in particular, so-
                                                     exposing the obligor to meaningful                      704 regarding DROs. Under § 1.704–                    called, ‘‘exculpatory liabilities,’’ and
                                                     liability) but suggested that                           1(b)(2)(ii)(c)(2) of the existing                     urged the Treasury Department and the
                                                     commercially required or prudent                        regulations, a partner’s DRO is not                   IRS to provide guidance with respect to
                                                     reserves not be considered. Both                        respected if the facts and circumstances              such liabilities. An exculpatory liability
                                                     commenters suggested that an example                    indicate a plan to circumvent or avoid                is a liability that is recourse to an entity
                                                     illustrating the restrictions that violate              the partner’s DRO. These proposed                     under state law and section 1001, but no
                                                     this factor would be helpful.                           regulations add a list of factors to                  partner bears the EROL within the
                                                        The commenters’ concerns should be                   § 1.704–1(b)(2)(ii)(c) that are similar to            meaning of section 752. Thus, the
                                                     largely addressed by making this
                                                                                                             the factors in the proposed anti-abuse                liability is treated as nonrecourse for
                                                     recognition factor one of many
                                                                                                             rule under § 1.752–2(j), but specific to              section 752 purposes. The Treasury
                                                     examined under the anti-abuse rule that
                                                                                                             DROs, to indicate when a plan to                      Department and the IRS are studying the
                                                     looks to whether there is a plan to
                                                     circumvent or avoid the obligation.                     circumvent or avoid an obligation                     treatment of exculpatory liabilities
                                                     Under the anti-abuse rule, an obligor’s                 exists. Under the proposed regulations,               under sections 704 and 752 and agree
                                                     retention of assets for its reasonable                  the following factors indicate a plan to              that guidance is warranted in this area.
                                                     foreseeable needs (such as for                          circumvent or avoid an obligation: (1)                However, the treatment of exculpatory
                                                     commercial or prudent business                          The partner is not subject to                         liabilities is beyond the scope of these
                                                     reasons) generally would not, on its                    commercially reasonable provisions for                proposed regulations. The Treasury
                                                     own, indicate that there is a plan to                   enforcement and collection of the                     Department and the IRS seek additional
                                                     circumvent or avoid the obligation.                     obligation; (2) the partner is not                    comments regarding the proper
                                                        Finally, the proposed regulations                    required to provide (either at the time               treatment of an exculpatory liability
                                                     provide two additional factors that                     the obligation is made or periodically)               under regulations under section 704(b)
                                                     indicate when a plan to circumvent or                   commercially reasonable documentation                 and the effect of such a liability’s
                                                     avoid an obligation exists. The first                   regarding the partner’s financial                     classification under section 1001.
                                                     provides that, in the case of a guarantee               condition to the partnership; (3) the                 Further, the Treasury Department and
                                                     or similar arrangement, the terms of the                obligation ends or could, by its terms, be            the IRS request additional comments
                                                     liability would be substantially the same               terminated before the liquidation of the              addressing the allocation of an
                                                     had the partner or related person not                   partner’s interest in the partnership or              exculpatory liability among multiple
                                                     agreed to provide the guarantee. This                   when the partner’s capital account as                 assets and possible methods for
                                                     factor indicates that the guarantee was                 provided in § 1.704–1(b)(2)(iv) is                    calculating minimum gain with respect
                                                     not required by the lender, presumably                  negative; and (4) the terms of the                    to such liability, such as the so-called
                                                     because the partnership had sufficient                  obligation are not provided to all the                ‘‘floating lien’’ approach (whereby all
                                                     assets to satisfy its obligation. The                   partners in the partnership in a timely               the assets in the entity, including cash,
                                                     second additional factor examines                       manner.                                               are considered to be subject to the
                                                     whether the creditor or other party                                                                           exculpatory liability) or a specific
                                                                                                                Notwithstanding the proposed factors,              allocation approach.
                                                     benefiting from the obligation received                 the Treasury Department and the IRS
                                                     executed documents with respect to the                  have concerns with whether and to                     5. Net Value
                                                     payment obligation from the partner or
                                                                                                             what extent it is appropriate to                         Section 1.752–2(b)(6) of the existing
                                                     related person before, or within a
                                                                                                             recognize DROs (and certain partner                   regulations provides that, for purposes
                                                     commercially reasonable time after, the
                                                                                                             notes treated as DROs) as meaningful                  of determining the extent to which a
                                                     creation of the obligation.
                                                                                                             payment obligations. Many DROs are                    partner or related person has a payment
                                                     3. Deficit Restoration Obligations                      triggered only on the liquidation of a                obligation and the EROL, it is assumed
                                                        The 2014 Proposed Regulations                        partnership. However, some                            that all partners and related persons
                                                     applied the list of recognition factors                 partnerships are intended to have                     who have obligations to make payments
                                                     discussed in Section 2 of this Summary                  perpetual life and other partnerships                 actually perform those obligations,
                                                     of Comments and Explanation of                          can effectively cease operations but not              irrespective of their actual net worth,
                                                     Provisions to all payment obligations                   actually liquidate; therefore, a partner’s            unless the facts and circumstances
                                                     under § 1.752–2(b), including a DRO, as                 DRO may never be required to be                       indicate a plan to circumvent or avoid
                                                     provided under the section 704(b)                       satisfied. In addition, some DROs can be              the obligation. See § 1.752–2(b)(6), cross
                                                     regulations. Commenters explained that                  terminated or significantly reduced in a              referencing § 1.752–2(j) and (k). Under
                                                     not all of the recognition factors could                manner that may not be appropriate,                   the anti-abuse rule in § 1.752–2(j), a
                                                     be satisfied with respect to a DRO. In                  and therefore, the DRO similarly may                  payment obligation is disregarded if
                                                     addition, commenters suggested that the                 never be triggered. The Treasury                      there is a plan to circumvent or avoid
                                                     regulations under section 704(b) be                     Department and the IRS request                        such obligation. Section 1.752–2(k)(1)
                                                                                                             comments on the extent to which such
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                                                     amended to clarify that if a DRO is not                                                                       provides that, when determining the
                                                     given effect under section 752, it should               DROs should be recognized. In addition,               extent to which a partner bears the
                                                     not be given effect under section 704(b).               certain partner notes are treated as                  EROL for a partnership liability, a
                                                        A DRO is an obligation to the                        DROs under § 1.704–1(b)(2)(ii)(c)(1) and              payment obligation of a business entity
                                                     partnership that is imposed by the                      (3) of these proposed regulations. The                that is disregarded as an entity separate
                                                     partnership agreement. In contrast, a                   Treasury Department and the IRS also                  from its owner under section 856(i),
                                                     guarantee or indemnity is a contractual                 request comments concerning whether                   section 1361(b)(3), or §§ 301.7701–1
                                                     obligation outside the partnership                      these obligations should continue to be               through 301.7701–3 of the Procedure
                                                     agreement. As a result of this difference               treated as DROs.                                      and Administration Regulations (a


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                                                                          Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules                                          69305

                                                     disregarded entity) is taken into account               obligation to the extent that such                       Some commenters were concerned
                                                     only to the extent of the net value of the              partner or related person would be able               that the 2014 Proposed Regulations
                                                     disregarded entity as of the allocation                 to pay on the obligation. After                       ‘‘delinked’’ the regulations under
                                                     date that is allocated to the partnership               consideration of the comments,                        sections 704 and 752 concerning DROs,
                                                     liability. Section 1.752–2(k)(2)(i)                     however, the Treasury Department and                  that is, that a DRO may somehow still
                                                     provides, in part, that net value is the                the IRS agree that expanding the                      be recognized under section 704 despite
                                                     fair market value of all assets owned by                application of the net value rules under              not meeting the requirements to be
                                                     the disregarded entity that may be                      § 1.752–2(k) may lead to more litigation              recognized as a payment obligation
                                                     subject to creditors’ claims under local                and may unduly burden taxpayers.                      under section 752. DROs are subject to
                                                     law less all obligations of the                         Furthermore, net value as provided in                 the bottom dollar payment obligation
                                                     disregarded entity that do not constitute               § 1.752–2(k) may not accurately take                  rules in the 752 Temporary Regulations,
                                                     § 1.752–2(b)(1) payment obligations of                  into account the future earnings of a                 but the rules in these proposed
                                                     the disregarded entity.                                 business entity, which normally factor                regulations concerning DROs will not be
                                                        The 2014 Proposed Regulations                        into lending decisions. Therefore, the                effective prior to the date they are
                                                     provided that, in determining the extent                Treasury Department and the IRS                       published as final regulations in the
                                                     to which a partner or related person                    propose to remove § 1.752–2(k) and                    Federal Register. However, these
                                                     other than an individual or a decedent’s                instead create a new presumption under                proposed regulations allow partnerships
                                                     estate bears the EROL for a partnership                 the anti-abuse rule in § 1.752–2(j).                  and their partners to rely on the
                                                     liability other than a trade payable, a                 Under the presumption in the proposed                 proposed regulations, which should
                                                     payment obligation is recognized only                   regulations, evidence of a plan to                    address this concern.
                                                     to the extent of the net value of the                   circumvent or avoid an obligation is
                                                     partner or related person that, as of the                                                                     Special Analyses
                                                                                                             deemed to exist if the facts and
                                                     allocation date, is allocated to the                    circumstances indicate that there is not                 Certain IRS regulations, including this
                                                     liability, as determined under § 1.752–                 a reasonable expectation that the                     one, are exempt from the requirements
                                                     2(k). The 2014 Proposed Regulations                     payment obligor will have the ability to              of Executive Order 12866, as
                                                     also provided that the partner must                     make the required payments if the                     supplemented and reaffirmed by
                                                     provide a statement concerning the net                  payment obligation becomes due and                    Executive Order 13563. Therefore, a
                                                     value of the payment obligor to the                     payable. A payment obligor includes                   regulatory impact assessment is not
                                                     partnership. The preamble to the 2014                   disregarded entities (including grantor               required. It also has been determined
                                                     Proposed Regulations requested                          trusts). These proposed regulations also              that section 553(b) of the Administrative
                                                     comments concerning whether the net                     add an example to illustrate the                      Procedure Act (5 U.S.C. chapter 5) does
                                                     value rule should also apply to                         application of the anti-abuse rule when               not apply to these regulations. It is
                                                     individuals and estates and whether the                 the payment obligor is an underfunded                 hereby certified that the collection of
                                                     regulations should consolidate these                    entity. Under these proposed                          information in these regulations will not
                                                     rules under § 1.752–2(k).                               regulations, § 1.752–2(b)(6) continues to             have a significant economic impact on
                                                        Commenters expressed concerns that                   presume that payment obligations with                 a substantial number of small entities.
                                                     an expansion of the net value rule                      respect to a partnership liability will be            This certification is based on the fact
                                                     would add considerable burden and                       satisfied unless evidence of a plan to                that the amount of time necessary to
                                                     expense to taxpayers and would likely                   circumvent or avoid the obligation                    report the required information will be
                                                     lead to time consuming and costly                       exists as determined under § 1.752–2(j).              minimal in that it requires partnerships
                                                     disputes regarding valuations. Another                  If evidence of a plan to circumvent or                (including partnerships that may be
                                                     commenter explained that taxpayers                      avoid the obligation exists or is deemed              small entities) to provide information
                                                     have often avoided the net value                        to exist, the obligation is not recognized            they already maintain or can easily
                                                     regulations (by not using disregarded                   under § 1.752–2(b) and therefore the                  obtain to the IRS. Moreover, it should
                                                     entities) or have applied the regulations               partnership liability is treated as a                 take a partnership no more than 2 hours
                                                     only when the disregarded entity has                    nonrecourse liability under § 1.752–                  to satisfy the information requirement in
                                                     minimal or no assets.                                   1(a)(2).                                              these regulations. Accordingly, a
                                                        Commenters suggested that if the net                                                                       Regulatory Flexibility Analysis under
                                                     value rule is retained, § 1.752–2(k)                    Proposed Applicability Dates                          the Regulatory Flexibility Act (5 U.S.C.
                                                     should be extended to all partners and                     The amendments to § 1.704–1 are                    chapter 6) does not apply. Pursuant to
                                                     related persons other than individuals.                 proposed to apply on or after the date                section 7805(f) of the Code, this notice
                                                     One commenter expressed concerns that                   these regulations are published as final              of proposed rulemaking has been
                                                     a partner who may be treated as bearing                 regulations in the Federal Register. The              submitted to the Chief Counsel for
                                                     the EROL with respect to a partnership                  amendments to § 1.752–2 are proposed                  Advocacy of the Small Business
                                                     liability would have to provide                         to apply to liabilities incurred or                   Administration for comment on its
                                                     information regarding the net value of                  assumed by a partnership and to                       impact on small business.
                                                     the payment obligor, which is                           payment obligations imposed or
                                                     unnecessarily intrusive. Another                        undertaken with respect to a                          Comments and Requests for a Public
                                                     commenter believed that if the rules                    partnership liability on or after the date            Hearing
                                                     requiring net value were extended to all                these regulations are published as final                Before these proposed regulations are
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                                                     partners in partnerships, the attempt to                regulations in the Federal Register.                  adopted as final regulations,
                                                     achieve more realistic substance would                  Partnerships and their partners may rely              consideration will be given to any
                                                     be accompanied by a corresponding                       on these proposed regulations prior to                written comments (a signed original and
                                                     increase in the potential for                           the date they are published as final                  eight (8) copies) or electronic comments
                                                     manipulation.                                           regulations in the Federal Register.                  that are submitted timely to the IRS. The
                                                        The Treasury Department and the IRS                  However, the rules in § 1.752–2(k) still              Treasury Department and the IRS
                                                     remain concerned with ensuring that a                   apply to disregarded entities until the               request comments on all aspects of the
                                                     partner or related person only be                       proposed regulations are published as                 proposed regulations. All comments
                                                     presumed to satisfy its payment                         final regulations in the Federal Register.            will be available for public inspection


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                                                     69306                Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules

                                                     and copying at www.regulations.gov or                   (b)(2)(ii)(c) of this section apply on or             partners’ positive capital account
                                                     upon request. A public hearing will be                  after the date these regulations are                  balances.
                                                     scheduled if requested in writing by a                  published as final regulations in the                    (7) See examples (1)(i) and (ii), (4)(i),
                                                     person who timely submits written                       Federal Register. However, taxpayers                  (8)(i), and (16)(i) of paragraph (b)(5) of
                                                     comments. If a public hearing is                        may rely on the last sentence of                      this section for issues concerning
                                                     scheduled, notice of the date, time, and                paragraph (b)(2)(ii)(b)(3) of this section            paragraph (b)(2)(ii)(b) of this section.
                                                     place of the hearing will be published                  and paragraphs (b)(2)(ii)(b)(4) through                  (c) Obligation to restore deficit—(1)
                                                     in the Federal Register.                                (7) and (b)(2)(ii)(c) of this section on or           Other arrangements treated as
                                                                                                             after October 5, 2016 and before the date             obligations to restore deficits. If a
                                                     Drafting Information                                                                                          partner is not expressly obligated to
                                                                                                             these regulations are published as final
                                                       The principal authors of these                        regulations in the Federal Register.                  restore the deficit balance in such
                                                     regulations are Caroline E. Hay and                                                                           partner’s capital account, such partner
                                                                                                             *       *    *      *     *
                                                     Deane M. Burke of the Office of the                                                                           nevertheless will be treated as obligated
                                                                                                                (2) * * *
                                                     Associate Chief Counsel (Passthroughs                                                                         to restore the deficit balance in his
                                                                                                                (ii) * * *
                                                     & Special Industries), IRS. However,                                                                          capital account (in accordance with the
                                                                                                                (b) * * *
                                                     other personnel from the Treasury                                                                             requirement in paragraph (b)(2)(ii)(b)(3)
                                                                                                                (3) * * * Notwithstanding the
                                                     Department and the IRS participated in                                                                        of this section and subject to paragraph
                                                                                                             partnership agreement, an obligation to
                                                     their development.                                                                                            (b)(2)(ii)(c)(2) of this section) to the
                                                                                                             restore a deficit balance in a partner’s
                                                                                                                                                                   extent of—
                                                     Withdrawal of Proposed Regulations                      capital account, including an obligation                 (A) The outstanding principal balance
                                                                                                             described in paragraph (b)(2)(ii)(c)(1) of            of any promissory note (of which such
                                                       Accordingly, under the authority of
                                                                                                             this section, will not be respected for               partner is the maker) contributed to the
                                                     26 U.S.C. 7805, § 1.752–2 of the notice
                                                                                                             purposes of this section to the extent the            partnership by such partner (other than
                                                     of proposed rulemaking (REG–119305–
                                                                                                             obligation is disregarded under                       a promissory note that is readily
                                                     11) that was published in the Federal
                                                                                                             paragraph (b)(2)(ii)(c)(4) of this section.           tradable on an established securities
                                                     Register on January 30, 2014 (79 FR
                                                                                                                (4) For purposes of paragraphs                     market), and
                                                     4826) is withdrawn.
                                                                                                             (b)(2)(ii)(b)(1) through (3) of this section,            (B) The amount of any unconditional
                                                     List of Subjects in 26 CFR Part 1                       a partnership taxable year shall be                   obligation of such partner (whether
                                                       Income taxes, Reporting and                           determined without regard to section                  imposed by the partnership agreement
                                                     recordkeeping requirements.                             706(c)(2)(A).                                         or by state or local law) to make
                                                                                                                (5) The requirements in paragraphs                 subsequent contributions to the
                                                     Proposed Amendments to the                              (b)(2)(ii)(b)(2) and (3) of this section are          partnership (other than pursuant to a
                                                     Regulations                                             not violated if all or part of the                    promissory note of which such partner
                                                       Accordingly, 26 CFR part 1 is                         partnership interest of one or more                   is the maker).
                                                     proposed to be amended as follows:                      partners is purchased (other than in                     (2) Satisfaction requirement. For
                                                                                                             connection with the liquidation of the                purposes of paragraph (b)(2)(ii)(c)(1) of
                                                     PART 1—INCOME TAXES                                     partnership) by the partnership or by                 this section, a promissory note or
                                                                                                             one or more partners (or one or more                  unconditional obligation is taken into
                                                     ■ Paragraph 1. The authority citation                   persons related, within the meaning of                account only if it is required to be
                                                     for part 1 continues to read in part as                 section 267(b) (without modification by               satisfied at a time no later than the end
                                                     follows:                                                section 267(e)(1)) or section 707(b)(1), to           of the partnership taxable year in which
                                                         Authority: 26 U.S.C. 7805 * * *                     a partner) pursuant to an agreement                   such partner’s interest is liquidated (or,
                                                                                                             negotiated at arm’s length by persons                 if later, within 90 days after the date of
                                                        Sections 1.707–2 through 1.707–9 also
                                                                                                             who at the time such agreement is                     such liquidation). If a promissory note
                                                     issued under 26 U.S.C. 707(a)(2)(B).
                                                                                                             entered into have materially adverse                  referred to in paragraph (b)(2)(ii)(c)(1) of
                                                     ■ Par. 2. Section 1.704–1 is amended
                                                                                                             interests and if a principal purpose of               this section is negotiable, a partner will
                                                     by:
                                                                                                             such purchase and sale is not to avoid                be considered required to satisfy such
                                                     ■ 1. Adding two sentences to the end of
                                                                                                             the principles of the second sentence of              note within the time period specified in
                                                     paragraph (b)(1)(ii)(a).
                                                     ■ 2. Adding a sentence to the end of
                                                                                                             paragraph (b)(2)(ii)(a) of this section.              this paragraph (b)(2)(ii)(c)(2) if the
                                                     paragraph (b)(2)(ii)(b)(3) introductory                    (6) The requirement in paragraph                   partnership agreement provides that, in
                                                     text.                                                   (b)(2)(ii)(b)(2) of this section is not               lieu of actual satisfaction, the
                                                     ■ 3. Removing the undesignated
                                                                                                             violated if, upon the liquidation of the              partnership will retain such note and
                                                     paragraph following paragraph                           partnership, the capital accounts of the              such partner will contribute to the
                                                     (b)(2)(ii)(b)(3).                                       partners are increased or decreased                   partnership the excess, if any, of the
                                                     ■ 4. Adding paragraphs (b)(2)(ii)(b)(4)
                                                                                                             pursuant to paragraph (b)(2)(iv)(f) of this           outstanding principal balance of such
                                                     through (7).                                            section as of the date of such liquidation            note over its fair market value at the
                                                     ■ 5. Revising paragraph (b)(2)(ii)(c).                  and the partnership makes liquidating                 time of liquidation. See paragraph
                                                        The additions and revisions read as                  distributions within the time set out in              (b)(2)(iv)(d)(2) of this section. See
                                                     follows:                                                the requirement in paragraph                          examples (1)(ix) and (x) of paragraph
                                                                                                             (b)(2)(ii)(b)(2) of this section in the               (b)(5) of this section.
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                                                     § 1.704–1   Partner’s distributive share.               ratios of the partners’ positive capital                 (3) Related party notes. For purposes
                                                     *      *     *     *    *                               accounts, except that it does not                     of paragraph (b)(2) of this section, if a
                                                       (b) * * *                                             distribute reserves reasonably required               partner contributes a promissory note to
                                                       (1) * * *                                             to provide for liabilities (contingent or             the partnership during a partnership
                                                       (ii) * * *                                            otherwise) of the partnership and                     taxable year beginning after December
                                                       (a) * * * Furthermore, the last                       installment obligations owed to the                   29, 1988, and the maker of such note is
                                                     sentence of paragraph (b)(2)(ii)(b)(3) of               partnership, so long as such withheld                 a person related to such partner (within
                                                     this section and paragraphs                             amounts are distributed as soon as                    the meaning of § 1.752–4(b)(1)), then
                                                     (b)(2)(ii)(b)(4) through (7) and                        practicable and in the ratios of the                  such promissory note shall be treated as


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                                                                          Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules                                           69307

                                                     a promissory note of which such partner                 ■ Par. 3. Section 1.707–0 is amended by               ■ 3. Adding entries for § 1.752–2(j)(3)(i)
                                                     is the maker.                                           revising the entries for § 1.707–5(a)(2)(i)           through (iii).
                                                        (4) Obligations disregarded—(A)                      and (ii) to read as follows:                          ■ 4. Revising the entries for § 1.752–
                                                     General rule. A partner in no event will                                                                      2(j)(3) and (4).
                                                                                                             § 1.707–0    Table of contents.                       ■ 5. Adding an entry for § 1.752–2(k).
                                                     be considered obligated to restore the
                                                     deficit balance in his capital account to               *       *     *       *      *                          The revisions and additions read as
                                                     the partnership (in accordance with the                                                                       follows:
                                                                                                             § 1.707–5 Disguised sales of property to
                                                     requirement in paragraph (b)(2)(ii)(b)(3)               partnership; special rules relating to                § 1.752–0    Table of contents.
                                                     of this section) to the extent such                     liabilities.
                                                                                                                                                                   *        *   *     *     *
                                                     partner’s obligation is a bottom dollar                    (a) * * *
                                                     payment obligation that is not                             (2) * * *                                          § 1.752–2 Partner’s share of recourse
                                                     recognized under § 1.752–2(b)(3) or is                     (i) In general.                                    liabilities.
                                                     not legally enforceable, or the facts and                  (ii) Partner’s share of § 1.752–7                  *      *    *     *      *
                                                     circumstances otherwise indicate a plan                 liability.                                              (b) * * *
                                                     to circumvent or avoid such obligation.                 *       *    *     *     *                              (3) * * *
                                                     See paragraphs (b)(2)(ii)(f), (b)(2)(ii)(h),                                                                    (i) In general.
                                                     and (b)(4)(vi) of this section for other                *      *    *     *     *                               (ii) Special rules for bottom dollar
                                                     rules regarding such obligation. To the                 ■ Par. 4. Section 1.707–5 is amended by               payment obligations.
                                                     extent a partner is not considered                      revising paragraph (a)(2) and Examples                  (A) In general.
                                                     obligated to restore the deficit balance                2, 3, 7, and 8 of paragraph (f) to read as              (B) Exception.
                                                     in the partner’s capital account to the                 follows:                                                (C) Definition of bottom dollar
                                                     partnership (in accordance with the                                                                           payment obligation.
                                                                                                             § 1.707–5 Disguised sales of property to                (1) In general.
                                                     requirement in paragraph (b)(2)(ii)(b)(3)
                                                                                                             partnership; special rules relating to                  (2) Exceptions.
                                                     of this section), the obligation is                     liabilities.
                                                     disregarded and paragraph (b)(2) of this                                                                        (3) Benefited party defined.
                                                                                                                (a) * * *                                            (D) Disclosure of bottom dollar
                                                     section and § 1.752–2 are applied as if                    (2) [The text of proposed § 1.707–
                                                     the obligation did not exist.                                                                                 payment obligations.
                                                                                                             5(a)(2) is the same as the text of § 1.707–             (iii) Special rule for indemnities and
                                                        (B) Factors indicating plan to                       5T(a)(2) published elsewhere in this
                                                     circumvent or avoid obligation. In the                                                                        reimbursement agreements.
                                                                                                             issue of the Federal Register].
                                                     case of an obligation to restore a deficit                                                                    *      *    *     *      *
                                                                                                             *      *     *     *    *                               (j) * * *
                                                     balance in a partner’s capital account                     (f) * * *
                                                     upon liquidation of a partnership,                                                                              (2) * * *
                                                     paragraphs (b)(2)(ii)(c)(4)(B)(i) through                  Example 2. [The text of proposed § 1.707–            (i) In general.
                                                                                                             5(f) Example 2 is the same as the text of               (ii) Economic risk of loss.
                                                     (iv) of this section provide a non-                     § 1.707–5T(f) Example 2 published elsewhere
                                                     exclusive list of factors that may                                                                              (3) Plan to circumvent or avoid an
                                                                                                             in this issue of the Federal Register].               obligation.
                                                     indicate a plan to circumvent or avoid                     Example 3. [The text of proposed § 1.707–            (i) General rule.
                                                     the obligation. For purposes of making                  5(f) Example 3 is the same as the text of               (ii) Factors indicating plan to
                                                     determinations under this paragraph                     § 1.707–5T(f) Example 3 published elsewhere
                                                                                                             in this issue of the Federal Register].               circumvent or avoid an obligation.
                                                     (b)(2)(ii)(c)(4), the weight to be given to                                                                     (iii) Deemed plan to circumvent or
                                                     any particular factor depends on the                    *       *     *       *      *                        avoid an obligation.
                                                     particular case and the presence or                        Example 7. [The text of proposed § 1.707–
                                                                                                                                                                     (4) Examples.
                                                     absence of any particular factor is not,                5(f) Example 7 is the same as the text of
                                                                                                             § 1.707–5T(f) Example 7 published elsewhere             (k) Effective/applicability dates.
                                                     in itself, necessarily indicative of
                                                     whether or not the obligation is                        in this issue of the Federal Register].               *      *    *     *      *
                                                                                                                Example 8. [The text of proposed § 1.707–          ■ Par. 7. Section 1.752–2 is amended
                                                     respected. The following factors are                    5(f) Example 8 is the same as the text of             by:
                                                     taken into consideration for purposes of                § 1.707–5T(f) Example 8 published elsewhere           ■ 1. Revising the last sentence of
                                                     this paragraph (b)(2):                                  in this issue of the Federal Register].               paragraph (a).
                                                        (i) The partner is not subject to                    *     *     *    *     *                              ■ 2. Revising paragraph (b)(3) and the
                                                     commercially reasonable provisions for                  ■ Par. 5. Section 1.707–9 is amended by               last sentence of paragraph (b)(6).
                                                     enforcement and collection of the                       adding paragraph (a)(5) to read as                    ■ 3. Adding a sentence to the end of
                                                     obligation.                                             follows:                                              paragraph (f) introductory text and
                                                        (ii) The partner is not required to                                                                        adding Examples 10 and 11 to
                                                     provide (either at the time the obligation              § 1.707–9    Effective dates and transitional
                                                                                                                                                                   paragraph (f).
                                                                                                             rules.
                                                     is made or periodically) commercially                                                                         ■ 4. Revising paragraphs (j)(2) and (3).
                                                     reasonable documentation regarding the                     (a) * * *                                          ■ 5. Adding paragraph (j)(4).
                                                     partner’s financial condition to the                       (5) [The text of proposed § 1.707–                 ■ 6. Removing paragraph (k).
                                                     partnership.                                            9(a)(5) is the same as the text of § 1.707–           ■ 7. Redesignating paragraph (l) as
                                                                                                             9T(a)(5) published elsewhere in this                  paragraph (k) and revising it.
                                                        (iii) The obligation ends or could, by               issue of the Federal Register].
                                                     its terms, be terminated before the                                                                             The revisions and additions read as
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                                                     liquidation of the partner’s interest in                *      *     *      *    *                            follows:
                                                                                                             ■ Par. 6. Section 1.752–0 is amended
                                                     the partnership or when the partner’s                                                                         § 1.752–2 Partner’s share of recourse
                                                                                                             by:
                                                     capital account as provided in § 1.704–                 ■ 1. Adding entries for § 1.752–2(b)(3)(i)            liabilities.
                                                     1(b)(2)(iv) is negative.                                and (ii), (b)(3)(ii)(A) and (B), (b)(3)(ii)(C),          (a) * * * The determination of the
                                                        (iv) The terms of the obligation are not             (b)(3)(ii)(C)(1) through (3), (b)(3)(ii)(D),          extent to which a partner bears the
                                                     provided to all the partners in the                     and (b)(3)(iii).                                      economic risk of loss for a partnership
                                                     partnership in a timely manner.                         ■ 2. Adding entries for § 1.752–2(j)(2)(i)            liability is made under the rules in
                                                     *       *    *      *    *                              and (ii).                                             paragraphs (b) through (j) of this section.


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                                                     69308                Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules

                                                        (b) * * *                                            distributions by the partner or related               to circumvent or avoid an obligation is
                                                        (3) [The text of proposed § 1.752–                   person to equity owners in the partner                deemed to exist if the facts and
                                                     2(b)(3) is the same as the text of § 1.752–             or related person.                                    circumstances indicate that there is not
                                                     2T(b)(3) published elsewhere in this                       (B) The partner or related person is               a reasonable expectation that the
                                                     issue of the Federal Register].                         not required to provide (either at the                payment obligor will have the ability to
                                                     *      *     *     *    *                               time the payment obligation is made or                make the required payments if the
                                                        (6) * * * See paragraph (j) of this                  periodically) commercially reasonable                 payment obligation becomes due and
                                                     section.                                                documentation regarding the partner’s                 payable. For purposes of this section, a
                                                     *      *     *     *    *                               or related person’s financial condition               payment obligor includes an entity
                                                        (f) Examples. * * * Unless otherwise                 to the benefited party.                               disregarded as an entity separate from
                                                     provided, for purposes of the following                    (C) The term of the payment                        its owner under section 856(i), section
                                                     examples, assume that any obligation of                 obligation ends prior to the term of the              1361(b)(3), or §§ 301.7701–1 through
                                                     a partner or related person to make a                   partnership liability, or the partner or              301.7701–3 of this chapter (a
                                                     payment is recognized under paragraph                   related person has a right to terminate               disregarded entity), and a trust to which
                                                     (b)(3) of this section.                                 its payment obligation, if the purpose of             subpart E of part I of subchapter J of
                                                                                                             limiting the duration of the payment                  chapter 1 of the Code applies.
                                                     *      *     *     *    *                               obligation is to terminate such payment
                                                        Example 10. [The text of proposed § 1.752–                                                                    (4) Examples. The following examples
                                                                                                             obligation prior to the occurrence of an              illustrate the principles of paragraph (j)
                                                     2(f) Example 10 is the same as the text of
                                                     § 1.752–2T(f) Example 10 published                      event or events that increase the risk of             of this section.
                                                     elsewhere in this issue of the Federal                  economic loss to the guarantor or
                                                                                                                                                                      Example 1. Gratuitous guarantee. (i) In
                                                     Register].                                              benefited party (for example,                         2016, A, B, and C form a domestic limited
                                                        Example 11. [The text of proposed § 1.752–           termination prior to the due date of a                liability company (LLC) that is classified as
                                                     2(f) Example 11 is the same as the text of              balloon payment or a right to terminate               a partnership for federal tax purposes. Also
                                                     § 1.752–2T(f) Example 11 published                      that can be exercised because the value               in 2016, LLC receives a loan from a bank. A,
                                                     elsewhere in this issue of the Federal                  of loan collateral decreases). This factor            B, and C do not bear the economic risk of loss
                                                     Register].                                              typically will not be present if the                  with respect to that partnership liability, and,
                                                     *       *    *     *     *                              termination of the obligation occurs by               as a result, the liability is treated as
                                                        (j) * * *                                            reason of an event or events that                     nonrecourse under § 1.752–1(a)(2) in 2016. In
                                                        (2) [The text of proposed § 1.752–                                                                         2018, A guarantees the entire amount of the
                                                                                                             decrease the risk of economic loss to the             liability. The bank did not request the
                                                     2(j)(2) is the same as the text of § 1.752–             guarantor or benefited party (for                     guarantee and the terms of the loan did not
                                                     2T(j)(2) published elsewhere in this                    example, the payment obligation                       change as a result of the guarantee. A did not
                                                     issue of the Federal Register].                         terminates upon the completion of a                   provide any executed documents with
                                                        (3) Plan to circumvent or avoid an                   building construction project, upon the               respect to A’s guarantee to the bank. The
                                                     obligation—(i) General rule. An                         leasing of a building, or when certain                bank also did not require any restrictions on
                                                     obligation of a partner or related person               income and asset coverage ratios are                  asset transfers by A and no such restrictions
                                                     to make a payment is not recognized                     satisfied for a specified number of                   exist.
                                                     under paragraph (b) of this section if the                                                                       (ii) Under paragraph (j)(3) of this section,
                                                                                                             quarters).
                                                     facts and circumstances evidence a plan                                                                       A’s 2018 guarantee (payment obligation) is
                                                                                                                (D) There exists a plan or arrangement             not recognized under paragraph (b)(3) of this
                                                     to circumvent or avoid the obligation.                  in which the primary obligor or any                   section if the facts and circumstances
                                                        (ii) Factors indicating plan to                      other obligor (or a person related to the             evidence a plan to circumvent or avoid the
                                                     circumvent or avoid an obligation. In                   obligor) with respect to the partnership              payment obligation. In this case, the
                                                     the case of a payment obligation, other                 liability directly or indirectly holds                following factors indicate a plan to
                                                     than an obligation to restore a deficit                 money or other liquid assets in an                    circumvent or avoid A’s payment obligation:
                                                     capital account upon liquidation of a                   amount that exceeds the reasonable                    (1) The partner is not subject to commercially
                                                     partnership, paragraphs (j)(3)(ii)(A)                   foreseeable needs of such obligor.                    reasonable contractual restrictions that
                                                     through (G) of this section provide a                      (E) The payment obligation does not                protect the likelihood of payment, such as
                                                     non-exclusive list of factors that may                                                                        restrictions on transfers for inadequate
                                                                                                             permit the creditor to promptly pursue                consideration or equity distributions; (2) the
                                                     indicate a plan to circumvent or avoid                  payment following a payment default on                partner is not required to provide (either at
                                                     the payment obligation. The presence or                 the partnership liability, or other                   the time the payment obligation is made or
                                                     absence of a factor is based on all of the              arrangements with respect to the                      periodically) commercially reasonable
                                                     facts and circumstances at the time the                 partnership liability or payment                      documentation regarding the partner’s or
                                                     partner or related person makes the                     obligation otherwise indicate a plan to               related person’s financial condition to the
                                                     payment obligation or if the obligation                 delay collection.                                     benefited party; (3) in the case of a guarantee
                                                     is modified, at the time of the                            (F) In the case of a guarantee or                  or similar arrangement, the terms of the
                                                     modification. For purposes of making                                                                          liability are the same as they would have
                                                                                                             similar arrangement, the terms of the
                                                                                                                                                                   been without the guarantee; and (4) the
                                                     determinations under this paragraph                     partnership liability would be                        creditor did not receive executed documents
                                                     (j)(3), the weight to be given to any                   substantially the same had the partner                with respect to the payment obligation from
                                                     particular factor depends on the                        or related person not agreed to provide               the partner or related person at the time the
                                                     particular case and the presence or                     the guarantee.                                        obligation was created. Absent the existence
                                                     absence of a factor is not necessarily                     (G) The creditor or other party                    of other facts or circumstances that would
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                                                     indicative of whether a payment                         benefiting from the obligation did not                weigh in favor of respecting A’s guarantee,
                                                     obligation is or is not recognized under                receive executed documents with                       evidence of a plan to circumvent or avoid the
                                                     paragraph (b) of this section.                          respect to the payment obligation from                obligation exists and, pursuant to paragraph
                                                        (A) The partner or related person is                                                                       (j)(3)(i) of this section, A’s guarantee is not
                                                                                                             the partner or related person before, or
                                                                                                                                                                   recognized under paragraph (b) of this
                                                     not subject to commercially reasonable                  within a commercially reasonable                      section. As a result, LLC’s liability continues
                                                     contractual restrictions that protect the               period of time after, the creation of the             to be treated as nonrecourse.
                                                     likelihood of payment, including, for                   obligation.                                              Example 2. Underfunded disregarded
                                                     example, restrictions on transfers for                     (iii) Deemed plan to circumvent or                 entity payment obligor. (i) In 2016, A forms
                                                     inadequate consideration or                             avoid an obligation. Evidence of a plan               a wholly owned domestic limited liability



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                                                                          Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / Proposed Rules                                                69309

                                                     company, LLC, with a contribution of                    paragraph (b)(1) of this section. Therefore,          incurred or assumed by a partnership
                                                     $100,000. A has no liability for LLC’s debts,           paragraph (j)(3)(iii) of this section is applied      and to payment obligations imposed or
                                                     and LLC has no enforceable right to a                   to the LLC and not to A. LLC has no assets            undertaken with respect to a
                                                     contribution from A. Under § 301.7701–                  with which to pay if the payment obligation
                                                                                                             becomes due and payable. As such, evidence
                                                                                                                                                                   partnership liability on or after the date
                                                     3(b)(1)(ii) of this chapter, LLC is a treated for
                                                     federal tax purposes as a disregarded entity.           of a plan to circumvent or avoid the                  these regulations are published as final
                                                     Also in 2016, LLC contributes $100,000 to               obligation is deemed to exist and, pursuant           regulations in the Federal Register,
                                                     LP, a limited partnership with a calendar               to paragraph (j)(3)(i) of this section, LLC’s         other than liabilities incurred or
                                                     year taxable year, in exchange for a general            obligation to restore its deficit capital             assumed by a partnership and payment
                                                     partnership interest in LP, and B and C each            account is not recognized under paragraph             obligations imposed or undertaken
                                                     contributes $100,000 to LP in exchange for a            (b) of this section. As a result, LP’s $300,000       pursuant to a written binding contract
                                                     limited partnership interest in LP. The                 debt is characterized as nonrecourse under
                                                                                                                                                                   in effect prior to that date. Taxpayers
                                                     partnership agreement provides that only                § 1.752–1(a)(2) and is allocated among A, B,
                                                                                                             and C under § 1.752–3.                                may rely on these regulations for the
                                                     LLC is required to restore any deficit in its
                                                     capital account. On January 1, 2017, LP                                                                       period between October 5, 2016 and the
                                                                                                                (k) Effective/applicability dates. (1)             date these regulations are published as
                                                     borrows $300,000 from a bank and uses
                                                                                                             Paragraph (h)(3) of this section applies              final regulations in the Federal Register.
                                                     $600,000 to purchase nondepreciable
                                                     property. The $300,000 is secured by the                to liabilities incurred or assumed by a
                                                                                                             partnership on or after October 11, 2006,                (2) [The text of proposed § 1.752–
                                                     property and is also a general obligation of
                                                                                                             other than liabilities incurred or                    2(k)(2) is the same as the text of § 1.752–
                                                     LP. LP makes payments of only interest on
                                                     its $300,000 debt during 2017. LP has a net             assumed by a partnership pursuant to a                2T(l)(2) published elsewhere in this
                                                     taxable loss in 2017, and, under §§ 1.705–1(a)          written binding contract in effect prior              issue of the Federal Register.]
                                                     and 1.752–4(d), LP determines its partners’             to that date. The rules applicable to                    (3) [The text of proposed § 1.752–
                                                     shares of the $300,000 debt at the end of its           liabilities incurred or assumed (or                   2(k)(3) is the same as the text of § 1.752–
                                                     taxable year, December 31, 2017. As of that             pursuant to a written binding contract                2T(l)(3) published elsewhere in this
                                                     date, LLC holds no assets other than its                in effect) prior to October 11, 2006, are             issue of the Federal Register.]
                                                     interest in LP.
                                                        (ii) Because LLC is a disregarded entity, A
                                                                                                             contained in § 1.752–2 in effect prior to
                                                                                                             October 11, 2006, (see 26 CFR part 1                  John Dalrymple,
                                                     is treated as the partner in LP for federal
                                                                                                             revised as of April 1, 2006). The last                Deputy Commissioner for Services and
                                                     income tax purposes. Only LLC has an
                                                                                                             sentence of paragraphs (a), (b)(6), and (f)           Enforcement.
                                                     obligation to make a payment on account of
                                                     the $300,000 debt if LP were to                         of this section and paragraphs (j)(3) and             [FR Doc. 2016–23390 Filed 10–4–16; 8:45 am]
                                                     constructively liquidate as described in                (4) of this section apply to liabilities              BILLING CODE 4830–01–P
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Document Created: 2016-10-05 03:28:59
Document Modified: 2016-10-05 03:28:59
CategoryRegulatory Information
CollectionFederal Register
sudoc ClassAE 2.7:
GS 4.107:
AE 2.106:
PublisherOffice of the Federal Register, National Archives and Records Administration
SectionProposed Rules
ActionPartial withdrawal of notice of proposed rulemaking and notice of proposed rulemaking, including by cross reference to temporary regulations.
DatesThe notice of proposed rulemaking under sections 707 and 752 that was published in the Federal Register on January 30, 2014 (REG- 119305-11, 79 FR 4826), is partially withdrawn as of October 5, 2016. Written or electronic comments and requests for a public hearing must be received by January 3, 2017.
ContactConcerning the proposed regulations, Caroline E. Hay or Deane M. Burke, (202) 317-5279; concerning submissions of comments and requests for a public hearing, Regina L. Johnson, (202) 317-6901 (not toll-free numbers).
FR Citation81 FR 69301 
RIN Number1545-BM83
CFR AssociatedIncome Taxes and Reporting and Recordkeeping Requirements

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