Posted by Lee Meyercord and Jessica Kirk
The IRS recently released final regulations under section 752 that ended the viability of bottom-dollar guarantees. The final regulations substantially adopt the temporary regulations issued on October 5, 2016. Bottom-dollar guarantees have long been a tax-planning technique to increase a partner’s basis in her partnership interest and defer gain recognition. The IRS has been critical of bottom-dollar guarantees because it believes they lack a substantial business purpose and economic significance.
The final regulations apply to liabilities and payment obligations occurring on or after October 5, 2016, unless such liabilities or payment obligations were pursuant to a written binding contract effective before that date. Therefore, if a debt entered into before October 5, 2016 is not modified or refinanced, the final regulations will not apply to the debt. But, if a pre-October 5, 2016 debt is modified or refinanced, then the final regulations will apply.
However, a partner may choose to apply a “transitional rule” for seven years after October 5, 2016 to the portion of any modified or refinanced amounts for which the partner bore the economic risk of loss immediately before October 5, 2016 that exceeds a partners outside basis (the grandfathered amount). That is, the grandfathered amount is the amount that was protecting a negative capital account.
Partners with bottom-dollar guarantees should determine the grandfathered amount and evaluate the impact of the transition rules if the debt is modified or refinanced during the seven-year transition period. Partners may want to consider restructuring their bottom-dollar guarantees prior to the end of the transition period. For those considering an alternative to the bottom-dollar guarantee, the vertical-slice guarantee may accomplish the parties’ objectives if structured correctly.
An article in the Texas Tax Lawyer written by two of our tax attorneys, Lee Meyercord and Jessica Kirk, summarizes bottom-dollar guarantees, their use in tax-planning, and the temporary and final regulations. If you have any questions about the final regulations or their impact on an existing bottom-dollar guarantee, please contact one of us or any of the other Tax lawyers at Thompson & Knight.
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