Partnership Tax Planning Issues When Raising Capital and Exchanging Debt for Equity

Private companies structured as partnerships must navigate complicated tax rules when faced with recapitalization. Tax counsel and advisers representing private investment funds and operating company partnerships must recognize the tax implications of changes in entity structure and exchanging debt for equity, along with strict rules regarding allocations for income tax purposes.

Generally, IRC Sec. 704 requires that allocations for income tax purposes must meet the substantial economic effect standard and be made in accordance with the partner's interest in the partnership. This also means that the partnership must adhere to strict capital account maintenance rules when analyzing potential tax consequences of equity infusions when a partnership's value has shifted.

New equity issued in exchange for funding may bring about various layers of complexity depending on whether it's a new partnership versus a partnership that's already operating. Any partner contributing an asset with a value that differs from its tax basis requires an analysis of Sec. 704(c), which should be negotiated carefully between the contributing partner and other partners due to the significant impact it has on taxable income.

Exchanging debt for equity also raises various tax implications that may change the liability allocation, minimum gain tracking, taxable income, and other key tax items. Counsel and advisers must be vigilant in evaluating debt and equity transactions in order to avoid or minimize tax liability.

Listen as Michael Walch, Shareholder at KIRTON MCCONKIE, discusses critical tax considerations in issuing new equity in exchange for funding and tax consequences of debt for equity under current tax law and offers essential planning techniques to avoid tax pitfalls.