Partnership Preferred Returns: Identifying Capital Shifts and Recharacterization Risks

The most critical task for tax counsel drafting partnership agreements is ensuring that the allocations in the operating documents reflect the partners' business intent while complying with IRS regulations. Target allocation provisions, which are increasingly popular in partnership agreements, present many issues. One of these issues is the risk that partnership preferred returns may be recharacterized as guaranteed payments or may require recognition of income without an associated partnership distribution. The guidance from the IRS is unclear as to the character and timing of including preferred returns as taxable income.

In partnership agreements where preferred returns are accrued but unpaid, there can be an implied shift of capital from subordinated partners to the partners entitled to the preferred return. The preferred partners may be required to recognize ordinary income with respect to the implied capital shift, which can generate a costly and often unforeseen current year tax. Because preferred returns are favored in certain types of partnerships, many partnership agreements contain allocations involving preferred returns that can create an unrecognized tax risk. Proper planning and drafting may mitigate the potential dangers of IRS challenges to the intended character and timing of income associated with preferred returns.

Listen as our experienced panel provides a thorough and practical guide to meeting the planning and reporting challenges involved in partnership agreements with preferred returns.

1. Target allocations and preferred returns
2. Risk of preferred returns being characterized as guaranteed payments
3. Capital account liquidation analysis and capital shifts
4. Tools to protect the intended tax treatment of preferred returns

The panel will discuss these and other important issues:

• The risks of having a preferred interest recharacterized as a guaranteed payment
• Current year tax consequences of noncompensatory capital shifts
• Determining whether a capital shift has occurred under the capital account liquidation rules

Learning Objectives

After completing this course, you will be able to:

• Identify the risks of having a preferred interest recharacterized as a guaranteed payment
• Ascertain current year tax consequences of noncompensatory capital shifts
• Determine whether a capital shift has occurred using capital account liquidation rules

• Field of Study: Taxes
• Level of Knowledge: Intermediate
• Advance Preparation: None
• Teaching Method: Seminar/Lecture
• Delivery Method: Group-Internet (via computer)
• Attendance Monitoring Method: Attendance is monitored electronically via a participant's PIN and through a series of attendance verification prompts displayed throughout the program
• Prerequisite: Three years+ business or public firm experience at mid-level within the organization, preparing complex tax forms and schedules, supervising other preparers/accountants. Specific knowledge and understanding of partnership structure, operating agreements and liquidation, including partner capital accounts, allocation and distributions; familiarity with the economic effect test; guaranteed payments under section 707

Strafford Publications, Inc. is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of Accountancy have final authority on the acceptance of individual courses for CPE Credits. Complaints regarding registered sponsons may be submitted to NASBA through its website: www.nasbaregistry.org.

IRS Approved Provider

Strafford is an IRS-approved continuing education provider offering certified courses for Enrolled Agents (EA) and Tax Return Preparers (RTRP).