Guaranteed Payments

andNIIT

1

Guaranteed payments are payments by the partnership to a partner:

1) for services or2) for the use of capital

and are determined without regard to the income of the partnership. 2

Guaranteed payments for services are

NOT NII (whether SE income or not)

3

Guaranteed payments for

capital are like interest thus NII if not subject to SE

tax4

Service Partners

Current Law

5

5-4

Rev Proc 93-27

IRS AdministrativeConcession For

Vested Profits Only Interest

6

5-5

7

Profits Intererst not taxable if NOT:

1) A substantially certain and predictable stream of income.

2) Disposed of within two years of receipt.

3) A limited partnership interest in a publicly traded partnership.

Profits InterestDefinition

8

A partnership interest other than a capital

interest.

Capital Interest Definition

9

A “capital interest is “an interest that would give the holder a share of the proceeds if the partnership’s assets were sold at fair market value and then the proceeds were distributed in a complete liquidation of the partnership.”

AB Partnership

Alice Bill

Land FMV $1,000,000Adj. Basis: $700,000

Services

50%50%

Profits Only InterestFor Bill

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Traditional “Layer Cake” Allocation

Provision

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Losses would be allocated

i. 50% to Bill and 50% to the Alice to the extent of income previously allocated in those ratios under clause (c) below,

ii. To Alice to the extent of Alice’s capital account and

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iii. 50% to the Bill and 50% to Alice.

Income would be allocated

a. to reverse prior allocations of losses under clause (iii) above,

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b. to reverse prior allocations in clause (ii) above so that the Alice’s capital account is fully restored to its balance prior to such losses and

c. 50% to Alice and 50% to Bill.

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Liquidate in accordance with

partner book (704(b)) capital

account balances

Target Allocation

Target Allocation:Partnership Profit or Loss shall be allocated in a manner to cause the Partners’ ending Capital Accounts to equal the amount they would receive if the Partnership were to sell all of its assets for Book Value and liquidate pursuant to the liquidation waterfall set forth in Section XX of this Agreement.

Liquidation Waterfall:Cash is distributed:

First to Alice to the extent of her contributed capital and then 50% Alice and 50% to Bill.

Year 1 Profit of $400,000

How Allocated?

Total HypoCash

Alice Bill

Beg $1,000,000End $1,400,000

$400,000

Target Allocation of $400,000

Total HypoCash

Alice Bill

Beg $1,000,000 $1,000,000 $0End $1,400,000

$400,000

Target Allocation of $400,000

Total HypoCash

Alice Bill

Beg $1,000,000 $1,000,000 $0End $1,400,000 1,200,000 $200,000

$400,000 $200,000 $200,000

Target Allocation of $400,000

Hypo Cash Distribution at Year End:1st $1,000,000 to Alice2nd $400,000 50/50

A Year 2 loss of <$400,000>

How Allocated?

Total HypoCash

Alice Bill

Beg $1,400,000 $1,200,000 $200,000End $1,000,000

($400,000)

Target Allocation of $400,000

Total HypoCash

Alice Bill

Beg $1,400,000 $1,200,000 $200,000End $1,000,000 1,000,000 $0

($400,000) ($200,000) ($200,000)

Target Allocation of $400,000

Hypo Cash Distribution at Year End:

1st $1,000,000 to Alice

Yr. 3 Loss of $400,000

(+ Php borrows $400,000)

How Allocated?

Liquidation Waterfall:Cash is distributed:

First to Alice to the extent of her contributed capital and then 50% Alice and 50% to Bill.

Total HypoCash

Alice Bill

Beg $1,000,000End $ 600,000

($400,000)

Target Allocation of <$400,000>

Total HypoCash

Alice Bill

Beg $1,000,000 $1,000,000 $0End $ 600,000

($400,000)

Target Allocation of <$400,000>

Total HypoCash

Alice Bill

Beg $1,000,000 $1,000,000 $0End $ 600,000 $600,000 $0

($400,000) (400,000)

Target Allocation of <$400,000>

Hypo Cash Distribution at Year End:

1st $600,000 to Alice

Capital Interest forServices

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AB Partnership

Alice Bill

Land FMV $1,000,000Adj. Basis: $700,000

Services

50%50%

Traditional Allocation (layer cake):

Profits split 50-50

Losses split 50-50

Liquidate in accordance with partner book (704(b)) capital account balances

The partnership agreement does NOT entitle Alice

to a priority return of her contributed

capital

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Bill: $500,000 of ordinary income (liquidation value)

Alice: $500,000 deduction (guaranteed payment).

On Formation of AB Php

Assets: Tax Basis704(b)

Book BasisCash $0 $0Land $700,000 $1,000,000

Total $700,000 $1,000,000Capital:

Alice $200,000 $500,000Bill $500,000 $500,000

Debt + Capital $700,000 $1,000,000

Balance Sheet After Formation

Target Allocation Liquidation Waterfall:

Cash is distributed:

50% to A and 50% to B

Example: If liquidated after formation, Alice and Bill each receive $500,000 cash.

Forfeitable Partnership

Capital Interest

Crescent Holdings LLC (Dec. 2, 2013)

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5-11

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The Tax Court addressed the treatment of a partner’s receipt of a nonvested partnership capital interest, which was forfeited prior to vesting (no 83(b) election).

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The nonvested partner does not recognize partnership income

until the interest vests

(absent an 83(b) election)