On July 22, the IRS issued final regulations regarding the impact of partnership technical terminations on unamortized organizational and startup costs. These regulations are essentially the same as the proposed regulations issued in December 2013. The final regulations apply to technical partnership terminations occurring on or after December 9, 2013.
By way of background, a partnership can terminate in two ways. Under a traditional partnership termination, the partners simply cease carrying on the partnership business. Under a technical partnership termination, “within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.” I.R.C. § 708(b)(1)(B). A technical termination does not terminate a partnership for legal and nontax purposes but rather only for tax purposes. The old partnership is deemed to have contributed “all of its assets and liabilities to a new partnership in exchange for an interest in the new partnership.” Treas. Reg. 1.708-1(b)(4). The terminated partnership then distributes its interest in the new partnership to the partners in proportion to their interests in the terminated partnership in liquidation of the terminated partnership. Id.
Section 709 defines organizational expenses as expenditures which “are incident to the creation of a partnership…are chargeable to capital account; and are of a character which…would be amortized.” I.R.C. § 709(b)(3). Startup costs include amounts paid investigating the creation or acquisition of a trade or business, creating a trade or business or engaging in activity for profit in anticipation of the activity becoming a trade or business. I.R.C. § 195(c)(1).
Generally speaking, taxpayers must capitalize organizational and startup costs. However, taxpayers may elect to deduct up to $5,000 of each of these costs in the year that the partnership trade or business begins. The $5,000 deduction is reduced for every dollar of organizational or startup costs in excess of $50,000. Taxpayers must ratably amortize the remaining costs over 15 years. If the partnership liquidates before the end of the 15 year period, the remaining costs are immediately deductible in the year of liquidation. Until now, practitioners and taxpayers did not know whether they could deduct such costs if the partnership underwent a technical termination before the end of the 15 year period.
Treasury has made clear that taxpayers may not immediately deduct remaining organizational or startup costs in the year of a technical termination. Rather, the new partnership must continuing amortizing the costs without restarting the amortization period. The proposed regulations explained that Congress intended section 195 and 709 expenses to be ratably deducted over the period during which the partnership benefits from the expenses. Given that under a technical termination the partnership does not legally terminate but still continues to benefit from startup and organizational expenses, allowing an accelerated deduction in the year of termination runs counter to the legislative intent of sections 195 and 709.