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Washington Tax Alert September 12, 2013 (Partnership COD income)

Washington Tax Alert from Don Barnes, dbarnes@washingtontaxlaw.com

September 12, 2013

In the case of a partnership realizing cancellation of indebtedness income, the insolvency exclusion provided by IRC § 108(a)(1)(B) applies at the partner level, not at the partnership level. IRC § 108(d)(6). In Rev. Rul. 2012-14, the Service permitted partners to include excess nonrecourse debt of the partnership (to the extent the partnership nonrecourse debt is cancelled) in determining the partners' insolvency.

The holding in Rev. Rul. 2012-14 was applauded by many tax professionals because it provided a result that can be favorable for partners trying to exclude partnership COD income from gross income, particularly corporate partners that have no assets or liabilities other than their interests in the partnership. Some commentators have taken the position that the holding in Rev. Rul. 2012-14 should apply to partnership recourse liabilities and liabilities of a limited liability company.

However, in some situations, a partner or LLC member may not want the result provided by Rev. Rul. 2012-14. Instead, the partner or LLC member may want to include partnership COD income in its gross income (and avoid attribute reduction) because the partner or LLC member can offset the COD income against other losses.

For several reasons, a taxpayer should be able to take a position contrary to the holding in Rev. Rul. 2012-14. The revenue ruling is arguably inconsistent with IRC § 108(d)(6), and the policy justification for the holding in the ruling (viz., the partner should obtain a fresh start) may not apply if the cancelled partnership liability is owed to a partner or a person related to the partner. In that event, the partner or related person may be entitled to a bad debt deduction with respect to the partnership liability.

Law Offices of Donald A. Barnes, PLLC
818 Connecticut Avenue, N.W.
Suite 1200
Washington, DC 20006
Telephone: (202) 728-4407
Cell: (202) 360-0275
E-Mail: dbarnes@washingtontaxlaw.com
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