The Tax Court has held that a partner was liable for tax on her distributive share of income from the partnership, regardless of whether she constructively received the share or not.
Code 702(a) provides that, “[i]n determining his income tax, each partner shall take into account separately his distributive share” of the partnership’s items of income and loss. Specifically, each partner must include his or her distributive share of the partnership’s “gains and losses from sales or exchanges of property described in section 1231.” (Code Sec. 702(a)(3))
This rule applies regardless of whether the partner receives the income currently, via distribution or otherwise. (Basye, (S Ct 1973) 31 AFTR 2d 73-802)
In 2013, a partnership in which Ms. Dodd was a partner sold a building. The partnership sent Dodd a K-1 showing $1 million as a net section 1231 gain for the year.
Also in 2013, the partnership paid back a loan it had taken out in 2011. Dodd was a co-borrower on the loan. The amount of the share of Dodd’s loan liability that was paid back was more than $1 million.
Dodd did not pay income tax on the 1231 gain, arguing that she never received the money because it was used to pay back the loan, that is, she did not constructively receive the funds under Reg §1.451-2.
The Tax Court disagreed with Dodd and found that for Federal tax purposes, however, the question is not whether Dodd constructively received the funds. Under Code Sec. 702(a), the Court said she is taxable on her distributive share of the section 1231 gain whether or not it was distributed.
To continue your research on distributive share related to section 1231 gain, see FTC 2d/FIN ¶B-1903.
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