Partnership Basis in Contributed Promissory Notes and Guarantees: Tax Tips

Partners of a partnership sometimes contribute promissory notes to the partnership.  As an example, a partner drafts a note payable to the partnership promising to pay the partnership a sum of money.  The question then becomes whether the partner has an increase in partner basis for this.  The other question is what is the partnership’s basis in the promissory note.

Another related scenario is where a partner guarantees a partnership debt owed to a third party.  The question is whether this guarantee increases the basis of the partner in the partnership.

Partnerships don’t pay income tax, but they do file  information returns, and partners are supposed to use the numbers from those returns on their own individual returns. See IRC secs. 701, 6031, 6222(a).  Partnership basis is important because it determines where a distribution such as cash is taxed or not.  It also determines the amount of taxable gain or loss upon sale. An increase in a partner’s basis is desirable.  We provide legal and tax services to partnerships.

The value of what a partner contributes to his partnership can be tricky when he contributes something other than cash–like promissory notes or guarantees. a partnership’s basis in property contributed by a partner is the adjusted basis of that property in the hands of the contributing partner at the time of the contribution. IRC sec. 723.

The Tax Court has held that the contribution of a partner’s own note to his partnership isn’t the equivalent of a contribution of cash, and without more, it will not increase his basis in his partnership interest. See Dakotah Hills Offices Ltd. P’ship v. Commissioner, T.C. Memo. 1998-134, 75 T.C.M. (CCH) 2122.

As such, the partner’s basis does not increase and the partnership’s basis in the notes is zero.

However, a guarantee of a partnership debt to a third party does increase a partner’s basis.

For example, in Gefen v. Commissioner, 87 T.C. 1471 (1986) a partner executed a limited guaranty as a condition of her acquisition of an interest in a limited partnership. Under its terms, she assumed personal liability to the partnership’s existing creditor for her pro rata share of the partnership’s recourse indebtedness to that creditor. She also agreed that the partnership could
call on her to contribute to the partnership an amount equal to the partnership’s outstanding debt.  The Tax Court upheld the partner’s increase in basis for her limited guarantee.

This can be a tricky area.  However, here are tax tips:

  1. Consider guaranteeing a preexisting third party debt rather than contributing a promissory note to the partnership.
  2. Document that the partner is providing personal credit to partnership vendors.
  3. The partner should be obliged to make additional contributions under the guarantee.
  4. The guarantee must create a liability to a third party, not the partnership.

Tax Compliance Check-Up

For Individuals, Small Businesses, Corporations, Partnerships, and Limited Liability Companies

Tax Compliance Checkup-Up by Tax Attorney Philip Falco, Attorney, CPA

As a licensed CPA and an Attorney, my office has direct IRS e-services. We can quickly find out what is not making you or your company tax compliant.

For example, an old unfiled tax return, a quarterly filing, or an IRS Form 940 might not have been filed at some point in time. You might not even know that the IRS has the non-compliance flagged until it is too late.  We can nip this in the bud and get you in 100% compliance.  We also provide tax preparation services so we can actually prepare your unfiled returns for you.

This service can help minimize exposure to an IRS Audit, issues with Unfiled Tax Returns, and Criminal Tax indictment.

Give us a call if you would like us to do a tax check-up for you (303) 626-7000.

Tax Preparation and Planning for Entrepreneurs and High Net Worth Individuals

Tax Preparation and Planning for Entrepreneurs and High Net Worth Individuals

During Tax season, we perform the most sophisticated tax preparation for you. We optimize shareholder and member basis, losses, gains, carryovers and carrybacks.  We ensure that you receive your deductions

Because we are vertically integrated, we provide you with simulated tax returns

If we find an error in your tax plan implementation, we bring it to your attention and provide our tax opinion.

We are vertically integrated.  To us this means that we start with the pieces that compose your tax return all the way up to strategic planning, legal planning, and integrate both for you.

After Tax Season
Tax season isn’t the only time to think about taxes. Nearly every business decision you make has a tax consequence, and we believe working with a tax professional year-round can help you make informed decisions to minimize tax liabilities and take advantage of every possible incentive.

It’s absolutely necessary to gain a thorough understanding of your company’s operations, tax elections and methods, not only to prepare an accurate, complete set of returns, but also to find the most effective means to save additional tax dollars and meet your financial objectives.

From implementing tax-saving strategies and reviewing new legislation to evaluating current elections and amending returns, our staff works tirelessly throughout the entire year to find the most effective ways to save you tax dollars and keep more of your hard-earned profits.

We are working on strategies to minimize the new Healthcare (ObamaCare) 3.8% Tax on Net Investment Income.  This tax is targeted at high income individuals (married filing jointly in excess of $250,000).

Click here to visit our Tax Preparation Page: Tax Preparation

Email us for a free consultation Phil@ColoradoLegal.com

Or call (303) 626-7000.