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Sunday, November 23, 2008

IRS ASSERTS NONOWNER CONTRIBUTIONS TO PARTNERSHIPS ARE TAXABLE

Both corporations and partnerships at times receive "capital contributions" from persons other than shareholders or partners/members. For example, such business entities often receive grants and subsidies from federal, State, and local governments.

Code Section 118 of the Code provides that such capital contributions to corporations do not give rise to income to the corporation. Other Code provisions reduce the basis of contributed property (or other corporate property when the contribution is cash) to offset such nontaxation and/or to prevent the corporation from depreciating such contributed property. These rules only apply to capital contributions - not amounts paid in exchange for goods or services.

If the entity receiving the contribution is a partnership (or LLC or other entity taxable as a partnership), Section 118 does not apply since it only addresses corporations. Nonetheless, partnerships receiving property from nonpartners have asserted that Section 118 concepts, or a nonstatutory common law capital contribution concept, apply to avoid income to partnerships in the same manner as Section 118.

The IRS is having none of that theory. In a Coordinated Issue Paper, it has stated that there is no corollary to Section 118 for noncorporate entities taxable as partnership, such that capital contributions to those entities by nonowners will be considered as taxable to the entity (and thus to its owners, per the pass-through nature of partnership) .

Coordinated Issue Paper All Industries, Exclusion Of Income: Non-Corporate Entities And Contributions to Capital (LMSB4-1008-051), Nov. 18, 2008

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