Liabilities Recognized as Recourse Partnership Liabilities Under Section 752, 69301-69309 [2016-23390]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 81, Number 193 (Wednesday, October 5, 2016)]
[Proposed Rules]
[Pages 69301-69309]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-23390]



Federal Register / Vol. 81, No. 193 / Wednesday, October 5, 2016 / 
Proposed Rules

[[Page 69301]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-122855-15]
RIN 1545-BM83


Liabilities Recognized as Recourse Partnership Liabilities Under 
Section 752

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Partial withdrawal of notice of proposed rulemaking and notice 
of proposed rulemaking, including by cross reference to temporary 
regulations.

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SUMMARY: This document contains proposed regulations that incorporate 
the text of related temporary regulations and withdraws a portion of a 
notice of proposed rulemaking (REG-119305-11) to the extent not adopted 
by final regulations. This document also contains new proposed 
regulations addressing when certain obligations to restore a deficit 
balance in a partner's capital account are disregarded under section 
704 of the Internal Revenue Code (Code) and when partnership 
liabilities are treated as recourse liabilities under section 752. 
These regulations would affect partnerships and their partners.

DATES: The notice of proposed rulemaking under sections 707 and 752 
that was published in the Federal Register on January 30, 2014 (REG-
119305-11, 79 FR 4826), is partially withdrawn as of October 5, 2016. 
Written or electronic comments and requests for a public hearing must 
be received by January 3, 2017.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-122855-15), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
122855-15), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC, or sent electronically, via the Federal 
eRulemaking Portal site at https://www.regulations.gov (indicate IRS and 
REG-122855-15).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Caroline E. Hay or Deane M. Burke, (202) 317-5279; concerning 
submissions of comments and requests for a public hearing, Regina L. 
Johnson, (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: In addition to these proposed regulations, 
the Treasury Department and the IRS are publishing in the Rules and 
Regulations section in this issue of the Federal Register: (1) Final 
regulations under section 707 concerning disguised sales and under 
section 752 regarding the allocation of excess nonrecourse liabilities 
and (2) temporary regulations concerning a partner's share of 
partnership liabilities for purposes of section 707 and the treatment 
of certain payment obligations under section 752.

Paperwork Reduction Act

    The collection of information related to these proposed regulations 
under section 752 is reported on Form 8275, Disclosure Statement, and 
has been reviewed in accordance with the Paperwork Reduction Act (44 
U.S.C. 3507) and approved by the Office of Management and Budget under 
control number 1545-0889. Comments concerning the collection of 
information and the accuracy of estimated average annual burden and 
suggestions for reducing this burden should be sent to the Office of 
Management and Budget, Attn: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503, with copies to the Internal Revenue Service, IRS Reports 
Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments 
on the burden associated with this collection of information should be 
received by December 5, 2016.
    The collection of information in these proposed regulations is in 
proposed Sec.  1.752-2(b)(3)(ii)(D) (which cross references the 
requirement in Sec.  1.752-2T(b)(3)(ii)(D)). This information is 
required by the IRS to ensure that section 752 of the Code and 
applicable regulations are properly applied for allocations of 
partnership liabilities. The respondents will be partners and 
partnerships.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by section 6103.

Background

1. Overview

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 704, 707, and 752 of the 
Code. On January 30, 2014, the Treasury Department and the IRS 
published a notice of proposed rulemaking in the Federal Register (REG-
119305-11, 79 FR 4826) to amend the then existing regulations under 
section 707 relating to disguised sales of property to or by a 
partnership and under section 752 concerning the treatment of 
partnership liabilities (the 2014 Proposed Regulations). The 2014 
Proposed Regulations provided certain technical rules intended to 
clarify the application of the disguised sale rules under section 707. 
The 2014 Proposed Regulations also contained rules regarding the 
sharing of partnership recourse and nonrecourse liabilities under 
section 752.
    A public hearing on the 2014 Proposed Regulations was not requested 
or held, but the Treasury Department and the IRS received written 
comments. After consideration of, and in response to, the comments on 
the 2014 Proposed Regulations, the Treasury Department and the IRS are 
withdrawing the 2014 Proposed Regulations under Sec.  1.752-2 and 
publishing new proposed regulations under Sec.  1.752-2, as well as 
proposed regulations under section 704. Concurrently in this issue of 
the Federal Register, the Treasury Department and the IRS are also 
publishing final regulations that adopt, as modified, the 2014 Proposed 
Regulations under section 707 and Sec.  1.752-3, and temporary 
regulations under sections 707 and 752.

2. Summary of Applicable Law

    Section 752 separates partnership liabilities into two categories: 
recourse liabilities and nonrecourse liabilities. Section 1.752-1(a)(1) 
provides that a partnership liability is a recourse liability to the 
extent that any partner or related person bears the economic risk of 
loss (EROL) for that liability under Sec.  1.752-2. Section 1.752-
1(a)(2) provides that a partnership liability is a nonrecourse 
liability to the extent that no partner or related person bears the 
EROL for that liability under Sec.  1.752-2.
    A partner generally bears the EROL for a partnership liability if 
the partner or related person has an obligation to make a payment to 
any person within the meaning of Sec.  1.752-2(b). For purposes of 
determining the extent to which a partner or related person has an 
obligation to make a payment, an obligation to restore a deficit 
capital account upon liquidation of the partnership under the section 
704(b) regulations is taken into account. Further, for this purpose, 
Sec.  1.752-2(b)(6)

[[Page 69302]]

of the existing regulations presumes that partners and related persons 
who have payment obligations actually perform those obligations, 
irrespective of their net worth, unless the facts and circumstances 
indicate a plan to circumvent or avoid the obligation (the satisfaction 
presumption). However, the satisfaction presumption is subject to an 
anti-abuse rule in Sec.  1.752-2(j) pursuant to which a payment 
obligation of a partner or related person may be disregarded or treated 
as an obligation of another person if facts and circumstances indicate 
that a principal purpose of the arrangement is to eliminate the 
partner's EROL with respect to that obligation or create the appearance 
of the partner or related person bearing the EROL when the substance is 
otherwise. Under the existing rules, the satisfaction presumption is 
also subject to a disregarded entity net value requirement under Sec.  
1.752-2(k) pursuant to which, for purposes of determining the extent to 
which a partner bears the EROL for a partnership liability, a payment 
obligation of a disregarded entity is taken into account only to the 
extent of the net value of the disregarded entity as of the allocation 
date that is allocated to the partnership liability.

3. 2014 Proposed Regulations

    As discussed in greater detail in the Summary of Comments and 
Explanation of Provisions section of this preamble, Sec.  1.752-2 of 
the 2014 Proposed Regulations generally, among other things, (1) 
provided that a partner's or related person's obligation to make a 
payment with respect to a partnership liability (excluding those 
imposed by state law) would not be recognized for purposes of section 
752 unless each recognition factor was satisfied; (2) applied the list 
of recognition factors to all payment obligations under Sec.  1.752-
2(b), including a partner's obligation to restore a deficit capital 
account upon liquidation of a partnership (deficit restoration 
obligations, or DROs) as provided under the section 704(b) regulations; 
and (3) provided generally that a payment obligation would be 
recognized to the extent of the net value of a partner or related 
person as of the allocation date.
    After consideration of the comments received on the 2014 Proposed 
Regulations, the Treasury Department and the IRS are reconsidering the 
rules under section 752 regarding payment obligations that are 
recognized under Sec.  1.752-2(b)(3), the satisfaction presumption 
under Sec.  1.752-2(b)(6), the anti-abuse rule provided in Sec.  1.752-
2(j), and the net value requirement as provided in Sec.  1.752-2(k). 
Accordingly, the Treasury Department and the IRS are withdrawing Sec.  
1.752-2 of the 2014 Proposed Regulations and publishing these new 
proposed regulations that would amend existing regulations under 
sections 704 and 752. These new provisions, and comments received on 
the 2014 Proposed Regulations that are pertinent to these new 
provisions, are discussed in the Summary of Comments and Explanation of 
Provisions section of the preamble that follows.

4. Final and Temporary Regulations Under Section 707 and Requests for 
Comments

    As previously mentioned, the Treasury Department and the IRS are 
concurrently publishing temporary regulations under section 707 
(concerning disguised sales) (the 707 Temporary Regulations) and 
section 752 (concerning recourse liabilities, in particular bottom 
dollar payment obligations) (the 752 Temporary Regulations), and final 
regulations under section 707 and Sec.  1.752-3. The temporary 
regulations are incorporated by cross reference in these proposed 
regulations. Notably, the 707 Temporary Regulations provide that, for 
disguised sale purposes, partners determine their share of any 
partnership liability in the manner in which excess nonrecourse 
liabilities are allocated under Sec.  1.752-3(a)(3) (with certain 
limitations). Generally, a partner's share of the excess nonrecourse 
liability is determined in accordance with the partner's share of 
partnership profits taking into account all the facts and circumstances 
relating to the economic arrangement of the partners. The Treasury 
Department and the IRS recognize that taxpayers may require further 
guidance regarding reasonable methods for determining a partner's share 
of partnership profits under Sec.  1.752-3(a)(3) for disguised sale 
purposes, especially given that a partner's share may change from year 
to year or differ with respect to different partnership assets and 
believe it may be appropriate to issue administrative guidance for this 
purpose. Accordingly, comments are requested regarding possible safe 
harbors and reasonable methods for determining a partner's share of 
profits, taking into account all of the relevant facts and 
circumstances relating to the economic arrangement of the partners. The 
preamble to the temporary regulations describes the provisions in 
greater detail. In addition, the final regulations under section 707 
also include a request for comments concerning the exception for 
reimbursements of preformation capital expenditures under Sec.  1.707-
4(d), which is described in greater detail in the preamble to the final 
regulations.

Summary of Comments and Explanation of Provisions

1. Rights of Reimbursement

    Section 1.752-2(b)(1) provides that, except as otherwise provided 
in Sec.  1.752-2, a partner bears the EROL for a partnership liability 
to the extent that, if the partnership constructively liquidated, the 
partner or related person would be obligated to make a payment to any 
person (or a contribution to the partnership) because that liability 
becomes due and payable and the partner or related person would not be 
entitled to reimbursement from another partner or a person that is a 
related person to another partner. Section 1.752-2(b)(1) presumes that, 
in the constructive liquidation, the partnership has a value of zero 
with which to pay its liabilities. Under the 2014 Proposed Regulations, 
a partner would not bear the EROL under Sec.  1.752-2(b)(1) if the 
partner or related person is entitled to a reimbursement from ``any 
person.'' Commenters noted that a reimbursement from ``any person'' 
would include a reimbursement from the partnership, which is contrary 
to the intent of the regulations under section 752. A right to be 
reimbursed by the partnership should be disregarded, as Sec.  1.752-
2(b)(1) presumes that the partnership would not be able to pay the 
liability or reimburse the partner. The Treasury Department and the IRS 
agree with the concerns expressed in the comments; therefore, these 
proposed regulations do not include the changes to Sec.  1.752-2(b)(1) 
that were in the 2014 Proposed Regulations.

2. Arrangements Part of a Plan To Circumvent or Avoid an Obligation

    The 2014 Proposed Regulations provided that a partner's or related 
person's obligation to make a payment with respect to a partnership 
liability (excluding those imposed by state law) will not be recognized 
for purposes of section 752 unless: (1) The partner or related person 
is (A) required to maintain a commercially reasonable net worth 
throughout the term of the payment obligation or (B) subject to 
commercially reasonable contractual restrictions on transfers of assets 
for inadequate consideration; (2) the partner or related person is 
required periodically to provide commercially reasonable documentation 
regarding the partner's or related person's financial condition; (3) 
the term of the payment obligation does not end prior to the term

[[Page 69303]]

of the partnership liability; (4) the payment obligation does not 
require that the primary obligor or any other obligor with respect to 
the partnership liability directly or indirectly hold money or other 
liquid assets in an amount that exceeds the reasonable needs of such 
obligor; (5) the partner or related person received arm's length 
consideration for assuming the payment obligation; and (6) the 
obligation is not a bottom dollar guarantee or indemnity (recognition 
factors).
    Commenters expressed concerns with the all-or-nothing approach in 
the 2014 Proposed Regulations. One commenter noted that a partner could 
cause an obligation to deliberately fail one of the recognition factors 
so as to cause a liability to be treated as nonrecourse if such 
characterization potentially would be beneficial to such partner, even 
if that partner did, in fact, bear the EROL. This commenter also noted 
that commercial arrangements rarely satisfy each and every one of the 
recognition factors and commercial practices tend to change over time, 
thereby rendering the recognition factors out of date. This commenter 
recommended that regulations instead provide a nonexclusive list of 
facts and circumstances containing as factors many of the items 
identified in the 2014 Proposed Regulations.
    The Treasury Department and the IRS believe that the concerns 
expressed by the commenters are valid and thus propose to move the list 
of factors to an anti-abuse rule in Sec.  1.752-2(j), other than the 
recognition factors concerning bottom dollar guarantees and 
indemnities, which are addressed in the 752 Temporary Regulations. 
Under the anti-abuse rule, factors are weighed to determine whether a 
payment obligation should be respected. The list of factors in the 
anti-abuse rule in these proposed regulations is nonexclusive, and the 
weight to be given to any particular factor depends on the particular 
case. Furthermore, the presence or absence of any particular factor, in 
itself, is not necessarily indicative of whether or not a payment 
obligation is recognized under Sec.  1.752-2(b).
    In addition to comments addressing the recognition factor approach 
in the 2014 Proposed Regulations, the Treasury Department and the IRS 
received specific comments regarding the individual recognition 
factors. With respect to the first recognition factor regarding 
commercially reasonable net worth or restrictions on transfers, one 
commenter agreed that an obligor should have the wherewithal to make a 
payment to the extent required for the entire duration of its 
obligation, but believed that this concern is alleviated by the anti-
abuse rule in the current regulations under Sec.  1.752-2(j). This 
commenter suggested that the anti-abuse rule in Sec.  1.752-2(j) 
contain additional examples to illustrate abusive or problematic 
situations. Another commenter noted that the 2014 Proposed Regulations 
did not address the consequences if a partner or related person 
breaches its payment obligation under an agreement regarding net worth 
or restrictions on transfers and suggested that the regulations address 
such consequences in an anti-abuse rule (for example, a partner's or 
related person's payment obligation may be disregarded if it is 
determined that the creditor lacked the intent to enforce its rights 
under the agreement).
    With respect to the first two recognition factors, commenters 
expressed concerns with the use of the terms ``commercially 
reasonable'' and ``commercially reasonable documentation.'' One 
commenter believed that these terms are vague and subjective and would 
require partnerships to make difficult judgments as to whether these 
recognition factors have been met prior to allocating any partnership 
liability. Another commenter noted that the ``commercially reasonable 
documentation'' recognition factor did not specify who should receive 
the documentation and that such documentation should be provided to the 
lender.
    Moving the list of factors to an anti-abuse rule should alleviate 
some of the concerns expressed regarding both whether a payment obligor 
has the wherewithal to pay and the use of the term ``commercially 
reasonable.'' The proposed regulations also revise the first two 
factors to provide clarity by limiting the first factor to examine 
solely whether the partner or related person is subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, such as restrictions on transfers for inadequate consideration 
or equity distributions. In addition, the proposed regulations do not 
retain the subjective commercially reasonable net worth factor, but 
instead include a new factor that examines whether the payment 
obligation restricts the creditor from promptly pursuing payment 
following a default on the partnership liability or whether there are 
other arrangements that indicate a plan to delay collection.
    The proposed regulations retain the use of the ``commercially 
reasonable'' standard, however, because different facts may require a 
different standard of whether contractual restrictions and 
documentation are ``commercially reasonable'' with respect to a 
particular industry, and the flexible nature of the term is helpful in 
informing partnerships and their partners that obligations should be 
consistent with what is customary in the marketplace. With respect to 
the second recognition factor regarding documentation, these proposed 
regulations also clarify that the factor examines whether commercially 
reasonable documentation was provided to the party that benefits from 
the payment obligation (for example, the creditor in the case of a 
guarantee or the indemnified party in the case of an indemnification 
arrangement).
    Commenters also noted that certain recognition factors do not take 
into account industry specific practices. One commenter pointed out 
that the requirement that a payment obligation last throughout the full 
term of the partnership's loan is contrary to commercial practice in 
some cases. In particular, the commenter noted that, in the real estate 
industry context, it is common for a construction loan to be guaranteed 
until the property reaches a required level of stabilization. This 
commenter did believe, however, that a payment obligation should be 
disregarded if the guarantor or other obligor has an unrestricted 
unilateral right to terminate the obligation at will, including 
immediately before the obligation becomes due and payable. Commenters 
also noted that the recognition factor that would require arm's length 
consideration is not commercial, as a partner is often willing to enter 
into a guarantee or other payment obligation with respect to a 
partnership liability because the partner will benefit from the 
liability in the obligor's capacity as a partner. The Treasury 
Department and the IRS agree with these recommendations; thus, these 
proposed regulations take into account industry practice with respect 
to terminations of payment obligations and do not include the arm's 
length consideration factor.
    A commenter also expressed concerns regarding the recognition 
factor that examines whether a primary obligor or any other obligor 
with respect to the partnership liability is required to hold assets in 
an amount that exceeds the reasonable needs of the obligor. The 
commenter noted that partnership agreements often include restrictions 
on distributions before certain hurdles are satisfied for a variety of 
reasons, such as to protect the interests of preferred partners or for 
prudent business management. Another commenter agreed with the legal 
theory

[[Page 69304]]

underpinning the recognition factor (to address fact patterns in which 
the taxpayer intended and acted to ensure the partnership maintained 
sufficient collateral to repay the creditor without exposing the 
obligor to meaningful liability) but suggested that commercially 
required or prudent reserves not be considered. Both commenters 
suggested that an example illustrating the restrictions that violate 
this factor would be helpful.
    The commenters' concerns should be largely addressed by making this 
recognition factor one of many examined under the anti-abuse rule that 
looks to whether there is a plan to circumvent or avoid the obligation. 
Under the anti-abuse rule, an obligor's retention of assets for its 
reasonable foreseeable needs (such as for commercial or prudent 
business reasons) generally would not, on its own, indicate that there 
is a plan to circumvent or avoid the obligation.
    Finally, the proposed regulations provide two additional factors 
that indicate when a plan to circumvent or avoid an obligation exists. 
The first provides that, in the case of a guarantee or similar 
arrangement, the terms of the liability would be substantially the same 
had the partner or related person not agreed to provide the guarantee. 
This factor indicates that the guarantee was not required by the 
lender, presumably because the partnership had sufficient assets to 
satisfy its obligation. The second additional factor examines whether 
the creditor or other party benefiting from the obligation received 
executed documents with respect to the payment obligation from the 
partner or related person before, or within a commercially reasonable 
time after, the creation of the obligation.

3. Deficit Restoration Obligations

    The 2014 Proposed Regulations applied the list of recognition 
factors discussed in Section 2 of this Summary of Comments and 
Explanation of Provisions to all payment obligations under Sec.  1.752-
2(b), including a DRO, as provided under the section 704(b) 
regulations. Commenters explained that not all of the recognition 
factors could be satisfied with respect to a DRO. In addition, 
commenters suggested that the regulations under section 704(b) be 
amended to clarify that if a DRO is not given effect under section 752, 
it should not be given effect under section 704(b).
    A DRO is an obligation to the partnership that is imposed by the 
partnership agreement. In contrast, a guarantee or indemnity is a 
contractual obligation outside the partnership agreement. As a result 
of this difference and based on the comments on the 2014 Proposed 
Regulations, the proposed regulations refine the list of factors 
applicable to DROs and clarify the interaction of section 752 with 
section 704 regarding DROs. Under Sec.  1.704-1(b)(2)(ii)(c)(2) of the 
existing regulations, a partner's DRO is not respected if the facts and 
circumstances indicate a plan to circumvent or avoid the partner's DRO. 
These proposed regulations add a list of factors to Sec.  1.704-
1(b)(2)(ii)(c) that are similar to the factors in the proposed anti-
abuse rule under Sec.  1.752-2(j), but specific to DROs, to indicate 
when a plan to circumvent or avoid an obligation exists. Under the 
proposed regulations, the following factors indicate a plan to 
circumvent or avoid an obligation: (1) The partner is not subject to 
commercially reasonable provisions for enforcement and collection of 
the obligation; (2) the partner is not required to provide (either at 
the time the obligation is made or periodically) commercially 
reasonable documentation regarding the partner's financial condition to 
the partnership; (3) the obligation ends or could, by its terms, be 
terminated before the liquidation of the partner's interest in the 
partnership or when the partner's capital account as provided in Sec.  
1.704-1(b)(2)(iv) is negative; and (4) the terms of the obligation are 
not provided to all the partners in the partnership in a timely manner.
    Notwithstanding the proposed factors, the Treasury Department and 
the IRS have concerns with whether and to what extent it is appropriate 
to recognize DROs (and certain partner notes treated as DROs) as 
meaningful payment obligations. Many DROs are triggered only on the 
liquidation of a partnership. However, some partnerships are intended 
to have perpetual life and other partnerships can effectively cease 
operations but not actually liquidate; therefore, a partner's DRO may 
never be required to be satisfied. In addition, some DROs can be 
terminated or significantly reduced in a manner that may not be 
appropriate, and therefore, the DRO similarly may never be triggered. 
The Treasury Department and the IRS request comments on the extent to 
which such DROs should be recognized. In addition, certain partner 
notes are treated as DROs under Sec.  1.704-1(b)(2)(ii)(c)(1) and (3) 
of these proposed regulations. The Treasury Department and the IRS also 
request comments concerning whether these obligations should continue 
to be treated as DROs.

4. Exculpatory Liabilities

    One commenter suggested that the 2014 Proposed Regulations would 
result in more liabilities being characterized as nonrecourse 
liabilities, in particular, so-called, ``exculpatory liabilities,'' and 
urged the Treasury Department and the IRS to provide guidance with 
respect to such liabilities. An exculpatory liability is a liability 
that is recourse to an entity under state law and section 1001, but no 
partner bears the EROL within the meaning of section 752. Thus, the 
liability is treated as nonrecourse for section 752 purposes. The 
Treasury Department and the IRS are studying the treatment of 
exculpatory liabilities under sections 704 and 752 and agree that 
guidance is warranted in this area. However, the treatment of 
exculpatory liabilities is beyond the scope of these proposed 
regulations. The Treasury Department and the IRS seek additional 
comments regarding the proper treatment of an exculpatory liability 
under regulations under section 704(b) and the effect of such a 
liability's classification under section 1001. Further, the Treasury 
Department and the IRS request additional comments addressing the 
allocation of an exculpatory liability among multiple assets and 
possible methods for calculating minimum gain with respect to such 
liability, such as the so-called ``floating lien'' approach (whereby 
all the assets in the entity, including cash, are considered to be 
subject to the exculpatory liability) or a specific allocation 
approach.

5. Net Value

    Section 1.752-2(b)(6) of the existing regulations provides that, 
for purposes of determining the extent to which a partner or related 
person has a payment obligation and the EROL, it is assumed that all 
partners and related persons who have obligations to make payments 
actually perform those obligations, irrespective of their actual net 
worth, unless the facts and circumstances indicate a plan to circumvent 
or avoid the obligation. See Sec.  1.752-2(b)(6), cross referencing 
Sec.  1.752-2(j) and (k). Under the anti-abuse rule in Sec.  1.752-
2(j), a payment obligation is disregarded if there is a plan to 
circumvent or avoid such obligation. Section 1.752-2(k)(1) provides 
that, when determining the extent to which a partner bears the EROL for 
a partnership liability, a payment obligation of a business entity that 
is disregarded as an entity separate from its owner under section 
856(i), section 1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-3 
of the Procedure and Administration Regulations (a

[[Page 69305]]

disregarded entity) is taken into account only to the extent of the net 
value of the disregarded entity as of the allocation date that is 
allocated to the partnership liability. Section 1.752-2(k)(2)(i) 
provides, in part, that net value is the fair market value of all 
assets owned by the disregarded entity that may be subject to 
creditors' claims under local law less all obligations of the 
disregarded entity that do not constitute Sec.  1.752-2(b)(1) payment 
obligations of the disregarded entity.
    The 2014 Proposed Regulations provided that, in determining the 
extent to which a partner or related person other than an individual or 
a decedent's estate bears the EROL for a partnership liability other 
than a trade payable, a payment obligation is recognized only to the 
extent of the net value of the partner or related person that, as of 
the allocation date, is allocated to the liability, as determined under 
Sec.  1.752-2(k). The 2014 Proposed Regulations also provided that the 
partner must provide a statement concerning the net value of the 
payment obligor to the partnership. The preamble to the 2014 Proposed 
Regulations requested comments concerning whether the net value rule 
should also apply to individuals and estates and whether the 
regulations should consolidate these rules under Sec.  1.752-2(k).
    Commenters expressed concerns that an expansion of the net value 
rule would add considerable burden and expense to taxpayers and would 
likely lead to time consuming and costly disputes regarding valuations. 
Another commenter explained that taxpayers have often avoided the net 
value regulations (by not using disregarded entities) or have applied 
the regulations only when the disregarded entity has minimal or no 
assets.
    Commenters suggested that if the net value rule is retained, Sec.  
1.752-2(k) should be extended to all partners and related persons other 
than individuals. One commenter expressed concerns that a partner who 
may be treated as bearing the EROL with respect to a partnership 
liability would have to provide information regarding the net value of 
the payment obligor, which is unnecessarily intrusive. Another 
commenter believed that if the rules requiring net value were extended 
to all partners in partnerships, the attempt to achieve more realistic 
substance would be accompanied by a corresponding increase in the 
potential for manipulation.
    The Treasury Department and the IRS remain concerned with ensuring 
that a partner or related person only be presumed to satisfy its 
payment obligation to the extent that such partner or related person 
would be able to pay on the obligation. After consideration of the 
comments, however, the Treasury Department and the IRS agree that 
expanding the application of the net value rules under Sec.  1.752-2(k) 
may lead to more litigation and may unduly burden taxpayers. 
Furthermore, net value as provided in Sec.  1.752-2(k) may not 
accurately take into account the future earnings of a business entity, 
which normally factor into lending decisions. Therefore, the Treasury 
Department and the IRS propose to remove Sec.  1.752-2(k) and instead 
create a new presumption under the anti-abuse rule in Sec.  1.752-2(j). 
Under the presumption in the proposed regulations, evidence of a plan 
to circumvent or avoid an obligation is deemed to exist if the facts 
and circumstances indicate that there is not a reasonable expectation 
that the payment obligor will have the ability to make the required 
payments if the payment obligation becomes due and payable. A payment 
obligor includes disregarded entities (including grantor trusts). These 
proposed regulations also add an example to illustrate the application 
of the anti-abuse rule when the payment obligor is an underfunded 
entity. Under these proposed regulations, Sec.  1.752-2(b)(6) continues 
to presume that payment obligations with respect to a partnership 
liability will be satisfied unless evidence of a plan to circumvent or 
avoid the obligation exists as determined under Sec.  1.752-2(j). If 
evidence of a plan to circumvent or avoid the obligation exists or is 
deemed to exist, the obligation is not recognized under Sec.  1.752-
2(b) and therefore the partnership liability is treated as a 
nonrecourse liability under Sec.  1.752-1(a)(2).

Proposed Applicability Dates

    The amendments to Sec.  1.704-1 are proposed to apply on or after 
the date these regulations are published as final regulations in the 
Federal Register. The amendments to Sec.  1.752-2 are proposed to apply 
to liabilities incurred or assumed by a partnership and to payment 
obligations imposed or undertaken with respect to a partnership 
liability on or after the date these regulations are published as final 
regulations in the Federal Register. Partnerships and their partners 
may rely on these proposed regulations prior to the date they are 
published as final regulations in the Federal Register. However, the 
rules in Sec.  1.752-2(k) still apply to disregarded entities until the 
proposed regulations are published as final regulations in the Federal 
Register.
    Some commenters were concerned that the 2014 Proposed Regulations 
``delinked'' the regulations under sections 704 and 752 concerning 
DROs, that is, that a DRO may somehow still be recognized under section 
704 despite not meeting the requirements to be recognized as a payment 
obligation under section 752. DROs are subject to the bottom dollar 
payment obligation rules in the 752 Temporary Regulations, but the 
rules in these proposed regulations concerning DROs will not be 
effective prior to the date they are published as final regulations in 
the Federal Register. However, these proposed regulations allow 
partnerships and their partners to rely on the proposed regulations, 
which should address this concern.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. It is hereby certified that the collection of 
information in these regulations will not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that the amount of time necessary to report the 
required information will be minimal in that it requires partnerships 
(including partnerships that may be small entities) to provide 
information they already maintain or can easily obtain to the IRS. 
Moreover, it should take a partnership no more than 2 hours to satisfy 
the information requirement in these regulations. Accordingly, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the 
Code, this notice of proposed rulemaking has been submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) or electronic comments that are submitted timely 
to the IRS. The Treasury Department and the IRS request comments on all 
aspects of the proposed regulations. All comments will be available for 
public inspection

[[Page 69306]]

and copying at www.regulations.gov or upon request. A public hearing 
will be scheduled if requested in writing by a person who timely 
submits written comments. If a public hearing is scheduled, notice of 
the date, time, and place of the hearing will be published in the 
Federal Register.

Drafting Information

    The principal authors of these regulations are Caroline E. Hay and 
Deane M. Burke of the Office of the Associate Chief Counsel 
(Passthroughs & Special Industries), IRS. However, other personnel from 
the Treasury Department and the IRS participated in their development.

Withdrawal of Proposed Regulations

    Accordingly, under the authority of 26 U.S.C. 7805, Sec.  1.752-2 
of the notice of proposed rulemaking (REG-119305-11) that was published 
in the Federal Register on January 30, 2014 (79 FR 4826) is withdrawn.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sections 1.707-2 through 1.707-9 also issued under 26 U.S.C. 
707(a)(2)(B).
0
Par. 2. Section 1.704-1 is amended by:
0
1. Adding two sentences to the end of paragraph (b)(1)(ii)(a).
0
2. Adding a sentence to the end of paragraph (b)(2)(ii)(b)(3) 
introductory text.
0
3. Removing the undesignated paragraph following paragraph 
(b)(2)(ii)(b)(3).
0
4. Adding paragraphs (b)(2)(ii)(b)(4) through (7).
0
5. Revising paragraph (b)(2)(ii)(c).
    The additions and revisions read as follows:


Sec.  1.704-1  Partner's distributive share.

* * * * *
    (b) * * *
    (1) * * *
    (ii) * * *
    (a) * * * Furthermore, the last sentence of paragraph 
(b)(2)(ii)(b)(3) of this section and paragraphs (b)(2)(ii)(b)(4) 
through (7) and (b)(2)(ii)(c) of this section apply on or after the 
date these regulations are published as final regulations in the 
Federal Register. However, taxpayers may rely on the last sentence of 
paragraph (b)(2)(ii)(b)(3) of this section and paragraphs 
(b)(2)(ii)(b)(4) through (7) and (b)(2)(ii)(c) of this section on or 
after October 5, 2016 and before the date these regulations are 
published as final regulations in the Federal Register.
* * * * *
    (2) * * *
    (ii) * * *
    (b) * * *
    (3) * * * Notwithstanding the partnership agreement, an obligation 
to restore a deficit balance in a partner's capital account, including 
an obligation described in paragraph (b)(2)(ii)(c)(1) of this section, 
will not be respected for purposes of this section to the extent the 
obligation is disregarded under paragraph (b)(2)(ii)(c)(4) of this 
section.
    (4) For purposes of paragraphs (b)(2)(ii)(b)(1) through (3) of this 
section, a partnership taxable year shall be determined without regard 
to section 706(c)(2)(A).
    (5) The requirements in paragraphs (b)(2)(ii)(b)(2) and (3) of this 
section are not violated if all or part of the partnership interest of 
one or more partners is purchased (other than in connection with the 
liquidation of the partnership) by the partnership or by one or more 
partners (or one or more persons related, within the meaning of section 
267(b) (without modification by section 267(e)(1)) or section 
707(b)(1), to a partner) pursuant to an agreement negotiated at arm's 
length by persons who at the time such agreement is entered into have 
materially adverse interests and if a principal purpose of such 
purchase and sale is not to avoid the principles of the second sentence 
of paragraph (b)(2)(ii)(a) of this section.
    (6) The requirement in paragraph (b)(2)(ii)(b)(2) of this section 
is not violated if, upon the liquidation of the partnership, the 
capital accounts of the partners are increased or decreased pursuant to 
paragraph (b)(2)(iv)(f) of this section as of the date of such 
liquidation and the partnership makes liquidating distributions within 
the time set out in the requirement in paragraph (b)(2)(ii)(b)(2) of 
this section in the ratios of the partners' positive capital accounts, 
except that it does not distribute reserves reasonably required to 
provide for liabilities (contingent or otherwise) of the partnership 
and installment obligations owed to the partnership, so long as such 
withheld amounts are distributed as soon as practicable and in the 
ratios of the partners' positive capital account balances.
    (7) See examples (1)(i) and (ii), (4)(i), (8)(i), and (16)(i) of 
paragraph (b)(5) of this section for issues concerning paragraph 
(b)(2)(ii)(b) of this section.
    (c) Obligation to restore deficit--(1) Other arrangements treated 
as obligations to restore deficits. If a partner is not expressly 
obligated to restore the deficit balance in such partner's capital 
account, such partner nevertheless will be treated as obligated to 
restore the deficit balance in his capital account (in accordance with 
the requirement in paragraph (b)(2)(ii)(b)(3) of this section and 
subject to paragraph (b)(2)(ii)(c)(2) of this section) to the extent 
of--
    (A) The outstanding principal balance of any promissory note (of 
which such partner is the maker) contributed to the partnership by such 
partner (other than a promissory note that is readily tradable on an 
established securities market), and
    (B) The amount of any unconditional obligation of such partner 
(whether imposed by the partnership agreement or by state or local law) 
to make subsequent contributions to the partnership (other than 
pursuant to a promissory note of which such partner is the maker).
    (2) Satisfaction requirement. For purposes of paragraph 
(b)(2)(ii)(c)(1) of this section, a promissory note or unconditional 
obligation is taken into account only if it is required to be satisfied 
at a time no later than the end of the partnership taxable year in 
which such partner's interest is liquidated (or, if later, within 90 
days after the date of such liquidation). If a promissory note referred 
to in paragraph (b)(2)(ii)(c)(1) of this section is negotiable, a 
partner will be considered required to satisfy such note within the 
time period specified in this paragraph (b)(2)(ii)(c)(2) if the 
partnership agreement provides that, in lieu of actual satisfaction, 
the partnership will retain such note and such partner will contribute 
to the partnership the excess, if any, of the outstanding principal 
balance of such note over its fair market value at the time of 
liquidation. See paragraph (b)(2)(iv)(d)(2) of this section. See 
examples (1)(ix) and (x) of paragraph (b)(5) of this section.
    (3) Related party notes. For purposes of paragraph (b)(2) of this 
section, if a partner contributes a promissory note to the partnership 
during a partnership taxable year beginning after December 29, 1988, 
and the maker of such note is a person related to such partner (within 
the meaning of Sec.  1.752-4(b)(1)), then such promissory note shall be 
treated as

[[Page 69307]]

a promissory note of which such partner is the maker.
    (4) Obligations disregarded--(A) General rule. A partner in no 
event will be considered obligated to restore the deficit balance in 
his capital account to the partnership (in accordance with the 
requirement in paragraph (b)(2)(ii)(b)(3) of this section) to the 
extent such partner's obligation is a bottom dollar payment obligation 
that is not recognized under Sec.  1.752-2(b)(3) or is not legally 
enforceable, or the facts and circumstances otherwise indicate a plan 
to circumvent or avoid such obligation. See paragraphs (b)(2)(ii)(f), 
(b)(2)(ii)(h), and (b)(4)(vi) of this section for other rules regarding 
such obligation. To the extent a partner is not considered obligated to 
restore the deficit balance in the partner's capital account to the 
partnership (in accordance with the requirement in paragraph 
(b)(2)(ii)(b)(3) of this section), the obligation is disregarded and 
paragraph (b)(2) of this section and Sec.  1.752-2 are applied as if 
the obligation did not exist.
    (B) Factors indicating plan to circumvent or avoid obligation. In 
the case of an obligation to restore a deficit balance in a partner's 
capital account upon liquidation of a partnership, paragraphs 
(b)(2)(ii)(c)(4)(B)(i) through (iv) of this section provide a non-
exclusive list of factors that may indicate a plan to circumvent or 
avoid the obligation. For purposes of making determinations under this 
paragraph (b)(2)(ii)(c)(4), the weight to be given to any particular 
factor depends on the particular case and the presence or absence of 
any particular factor is not, in itself, necessarily indicative of 
whether or not the obligation is respected. The following factors are 
taken into consideration for purposes of this paragraph (b)(2):
    (i) The partner is not subject to commercially reasonable 
provisions for enforcement and collection of the obligation.
    (ii) The partner is not required to provide (either at the time the 
obligation is made or periodically) commercially reasonable 
documentation regarding the partner's financial condition to the 
partnership.
    (iii) The obligation ends or could, by its terms, be terminated 
before the liquidation of the partner's interest in the partnership or 
when the partner's capital account as provided in Sec.  1.704-
1(b)(2)(iv) is negative.
    (iv) The terms of the obligation are not provided to all the 
partners in the partnership in a timely manner.
* * * * *
0
Par. 3. Section 1.707-0 is amended by revising the entries for Sec.  
1.707-5(a)(2)(i) and (ii) to read as follows:


Sec.  1.707-0  Table of contents.

* * * * *


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

    (a) * * *
    (2) * * *
    (i) In general.
    (ii) Partner's share of Sec.  1.752-7 liability.
* * * * *
* * * * *
0
Par. 4. Section 1.707-5 is amended by revising paragraph (a)(2) and 
Examples 2, 3, 7, and 8 of paragraph (f) to read as follows:


Sec.  1.707-5  Disguised sales of property to partnership; special 
rules relating to liabilities.

    (a) * * *
    (2) [The text of proposed Sec.  1.707-5(a)(2) is the same as the 
text of Sec.  1.707-5T(a)(2) published elsewhere in this issue of the 
Federal Register].
* * * * *
    (f) * * *

    Example 2. [The text of proposed Sec.  1.707-5(f) Example 2 is 
the same as the text of Sec.  1.707-5T(f) Example 2 published 
elsewhere in this issue of the Federal Register].
    Example 3. [The text of proposed Sec.  1.707-5(f) Example 3 is 
the same as the text of Sec.  1.707-5T(f) Example 3 published 
elsewhere in this issue of the Federal Register].
* * * * *
    Example 7. [The text of proposed Sec.  1.707-5(f) Example 7 is 
the same as the text of Sec.  1.707-5T(f) Example 7 published 
elsewhere in this issue of the Federal Register].
    Example 8. [The text of proposed Sec.  1.707-5(f) Example 8 is 
the same as the text of Sec.  1.707-5T(f) Example 8 published 
elsewhere in this issue of the Federal Register].
* * * * *
0
Par. 5. Section 1.707-9 is amended by adding paragraph (a)(5) to read 
as follows:


Sec.  1.707-9  Effective dates and transitional rules.

    (a) * * *
    (5) [The text of proposed Sec.  1.707-9(a)(5) is the same as the 
text of Sec.  1.707-9T(a)(5) published elsewhere in this issue of the 
Federal Register].
* * * * *
0
Par. 6. Section 1.752-0 is amended by:
0
1. Adding entries for Sec.  1.752-2(b)(3)(i) and (ii), (b)(3)(ii)(A) 
and (B), (b)(3)(ii)(C), (b)(3)(ii)(C)(1) through (3), (b)(3)(ii)(D), 
and (b)(3)(iii).
0
2. Adding entries for Sec.  1.752-2(j)(2)(i) and (ii).
0
3. Adding entries for Sec.  1.752-2(j)(3)(i) through (iii).
0
4. Revising the entries for Sec.  1.752-2(j)(3) and (4).
0
5. Adding an entry for Sec.  1.752-2(k).
    The revisions and additions read as follows:


Sec.  1.752-0  Table of contents.

* * * * *


Sec.  1.752-2  Partner's share of recourse liabilities.

* * * * *
    (b) * * *
    (3) * * *
    (i) In general.
    (ii) Special rules for bottom dollar payment obligations.
    (A) In general.
    (B) Exception.
    (C) Definition of bottom dollar payment obligation.
    (1) In general.
    (2) Exceptions.
    (3) Benefited party defined.
    (D) Disclosure of bottom dollar payment obligations.
    (iii) Special rule for indemnities and reimbursement agreements.
* * * * *
    (j) * * *
    (2) * * *
    (i) In general.
    (ii) Economic risk of loss.
    (3) Plan to circumvent or avoid an obligation.
    (i) General rule.
    (ii) Factors indicating plan to circumvent or avoid an obligation.
    (iii) Deemed plan to circumvent or avoid an obligation.
    (4) Examples.
    (k) Effective/applicability dates.
* * * * *
0
Par. 7. Section 1.752-2 is amended by:
0
1. Revising the last sentence of paragraph (a).
0
2. Revising paragraph (b)(3) and the last sentence of paragraph (b)(6).
0
3. Adding a sentence to the end of paragraph (f) introductory text and 
adding Examples 10 and 11 to paragraph (f).
0
4. Revising paragraphs (j)(2) and (3).
0
5. Adding paragraph (j)(4).
0
6. Removing paragraph (k).
0
7. Redesignating paragraph (l) as paragraph (k) and revising it.
    The revisions and additions read as follows:


Sec.  1.752-2  Partner's share of recourse liabilities.

    (a) * * * The determination of the extent to which a partner bears 
the economic risk of loss for a partnership liability is made under the 
rules in paragraphs (b) through (j) of this section.

[[Page 69308]]

    (b) * * *
    (3) [The text of proposed Sec.  1.752-2(b)(3) is the same as the 
text of Sec.  1.752-2T(b)(3) published elsewhere in this issue of the 
Federal Register].
* * * * *
    (6) * * * See paragraph (j) of this section.
* * * * *
    (f) Examples. * * * Unless otherwise provided, for purposes of the 
following examples, assume that any obligation of a partner or related 
person to make a payment is recognized under paragraph (b)(3) of this 
section.
* * * * *
    Example 10. [The text of proposed Sec.  1.752-2(f) Example 10 is 
the same as the text of Sec.  1.752-2T(f) Example 10 published 
elsewhere in this issue of the Federal Register].
    Example 11. [The text of proposed Sec.  1.752-2(f) Example 11 is 
the same as the text of Sec.  1.752-2T(f) Example 11 published 
elsewhere in this issue of the Federal Register].
* * * * *
    (j) * * *
    (2) [The text of proposed Sec.  1.752-2(j)(2) is the same as the 
text of Sec.  1.752-2T(j)(2) published elsewhere in this issue of the 
Federal Register].
    (3) Plan to circumvent or avoid an obligation--(i) General rule. An 
obligation of a partner or related person to make a payment is not 
recognized under paragraph (b) of this section if the facts and 
circumstances evidence a plan to circumvent or avoid the obligation.
    (ii) Factors indicating plan to circumvent or avoid an obligation. 
In the case of a payment obligation, other than an obligation to 
restore a deficit capital account upon liquidation of a partnership, 
paragraphs (j)(3)(ii)(A) through (G) of this section provide a non-
exclusive list of factors that may indicate a plan to circumvent or 
avoid the payment obligation. The presence or absence of a factor is 
based on all of the facts and circumstances at the time the partner or 
related person makes the payment obligation or if the obligation is 
modified, at the time of the modification. For purposes of making 
determinations under this paragraph (j)(3), the weight to be given to 
any particular factor depends on the particular case and the presence 
or absence of a factor is not necessarily indicative of whether a 
payment obligation is or is not recognized under paragraph (b) of this 
section.
    (A) The partner or related person is not subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, including, for example, restrictions on transfers for 
inadequate consideration or distributions by the partner or related 
person to equity owners in the partner or related person.
    (B) The partner or related person is not required to provide 
(either at the time the payment obligation is made or periodically) 
commercially reasonable documentation regarding the partner's or 
related person's financial condition to the benefited party.
    (C) The term of the payment obligation ends prior to the term of 
the partnership liability, or the partner or related person has a right 
to terminate its payment obligation, if the purpose of limiting the 
duration of the payment obligation is to terminate such payment 
obligation prior to the occurrence of an event or events that increase 
the risk of economic loss to the guarantor or benefited party (for 
example, termination prior to the due date of a balloon payment or a 
right to terminate that can be exercised because the value of loan 
collateral decreases). This factor typically will not be present if the 
termination of the obligation occurs by reason of an event or events 
that decrease the risk of economic loss to the guarantor or benefited 
party (for example, the payment obligation terminates upon the 
completion of a building construction project, upon the leasing of a 
building, or when certain income and asset coverage ratios are 
satisfied for a specified number of quarters).
    (D) There exists a plan or arrangement in which the primary obligor 
or any other obligor (or a person related to the obligor) with respect 
to the partnership liability directly or indirectly holds money or 
other liquid assets in an amount that exceeds the reasonable 
foreseeable needs of such obligor.
    (E) The payment obligation does not permit the creditor to promptly 
pursue payment following a payment default on the partnership 
liability, or other arrangements with respect to the partnership 
liability or payment obligation otherwise indicate a plan to delay 
collection.
    (F) In the case of a guarantee or similar arrangement, the terms of 
the partnership liability would be substantially the same had the 
partner or related person not agreed to provide the guarantee.
    (G) The creditor or other party benefiting from the obligation did 
not receive executed documents with respect to the payment obligation 
from the partner or related person before, or within a commercially 
reasonable period of time after, the creation of the obligation.
    (iii) Deemed plan to circumvent or avoid an obligation. Evidence of 
a plan to circumvent or avoid an obligation is deemed to exist if the 
facts and circumstances indicate that there is not a reasonable 
expectation that the payment obligor will have the ability to make the 
required payments if the payment obligation becomes due and payable. 
For purposes of this section, a payment obligor includes an entity 
disregarded as an entity separate from its owner under section 856(i), 
section 1361(b)(3), or Sec. Sec.  301.7701-1 through 301.7701-3 of this 
chapter (a disregarded entity), and a trust to which subpart E of part 
I of subchapter J of chapter 1 of the Code applies.
    (4) Examples. The following examples illustrate the principles of 
paragraph (j) of this section.

    Example 1. Gratuitous guarantee. (i) In 2016, A, B, and C form a 
domestic limited liability company (LLC) that is classified as a 
partnership for federal tax purposes. Also in 2016, LLC receives a 
loan from a bank. A, B, and C do not bear the economic risk of loss 
with respect to that partnership liability, and, as a result, the 
liability is treated as nonrecourse under Sec.  1.752-1(a)(2) in 
2016. In 2018, A guarantees the entire amount of the liability. The 
bank did not request the guarantee and the terms of the loan did not 
change as a result of the guarantee. A did not provide any executed 
documents with respect to A's guarantee to the bank. The bank also 
did not require any restrictions on asset transfers by A and no such 
restrictions exist.
    (ii) Under paragraph (j)(3) of this section, A's 2018 guarantee 
(payment obligation) is not recognized under paragraph (b)(3) of 
this section if the facts and circumstances evidence a plan to 
circumvent or avoid the payment obligation. In this case, the 
following factors indicate a plan to circumvent or avoid A's payment 
obligation: (1) The partner is not subject to commercially 
reasonable contractual restrictions that protect the likelihood of 
payment, such as restrictions on transfers for inadequate 
consideration or equity distributions; (2) the partner is not 
required to provide (either at the time the payment obligation is 
made or periodically) commercially reasonable documentation 
regarding the partner's or related person's financial condition to 
the benefited party; (3) in the case of a guarantee or similar 
arrangement, the terms of the liability are the same as they would 
have been without the guarantee; and (4) the creditor did not 
receive executed documents with respect to the payment obligation 
from the partner or related person at the time the obligation was 
created. Absent the existence of other facts or circumstances that 
would weigh in favor of respecting A's guarantee, evidence of a plan 
to circumvent or avoid the obligation exists and, pursuant to 
paragraph (j)(3)(i) of this section, A's guarantee is not recognized 
under paragraph (b) of this section. As a result, LLC's liability 
continues to be treated as nonrecourse.
    Example 2. Underfunded disregarded entity payment obligor. (i) 
In 2016, A forms a wholly owned domestic limited liability

[[Page 69309]]

company, LLC, with a contribution of $100,000. A has no liability 
for LLC's debts, and LLC has no enforceable right to a contribution 
from A. Under Sec.  301.7701-3(b)(1)(ii) of this chapter, LLC is a 
treated for federal tax purposes as a disregarded entity. Also in 
2016, LLC contributes $100,000 to LP, a limited partnership with a 
calendar year taxable year, in exchange for a general partnership 
interest in LP, and B and C each contributes $100,000 to LP in 
exchange for a limited partnership interest in LP. The partnership 
agreement provides that only LLC is required to restore any deficit 
in its capital account. On January 1, 2017, LP borrows $300,000 from 
a bank and uses $600,000 to purchase nondepreciable property. The 
$300,000 is secured by the property and is also a general obligation 
of LP. LP makes payments of only interest on its $300,000 debt 
during 2017. LP has a net taxable loss in 2017, and, under 
Sec. Sec.  1.705-1(a) and 1.752-4(d), LP determines its partners' 
shares of the $300,000 debt at the end of its taxable year, December 
31, 2017. As of that date, LLC holds no assets other than its 
interest in LP.
    (ii) Because LLC is a disregarded entity, A is treated as the 
partner in LP for federal income tax purposes. Only LLC has an 
obligation to make a payment on account of the $300,000 debt if LP 
were to constructively liquidate as described in paragraph (b)(1) of 
this section. Therefore, paragraph (j)(3)(iii) of this section is 
applied to the LLC and not to A. LLC has no assets with which to pay 
if the payment obligation becomes due and payable. As such, evidence 
of a plan to circumvent or avoid the obligation is deemed to exist 
and, pursuant to paragraph (j)(3)(i) of this section, LLC's 
obligation to restore its deficit capital account is not recognized 
under paragraph (b) of this section. As a result, LP's $300,000 debt 
is characterized as nonrecourse under Sec.  1.752-1(a)(2) and is 
allocated among A, B, and C under Sec.  1.752-3.

    (k) Effective/applicability dates. (1) Paragraph (h)(3) of this 
section applies to liabilities incurred or assumed by a partnership on 
or after October 11, 2006, other than liabilities incurred or assumed 
by a partnership pursuant to a written binding contract in effect prior 
to that date. The rules applicable to liabilities incurred or assumed 
(or pursuant to a written binding contract in effect) prior to October 
11, 2006, are contained in Sec.  1.752-2 in effect prior to October 11, 
2006, (see 26 CFR part 1 revised as of April 1, 2006). The last 
sentence of paragraphs (a), (b)(6), and (f) of this section and 
paragraphs (j)(3) and (4) of this section apply to liabilities incurred 
or assumed by a partnership and to payment obligations imposed or 
undertaken with respect to a partnership liability on or after the date 
these regulations are published as final regulations in the Federal 
Register, other than liabilities incurred or assumed by a partnership 
and payment obligations imposed or undertaken pursuant to a written 
binding contract in effect prior to that date. Taxpayers may rely on 
these regulations for the period between October 5, 2016 and the date 
these regulations are published as final regulations in the Federal 
Register.
    (2) [The text of proposed Sec.  1.752-2(k)(2) is the same as the 
text of Sec.  1.752-2T(l)(2) published elsewhere in this issue of the 
Federal Register.]
    (3) [The text of proposed Sec.  1.752-2(k)(3) is the same as the 
text of Sec.  1.752-2T(l)(3) published elsewhere in this issue of the 
Federal Register.]

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-23390 Filed 10-4-16; 8:45 am]
BILLING CODE 4830-01-P