Many of the provisions in the Tax Cuts and Jobs Act (TCJA) will have significant impact on individual taxpayers as well as all types of tax entities, including partnerships and limited liability companies (LLCs). However, there are some provisions of the TCJA that will only impact partnerships and LLCs that are taxed as partnerships. This update is the next in a series that address those specific provisions in greater detail. See the previous updates about the new three-year holding period for certain carried interests and the repeal of the partnership technical termination rule and U.S. withholding on foreign partner's disposal of interest in partnership.
Basis Adjustments for Charitable Contributions and Foreign Taxes
A partner’s initial tax basis in their partnership interest at the time of acquisition is:
- Contributions they make to the partnership
- Their allocated share of the partnership’s taxable income
- Their allocated share of the partnership’s tax-exempt income
Decreased (but not below zero) by:
- Distributions they receive from the partnership
- Their allocated share of the partnership’s losses and other deductions
- Their allocated share of partnership nondeductible expenditures that are not properly chargeable to a capital account
A partner is generally allowed to deduct their distributive share of flow-through partnership losses and deductions only to the extent the partner has sufficient tax basis at the end of the partnership year in which those losses and deductions occurred. The Treasury regulations on this issue, however, didn’t take into account the partner’s share of the partnership’s charitable contributions or foreign taxes when applying this basis limitation. The IRS therefore took the position that the basis limitation on the deductibility of partner losses did not apply to limit the partner’s deduction for its share of the partnership’s charitable contributions.
The TCJA effectively negates that prior ruling by stating that the calculation limiting a partner’s deductible amount of flow-through losses to their basis in their partnership interest now requires the partner to reduce their tax basis by their share of the partnership’s charitable contributions and foreign taxes. This expansion of the basis limitation rule for partnerships to include charitable contributions and foreign taxes is consistent with the basis limitation rules that have always applied for S corporations and their shareholders.
Note that in the case of a charitable contribution by the partnership of appreciated property (property is deemed appreciated for this purpose if the property’s fair market value at the time of the contribution exceeds its adjusted tax basis at the time of the contributions), the partner needs to consider only the adjusted tax basis of the contributed property, not the fair market value, when calculating if they have sufficient tax basis to deduct their flow-through losses.