Many of the provisions in the TCJA will have a significant impact on individual taxpayers as well as all types of business entities, including partnerships and limited liability companies (LLC) that are taxed as partnerships. However, there are some specific provisions of the TCJA that will impact only partnerships and LLCs. This Update is the second of two that will address those specific provisions in greater detail.
Under prior law, a partnership experienced what was referred to as a technical termination if within any 12-month period there was a sale or exchange of 50% or more of the total interests in the partnership’s capital and profits. In such a case, the partnership was deemed to have contributed all of its assets and liabilities to a new partnership in exchange for equity interests in the new partnership and then to have distributed those equity interests in the new partnership to the purchasing partners and the other remaining partners in proportion to their respective interests in the terminated partnership.
The implications of a technical termination could be positive or negative depending on the facts and circumstances of the partnership and the partners. The following is a list of some, but not all, of those implications:
- The partnership’s taxable year closed, requiring the filing of two short-year income tax returns. One return was filed for the year ended on the date of the termination, and one return was filed for the year ended on the partnership’s normal year-end. If the partnership or its tax preparer was unaware that a technical termination had occurred, it could miss the filing deadline for the first short-year tax return, resulting in late-filing penalties. The filing of two short-period tax returns could also result in a bunching of taxable income for any partner that had a different tax year-end than the partnership and in a potentially higher income tax liability for that partner.
- Partnership-level elections previously made were terminated, and the partnership had the ability to make new elections. Because there was a deemed new partnership, the new partnership could/was required to make all new partnership-level elections. This provided an otherwise unavailable opportunity for a partnership to make different elections going forward than it previously had made — without incurring the cost of having to file a Form 3115 requesting the change or paying a fee for nonautomatic changes. In some cases, absent a technical termination, the partnership might not have had the option available to make changes to prior elections.
- The partnership’s depreciation recovery periods for all of its fixed assets restarted. This rule meant that the net depreciated tax basis (original cost less accumulated depreciation) of each and every fixed asset of the old partnership carried over to the new partnership, where it was then treated as a new asset first placed in service on the date of the technical termination. For example, a commercial building with a 39-year life having an original cost of $1 million and accumulated depreciation of $333,000 after 13 years would be depreciated by the new partnership based on $667,000 cost over 39 years. This obviously resulted in lower annual tax depreciation deductions and higher taxable income to the partners going forward.
Because the prior law often resulted in unintended burdens and costs on unsuspecting partnerships, it’s repeal will be welcomed by most taxpayers and their tax preparers. This change is effective for partnership tax years beginning after December 31, 2017.