Technical information regarding the termination policy | Cadwalader, Wickersham & Taft LLP

The Tax Tribunal recently ruled that a new partnership (“New Shoals”) deemed to have been formed upon a technical termination may apply the taxable year beginning on the date of dissolution of the old partnership (“Old Shoals”), rejecting the government’s argument that the new tax year begins the day after the technical end. At stake was New Shoals’s easement deduction for a donation of an easement, which the government argued should be disallowed because New Shoals had not transferred the easement during the tax year and therefore failed to meet the substantive and reporting requirements for deductions for non-cash donations to charitable purposes.

On December 28, 2017, the River Club sold its 92% interest in Shoals to Savannah Shoals Investments, LLC (“Investments”) for $515,000, resulting in the technical termination of Old Shoals and the deemed creation of New Shoals. On the same day, the act granting the conservation easement was signed and registered by a majority of votes of the Investment members. New Shoals claimed the easement deduction on its tax return filed for the remainder of the tax year. Savannah Shoals, LLC (“Shoals”) and the government agreed that Old Shoals’ fiscal year ended on December 28, 2017, but disagreed on the start date of New Shoals’ fiscal year. The Tax Court rejected the government’s argument that New Shoals’ fiscal year must begin on the day after Old Shoals’ dissolution and sided with Shoals that New Shoals’ fiscal year could begin on the same day as its dissolution.

Under the Code and pre-2018 Treasury regulations, a partnership was deemed to dissolve and its taxable year ended when at least 50% of its total capital and profit interests were sold or exchanged within a 12-month period. Although the Tax Cuts and Jobs Act repealed the technical termination rule for tax years beginning after December 31, 2017, the rule remains an issue for partnerships with open years prior to 2018.

In rejecting the government’s argument, the Court pointed to plain language in the applicable Internal Revenue Regulation stating that a new partnership is formed “immediately” upon the technical termination of the contract, which the Court held did not necessarily mean the next day. The Tribunal also referred to the basic tax principle of a partnership, according to which a partnership is established when it generates income or incurs an expense. New Shoals began operations on December 28, 2017, when its members voted to surrender the easement and the deed was signed and recorded, and New Shoals began its existence on December 28 for tax purposes. The Tribunal’s conclusion is also consistent with another fundamental axiom of tax law, according to which an expense is deductible only by the person or persons who incur it. Because New Shoals members financed the purchase of the 92% interest in New Shoals, they are rightfully entitled to the easement deduction.

The tax court provided a common sense interpretation of the provisions on partnership tax in the way taxpayers understand them, rejecting overly complicated and technical interpretations.