When is guaranteed payment taken into account?

One of the partners in a partnership is entitled to a developer’s fee in a new and risky project. Partnership is a calendar year, accrual method taxpayer, and partner is on the cash method. The fee is earned in 2017 as a % of costs incurred, but is not payable until a pending loan is repaid, expected in 2020. The liability for the fee is subordinated to the loan.

The questions are, in what year is the fee added to basis, and, if the fee were instead a deductible item, in what year would the deduction occur?

If the fee is a guaranteed payment, 707(c) covers it. And 267(e)(4) seems to say that 267(a)(2), re: matching payor's deduction to payee's cost, does not apply if 707(c) applies. Reg.1.707-1(c) says

For a guaranteed payment to be a partnership deduction, it must meet the same tests under section 162(a) as it would if the payment had been made to a person who is not a member of the partnership, and the rules of section 263 (relating to capital expenditures) must be taken into account.

Would this include the timing rules? An accrual method taxpayer generally needs to comply with the 2-1/2 month rule for a deduction of deferred compensation. If the accrual (timing) requirement does apply, i.e. the 2-1/2 month rule defers the deduction or addition to basis, the question is why or why not, given the wording in 707(c):

(c) Guaranteed payments
To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses).

And I see we have this in the preamble to the final regs. under 409A:

Taxpayers also may continue to rely upon the explanation in the preamble to the proposed regulations regarding the application of section 409A to guaranteed payments for services described in section 707(c). As stated in that preamble, until further guidance is issued, section 409A will apply to guaranteed payments described in section 707(c) (and rights to receive such guaranteed payments in the future), only in cases where the guaranteed payment is for services and the partner providing services does not include the payment in income by the 15th day of the third month following the end of the taxable year of the partner in which the partner obtained a legally binding right to the guaranteed payment or, if later, the taxable year in which the right to the guaranteed payment is first no longer subject to a substantial risk of forfeiture.

. This was published in TD 9321, in 2007.

¡Ay, caramba! I'll get back to this when I get back from the refrigpbrerator...

Although Leon Sicard is no longer with us, his Tax Court case still is…

Well, I'll be. So it is, right here, https://www.leagle.com/decision/1996279 ... m272512625. And it is a good find for this thread, so thank you. I read it and here are my thoughts.

There was an accrual-method partnership back in the early to mid-80s, between Sicard and another guy, formed to develop and sell condos. There was an agreement to pay certain amounts to Sicard as guaranteed payments, not based on or affected by income of the partnership, for management services he provided to the partnership. The GPs to Sicard in the aggregate of $215k were accrued on a monthly basis from 1983 to 1986, but only $25k was actually drawn down by him (and reported on his 1040s). The rest ($190k) was paid to Sicard in 1987. Because of a misunderstanding by the bookkeeper and the return preparer, the $190k was not included in the 1987 return. This turned out to be rather fortunate. 1983-86 were closed years when IRS assessed a deficiency for 1987, using the argument that, just like the earlier $25k, the income was taxable to Sicard on the cash method.

Citing section 706(a) and reg. 1.707-1(c), the Tax Court held that the guaranteed payments were properly includible in the earlier closed years. Here's part of what the court said.

The tax accounting treatment of a guaranteed payment is determined at the partnership level regardless of the partner's method of accounting. Pratt v. Commissioner [Dec. 33,189], 64 T.C. 203, 212214 (1975) (and cases cited therein), affd. in part and revd. in part on another issue [77-1 USTC ¶ 9347] 550 F.2d 1023 (5th Cir. 1977); Cagle v. Commissioner [Dec. 32,828], 63 T.C. 86, 95 (1974), affd. [76-2 USTC ¶ 9672] 539 F.2d 409 (5th Cir. 1976); S. Rept. 1622, 83d Cong., 2d Sess. 94, 385, 387 (1954). A guaranteed payment is includable in a partner's income in the partner's taxable year in which the payment's tax accounting treatment is determined at the partnership level. Cagle v. Commissioner, supra at 95.

. The court pointed out also that IRS did not argue the duty of consistency, the mitigation provisions of 1311-1314, or the 6-year SOL, and neither will I.

And a little later, as if to emphasize the correctness of its decision, the court awarded Sicard $74k in fees and costs under sec 7430. https://www.leagle.com/decision/1996115472fstcm10821980

The case does not raise 267, but I think we are OK because of 267(e)(4).

So I think we can conclude that the GPs are clearly taxable in the year accrued by the partnership, despite the cash method of the partner. But wait! They do need to be GPs. There is this in a reg. from an unrelated area (section 2701).

Right to a guaranteed payment of a fixed amount under section 707(c). The right to a guaranteed payment of a fixed amount under section 707(c) is the right to a guaranteed payment (within the meaning of section 707(c)) the amount of which is determined at a fixed rate (including a rate that bears a fixed relationship to a specified market interest rate). A payment that is contingent as to time or amount is not a guaranteed payment of a fixed amount.

. Now, as I said, that's an unrelated reg., so maybe that excerpt, for our purposes, is dictum, but I'd like some views here.

And for completeness in response to post #2, yes, Mr Sicard did pass (in 2003), but at least during his life he had the satisfaction of really beating the 900 pound gorilla, making about $1,500,000 on the development that was the subject of the case, and having once been the business partner of Arnold Palmer (though I think not the famous one).

So, in light of the 1.707-1(c) reg. and the holding in Sicard, there is still a loose end as to whether the limitation (that the GP will not be paid unless and until the loan is repaid) causes the accrual not to be a GP at all, and therefore, not controlled by 707(c) as to timing. I think not, i.e., it is a GP. Here's why:

1. Section 707(c) only requires that the amount be payable

... without regard to the income of the partnership.

. I don't see that as a problem, because the facts given indicate no connection to income, and it is entirely possible that the payment will be made from cash flow, even if there is not sufficient income, for example by borrowing or from a buyout of the entity or project. The law does not say there can be no contingency, just that it cannot depend on income.

2. Section 707(c) also says

... but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263, for purposes of section 162(a) (relating to trade or business expenses).

. That seems to me to clearly encompass ordinary and necessary and not charitable and not illegal, etc., but has nothing to do with 267 or 404.

3. The time for inclusion is, per the regs. and the case, as well as section 706(a), in

... the year in which the partnership deducted such payments as paid or accrued under its method of accounting.

4, The rule cited above from section 2701 should not apply, because it is about valuations in gift and estate taxes, nothing to do with income taxes. One is in Subtitle B, the other Subtitle A. And the one in 2701 adds language to the description of guaranteed payment that does not appear in 707:

2701:

(iii) any right to receive any guaranteed payment described in section 707(c) of a fixed amount.

707:

To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership,

But what about section 404(b) and the 2-1/2 month rule? How does that play into the facts?

What I am getting at is this. Even if all the stuff above is right, we have not answered (or maybe even not asked) this question:

Since a guaranteed payment is treated as though the recipient partner is not a partner, then do 404 and the 2-1/2 month rule applies?

The 2-1/2 month rule was not an issue in the Sicard case above. So the analysis applicable to my question would need to take the rule into account. We have a contract between a partnership and a partner to pay an amount not dependent on income but for which payment will be deferred for a few years. Do we treat the partner/recipient as a non-partner, thus making the accrual not available to the partnership because it violates the 2-1/2 month rule? And does it make a difference that the accrual would be capitalized, not expensed, by the partnership? Any specific authority on point would be very much appreciated. And, assuming this is a case of first impression, where on the 6662(d) spectrum would we be if we included the accrual as part of the tax basis of the property being developed?

For reference, the relevant reg. for the 2-1/2 month rule is 1.404(b)-1T.
https://www.law.cornell.edu/cfr/text/26/1.404%28b%29-1T

And the answer would be the same whether we'd consider the recipient partner as an employee or a contractor. See section 404(d).

https://www.nysba.org/Sections/Tax/Tax_ ... _1357.html

Check this out.

Did you check it out?

As we know, whether paid or not, when a gtd pmt is properly deducted by a partnership, that is when it’s included in income by the “recipient” partner. As to this rule, the linked material states:

This rule is consistent with language from the legislative history of the 1954 Code, but importantly, it does not dictate, for an accrual-basis partnership, the year in which a guaranteed payment is deemed to accrue.

Two thoughts about that:

1. First, it seems to me that your question is more about of a basic accounting method question, about when the partnership properly makes the accrual, correct?
2. And second, if that accrual hits the partnership’s Balance Sheet and gets capitalized, how does that affect the partner’s inclusion?

I checked t out but did not see a clear answer to my questions. So I went to sleep. Then I started to come back to it but had my priorities straight and went out to walk my daughter's dog as I had promised. Then I checked my messages and got diverted and, now, I have to go get lunch, another priority to me, as anyone who sees me would realize immediately. In fact, just last night, a 20-something young lady asked me what sort of business did I think could be opened locally that would succeed, and I suggested a healthy-dining restaurant, and she asked if I ate in those places, and I knew right then and there that she has limited powers of observation and judgment. She should stick to being a model.

I will come back to all this. Eventually. It's tax season, don'tcha know?

and I knew right then and there that she has limited powers of observation and judgment.

Do you mean because your answer involved a place that didn’t exist yet, so it would be impossible for you to have eaten at such a non-existent place?

No, there actually are a few around, but their food is not very good. I apologize, because what she asked me was whether I ate in those types of places.

My reference to her absence of powers of observation and judgment was more about my waist measurement relative to my height.

I apologize, because what she asked me was whether I ate in those types of places.

Oh, ok. I thought the type of place you were talking about was the non-existent type.

Not sure why they call it a waist “line” anyway, given the definition of a line, which I haven’t looked up in a while, mind you. So I applaud your use of the word, “measurement.”

Well, back to the issues.

I have explained why I believe the obligation described in OP is a GP, so let's go from there. As such, the recipient's accounting method does not control when he must pick up the income. The linked NY Bar paper explains it thusly.

. As described above, Treas. Reg. § 1.707-1(c) provides that a partner must include a guaranteed payment as ordinary income in the partner’s taxable year within or with which ends the partnership taxable year in which the partnership deducted the guaranteed payment as paid or accrued under the partnership’s method of accounting.28. This rule is consistent with language from the legislative history of the 1954 Code,29 but importantly, it does not dictate, for an accru- al-basis partnership, the year in which a guaranteed payment is deemed to accrue.

. That explanation is correct, and the last part is my issue.

My issue is how to determine when the GP is taken into account by the accrual method partnership. I think Jeff-Ohio's comments in post #8 have correctly stated the issues. Can the partnership accrue the GP in light of the fact that the amounts will not be paid for several years, let alone within 2-1/2 months from year-end? I don't think they can, because 707(c) and its reg. say the partner is treated as not a partner. (You know what I mean, it's covered above).

And while I'd like to see it more clearly, the linked paper does seem to agree with me.

A taxpayer (including a partnership) on the accrual method of account- ing generally is not permitted to treat a liability as accrued until the “all-events test” is satisfied (i.e., all events have occurred which determine the fact of the liability and the amount thereof can be determined with reasonable accuracy) and economic performance is deemed to have occurred. Different rules apply for determining the time when economic performance occurs with regard to different types of liabilities, and, in the case of a partnership’s guaranteed payment to a partner for the use of capital, three distinct rules may apply.

. The paper then jumps to a discussion of GPs for use of money/property, as distinguished from those for services.

There is no question that the services have been provided. There is no question that the actual payment of the GP is deferred until the note is repaid, which is well after the 2-1/2 months. And there is even the possibility that the GP won't get paid at all (if the partnership itself can't or doesn't pay the note). So I think the GP cannot be accrued for tax purposes.

I guess we should also consider whether the 2-1/2 month rule applies not just to accrual of liabilities for items that are immediately deductible (162 expenses) but also to accrual of liabilities for items that, like in OP facts, must be capitalized. Reg. 1.263A-1(c)(2)(ii) says

(ii) The amount of any cost required to be capitalized under section 263A may not be included in inventory or charged to capital accounts or basis any earlier than the taxable year during which the amount is incurred within the meaning of § 1.446-1(c)(1)(ii).

. That worried me, because it might mean deferring the GP to a year after some/many condos have been sold and their gains have been reported, a rotten-sounding deal.

So I went to that 446 reg.

(ii)Accrual method.

(A) Generally, under an accrual method, income is to be included for the taxable year when all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy. Under such a method, a liability is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. (See paragraph (a)(2)(iii)(A) of § 1.461-1 for examples of liabilities that may not be taken into account until after the taxable year incurred, and see §§ 1.461-4 through 1.461-6 for rules relating to economic performance.) Applicable provisions of the Code, the Income Tax Regulations, and other guidance published by the Secretary prescribe the manner in which a liability that has been incurred is taken into account. For example, section 162 provides that a deductible liability generally is taken into account in the taxable year incurred through a deduction from gross income. As a further example, under section 263 or 263A, a liability that relates to the creation of an asset having a useful life extending substantially beyond the close of the taxable year is taken into account in the taxable year incurred through capitalization (within the meaning of § 1.263A-1(c)(3)) and may later affect the computation of taxable income through depreciation or otherwise over a period including subsequent taxable years, in accordance with applicable Internal Revenue Code sections and related guidance.

(B) The term “liability” includes any item allowable as a deduction, cost, or expense for Federal income tax purposes. In addition to allowable deductions, the term includes any amount otherwise allowable as a capitalized cost, as a cost taken into account in computing cost of goods sold, as a cost allocable to a long-term contract, or as any other cost or expense. Thus, for example, an amount that a taxpayer expends or will expend for capital improvements to property must be incurred before the taxpayer may take the amount into account in computing its basis in the property. The term “liability” is not limited to items for which a legal obligation to pay exists at the time of payment. Thus, for example, amounts prepaid for goods or services and amounts paid without a legal obligation to do so may not be taken into account by an accrual basis taxpayer any earlier than the taxable year in which those amounts are incurred.

(C) No method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income. The method used by the taxpayer in determining when income is to be accounted for will generally be acceptable if it accords with generally accepted accounting principles, is consistently used by the taxpayer from year to year, and is consistent with the Income Tax Regulations. For example, a taxpayer engaged in a manufacturing business may account for sales of the taxpayer's product when the goods are shipped, when the product is delivered or accepted, or when title to the goods passes to the customers, whether or not billed, depending on the method regularly employed in keeping the taxpayer's books.

(iii)Other permissible methods. Special methods of accounting are described elsewhere in chapter 1 of the Code and the regulations thereunder. For example, see the following sections and the regulations thereunder: Sections 61 and 162, relating to the crop method of accounting; section 453, relating to the installment method; section 460, relating to the long-term contract methods. In addition, special methods of accounting for particular items of income and expense are provided under other sections of chapter 1. For example, see section 174, relating to research and experimental expenditures, and section 175, relating to soil and water conservation expenditures.

(iv)Combinations of the foregoing methods.

(a) In accordance with the following rules, any combination of the foregoing methods of accounting will be permitted in connection with a trade or business if such combination clearly reflects income and is consistently used. Where a combination of methods of accounting includes any special methods, such as those referred to in subdivision (iii) of this subparagraph, the taxpayer must comply with the requirements relating to such special methods. A taxpayer using an accrual method of accounting with respect to purchases and sales may use the cash method in computing all other items of income and expense. However, a taxpayer who uses the cash method of accounting in computing gross income from his trade or business shall use the cash method in computing expenses of such trade or business. Similarly, a taxpayer who uses an accrual method of accounting in computing business expenses shall use an accrual method in computing items affecting gross income from his trade or business.

(b) A taxpayer using one method of accounting in computing items of income and deductions of his trade or business may compute other items of income and deductions not connected with his trade or business under a different method of accounting.

I am now reminded about why I did not care to read all those regs. Anyway, at this point, I still think the partnership can't accrue the GPs. But I'd sure like to be corrected.