Loan reallocation enters the imputed underpayment but deemed distribution does not

Plain-English summary

A partnership reported a $5 million loan equally between two partners, although one partner had supplied the money, and Exam proposed reallocating the entire liability to that partner. Chief Counsel advised that the resulting section 752(b) deemed distribution to the other partner is not a partnership-related item because it is not reported on Form 1065. It therefore is not a centralized partnership audit adjustment and does not enter the imputed underpayment calculation. The loan allocation itself is a partnership-related item, and reallocating $2.5 million to one partner and away from the other produces two positive non-income adjustments. Using the stated 37 percent rate, those adjustments produce a $1.85 million imputed underpayment, or $925,000 if the IRS treats one adjustment as zero because its effect is already reflected in the other.

Ruling snapshot

• Question: Does a deemed distribution caused by reallocating a partnership liability count as a partnership audit adjustment?
• Outcome: Advice given, the deemed distribution does not, but the liability reallocation does
• Key authorities: IRC §§ 752(b), 6241(2); Treas. Reg. §§ 301.6225-1, 301.6241-1

Full text (IRS public release)

ID: CCA_2023071909112214 [Third Party Communication:

UILC: 6225.01-00 Date of Communication: Month DD, YYYY]

Number: 202444004
Release Date: 11/1/2024
From: ------------------
Sent: Wednesday, July 19, 2023 9:11:23 AM
To: ----------------
Cc: --------------------
Bcc: ------------------
Subject: RE: ----------------- BBA Adjustment vs. Push-Out Adjustment

Hi ---------,

My response to your question is below. Please let me know if you have any questions.

Issue
Whether a deemed distribution resulting from a partnership level adjustment is a BBA
adjustment.

Facts
-----------------is a BBA partnership with two 50/50 partners, Partner A and Partner
B. The year under audit is 2020. The partnership has approximately $5M in loans that
it allocated 50/50 between the two partners on the Form 1065 and the Schedule K-
1s. This loan originated as money lent by Partner A to the partnership. There is no
documentation for the loan. Exam wants to reallocate this loan 100% to Partner A,
which under section 752(b), would result in a deemed distribution to Partner B.

Law
Section 6241(2)(A) defines a partnership adjustment as any adjustment to a
partnership-related item (PRI). A PRI is any item or amount with respect to the
partnership that is relevant in determining the tax liability of any person under chapter 1
and any partner’s distributive share. IRC § 6241(2)(B); Treas. Reg. § 301.6241-
1(a)(6)(v). There are two types of adjustments to PRIs: negative and positive. Treas.
Reg. § 301.6225-1(d)(2). Adjustments to non-income items (e.g., assets and liabilities)
are positive adjustments. Treas. Reg. § 301.6225-1(d)(2)(iii). A net positive adjustment
results in an imputed underpayment (IU). See Treas. Reg. § 301.6225-1(c)(4). Solely for
purposes of calculating the IU, the IRS may treat an adjustment as zero, if the effect of
the adjustment is already reflected in one or more other adjustments. See Treas. Reg. §
301.6225-1(b)(4). Any adjustment that allocates or reallocates a PRI to and from a
particular partner or partners is a reallocation adjustment. Treas. Reg. § 301.6225-
1(c)(2).

                                        2

Conclusion
The deemed distribution attributable to Partner B is not a PRI (i.e., it is not an amount
that would be reported on the Form 1065). Therefore, it is not an adjustment under BBA
and not included in the IU calculation. However, Exam may make the reallocation
adjustment so that the $5M loan is allocated 100% to Partner A. The reallocation results
in two adjustments of $2,500,000 (see table below). Because the adjustments are to
non-income items (i.e., a loan), both adjustments are positive adjustments. This results
in an IU of $1,850,000 (applying the highest tax rate in tax year 2020). If the IRS were to
treat one of the adjustments as zero, the IU would be $925,000 (adjustment of
2,500,000 multiplied by the highest tax rate of 37%).

$5M Loan Partner A Partner B
2020 Return 2,500,000 2,500,000
Reallocation Adjustments 2,500,000 (2,500,000)
2020 Adjusted Return 5,000,000 0

Imputed Underpayment Calculation
Partner A’s Adjustment 2,500,000
Partner B’s Adjustment 2,500,000
Total Adjustment 5,000,000
Highest Tax Rate 37%
Imputed Underpayment $1,850,000

Thanks,
Nikki

Nikki S. Bossert (she/her)
Attorney, CC:PA:7
(202) 317-5185
[email protected]