Law Firms: Selected Partnership Tax Problems of Formation and Admission of New Partners

I. Introduction II. Five Typical Situations … A. Situation 1: Formation of a Partnership—the Established Practitioner and the Recent Graduate … 1. Federal Tax Consequences to the Partners upon Formation … a. Section 721 Nonrecognition Treatment: The Established Practitioner\u27s Section 721 Property … b. Consequences of the Recent Graduate\u27s Cash Contribution … c. Exceptions to Section 721 Nonrecognition Treatment … d. Recapture of Investment Credit upon the Contribution of Section 38 Property … e. The Partners\u27 Bases in Their Partnership Interests … f. The Partners\u27 Holding Periods for Partnership Interests … 2. Federal Tax Consequences to the Newly Formed Partnership… 3. Admission of a New Partner … B. Situation II: Promotion of Associate to Full Partner—Full Capital and Profits Interest in Exchange for Property and Services … 1. Recognition of Gain or Loss by the New Partner … a. Capital Interest Received as Compensation for Services … b. Recognition of Compensation Income by the Associate … 2. The Frazell Approach—Bifurcation of the Transaction … a. Consequences to the Associate … b. Consequences to the Partnership … (1) The Two-Step Analysis … (2) The One-Step Entity Approach … c. Recapture of Investment Credit by the Existing Partners … C. Situation III: Admission of a New Partner—the Problem of Existing Receivables … 1. Defining the New Partner\u27s Capital Interest … 2. Bifurcation of the Transaction … 3. Treatment of the Bifurcated Transaction … a. Tax Consequences of a Promise of a Future Capital Interest … (1) Receipt of the Promise … (2) Receipt of the Promised Capital Interest … b. Restricted Transfer of Property for Services—Section 83(a) … (1) Valuation and Inclusion—Timing … (2) Holding Period for the Interest in Receivables … (3) Other Consequences of Applying Section 83 to the Transaction … (a) The Partnership Deduction … (b) Recognition of Gain by the Partnership … c. The Section 83(b) Election Approach … d. Recapture of Investment Credit … D. Situation IV: Annual Shifts of the Partners\u27 Capital Interests … 1. Tax Consequences of Receiving Annual Capital Shifts … 2. Tax Consequences to the Partnership … E. Situation V: The Profits Interests in Situations I–IV III. Conclusio