After much promise, the IRS issued two sets of regulations to address the potential avoidance of gain by corporate partners.  First, new § 337(d) temporary regulations, often referred to as the “May Company” regulations, define when and how a corporate partner is deemed to recognize taxable gain in its partnership interest if the partnership acquires stock in such corporate partner.  Second, new § 732(f) proposed regulations clarify when a corporate partner recognizes gain when a partnership distributes stock of a different corporation to such partner.

Section 337(d) May Company Regulations

The § 337(d) temporary regulations replace 1992 proposed regulations on when a corporate partner recognizes gain when the partnership acquires stock in such partner.  The regulations address the gain avoidance that occurred when May Company contributed appreciated property to a partnership and effectively sold that property by having the partnership use cash to purchase May Company stock.  When the partnership later distributed the acquired stock back to May Company, the gain effectively disappeared.  The original proposed regulations imposed arguably overlapping gain recognition rules both when the corporate partner obtained an indirect interest in the stock through its partnership interest (the deemed redemption rule) and when the partnership distributed the stock to the corporate partner.  The new regulations streamlined the rules by eliminating the distribution rule and incorporating certain concepts into a single deemed redemption rule that imposes taxable gain on the corporate partner when there is an expansion of the partner’s share of its stock held by the partnership.  The regulations make a number of additional nuanced mechanical changes to clarify administration of the rule and require that consistent concepts be applied in the tiered partnership context.

Section 732(f) Partnership Distributions of Stock to Corporate Partners

The second set of regulations propose to update rules under § 732(f), enacted in 1999, which prevents corporate partners from avoiding tax on their share of partnership appreciation by having the partnership redeem them with a controlling interest in stock of a new corporation (Newco), where Newco holds high-basis assets. The avoidance occurred because, although the corporate partner received a low-basis in the distributed Newco stock, the corporate partner simply liquidated Newco, and the high-basis assets inside Newco carried over to the corporate partner. In such context, § 732(f) generally requires that both the Newco stock and the Newco assets be stepped down. The new regulations further clarify the mechanics of these rules, including addressing tiered partnerships and adding a special rule to aggregate basis computations if the partnership distributes stock to multiple members of the same consolidated group.