ACCOUNTING

Running head: ACCOUNTING
Basis adjustment under section 734(b)
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Basis adjustment under section 734(b)
Introduction
A policy of maximum recognition is pursued by the partnership tax contribution and distribution rules. When people enter into a partnership, there is very little tax disincentive involved when property is moved in and out of the partnership by the partners. The importance of this policy is that it ensures efficient formation of the partnership as well as making operation decisions. However, Osofsky (2006) says that partners are allowed by the nonrecognition of rules to shift and defer gains. Therefore, tax revenues are threatened and businesses can take advantage of inefficient transactions can be encouraged.
There are some contribution and distribution rules provided under Subchapter K which curb shifting and deferral of gains and act as a backstop to the nonrecognition regime. Section 734(b) is an example of such a rule. The aim of section 734(b) is to preserve the correct amount of income after distribution (Osofsky, 2006). To be more specific, this section requires that when loss or gain is recognized by the distributee partner, there has to be basis adjustment inside the partnership. Second, the same will apply after the distributee partner changes the basis of assets in his or her hands upon distribution.
Potential challenges
Subchapter K of the Internal Revenue Code provides some efficient partnership tax provisions. The provisions may face some challenging tasks since they have to establish a sensible mechanism for tax arrangements between partners which can at times be difficult to calculate. According to Abrams (n.d), when two partners contribute equally to start a business where revenues from the investment will be shared equally, it should not be challenging when it comes to taxing the individuals.
However, problems will arise during taxation when one of the partners requests for a bigger share of initial receipts and lower share of back-end receipts. When the amount they have contributed to start the partnership are unequal, a mechanism will be establish to account for the difference and that structure will be used during taxation (Cartono, 2008). Scholars believe that a partnership is a very flexible type of business and this flexibility is captured well by the rules of Subchapter K.
Tax transparency is the core paradigm which best describes Subchapter K. This implies that a partnership is supposed to be all but invisible when it comes to the taxing system. Specifically, transactions carried out between a partner of the partnership should as mush as possible be free from taxation (Abrams, n.d). However, when partners of the partnership enter into deals with third-parties, the activities they engage in are taxable. Therefore, many contributions and distributions are not taxed but when interests and partnership assets are transferred to non-partners, the activities will be liable to taxation. There are some simple examples which are helpful in elucidating the role of section 734(b).
Adjusting an asset’s basis upon distribution
To start with, the right amount of partnership income is preserved by section 734(b) if the partner wants to adjust an asset basis in his or her hands upon distribution. Take example of a partner A who gains a liquidating distribution of Greenacre with an inside basis $100 (Osofsky, 2006). In Greenacre, A will have to take a basis of $300 if A has an outside basis of $300. This implies that in A’s hands, Greenacre’s basis will increase by $200. A $200 of gain has been evaded by the partnership and the amount could be deferred until the liquidation of the partnership.
Section 734(b) requires $200 basis points to be adjusted downwards to a fitting asset in the business so that the partnership can maintain the $200 of gain evaded in Greenacre. On the same note, when A gains a liquidating distribution of Greenacre having an inside basis of $200 while the outside basis of A is 0, A will be required to take a 0 basis in Greenacre (Osofsky, 2006). This is because a $200 of loss has not been taken by the partnership and this may continue until the partnership is liquidated. A basis of $200 will have to be adjusted upwards according to section 734(b) to a suitable asset in the business so that the $200 of loss evaded in Greenacre can be maintained in the partnership.
Recognition of loss or gain upon distribution
The second example related to section 734(b) usually reserve the correct amount of partnership income whenever loss or gain upon distribution is recognized by a partner. If A has an outside basis of 0 and he gets a liquidating distribution of $200 in cash, he will have to recognize the $200 gain (Osofsky, 2006). The $200 gain is recognized on the basis of distribution since the partnership possessed a basis of $200 in cash.
Therefore, the extra $200 gain from the distribution will be offset after a fitting asset valued at $200 in the partnership is raised by the partners. On the same note, if A has an outside basis of $400, he will have to recognize the $200 loss if he gets a liquidating distribution of $200 in cash (Osofsky, 2006). In the cash, there was a basis of $200 so the partnership will have to recognize the additional $200 by virtue of the distribution. This implies that the additional $200 loss from the distribution will be offset after the partnership lowers the basis of an appropriate asset in the business.
Inside and outside basis disparities
One of the complexities of partnership taxation is related to inside/outside basis disparities. In his partnership interest, a partner may have an outside basis which varies from his share of the partnership’s inside basis in its assets. This disparities can take place when partnership interest is transferred (includes when one partner dies), or when a partner receives property from the partnership (Thomas & Kaplon, n.d). Under both sections 734(b) and 743(b), the main intention of basis adjustments is to restore equality within outside and inside basis so that entity and aggregate principals can blend. When a partnership interest is sold or a partner dies, the outside basis of the partnership will be affected but the inside basis will not be directly affected. Just like the way disparities occur when an interest is transferred, inside and outside disparities can occur after certain properties are transferred to a partner. According to section 734(b), the partnership is allowed to adjust the basis of retained property.
Section 734(b) – Revenue Ruling 92-115
The above ruling provided guidelines on which section 734(b) can be applie...