| ||Fun and Games with Guaranteed Payments|
Lewis R. Steinberg*
*Partner, Cravath, Swaine & Moore LLP, New York, New York; Amherst College, B.A. 1978; New York University School of Law, J.D. 1984, LL.M. 1992. The author would like to express his gratitude to his associates, Lauren Angelilli and David Dubner, for their invaluable assistance in the research and writing of this paper. An earlier version of this article was presented at the Tax Forum in New York City on April 7, 2003.
Over the past thirty years, there have been a number of court cases, published rulings, private letter rulings, general counsel memoranda, and other legal authorities dealing with guaranteed payments. Nevertheless, there remains great uncertainty as to the treatment of guaranteed payments-as compared to other areas of partnership or corporate tax law, far less is known about the treatment of guaranteed payments. With respect to a few issues, the legal authorities are conflicting or inconclusive. With respect to many other questions, however, guidance is simply nonexistent.
In the spirit of attempting to clear up some of the mystery, this paper analyzes a number of common factual situations involving guaranteed payments and attempts to give tentative and, hopefully, reasonable answers to some of the open questions. It is written from the point of view of someone who, while not an expert in partnership taxation, frequently confronts questions regarding guaranteed payments in the context of corporate joint ventures, structured finance transactions, and investment partnerships. The fact patterns discussed are those typically encountered in these areas of practice.
Three general observations emerge from the discussion that follows. First, the absence of relevant and unambiguous legal authority on a number of fundamental issues concerning section 707(c) may hinder legitimate tax planning, as well as encourage aggressive tax strategies. Second, the reason for the sparse legal authority dealing with guaranteed payments remains something of a mystery; given the importance of guaranteed payments as a tax planning tool, the fact that the bulk of the extant legal precedent derives from the period prior to the mid-1980s, and the lack of guidance on a number of threshold issues, are surprising. Finally, and perhaps most importantly, the absence of a refined system for dealing with guaranteed payments similar to that found in section 704(b) regarding allocations of partnership income and expense may provide opportunities for abusive transactions.
This paper is divided into seven parts. Part I provides an overview of section 707(c) and the Treasury regulations thereunder. Part II explores the distinctions, if any, among guaranteed payments, gross income allocations, and section 707(a) payments. Part III examines the sourcing of the income and deduction for guaranteed payments for services. Part IV discusses guaranteed payments for the use of capital. Part V analyzes, through various examples, how guaranteed payments affect allocations of other partnership items. Part VI addresses the accounting of returns on preferred equity. Lastly, Part VII reviews the treatment of guaranteed payments under certain other sections of the Code.