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The Tax Lawyer

Tax Flotsam of Partnership Mergers and Divisions

Bradley T. Borden, Douglas L. Longhofer, and Matthew E. Rappaport


Non-tax business exigencies often compel owners of businesses organized as tax partnerships to combine with another business organized as a tax partnership (a “partnership merger”) or to split the tax partnership into two or more tax partnerships (a “partnership division”). Such restructuring transactions can take any one of several different forms but be subject to the partnership tax merger and divisions rules. Despite being common business transactions, such transactions often raise complicated federal income tax challenges that, if overlooked, could present unwanted tax consequences. Without careful planning and considering the myriad tax issues raised by partnership mergers and divisions, the parties to such transactions could find themselves ensnared in the tax flotsam of those transactions.

This article provides guideposts that advisors should use to help their clients avoid such unpleasant outcomes. The article presents a hypothetical that helps set the stage for and illustrate the application of the technical tax rules that arise with mergers and divisions. The article provides the basis for an operative checklist that advisors can use as they work with business owners engaged in tax partnership restructurings.

The article proceeds as follows. Part II presents two hypothetical partnerships and the tax and financial situation of each partnership. The article uses the basic facts presented in the hypothetical to illustrate how partnership mergers and divisions can raise tax issues. Part III describes the forms of partnership mergers and divisions that federal income tax law recognizes—which forms may differ from the form of the transactions for state law purposes. Part IV presents the general rules governing partnership mergers, and Part V presents the general rules governing partnership divisions. Understanding these rules and scope of the tax partnership merger and division rules is critical because the rules apply broadly and may encompass transactions that do not intuitively appear to be merger or division transactions.

With the background established and stage set, Part VI presents the numerous tax rules that partnership mergers and divisions can implicate. The article refers to these rules a tax flotsam because if not accounted for as part of a merger or division, they can wreak havoc on the parties to the transaction. This part provides a veritable checklist of issues that advisors should consider any time a transaction is subject to the tax partnership merger and division rules. Part VII concludes.