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Noncompensatory Partnership Options; Correction

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Internal Revenue Service (IRS), Treasury.


Correcting amendment.


This document contains corrections to final regulations (TD 9612) that were published in the Federal Register on Tuesday, February 5, 2013 (78 FR 7997) relating to the tax treatment of noncompensatory options and convertible instruments issued by a partnership. The final regulations generally provide that the exercise of a noncompensatory option does not cause the recognition of immediate income or loss by either the issuing partnership or the option holder. The final regulations also modify the regulations under section 704(b) regarding the maintenance of the partners' capital accounts and the determination of the partners' distributive shares of partnership items. The final regulations also contain a characterization rule providing that the holder of a noncompensatory option is treated as a partner under certain circumstances.


This correction is effective on March 25, 2013 and is applicable on or after February 5, 2013.

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Benjamin Weaver, at (202) 622-3050 (not a toll-free number).

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The final regulations that are the subject of this document are under sections 171, 704, 721, 761, 1272, 1273, and 1275 of the Internal Revenue Code.

Need for Correction

As published, the final regulations (TD 9612) contain errors that may prove to be misleading and are in need of clarification.

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List of Subjects in 26 CFR Part 1

  • Income taxes
  • Reporting and recordkeeping requirements
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Correction of Publication

Accordingly, 26 CFR part 1 is corrected by making the following correcting amendments:

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Paragraph 1. The authority citation for part 1 continues to read in part as follows:

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Authority: 26 U.S.C. 7805 * * *

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Par. 2. Section 1.704-1 is amended by revising the table in paragraph (b)(5) Example 35 (ii), and the first sentence of paragraph (b)(5) Example 35 (iii) to read as follows:

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Partner's distributive share.
* * * * *

(b) * * *

(5) * * *

Example 35. * * *

(ii) * * *

Initial capital account$10,000$10,000$10,000$10,00000
Year 1 net income1,0001,0001,0001,00000
Year 2 net income1,0001,0001,0001,00000
Year 3 net income1,0001,0001,0001,00000
Year 4 initial capital account13,00013,00013,00013,00000
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(iii) At the beginning of Year 4, at a time when property D, LLC's only asset, has a value of $33,000 and basis of $24,000 ($30,000 original basis less $6,000 depreciation in Years 1 through 3), and LLC has accumulated undistributed cash of $12,000 ($15,000 gross income less $3,000 of interest payments) in LLC, M converts the debt into a 1/3 interest in LLC. * * *

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Par. 3. Section 1.761-3 is amended by:

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a. Revising the second sentence of paragraph (b)(3);

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b. Revising paragraph (f) introductory text;

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c. Removing “1” from paragraph (f) Example heading; and

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d. Revising the second sentence in the paragraph (f) Example.

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The revisions read as follows:

Certain option holders treated as partners.
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(b) * * *

(3) * * * In addition, an option includes convertible debt (as defined in § 1.721-2(g)(2)) and convertible equity (as defined in § 1.721-2(g)(3)). * * *

* * * * *

(f) Example. The following example illustrates the provisions of this section. For purposes of the example, assume that PRS is a partnership for Federal tax purposes, none of the noncompensatory option holders or partners are related persons, and that general principles of law do not apply to treat the noncompensatory option as a partnership interest. The example reads as follows:


* * * In exchange for a premium of $10x, PRS issues a noncompensatory option to A to acquire a 10 percent interest in PRS for $110x at any time during a 3-year period commencing on the date on which the option is issued. * * *

* * * * *
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LaNita VanDyke,

Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel, (Procedure and Administration).

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[FR Doc. 2013-06703 Filed 3-22-13; 8:45 am]