IRS Issues Another Trick: Bottom-Dollar Guarantee Applies to Certain Deficit Restoration Obligations
In addition to the issues discussed in our October client alert, the final regulations revised the definition of a bottom-dollar payment obligation to specifically address capital contribution obligations and deficit restoration obligations. The bottom-dollar guarantee definition includes any payment obligations from capital contribution obligations and deficit restoration obligations “other than one in which the partner is or would be required to make the full amount of the partner’s capital contribution or to restore the full amount of the partner’s deficit capital account.”
The final regulations include a rule under Treasury Regulation Section 1.704-1 that capital contribution obligations and deficit restoration obligations are not respected if the facts and circumstances otherwise indicate a plan to circumvent or avoid such obligation. The final regulations provide a non-exclusive list of factors that may indicate a plan to circumvent or avoid the obligation, including:
The partner is not subject to commercially reasonable provisions for enforcement and collection of the obligation.
The partner is not required to provide (either at the time the obligation is made or periodically) commercially reasonable documentation regarding the partner’s financial condition to the partnership.
The obligation ends or could, by its terms, be terminated before the liquidation of the partner’s interest in the partnership or when the partner’s capital account is negative (other than when a transferee partner assumes the obligation).
The terms of the obligation are not provided to all the partners in the partnership in a timely manner.
The final regulations added an exception to the third factor for when a transferee partner assumes the obligation. The IRS emphasized in the preamble that the weight to be given to any particular factor depends on the particular facts, and the presence or absence of any particular factor is not, in itself, necessarily indicative of whether the obligation is respected.
The taxpayer must disclose bottom-dollar guarantees by filing IRS Form 8275, Disclosure Statement, with the return of the partnership for the taxable year in which a bottom-dollar payment obligation is undertaken or modified, identifying the payment obligation, including whether the obligation is a guarantee, a reimbursement, an indemnity, or a deficit restoration obligation.