Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 64-90

1964-1 C.B. 226

Sec. 165

Sec. 702

IRS Headnote

Federal income tax treatment of compensation received by a partner and paid over to a partnership where the partner, who uses the cash receipts and disbursements method of accounting, files his returns on a calendar year basis and the partnership, which also uses the cash method, files its returns on a fiscal year basis.

I.T. 3824, C.B. 1946-2, 37, and Revenue Ruling 54-167, C.B. 1954-1, 152, amplified.

Full Text

Rev. Rul. 64-90

Advice has been requested regarding the Federal income tax consequences of a change in the terms of a partnership agreement to provide that all compensation received by the partners will be paid over to the partnership immediately upon receipt.

In the instant case, several individuals formed a partnership for the purpose of engaging in the general practice of law. Aside from the partnership business, each of the partners has performed services from time to time in his individual capacity and not as a partner. The several partners have always regarded the fees received for such services as compensation to the recipient as an individual.

The partnership which was formed in 1954 and uses the cash receipts and disbursements method of accounting files its Federal income tax returns for fiscal years ending January 31, and the partners file their individual returns on the cash method for calendar years. Each partner reports his distributive share of the partnership income, gain, loss, deduction or credit for the partnership fiscal year ending within the calendar year for which his individual return is filed. All compensation received by each partner for services performed in his individual capacity is reported in that partner's return for the calendar year when received.

It is proposed to amend the partnership agreement as of the beginning of the partnership's next fiscal year to provide that all compensation received by the partners be paid over to the partnership immediately upon receipt.

The question in the instant case is whether compensation remitted to the partnership pursuant to this provision will constitute partnership income.

Similar inquiries were previously considered by the Internal Revenue Service. For example, see I.T. 3824, C.B. 1946-2, 37, and Revenue Ruling 54-167, C.B. 1954-1, 152, relating to similar arrangements involving, (1) compensation and allowances of a member of the military forces of the United States, and (2) the compensation and expense allowances received by an elected public official. In both instances, it was pointed out that a partnership could not exist for the purpose of performing the services for which the compensation and allowances were received, and, thus, the recipient partner would be required to report the taxable portion of the compensation and allowances in his individual return, even though these items were pooled with partnership earnings. It was also held that a comparison should be made between (a) the partner's share of pooled income, consisting of the compensation paid over to the partnership and partnership earnings, and (b) the amount paid by the partner to the pool; and that any excess of (a) over (b) would be treated as his distributive share of partnership income and any deficiency would be a loss deductible under section 23(e) of the Internal Revenue Code of 1939 which is substantially similar to section 165 of the 1954 Code.

In the instant case, the general practice of the partnership consists of rendering legal advice and services. Consequently, fees received by a partner for similar services performed in his individual capacity will be considered as partnership income if paid to the partnership in accordance with the agreement. Those fees need not be reported separately by the partner on his individual return. However, the partner's distributive share of the partnership's taxable income which he must report on his individual return will include a portion of such fees.

However, the proposed amendment is so general as to require the partners to pay over amounts similar to those described in I.T. 3824 and Revenue Ruling 54-167, as well as amounts related to the business of the partnership. Therefore, it is not possible to issue an advance ruling with respect to the effect of all such payments which may occur. A determination in each instance will depend upon all the facts and circumstances involved, including the nature of the services, the arrangement with the party for whom the services are performed, and any relevant Federal or local law governing the relationship between the partner and the recipient of the services.

In the event that any amount is to be treated in the manner described in I.T. 3824 and Revenue Ruling 54-167, such amount will be taxed to the recipient partner in the calendar year of receipt. If the compensation remitted by a partner to the partnership during a given partnership fiscal year exceeds the partner's share of pooled income for that fiscal year, the excess is a deductible loss to the partner for the calendar year within which the fiscal year involved ends. Conversely, if a partner's share of pooled income for a particular fiscal year exceeds the compensation paid over to the partnership during that year, the excess is considered the partner's distributive share of partnership income for the calendar year during which the partnership fiscal year ends.

The above may be illustrated by the following example:

A partnership is composed of three partners who share the profits and losses of the partnership equally. If A , one of the partners, receives as compensation on November 1, 1960, $10,000, under circumstance which require the application of the rules stated in I.T. 3824 and Revenue Ruling 54-167, this amount would be reported by A on his individual return for 1960. Assuming partnership earnings for the year ended January 31, 1961, of $50,000, the pooled income is $60,000, and A would report as his distributive share of partnership income in his 1961 return $10,000 (the difference between $20,000, his share of pooled income, and $10,000, the amount he paid into the pool during the partnership taxable year). If the partnership income for the fiscal year ended January 31, 1961, is $8,000 the pooled income is $18,000, and A will be entitled to a deduction in 1961, under section 165 of the Code, of $4,000 (the excess of the amount paid into the pool during the partnership taxable year, $10,000, over A's share of the pooled income for that year, $6,000). In addition, of course, A would report on his 1960 calendar-year return his distributive share of partnership income for the partnership taxable year ended January 31, 1960.

This amplifies I.T. 3824, C.B. 1946-2, 37 and Revenue Ruling 54-167, C.B. 1954-1, 152, to indicate the effect of the use of a partnership fiscal year which is not the same as the partners' taxable year.