Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 66-95

1966-1 C.B. 169

Sec. 162

Sec. 707

IRS Headnote

Where a partner's percentage of the partnership profits is less than his guaranteed minimum, the partner's share, computed on the percentage basis, of partnership income before deduction of the guaranteed payment is his distributive share of partnership income. The guaranteed payment, as that term is used in section 707(c) of the Internal Revenue Code of 1954, is the difference between the partner's minimum guarantee and his distributive share of partnership income determined before deduction of the guaranteed payment.

Full Text

Rev. Rul. 66-95

Advice has been requested whether the total amount of the minimum yearly profit participation of certain members of a partnership is a guaranteed payment under section 707(c) of the Internal Revenue Code of 1954, or whether only a portion of such amount is a guaranteed payment in the following circumstances.

The ABC Partnership, a limited partnership, was formed pursuant to an Agreement of Limited Partnership and consisted of both general and limited partners.

Article I of the Agreement provides that the general partners shall receive 75 percent of the net profits and the limited partners shall receive 25 percent of the net profits. Under Article II the partnership losses are borne by the general partners.

Article III of the Agreement states:

Anything hereinabove to the countrary notwithstanding, the Limited Partners shall be paid the sum of 4 x dollars per annum for each 100 x dollars of contributed Contract Capital as minimum yearly profit participation, and if the profit participation calculated on the percentage basis above set forth shall be less than said minimum amount, or if there shall be losses, said minimum amount shall nevertheless be paid to the Limited Partners and said payment shall in all respects be treated as if it were an expense of the Limited Partnership.

Article IV of the Agreement provides that the minimum profit participation payments to limited partners to the extent set forth in Article III shall be charged as a part of the expense of doing business in determining the partnership profits and losses, but only in the event that their respective profit participation in any one year would otherwise be less than said guaranteed payment.

In the partnership taxable year in question the limited partners' profit participation calculated on the percentage basis was less than the minimum yearly profit participation as determined by using the formula stated in Article III of the Agreement.

Section 707(c) of the Code provides that to the extent determined without regard to the income of the partnership, payments to a partner for services or use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61(a) (relating to gross income) and section 162(a) (relating to trade or business expenses).

Section 1.707-1(c) of the Income Tax Regulations provides, in part, that a partner must include such payments as ordinary income for his taxable year within or with which ends the partnership taxable year in which the partnership deducted such payments as paid or accrued under its method of accounting. Under these regulations where a partner's percentage of profits is less than his guaranteed minimum, the partner's share, computed on the percentage basis, of partnership income before deduction of guaranteed payment is his distributive share of partnership income; and the guaranteed payment, as the term is used in section 707(c) of the Code, is the difference between the partner's minimum guarantee and his distributive share of partnership income before taking into account the guaranteed payment. See example 2 of section 1.707-1(c) of the regulations.

The fact that a partnership agreement provides that, in the event a minimum payment must be made to certain partners, the payment shall in all respects be treated as if it were an expense of the partnership, does not control as to whether the entire minimum amount will be considered an expense for Federal income tax purposes.

Accordingly, notwithstanding those provisions of Article III and IV of the Agreement which require that the minimum profit participation payments be treated as an expense in all respects in the years the limited partner's guaranteed minimum is greater than their profit participation, when the guaranteed minimum is the greater, then only the difference between the limited partners' guaranteed minimum and their distributive share of the partnership income is a guaranteed payment for Federal tax purposes. Only the amount of the guaranteed payment (section 707(c) of the Code) as thus determined should be considered as a business expense under section 162(a) of the Code for Federal income tax purposes.