§761 — Terms defined
30 citing cases
Statute Text — 26 U.S.C. §761
For purposes of this subtitle, the term “partnership” includes a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a corporation or a trust or estate. Under regulations the Secretary may, at the election of all the members of an unincorporated organization, exclude such organization from the application of all or part of this subchapter, if it is availed of—
for investment purposes only and not for the active conduct of a business,
for the joint production, extraction, or use of property, but not for the purpose of selling services or property produced or extracted, or
by dealers in securities for a short period for the purpose of underwriting, selling, or distributing a particular issue of securities,
if the income of the members of the organization may be adequately determined without the computation of partnership taxable income.
For purposes of this subtitle, the term “partner” means a member of a partnership. In the case of a capital interest in a partnership in which capital is a material income-producing factor, whether a person is a partner with respect to such interest shall be determined without regard to whether such interest was derived by gift from any other person.
For purposes of this subchapter, a partnership agreement includes any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the filing of the partnership return for the taxable year (not including extensions) which are agreed to by all the partners, or which are adopted in such other manner as may be provided by the partnership agreement.
For purposes of this subchapter, the term “liquidation of a partner’s interest” means the termination of a partner’s entire interest in a partnership by means of a distribution, or a series of distributions, to the partner by the partnership.
Except as otherwise provided in regulations, for purposes of—
section 708 (relating to continuation of partnership),
section 743 (relating to optional adjustment to basis of partnership property), and
any other provision of this subchapter specified in regulations prescribed by the Secretary,
any distribution of an interest in a partnership (not otherwise treated as an exchange) shall be treated as an exchange.
In the case of a qualified joint venture conducted by a husband and wife who file a joint return for the taxable year, for purposes of this title—
such joint venture shall not be treated as a partnership,
all items of income, gain, loss, deduction, and credit shall be divided between the spouses in accordance with their respective interests in the venture, and
each spouse shall take into account such spouse’s respective share of such items as if they were attributable to a trade or business conducted by such spouse as a sole proprietor.
For purposes of paragraph (1), the term “qualified joint venture” means any joint venture involving the conduct of a trade or business if—
the only members of such joint venture are a husband and wife,
both spouses materially participate (within the meaning of section 469(h) without regard to paragraph (5) thereof) in such trade or business, and
both spouses elect the application of this subsection.
For rules in the case of the sale, exchange, liquidation, or reduction of a partner’s interest, see sections 704(b) and 706(c)(2).
Treasury Regulations
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Treas. Reg. §1.761-1Terms defined
(a) Partnership. The term partnership means a partnership as determined under §§ 301.7701-1, 301.7701-2, and 301.7701-3 of this chapter.
(b) Partner. The term partner means a member of a partnership.
(c) Partnership agreement. For the purposes of subchapter K, a partnership agreement includes the original agreement and any modifications thereof agreed to by all the partners or adopted in any other manner provided by the partnership agreement. Such agreement or modifications can be oral or written. A partnership agreement may be modified with respect to a particular taxable year subsequent to the close of such taxable year, but not later than the date (not including any extension of time) prescribed by law for the filing of the partnership return. As to any matter on which the partnership agreement, or any modification thereof, is silent, the provisions of local law shall be considered to constitute a part of the agreement.
(d) Liquidation of partner's interest. The term liquidation of a partner's interest means the termination of a partner's entire interest in a partnership by means of a distribution, or a series of distributions, to the partner by the partnership. A series of distributions will come within the meaning of this term whether they are made in one year or in more than one year. Where a partner's interest is to be liquidated by a series of distributions, the interest will not be considered as liquidated until the final distribution has been made. For the basis of property distributed in one liquidating distribution, or in a series of distributions in liquidation, see section 732(b). A distribution which is not in liquidation of a partner's entire interest, as defined in this paragraph, is a current distribution. Current distributions, therefore, include distributions in partial liquidation of a partner's interest, and distributions of the partner's distributive share. See paragraph (a)(1)(ii) of § 1.731-1.
(e) Distribution of partnership interest. For purposes of section 708(b)(1)(B) and § 1.708-1(b)(1)(iv), the deemed distribution of an interest in a new partnership by a partnership that terminates under section 708(b)(1)(B) is not a sale or exchange of an interest in the new partnership. However, the deemed distribution of an interest in a new partnership by a partnership that terminates under section 708(b)(1)(B) is treated as an exchange of the interest in the new partnership for purposes of section 743. This paragraph (e) applies to terminations of partnerships under section 708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph (e) may be applied to terminations occurring on or after May 9, 1996, provided that the partnership and its partners apply this paragraph (e) to the termination in a consistent manner.
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Treas. Reg. §1.761-1(a)Partnership.
Partnership. The term partnership means a partnership as determined under §§ 301.7701-1, 301.7701-2, and 301.7701-3 of this chapter.
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Treas. Reg. §1.761-1(b)Partner.
Partner. The term partner means a member of a partnership.
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Treas. Reg. §1.761-1(c)Partnership agreement.
Partnership agreement. For the purposes of subchapter K, a partnership agreement includes the original agreement and any modifications thereof agreed to by all the partners or adopted in any other manner provided by the partnership agreement. Such agreement or modifications can be oral or written. A partnership agreement may be modified with respect to a particular taxable year subsequent to the close of such taxable year, but not later than the date (not including any extension of time) prescribed by law for the filing of the partnership return. As to any matter on which the partnership agreement, or any modification thereof, is silent, the provisions of local law shall be considered to constitute a part of the agreement.
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Treas. Reg. §1.761-1(d)Liquidation of partner's interest.
Liquidation of partner's interest. The term liquidation of a partner's interest means the termination of a partner's entire interest in a partnership by means of a distribution, or a series of distributions, to the partner by the partnership. A series of distributions will come within the meaning of this term whether they are made in one year or in more than one year. Where a partner's interest is to be liquidated by a series of distributions, the interest will not be considered as liquidated until the final distribution has been made. For the basis of property distributed in one liquidating distribution, or in a series of distributions in liquidation, see section 732(b). A distribution which is not in liquidation of a partner's entire interest, as defined in this paragraph, is a current distribution. Current distributions, therefore, include distributions in partial liquidation of a partner's interest, and distributions of the partner's distributive share. See paragraph (a)(1)(ii) of § 1.731-1.
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Treas. Reg. §1.761-1(e)Distribution of partnership interest.
Distribution of partnership interest. For purposes of section 708(b)(1)(B) and § 1.708-1(b)(1)(iv), the deemed distribution of an interest in a new partnership by a partnership that terminates under section 708(b)(1)(B) is not a sale or exchange of an interest in the new partnership. However, the deemed distribution of an interest in a new partnership by a partnership that terminates under section 708(b)(1)(B) is treated as an exchange of the interest in the new partnership for purposes of section 743. This paragraph (e) applies to terminations of partnerships under section 708(b)(1)(B) occurring on or after May 9, 1997; however, this paragraph (e) may be applied to terminations occurring on or after May 9, 1996, provided that the partnership and its partners apply this paragraph (e) to the termination in a consistent manner.
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Treas. Reg. §1.761-2Exclusion of certain unincorporated organizations from the application of all or part of subchapter K of chapter 1 of the Internal Revenue Code
(a) Exclusion of eligible unincorporated organizations—(1) In general. Under the conditions set forth in this section, an unincorporated organization described in paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) may be excluded from the application of all or a part of the provisions of subchapter K of chapter 1 of the Internal Revenue Code (subchapter K). Such organization must be availed of for investment purposes only and not for the active conduct of a business, or for the joint production, extraction, or use of property, but not for the purpose of selling services or property produced or extracted. The members of such organization must be able to compute their income without the necessity of computing partnership taxable income. Any syndicate, group, pool, or joint venture which is treated as a corporation for Federal tax purposes does not fall within the provisions in this paragraph (a)(1).
(2) Investing partnership. Where the participants in the joint purchase, retention, sale, or exchange of investment property:
(i) Own the property as co-owners;
(ii) Reserve the right separately to take or dispose of their shares of any property acquired or retained, and
(iii) Do not actively conduct business or irrevocably authorize some person or persons acting in a representative capacity to purchase, sell, or exchange such investment property, although each separate participant may delegate authority to purchase, sell, or exchange his share of any such investment property for the time being for his account, but not for a period of more than a year, then
such group may be excluded from the application of the provisions of subchapter K under the rules set forth in paragraph (b) of this section.
(3) Operating agreements. Where the participants in the joint production, extraction, or use of property:
(i) Own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights; and
(ii) Reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used, and
(iii) Do not jointly sell services or the property produced or extracted, although each separate participant may delegate authority to sell his share of the property produced or extracted for the time being for his account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than 1 year, then such group may be excluded from the application of the provisions of subchapter K under the rules set forth in paragraph (b) of this section. However, the preceding sentence does not apply to any unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. In addition, except as provided in paragraph (d)(2)(i) of this section, this paragraph (a)(3) does not apply to any unincorporated organization that produces natural gas under a joint operating agreement, unless all members of the unincorporated organization comply with paragraph (d) of this section.
(4) Modifications for certain joint ownership arrangements of applicable credit property—(i) Scope. Paragraph (a)(4)(iii) of this section provides certain modifications to specified rules in paragraph (a)(3) of this section in the case of an applicable unincorporated organization meeting the requirements of paragraph (a)(4)(ii) of this section.
(ii) Applicable unincorporated organization. For purposes of this section, an applicable unincorporated organization is an unincorporated organization:
(A) That is owned, in whole or in part, by one or more applicable entities, as defined in section 6417(d)(1)(A) and § 1.6417-1(c);
(B) The members of which enter into a joint operating agreement in which the members reserve the right separately to take in kind or dispose of their pro rata shares of any property produced, extracted, or used, and any associated renewable energy credits or similar credits;
(C) That, pursuant to the joint operating agreement, is organized exclusively to own and operate applicable credit property (as defined in § 1.6417-1(e));
(D) For which one or more of the applicable entities will make an elective payment election under section 6417(a) for the applicable credits determined with respect to its share of the applicable credit property;
(E) The members of which are able to compute their income without the necessity of computing partnership taxable income; and
(F) Which is not a syndicate, group, pool, or joint venture which is classifiable as an association, or any group operating under an agreement which creates an organization classifiable as an association.
(iii) Specified modifications for applicable unincorporated organizations. Solely for purposes of an election under section 761(a) by an applicable unincorporated organization that meets the requirements of paragraphs (b) and (e) of this section:
(A) The requirement in paragraph (a)(3)(i) of this section is modified such that the participants are permitted to own the applicable credit property through an unincorporated organization that is an entity, other than one that is treated as a corporation for Federal tax purposes; and
(B) The requirement in paragraph (a)(3)(iii) of this section is modified such that the delegation of authority to sell the participant's share of the property produced or used may allow the delegee to enter into contracts the duration of which exceeds the minimum needs of the industry and may be for more than one year, provided that the delegation of authority to act on behalf of the participant may not be for a period of time that exceeds the minimum needs of the industry, and in no event for more than one year.
(5) Examples. The following examples are intended to illustrate the principles of this section.
(i) Example 1—(A) Facts. G and H enter into a joint operating agreement to own and operate a facility that will produce solar energy. G, an applicable entity, is entitled under the joint operating agreement to take in kind or dispose of 40% of the energy produced by the unincorporated organization and H, which is not an applicable entity, is entitled to the remaining 60%. G and H form LLC, a limited liability company, to hold the solar energy property that G and H intend to operate pursuant to the joint operating agreement. In accordance with the joint operating agreement, G owns a 40% ownership interest in LLC and H owns the remaining 60% ownership interest. G will sell its share of energy produced by the facility in a manner designed to generate applicable credits under section 45(a) and will make an election under section 6417(a) with respect thereto. LLC makes a valid election under section 761(a) to be excluded from subchapter K.
(B) Analysis. G will be entitled to any credits under section 45(a) generated by its sale of energy produced by LLC that G has the right to take in kind or dispose of (which, under the joint operating agreement, is 40% of the energy produced by LLC). Assuming all other requirements are met, G will be able to make an elective payment election under section 6417 for the applicable credits determined with respect to its ownership share of the solar energy property.
(ii) Example 2—(A) Facts. T is an Indian Tribal government as defined in § 1.6417-1(k) and an applicable entity. Through a limited liability company organized under T's Tribal law (TLLC), T and Y own and operate applicable credit property that will generate electricity the sale of which will generate applicable credits under section 45(a). TLLC is not treated as an association taxable as a corporation for Federal tax purposes and no election under § 301.7701-3 of this chapter has been made to treat TLLC as such. T and Y enter into a joint operating agreement with respect to the ownership and operation of the applicable credit property in which each of T and Y reserve the right separately to take in kind or dispose of their pro rata shares of property produced, extracted, or used and any associated renewable energy credits or similar credits. TLLC is formed exclusively to own and operate an applicable credit property with respect to which section 45(a) credits will be determined. On January 1st of year 1, T and Y enter into delegation agreements with Q that delegate T's and Y's authority to Q to sell the electricity generated by T's and Y's shares of the applicable credit property. The term of the delegation agreements is one year, which does not exceed the minimum needs of the industry. On June 1st of year 1, Q enters into a power purchase agreement with Utility on T's and Y's behalf that commits T and Y to sell the electricity produced from their shares of the applicable credit property to Utility for a term of 15 years. At the end of the day on December 31st of year 1, the delegation agreements terminate.
(B) Analysis. Because T and Y did not delegate authority for a period of more than one year to sell the output from their shares of the applicable credit property, the requirements of paragraph (a)(3)(iii) of this section (as modified by paragraph (a)(4)(iii)(B) of this section) are met. Assuming that TLLC otherwise qualifies as an applicable unincorporated organization, TLLC is an organization described in paragraph (a)(4)(iii)(A) of this section and can make an election under paragraphs (b) and (e) of this section to be excluded from the application of all of subchapter K under section 761(a). As such, T can make an elective payment election for the applicable credits determined with respect to its share of the applicable credit property held by TLLC, assuming the requirements of section 6417 are otherwise met. The analysis in this example would be the same whether Y is also an Indian Tribal government, another applicable entity, or some other person.
(iii) Example 3—(A) Facts. The facts are the same as in paragraph (a)(5)(ii)(A) of this section (Example 2), except that at the end of the day on December 31, T and Y each agree, in writing, to a new agent delegation agreement with Q with substantively identical terms as the agent delegation agreement in effect during year 1.
(B) Analysis. Because each of T and Y have agreed, in writing, to engage Q in an agency relationship lasting no longer than one year, the results are the same as in paragraph (a)(5)(ii)(B) of this section (Example 2). In contrast, if the agent delegation agreement renewed automatically, T and Y have effectively entered into an agent delegation agreement lasting longer than one year and have violated the requirements of paragraph (a)(4)(iii)(B) of this section. In that case, TLLC would not be eligible to make or maintain an election under section 761(a). As such, T could not make an elective payment election for the applicable credits determined with respect to its share of the applicable credit property held through TLLC.
(b) Complete exclusion from subchapter K—(1) Time for making election for exclusion. Any unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) that wishes to be excluded from all of subchapter K must make the election provided in section 761(a) not later than the time prescribed by § 1.6031(a)-1(e) (including extensions thereof) for filing the partnership return for the first taxable year for which exclusion from subchapter K is desired. Notwithstanding the prior sentence, such organization may be deemed to have made the election in the manner prescribed in paragraph (b)(2)(ii) of this section.
(2) Method of making election—(i) In general. Except as provided in paragraph (b)(2)(ii) of this section, any unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) which wishes to be excluded from all of subchapter K must make the election provided in section 761(a) in a statement attached to, or incorporated in, a properly executed partnership return, Form 1065, U.S. Return of Partnership Income, which must contain the information required in this paragraph (b)(2)(i). Such return must be filed with the Internal Revenue Service Center where the partnership return, Form 1065, would be required to be filed if no election were made. To determine the appropriate Internal Revenue Service Center, the principal office or place of business of the person filing the return will be considered the principal office or place of business of the organization. The partnership return must be filed not later than the time prescribed § 1.6031(a)-1(e) (including extensions thereof) for filing the partnership return with respect to the first taxable year for which exclusion from subchapter K is desired. Such partnership return must contain, in lieu of the information required by Form 1065 and by the instructions relating thereto, only the name or other identification and the address of the organization together with information on the return, or in the statement attached to the return, showing the names, addresses, and taxpayer identification numbers of all the members of the organization; a statement that the organization qualifies under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable); a statement that all of the members of the organization elect that it be excluded from all of subchapter K; and a statement indicating where a copy of the agreement under which the organization operates is available (or if the agreement is oral, from whom the provisions of the agreement may be obtained).
(ii) Deemed election rule. If an unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) does not make the election provided in section 761(a) in the manner prescribed by paragraph (b)(2)(i) of this section, it will nevertheless be deemed to have made the election if it can be shown from all the surrounding facts and circumstances that it was the intention of the members of such organization at the time of its formation to secure exclusion from all of subchapter K beginning with the first taxable year of the organization. Although the following facts are not exclusive, either one of such facts may indicate the requisite intent:
(A) At the time of the formation of the organization there is an agreement among the members that the organization be excluded from subchapter K beginning with the first taxable year of the organization; or
(B) The members of the organization owning substantially all of the capital interests report their respective shares of the items of income, deductions, and credits of the organization on their respective returns (making such elections as to individual items as may be appropriate) in a manner consistent with the exclusion of the organization from subchapter K beginning with the first taxable year of the organization.
(3) Effect of election—(i) In general. An election under this section to be excluded will be effective unless within 90 days after the formation of the organization any member of the organization notifies the Commissioner that the member desires subchapter K to apply to such organization, and also advises the Commissioner that the member has so notified all other members of the organization by registered or certified mail. Such election is irrevocable as long as the organization remains qualified under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable), or unless approval of revocation of the election is secured from the Commissioner.
(ii) Special rule. Notwithstanding subdivision (i) of this subparagraph, an election deemed made pursuant to subparagraph (2)(ii) of this paragraph will not be effective in the case of an organization which had a taxable year ending on or before November 30, 1972, if any member of the organization notifies the Commissioner that the member desires subchapter K to apply to such organization, and also advises the Commissioner that he has so notified all other members of the organization by registered or certified mail. Such notification to the Commissioner must be made on or before January 2, 1973 and must include the names and addresses of all of the members of the organization.
(c) Partial exclusion from subchapter K. An unincorporated organization which wishes to be excluded from only certain sections of subchapter K must submit to the Commissioner, no later than 90 days after the beginning of the first taxable year for which partial exclusion is desired, a request for permission to be excluded from certain provisions of subchapter K. The request must set forth the sections of subchapter K from which exclusion is sought and must state that such organization qualifies under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable), and that the members of the organization elect to be excluded to the extent indicated. Such exclusion will be effective only upon approval of the election by the Commissioner and subject to the conditions the Commissioner may impose.
(d) Rules for gas producers that produce natural gas under joint operating agreements—(1) Joint operating agreements and gas balancing. Co-owners of a property producing natural gas enter into a joint operating agreement (JOA) to define the rights and obligations of each co- producer of the gas in place. The JOA determines, among other things, each co-producer's proportionate share of the natural gas as it is produced from the reservoir, together with the associated production expenses. A gas imbalance arises when a co-producer does not take its proportionate share of current gas production under the JOA (underproducer) and another co-producer takes more than its proportionate share of current production (overproducer). The co-producers often enter into a gas balancing agreement (GBA) as an addendum to their JOA to establish their rights and obligations when a gas imbalance arises. A GBA typically allows the overproducer to take the amount of the gas imbalance (overproduced gas) and entitles the underproducer to recoup the overproduced gas either from the volume of the gas remaining in the reservoir or by a cash balancing payment.
(2) Permissible gas balancing methods—(i) General requirement. All co-producers of natural gas operating under the same JOA must use the cumulative gas balancing method, as described in paragraph (d)(3) of this section, unless they use the annual gas balancing method described in paragraph (d)(4) of this section. A co-producer's failure to comply with the provisions of this paragraph (d)(2)(i) generally constitutes the use of an impermissible method of accounting, requiring a change to a permissible method under § 1.446-1(e)(3) with any terms and conditions as may be imposed by the Commissioner. The co-producers' election to be excluded from all or part of subchapter K will not be revoked, unless the Commissioner determines that there was willful failure to comply with the requirements of this paragraph (d)(2)(i).
(ii) Change in method of accounting; adoption of method of accounting—(A) In general. The annual gas balancing method and the cumulative gas balancing method are methods of accounting. Accordingly, a change to or from either of these methods is a change in method of accounting that requires the consent of the Commissioner. See section 446(e) and § 1.446-1(e). For purposes of this section, each JOA is treated as a separate trade or business. Paragraph (d)(2)(ii)(B) of this section provides rules for adopting either permissible method of accounting. Paragraph (d)(2)(ii)(C) of this section provides rules on the timing of required changes to either permissible method during the transitional period, and paragraph (d)(5) of this section contains the procedural provisions for making a change in method of accounting required in paragraph (d)(2)(ii)(C) of this section.
(B) Adoption of method of accounting. A co-producer must adopt a permissible method for each JOA entered into on or after the start of the co-producer's first taxable year beginning after December 31, 1994 (or, in the case of the use of the annual gas balancing method by co-producers not having the same taxable year, the start of the first taxable year beginning after December 31, 1994, of the co-producer whose taxable year begins latest in the calendar year). If a co-producer is adopting the cumulative method, the co-producer may adopt the method by using the method on its timely filed return for the taxable year of adoption. A co-producer may adopt the annual gas balancing method with the permission of the Commissioner under guidelines set forth in paragraph (d)(4)(ii) of this section.
(C) Required change in method of accounting for certain joint operating agreements. This paragraph (d)(2)(ii)(C) applies to certain JOAs entered into prior to 1996. Except in the case of a part-year change in method of accounting or in the case of the cessation of a JOA (both of which are described in this paragraph (d)(2)(ii)(C)), for each JOA entered into prior to a co-producer's first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year, the co-producer must change its method of accounting for sales of gas and its treatment of certain related deductions and credits to a permissible method as of the start of its first taxable year beginning after December 31, 1994. In the case of a JOA of co-producers that do not all have the same taxable year and that choose the annual gas balancing method, if the JOA is entered into prior to the first taxable year beginning after December 31, 1994 of the co-producer whose taxable year begins latest in the calendar year and the JOA is in effect as of January 1, 1996, a change to the annual gas balancing method by each co-producer under that JOA is made as of January 1, 1996 (part-year change in method of accounting). If the co-producers would have made a part-year change to the annual gas balancing method but for the fact that their JOA ceased to be in effect before January 1, 1996 (cessation of a JOA), the co-producers do not change their method of accounting with respect to the JOA. Rather, for their taxable years in which the JOA ceases to be in effect, the co-producers use their current method of accounting with respect to that JOA.
(3) Cumulative gas balancing method—(i) In general. The cumulative gas balancing method (cumulative method), solely for purposes of reporting income from gas sales and certain related deductions and credits, treats each co-producer under the same JOA as the sole owner of its percentage share of the total gas in the reservoir and disregards the ownership arrangement described in the JOA for gas as it is produced from the reservoir. Each co-producer is considered to be taking only its share of the total gas in the reservoir as long as the gas remaining in the reservoir is sufficient to satisfy the ownership rights of the co-producers in their percentage shares of the total gas in the reservoir. After a co-producer has taken its entire share of the total gas in the reservoir, any additional gas taken by that co-producer (taking co-producer) is treated as having been taken from its other co-producers' shares of the total gas in the reservoir. The effect of being treated as a taking co-producer under the cumulative method is that the taking co-producer generally may not claim an allowance for depletion and a production credit on its sales of its other co-producers' percentage shares of the total gas in the reservoir.
(ii) Requirements—(A) Reporting of income from sales of gas. Under the cumulative method, each co-producer must include in gross income under its overall method of accounting the amount of its sales from all gas produced from the reservoir, including sales of gas taken from another co-producer's share of the gas in the reservoir.
(B) Reporting of deduction of taking co-producer. A taking co-producer deducts the amount of a payment (in cash or property, other than gas produced under the JOA) made to another co-producer for sales of that co-producer's gas, but only for the taxable year in which the payment is made. Thus, an accrual method taking co-producer is not permitted a deduction for any obligation it has to pay another co-producer for sales of that co-producer's gas until a payment is made. See paragraph (d)(3)(iii)(B) of this section for a rule requiring a reduction of the amount of the deduction described in this paragraph (d)(3)(ii)(B) if the taking co-producer had mistakenly claimed a depletion deduction relating to those sales.
(C) Reporting of income by other co-producers. Any co-producer that is entitled to receive a payment from a taking co-producer must include the amount of the payment in gross income as proceeds from the sale of its gas only for the taxable year that the payment is actually received, regardless of its overall method of accounting.
(D) Reporting of production expenses. Each co-producer deducts its proportionate share of production expenses, as provided in the JOA, under its regular method of accounting for the expenses.
(iii) Special rules for production credits and depletion deductions under the cumulative method—(A) In general. Under the cumulative method, a co-producer's depletion allowance and production credit for a taxable year are based on its income from gas sales and production of gas from its percentage share of the total gas in the reservoir, and are not based on its current proportionate share of income and production as determined under the JOA. Thus, in general, a taking co-producer is not allowed a production credit or an allowance for depletion on its sales of gas in excess of its percentage share of the total gas in the reservoir. However, the Service will not disallow depletion deductions or production credits claimed by a taking co-producer on the gas of other co-producers if the taking co-producer had a reasonable but mistaken belief that the deductions or credits were claimed with respect to the taking co-producer's percentage share of total gas in the reservoir and the taking co-producer makes the appropriate reductions and additions to tax required in paragraphs (d)(3)(iii)(B) and (d)(3)(iii)(C) of this section. The reasonableness of the mistaken belief is determined at the time of filing the return claiming the deductions or credits. A co-producer receiving a payment for sales of its gas from a taking co-producer claims a production credit and an allowance for depletion relating to those sales only for the taxable year in which the amount of the payment is included in its gross income.
(B) Reduction of taking co-producer's payment deduction for depletion claimed on another co-producer's gas. If a taking co-producer claims an allowance for depletion on another co-producer's gas, the taking co-producer must reduce its deduction claimed in a later year for making a payment to the other co-producer for sales of that co-producer's gas by the amount of any percentage depletion deduction allowed on the gas sales to which the payment relates. If the percentage limitation of section 613A(d)(1) applied to disallow a depletion deduction for a previous year, the taking co-producer must reduce the amount of any carried over depletion deduction allowable in the year of the payment or in a future year by the portion of the carried over depletion deduction, if any, that relates to another co-producer's gas.
(C) Addition to tax of taking co-producer for production credit claimed on another co-producer's gas. If a taking co-producer claims a production credit on another co-producer's gas, the taking co-producer must add to its tax for the taxable year that it makes a payment to the other co-producer for sales of that co-producer's gas any production credit allowed in an earlier taxable year on the gas sales to which the payment relates, but only to the extent the credit allowed actually reduced the taking co- producer's tax in any earlier year. The taking co-producer also must reduce the amount of its minimum tax credit allowable by reason of section 53(d)(1)(B)(iii) in the year of the payment or in a future year by the portion of the credit, if any, that relates to another co-producer's gas.
(iv) Anti-abuse rule. If the Commissioner determines that co-producers using the cumulative method have arranged or altered their taking of production for a taxable year with a principal purpose of shifting the income, deductions, or credits relating to that production to avoid tax, the co- producers' election to be excluded from all or part of subchapter K will be revoked for that year and for subsequent years. In determining that a principal purpose was to avoid tax, the Commissioner will examine all the facts and circumstances surrounding the use of the cumulative method by the co-producers. See Examples 3 and 4 of paragraph (d)(6) of this section.
(4) Annual gas balancing method—(i) In general. The annual gas balancing method (annual method) takes into account each co-producer's ownership rights and obligations, as described in the JOA, with respect to the co-producer's current proportionate share of gas as it is produced from the reservoir. Under the annual method, gas imbalances relating to a JOA must be eliminated annually through a balancing payment, which may be in the form of cash, gas produced under the same JOA, or other property. If all the co-producers under a JOA have the same taxable year, any gas imbalance remaining at the end of a taxable year must be eliminated by a balancing payment from the overproducer to the underproducer by the due date of the overproducer's tax return for that taxable year (including extensions). If all the co-producers under a JOA do not have the same taxable year, any gas imbalance remaining at the end of a calendar year must be eliminated by a balancing payment from the overproducer to the underproducer by September 15 of the following calendar year. The annual method may be used only if the Commissioner's permission is obtained. Paragraph (d)(4)(ii) of this section provides guidelines for applying for this permission. The annual method is not available for a JOA with respect to which any co-producer made an election under paragraph (d)(5)(i)(B)(3) of this section (to take an aggregate section 481(a) adjustment for all JOAs of a co-producer into account in the year of change).
(ii) Obtaining the Commissioner's permission to use the annual method. A request for the Commissioner's permission to adopt the annual method for a new JOA must be in writing and must set forth the names of all the co-producers under the JOA and the respective taxable year of adoption. See paragraphs (d)(2)(ii) and (d)(5)(ii) of this section for the rules for a change in method of accounting to the annual method. In addition, the request must contain an explanation of how the co-producers will report income from gas sales, the making or receiving of a balancing payment, production expenses, depletion deductions, and production credits. Permission will be granted under appropriate conditions, including, but not limited to, an agreement in writing by all co-producers to use the annual method and to eliminate any gas imbalances annually in accordance with paragraph (d)(4)(i) of this section.
(5) Transitional rules for making a change in method of accounting required in paragraph (d)(2)(ii)(C) of this section—(i) Change in method of accounting to the cumulative method—(A) Automatic consent to change in method of accounting to the cumulative method. A co-producer changing to the cumulative method for any JOA entered into prior to its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year is granted the consent of the Commissioner to change its method of accounting with respect to each JOA to the cumulative method, provided the co-producer—
(1) Makes the change on its timely filed return for its first taxable year beginning after December 31, 1994;
(2) Attaches a completed and signed Form 3115 to the co-producer's tax return for the year of change, stating that, pursuant to § 1.761-2(d)(2)(ii) of the regulations, the co-producer is changing its method of accounting for sales of gas and its treatment of certain related deductions and credits under each JOA to the cumulative method;
(3) In the case of a co-producer making an election under paragraph (d)(5)(i)(B)(3) of this section to take the aggregate section 481(a) adjustment into account in the year of change, attaches the statement described in paragraph (d)(5)(i)(B)(3)(ii) of this section; and
(4) In the case of a co-producer not making an election under paragraph (d)(5)(i)(B)(3) of this section, attaches a list of each JOA with respect to which there is a section 481(a) adjustment computed in accordance with paragraph (d)(5)(i)(B)(2)(i) of this section.
(B) Section 481(a) adjustment—(1) Application of section 481(a). A change in method of accounting to the cumulative method under the automatic consent procedure in paragraph (d)(5)(i)(A) of this section is a change in method of accounting to which the provisions of section 481(a) apply. Thus, a section 481(a) adjustment must be taken into account in the manner provided by this paragraph (d)(5)(i)(B) to prevent the omission or duplication of income. Paragraph (d)(5)(i)(B)(2) of this section provides the general rules for computing the amount of the section 481(a) adjustment of a co-producer relating to a particular JOA and for taking the section 481(a) adjustment into account. Paragraph (d)(5)(i)(B)(3) of this section provides rules for electing to take a co-producer's section 481(a) adjustment computed on an aggregate basis for all JOAs into account in the year of change. Paragraph (d)(5)(i)(C) of this section provides rules to coordinate the taking of a depletion deduction or a production credit with the inclusion of a section 481(a) adjustment arising from a change in method of accounting to the cumulative method under this paragraph (d)(5)(i).
(2) Computation of the section 481(a) adjustment relating to a joint operating agreement—(i) In general. The section 481(a) adjustment of a co-producer relating to a JOA is computed as of the first day of the co-producer's year of change and is equal to the difference between the amount of income reported under the co-producer's former method of accounting for all taxable years prior to the year of change and the amount of income that would have been reported if the co-producer's new method had been used in all those taxable years.
(ii) Section 481(a) adjustment period. Except to the extent that paragraph (d)(5)(i)(B)(3) of this section applies, a co-producer's section 481(a) adjustment relating to a JOA, whether positive or negative, is taken into account in computing taxable income ratably over the 6-taxable-year period beginning with the year of change (the section 481(a) adjustment period). If the co-producer has been in existence less than 6 taxable years, the adjustment is taken into account over the number of years the co-producer has been in existence. If the co-producer ceases to engage in the trade or business that gave rise to the section 481(a) adjustment at any time during the section 481(a) adjustment period, the entire remaining balance of the section 481(a) adjustment relating to that trade or business must be taken into account in the year of the cessation. For purposes of this paragraph (d)(5)(i)(B)(2)(ii), production under each JOA is treated as a separate trade or business. The determination as to whether the co-producer ceases to engage in its trade or business is to be made under the principles of § 1.446-1(e)(3)(ii) and its underlying administrative procedures. For example, the permanent cessation of production under a co-producer's JOA constitutes the cessation of a trade or business of the co-producer. Accordingly, for the year that production under a JOA permanently ceases, the remaining balance of the section 481(a) adjustment relating to the JOA must be taken into account.
(3) Election to take aggregate section 481(a) adjustment for all joint operating agreements into account in the year of change—(i) In general. A co-producer may elect to take into account its section 481(a) adjustment, computed on an aggregate basis for all of its JOAs, whether negative or positive, in the year of change, provided the co-producer uses the cumulative method for all of its JOAs entered into prior to its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year. The aggregate section 481(a) adjustment of a co-producer is equal to the difference between the amount of income reported under the co-producer's former method of accounting for all taxable years prior to the year of change and the amount of income that would have been reported if the co-producer's new method had been used in all of those taxable years for all JOAs for which the co-producer changes its method of accounting. An election made under this paragraph (d)(5)(i)(B)(3) is irrevocable. If any person who, together with another person, would be treated as a single taxpayer under section 41(f)(1) (A) or (B) makes an election under this paragraph (d)(5)(i)(B)(3), all persons within that single taxpayer group will be treated as if they had made an election under this paragraph (d)(5)(i)(B)(3) and, as such, will be irrevocably bound by that election. If a co-producer does not make an election under this paragraph, each JOA entered into prior to the start of its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year must be accounted for separately in computing the section 481(a) adjustment and taxable income of the co-producer for any year to which this paragraph (d) applies.
(ii) Time and manner for making the election. An election under this paragraph (d)(5)(i)(B)(3) is made by attaching a statement to the co-producer's timely filed return for its year of change indicating that the co- producer is electing under § 1.761-2(d)(5)(i)(B)(3) to take its aggregate section 481(a) adjustment into account in the year of change.
(C) Treatment of section 481(a) adjustment as a sale for purposes of computing a production credit and as gross income from the property for purposes of depletion deductions. Any positive section 481(a) adjustment arising as a result of a change in method of accounting for gas imbalances under this paragraph (d)(5)(i) and taken into account in computing taxable income under paragraph (d)(5)(i)(B) of this section is considered a sale by the taxpayer for purposes of computing any production credit in the year that the adjustment is taken into account. Similarly, the positive section 481(a) adjustment is considered gross income from the property and taxable income from the property for purposes of computing depletion deductions in the year the adjustment is taken into account. Sales amounts used in computing any production credit in any year in which a negative section 481(a) adjustment is taken into account in computing taxable income under paragraph (d)(5)(i)(B) of this section must be reduced by the amount of the negative section 481(a) adjustment taken into account in that year. Similarly, gross income from the property and taxable income from the property used in computing any depletion deduction in any year in which the negative section 481(a) adjustment is taken into account must be reduced by the amount of the negative adjustment. For these purposes, any taxpayer that makes an aggregate section 481(a) adjustment election under paragraph (d)(5)(i)(B)(3) of this section must allocate the adjustment among its properties in any reasonable manner that prevents a duplication or omission of depletion deductions.
(ii) Change in method of accounting to the annual method—(A) In general. A co-producer changing to the annual method in accordance with paragraph (d)(2)(ii) of this section must request a change under § 1.446-1(e)(3) and will be subject to any terms and conditions as may be imposed by the Commissioner.
(B) Section 481(a) adjustment. A change in method of accounting to the annual method is a change in method of accounting to which the provisions of section 481(a) apply. Thus, a section 481(a) adjustment must be taken into account to prevent the omission or duplication of income. If all the co-producers under a JOA have the same taxable year, the section 481(a) adjustment involved in a change to the annual method by a co-producer relating to the JOA is computed as of the first day of the co-producer's year of change. If the co-producers under a JOA do not all have the same taxable year (that is, in the case of a part-year change described in paragraph (d)(2)(ii)(C) of this section), the change in method of accounting occurs on January 1, 1996, and the section 481(a) adjustment is computed on that date.
(iii) Untimely change in method of accounting to comply with this section. Unless a co-producer required by this section to change its method of accounting complies with the provisions of this paragraph (d)(5) for its first applicable taxable year within the time prescribed by this paragraph (d)(5), the co-producer must take the section 481(a) adjustment into account under the provisions of any applicable administrative procedure that is prescribed by the Commissioner specifically for purposes of complying with this section. Absent such an administrative procedure, a co-producer must request a change under § 1.446-1(e)(3) and will be subject to any terms and conditions as may be imposed by the Commissioner.
(6) Examples. The following examples illustrate the application of the cumulative method described in paragraph (d)(3) of this section.
(7) Effective date. Except in the case of a part-year change to the annual method or the cessation of a JOA, both of which are described in paragraph (d)(2)(ii)(C) of this section, the provisions of this paragraph (d) apply to all taxable years beginning after December 31, 1994, of any producer that is a member of an unincorporated organization that produces natural gas under a JOA in effect on or after the start of the producer's first taxable year beginning after December 31, 1994. In the case of a part-year change, the provisions of this paragraph (d) apply on and after January 1, 1996. In the case of the cessation of a JOA, the co-producers use their current method of accounting with respect to that JOA until the JOA ceases to be in effect.
(e) Cross reference. For requirements with respect to the filing of a return on Form 1065 by a partnership, see § 1.6031(a)-1.
(f) Applicability date. Except as provided in paragraph (d) of this section, this section applies to taxable years ending on or after March 11, 2024.
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Treas. Reg. §1.761-2(a)Exclusion of eligible unincorporated organizations—(1) In general.
Exclusion of eligible unincorporated organizations—(1) In general. Under the conditions set forth in this section, an unincorporated organization described in paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) may be excluded from the application of all or a part of the provisions of subchapter K of chapter 1 of the Internal Revenue Code (subchapter K). Such organization must be availed of for investment purposes only and not for the active conduct of a business, or for the joint production, extraction, or use of property, but not for the purpose of selling services or property produced or extracted. The members of such organization must be able to compute their income without the necessity of computing partnership taxable income. Any syndicate, group, pool, or joint venture which is treated as a corporation for Federal tax purposes does not fall within the provisions in this paragraph (a)(1).
(2) Investing partnership. Where the participants in the joint purchase, retention, sale, or exchange of investment property:
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Treas. Reg. §1.761-2(b)Complete exclusion from subchapter K—(1) Time for making election for exclusion.
Complete exclusion from subchapter K—(1) Time for making election for exclusion. Any unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) that wishes to be excluded from all of subchapter K must make the election provided in section 761(a) not later than the time prescribed by § 1.6031(a)-1(e) (including extensions thereof) for filing the partnership return for the first taxable year for which exclusion from subchapter K is desired. Notwithstanding the prior sentence, such organization may be deemed to have made the election in the manner prescribed in paragraph (b)(2)(ii) of this section.
(2) Method of making election—(i) In general. Except as provided in paragraph (b)(2)(ii) of this section, any unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) which wishes to be excluded from all of subchapter K must make the election provided in section 761(a) in a statement attached to, or incorporated in, a properly executed partnership return, Form 1065, U.S. Return of Partnership Income, which must contain the information required in this paragraph (b)(2)(i). Such return must be filed with the Internal Revenue Service Center where the partnership return, Form 1065, would be required to be filed if no election were made. To determine the appropriate Internal Revenue Service Center, the principal office or place of business of the person filing the return will be considered the principal office or place of business of the organization. The partnership return must be filed not later than the time prescribed § 1.6031(a)-1(e) (including extensions thereof) for filing the partnership return with respect to the first taxable year for which exclusion from subchapter K is desired. Such partnership return must contain, in lieu of the information required by Form 1065 and by the instructions relating thereto, only the name or other identification and the address of the organization together with information on the return, or in the statement attached to the return, showing the names, addresses, and taxpayer identification numbers of all the members of the organization; a statement that the organization qualifies under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable); a statement that all of the members of the organization elect that it be excluded from all of subchapter K; and a statement indicating where a copy of the agreement under which the organization operates is available (or if the agreement is oral, from whom the provisions of the agreement may be obtained).
(ii) Deemed election rule. If an unincorporated organization described in paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable) does not make the election provided in section 761(a) in the manner prescribed by paragraph (b)(2)(i) of this section, it will nevertheless be deemed to have made the election if it can be shown from all the surrounding facts and circumstances that it was the intention of the members of such organization at the time of its formation to secure exclusion from all of subchapter K beginning with the first taxable year of the organization. Although the following facts are not exclusive, either one of such facts may indicate the requisite intent:
(A) At the time of the formation of the organization there is an agreement among the members that the organization be excluded from subchapter K beginning with the first taxable year of the organization; or
(B) The members of the organization owning substantially all of the capital interests report their respective shares of the items of income, deductions, and credits of the organization on their respective returns (making such elections as to individual items as may be appropriate) in a manner consistent with the exclusion of the organization from subchapter K beginning with the first taxable year of the organization.
(3) Effect of election—(i) In general. An election under this section to be excluded will be effective unless within 90 days after the formation of the organization any member of the organization notifies the Commissioner that the member desires subchapter K to apply to such organization, and also advises the Commissioner that the member has so notified all other members of the organization by registered or certified mail. Such election is irrevocable as long as the organization remains qualified under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable), or unless approval of revocation of the election is secured from the Commissioner.
(ii) Special rule. Notwithstanding subdivision (i) of this subparagraph, an election deemed made pursuant to subparagraph (2)(ii) of this paragraph will not be effective in the case of an organization which had a taxable year ending on or before November 30, 1972, if any member of the organization notifies the Commissioner that the member desires subchapter K to apply to such organization, and also advises the Commissioner that he has so notified all other members of the organization by registered or certified mail. Such notification to the Commissioner must be made on or before January 2, 1973 and must include the names and addresses of all of the members of the organization.
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Treas. Reg. §1.761-2(c)Partial exclusion from subchapter K.
Partial exclusion from subchapter K. An unincorporated organization which wishes to be excluded from only certain sections of subchapter K must submit to the Commissioner, no later than 90 days after the beginning of the first taxable year for which partial exclusion is desired, a request for permission to be excluded from certain provisions of subchapter K. The request must set forth the sections of subchapter K from which exclusion is sought and must state that such organization qualifies under paragraph (a)(1) of this section and either paragraph (a)(2) or (3) of this section (taking into account paragraph (a)(4) of this section, as applicable), and that the members of the organization elect to be excluded to the extent indicated. Such exclusion will be effective only upon approval of the election by the Commissioner and subject to the conditions the Commissioner may impose.
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Treas. Reg. §1.761-2(d)Rules for gas producers that produce natural gas under joint operating agreements—(1) Joint operating agreements and gas balancing.
Rules for gas producers that produce natural gas under joint operating agreements—(1) Joint operating agreements and gas balancing. Co-owners of a property producing natural gas enter into a joint operating agreement (JOA) to define the rights and obligations of each co- producer of the gas in place. The JOA determines, among other things, each co-producer's proportionate share of the natural gas as it is produced from the reservoir, together with the associated production expenses. A gas imbalance arises when a co-producer does not take its proportionate share of current gas production under the JOA (underproducer) and another co-producer takes more than its proportionate share of current production (overproducer). The co-producers often enter into a gas balancing agreement (GBA) as an addendum to their JOA to establish their rights and obligations when a gas imbalance arises. A GBA typically allows the overproducer to take the amount of the gas imbalance (overproduced gas) and entitles the underproducer to recoup the overproduced gas either from the volume of the gas remaining in the reservoir or by a cash balancing payment.
(2) Permissible gas balancing methods—(i) General requirement. All co-producers of natural gas operating under the same JOA must use the cumulative gas balancing method, as described in paragraph (d)(3) of this section, unless they use the annual gas balancing method described in paragraph (d)(4) of this section. A co-producer's failure to comply with the provisions of this paragraph (d)(2)(i) generally constitutes the use of an impermissible method of accounting, requiring a change to a permissible method under § 1.446-1(e)(3) with any terms and conditions as may be imposed by the Commissioner. The co-producers' election to be excluded from all or part of subchapter K will not be revoked, unless the Commissioner determines that there was willful failure to comply with the requirements of this paragraph (d)(2)(i).
(ii) Change in method of accounting; adoption of method of accounting—(A) In general. The annual gas balancing method and the cumulative gas balancing method are methods of accounting. Accordingly, a change to or from either of these methods is a change in method of accounting that requires the consent of the Commissioner. See section 446(e) and § 1.446-1(e). For purposes of this section, each JOA is treated as a separate trade or business. Paragraph (d)(2)(ii)(B) of this section provides rules for adopting either permissible method of accounting. Paragraph (d)(2)(ii)(C) of this section provides rules on the timing of required changes to either permissible method during the transitional period, and paragraph (d)(5) of this section contains the procedural provisions for making a change in method of accounting required in paragraph (d)(2)(ii)(C) of this section.
(B) Adoption of method of accounting. A co-producer must adopt a permissible method for each JOA entered into on or after the start of the co-producer's first taxable year beginning after December 31, 1994 (or, in the case of the use of the annual gas balancing method by co-producers not having the same taxable year, the start of the first taxable year beginning after December 31, 1994, of the co-producer whose taxable year begins latest in the calendar year). If a co-producer is adopting the cumulative method, the co-producer may adopt the method by using the method on its timely filed return for the taxable year of adoption. A co-producer may adopt the annual gas balancing method with the permission of the Commissioner under guidelines set forth in paragraph (d)(4)(ii) of this section.
(C) Required change in method of accounting for certain joint operating agreements. This paragraph (d)(2)(ii)(C) applies to certain JOAs entered into prior to 1996. Except in the case of a part-year change in method of accounting or in the case of the cessation of a JOA (both of which are described in this paragraph (d)(2)(ii)(C)), for each JOA entered into prior to a co-producer's first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year, the co-producer must change its method of accounting for sales of gas and its treatment of certain related deductions and credits to a permissible method as of the start of its first taxable year beginning after December 31, 1994. In the case of a JOA of co-producers that do not all have the same taxable year and that choose the annual gas balancing method, if the JOA is entered into prior to the first taxable year beginning after December 31, 1994 of the co-producer whose taxable year begins latest in the calendar year and the JOA is in effect as of January 1, 1996, a change to the annual gas balancing method by each co-producer under that JOA is made as of January 1, 1996 (part-year change in method of accounting). If the co-producers would have made a part-year change to the annual gas balancing method but for the fact that their JOA ceased to be in effect before January 1, 1996 (cessation of a JOA), the co-producers do not change their method of accounting with respect to the JOA. Rather, for their taxable years in which the JOA ceases to be in effect, the co-producers use their current method of accounting with respect to that JOA.
(3) Cumulative gas balancing method—(i) In general. The cumulative gas balancing method (cumulative method), solely for purposes of reporting income from gas sales and certain related deductions and credits, treats each co-producer under the same JOA as the sole owner of its percentage share of the total gas in the reservoir and disregards the ownership arrangement described in the JOA for gas as it is produced from the reservoir. Each co-producer is considered to be taking only its share of the total gas in the reservoir as long as the gas remaining in the reservoir is sufficient to satisfy the ownership rights of the co-producers in their percentage shares of the total gas in the reservoir. After a co-producer has taken its entire share of the total gas in the reservoir, any additional gas taken by that co-producer (taking co-producer) is treated as having been taken from its other co-producers' shares of the total gas in the reservoir. The effect of being treated as a taking co-producer under the cumulative method is that the taking co-producer generally may not claim an allowance for depletion and a production credit on its sales of its other co-producers' percentage shares of the total gas in the reservoir.
(ii) Requirements—(A) Reporting of income from sales of gas. Under the cumulative method, each co-producer must include in gross income under its overall method of accounting the amount of its sales from all gas produced from the reservoir, including sales of gas taken from another co-producer's share of the gas in the reservoir.
(B) Reporting of deduction of taking co-producer. A taking co-producer deducts the amount of a payment (in cash or property, other than gas produced under the JOA) made to another co-producer for sales of that co-producer's gas, but only for the taxable year in which the payment is made. Thus, an accrual method taking co-producer is not permitted a deduction for any obligation it has to pay another co-producer for sales of that co-producer's gas until a payment is made. See paragraph (d)(3)(iii)(B) of this section for a rule requiring a reduction of the amount of the deduction described in this paragraph (d)(3)(ii)(B) if the taking co-producer had mistakenly claimed a depletion deduction relating to those sales.
(C) Reporting of income by other co-producers. Any co-producer that is entitled to receive a payment from a taking co-producer must include the amount of the payment in gross income as proceeds from the sale of its gas only for the taxable year that the payment is actually received, regardless of its overall method of accounting.
(D) Reporting of production expenses. Each co-producer deducts its proportionate share of production expenses, as provided in the JOA, under its regular method of accounting for the expenses.
(iii) Special rules for production credits and depletion deductions under the cumulative method—(A) In general. Under the cumulative method, a co-producer's depletion allowance and production credit for a taxable year are based on its income from gas sales and production of gas from its percentage share of the total gas in the reservoir, and are not based on its current proportionate share of income and production as determined under the JOA. Thus, in general, a taking co-producer is not allowed a production credit or an allowance for depletion on its sales of gas in excess of its percentage share of the total gas in the reservoir. However, the Service will not disallow depletion deductions or production credits claimed by a taking co-producer on the gas of other co-producers if the taking co-producer had a reasonable but mistaken belief that the deductions or credits were claimed with respect to the taking co-producer's percentage share of total gas in the reservoir and the taking co-producer makes the appropriate reductions and additions to tax required in paragraphs (d)(3)(iii)(B) and (d)(3)(iii)(C) of this section. The reasonableness of the mistaken belief is determined at the time of filing the return claiming the deductions or credits. A co-producer receiving a payment for sales of its gas from a taking co-producer claims a production credit and an allowance for depletion relating to those sales only for the taxable year in which the amount of the payment is included in its gross income.
(B) Reduction of taking co-producer's payment deduction for depletion claimed on another co-producer's gas. If a taking co-producer claims an allowance for depletion on another co-producer's gas, the taking co-producer must reduce its deduction claimed in a later year for making a payment to the other co-producer for sales of that co-producer's gas by the amount of any percentage depletion deduction allowed on the gas sales to which the payment relates. If the percentage limitation of section 613A(d)(1) applied to disallow a depletion deduction for a previous year, the taking co-producer must reduce the amount of any carried over depletion deduction allowable in the year of the payment or in a future year by the portion of the carried over depletion deduction, if any, that relates to another co-producer's gas.
(C) Addition to tax of taking co-producer for production credit claimed on another co-producer's gas. If a taking co-producer claims a production credit on another co-producer's gas, the taking co-producer must add to its tax for the taxable year that it makes a payment to the other co-producer for sales of that co-producer's gas any production credit allowed in an earlier taxable year on the gas sales to which the payment relates, but only to the extent the credit allowed actually reduced the taking co- producer's tax in any earlier year. The taking co-producer also must reduce the amount of its minimum tax credit allowable by reason of section 53(d)(1)(B)(iii) in the year of the payment or in a future year by the portion of the credit, if any, that relates to another co-producer's gas.
(iv) Anti-abuse rule. If the Commissioner determines that co-producers using the cumulative method have arranged or altered their taking of production for a taxable year with a principal purpose of shifting the income, deductions, or credits relating to that production to avoid tax, the co- producers' election to be excluded from all or part of subchapter K will be revoked for that year and for subsequent years. In determining that a principal purpose was to avoid tax, the Commissioner will examine all the facts and circumstances surrounding the use of the cumulative method by the co-producers. See Examples 3 and 4 of paragraph (d)(6) of this section.
(4) Annual gas balancing method—(i) In general. The annual gas balancing method (annual method) takes into account each co-producer's ownership rights and obligations, as described in the JOA, with respect to the co-producer's current proportionate share of gas as it is produced from the reservoir. Under the annual method, gas imbalances relating to a JOA must be eliminated annually through a balancing payment, which may be in the form of cash, gas produced under the same JOA, or other property. If all the co-producers under a JOA have the same taxable year, any gas imbalance remaining at the end of a taxable year must be eliminated by a balancing payment from the overproducer to the underproducer by the due date of the overproducer's tax return for that taxable year (including extensions). If all the co-producers under a JOA do not have the same taxable year, any gas imbalance remaining at the end of a calendar year must be eliminated by a balancing payment from the overproducer to the underproducer by September 15 of the following calendar year. The annual method may be used only if the Commissioner's permission is obtained. Paragraph (d)(4)(ii) of this section provides guidelines for applying for this permission. The annual method is not available for a JOA with respect to which any co-producer made an election under paragraph (d)(5)(i)(B)(3) of this section (to take an aggregate section 481(a) adjustment for all JOAs of a co-producer into account in the year of change).
(ii) Obtaining the Commissioner's permission to use the annual method. A request for the Commissioner's permission to adopt the annual method for a new JOA must be in writing and must set forth the names of all the co-producers under the JOA and the respective taxable year of adoption. See paragraphs (d)(2)(ii) and (d)(5)(ii) of this section for the rules for a change in method of accounting to the annual method. In addition, the request must contain an explanation of how the co-producers will report income from gas sales, the making or receiving of a balancing payment, production expenses, depletion deductions, and production credits. Permission will be granted under appropriate conditions, including, but not limited to, an agreement in writing by all co-producers to use the annual method and to eliminate any gas imbalances annually in accordance with paragraph (d)(4)(i) of this section.
(5) Transitional rules for making a change in method of accounting required in paragraph (d)(2)(ii)(C) of this section—(i) Change in method of accounting to the cumulative method—(A) Automatic consent to change in method of accounting to the cumulative method. A co-producer changing to the cumulative method for any JOA entered into prior to its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year is granted the consent of the Commissioner to change its method of accounting with respect to each JOA to the cumulative method, provided the co-producer—
(1) Makes the change on its timely filed return for its first taxable year beginning after December 31, 1994;
(2) Attaches a completed and signed Form 3115 to the co-producer's tax return for the year of change, stating that, pursuant to § 1.761-2(d)(2)(ii) of the regulations, the co-producer is changing its method of accounting for sales of gas and its treatment of certain related deductions and credits under each JOA to the cumulative method;
(3) In the case of a co-producer making an election under paragraph (d)(5)(i)(B)(3) of this section to take the aggregate section 481(a) adjustment into account in the year of change, attaches the statement described in paragraph (d)(5)(i)(B)(3)(ii) of this section; and
(4) In the case of a co-producer not making an election under paragraph (d)(5)(i)(B)(3) of this section, attaches a list of each JOA with respect to which there is a section 481(a) adjustment computed in accordance with paragraph (d)(5)(i)(B)(2)(i) of this section.
(B) Section 481(a) adjustment—(1) Application of section 481(a). A change in method of accounting to the cumulative method under the automatic consent procedure in paragraph (d)(5)(i)(A) of this section is a change in method of accounting to which the provisions of section 481(a) apply. Thus, a section 481(a) adjustment must be taken into account in the manner provided by this paragraph (d)(5)(i)(B) to prevent the omission or duplication of income. Paragraph (d)(5)(i)(B)(2) of this section provides the general rules for computing the amount of the section 481(a) adjustment of a co-producer relating to a particular JOA and for taking the section 481(a) adjustment into account. Paragraph (d)(5)(i)(B)(3) of this section provides rules for electing to take a co-producer's section 481(a) adjustment computed on an aggregate basis for all JOAs into account in the year of change. Paragraph (d)(5)(i)(C) of this section provides rules to coordinate the taking of a depletion deduction or a production credit with the inclusion of a section 481(a) adjustment arising from a change in method of accounting to the cumulative method under this paragraph (d)(5)(i).
(2) Computation of the section 481(a) adjustment relating to a joint operating agreement—(i) In general. The section 481(a) adjustment of a co-producer relating to a JOA is computed as of the first day of the co-producer's year of change and is equal to the difference between the amount of income reported under the co-producer's former method of accounting for all taxable years prior to the year of change and the amount of income that would have been reported if the co-producer's new method had been used in all those taxable years.
(ii) Section 481(a) adjustment period. Except to the extent that paragraph (d)(5)(i)(B)(3) of this section applies, a co-producer's section 481(a) adjustment relating to a JOA, whether positive or negative, is taken into account in computing taxable income ratably over the 6-taxable-year period beginning with the year of change (the section 481(a) adjustment period). If the co-producer has been in existence less than 6 taxable years, the adjustment is taken into account over the number of years the co-producer has been in existence. If the co-producer ceases to engage in the trade or business that gave rise to the section 481(a) adjustment at any time during the section 481(a) adjustment period, the entire remaining balance of the section 481(a) adjustment relating to that trade or business must be taken into account in the year of the cessation. For purposes of this paragraph (d)(5)(i)(B)(2)(ii), production under each JOA is treated as a separate trade or business. The determination as to whether the co-producer ceases to engage in its trade or business is to be made under the principles of § 1.446-1(e)(3)(ii) and its underlying administrative procedures. For example, the permanent cessation of production under a co-producer's JOA constitutes the cessation of a trade or business of the co-producer. Accordingly, for the year that production under a JOA permanently ceases, the remaining balance of the section 481(a) adjustment relating to the JOA must be taken into account.
(3) Election to take aggregate section 481(a) adjustment for all joint operating agreements into account in the year of change—(i) In general. A co-producer may elect to take into account its section 481(a) adjustment, computed on an aggregate basis for all of its JOAs, whether negative or positive, in the year of change, provided the co-producer uses the cumulative method for all of its JOAs entered into prior to its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year. The aggregate section 481(a) adjustment of a co-producer is equal to the difference between the amount of income reported under the co-producer's former method of accounting for all taxable years prior to the year of change and the amount of income that would have been reported if the co-producer's new method had been used in all of those taxable years for all JOAs for which the co-producer changes its method of accounting. An election made under this paragraph (d)(5)(i)(B)(3) is irrevocable. If any person who, together with another person, would be treated as a single taxpayer under section 41(f)(1) (A) or (B) makes an election under this paragraph (d)(5)(i)(B)(3), all persons within that single taxpayer group will be treated as if they had made an election under this paragraph (d)(5)(i)(B)(3) and, as such, will be irrevocably bound by that election. If a co-producer does not make an election under this paragraph, each JOA entered into prior to the start of its first taxable year beginning after December 31, 1994, and in effect as of the beginning of that year must be accounted for separately in computing the section 481(a) adjustment and taxable income of the co-producer for any year to which this paragraph (d) applies.
(ii) Time and manner for making the election. An election under this paragraph (d)(5)(i)(B)(3) is made by attaching a statement to the co-producer's timely filed return for its year of change indicating that the co- producer is electing under § 1.761-2(d)(5)(i)(B)(3) to take its aggregate section 481(a) adjustment into account in the year of change.
(C) Treatment of section 481(a) adjustment as a sale for purposes of computing a production credit and as gross income from the property for purposes of depletion deductions. Any positive section 481(a) adjustment arising as a result of a change in method of accounting for gas imbalances under this paragraph (d)(5)(i) and taken into account in computing taxable income under paragraph (d)(5)(i)(B) of this section is considered a sale by the taxpayer for purposes of computing any production credit in the year that the adjustment is taken into account. Similarly, the positive section 481(a) adjustment is considered gross income from the property and taxable income from the property for purposes of computing depletion deductions in the year the adjustment is taken into account. Sales amounts used in computing any production credit in any year in which a negative section 481(a) adjustment is taken into account in computing taxable income under paragraph (d)(5)(i)(B) of this section must be reduced by the amount of the negative section 481(a) adjustment taken into account in that year. Similarly, gross income from the property and taxable income from the property used in computing any depletion deduction in any year in which the negative section 481(a) adjustment is taken into account must be reduced by the amount of the negative adjustment. For these purposes, any taxpayer that makes an aggregate section 481(a) adjustment election under paragraph (d)(5)(i)(B)(3) of this section must allocate the adjustment among its properties in any reasonable manner that prevents a duplication or omission of depletion deductions.
(ii) Change in method of accounting to the annual method—(A) In general. A co-producer changing to the annual method in accordance with paragraph (d)(2)(ii) of this section must request a change under § 1.446-1(e)(3) and will be subject to any terms and conditions as may be imposed by the Commissioner.
(B) Section 481(a) adjustment. A change in method of accounting to the annual method is a change in method of accounting to which the provisions of section 481(a) apply. Thus, a section 481(a) adjustment must be taken into account to prevent the omission or duplication of income. If all the co-producers under a JOA have the same taxable year, the section 481(a) adjustment involved in a change to the annual method by a co-producer relating to the JOA is computed as of the first day of the co-producer's year of change. If the co-producers under a JOA do not all have the same taxable year (that is, in the case of a part-year change described in paragraph (d)(2)(ii)(C) of this section), the change in method of accounting occurs on January 1, 1996, and the section 481(a) adjustment is computed on that date.
(iii) Untimely change in method of accounting to comply with this section. Unless a co-producer required by this section to change its method of accounting complies with the provisions of this paragraph (d)(5) for its first applicable taxable year within the time prescribed by this paragraph (d)(5), the co-producer must take the section 481(a) adjustment into account under the provisions of any applicable administrative procedure that is prescribed by the Commissioner specifically for purposes of complying with this section. Absent such an administrative procedure, a co-producer must request a change under § 1.446-1(e)(3) and will be subject to any terms and conditions as may be imposed by the Commissioner.
(6) Examples. The following examples illustrate the application of the cumulative method described in paragraph (d)(3) of this section.
(7) Effective date. Except in the case of a part-year change to the annual method or the cessation of a JOA, both of which are described in paragraph (d)(2)(ii)(C) of this section, the provisions of this paragraph (d) apply to all taxable years beginning after December 31, 1994, of any producer that is a member of an unincorporated organization that produces natural gas under a JOA in effect on or after the start of the producer's first taxable year beginning after December 31, 1994. In the case of a part-year change, the provisions of this paragraph (d) apply on and after January 1, 1996. In the case of the cessation of a JOA, the co-producers use their current method of accounting with respect to that JOA until the JOA ceases to be in effect.
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Treas. Reg. §1.761-2(e)Cross reference.
Cross reference. For requirements with respect to the filing of a return on Form 1065 by a partnership, see § 1.6031(a)-1.
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Treas. Reg. §1.761-2(f)Applicability date.
Applicability date. Except as provided in paragraph (d) of this section, this section applies to taxable years ending on or after March 11, 2024.
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Treas. Reg. §1.761-2(i)Example 1—(A) Facts.
Example 1—(A) Facts. G and H enter into a joint operating agreement to own and operate a facility that will produce solar energy. G, an applicable entity, is entitled under the joint operating agreement to take in kind or dispose of 40% of the energy produced by the unincorporated organization and H, which is not an applicable entity, is entitled to the remaining 60%. G and H form LLC, a limited liability company, to hold the solar energy property that G and H intend to operate pursuant to the joint operating agreement. In accordance with the joint operating agreement, G owns a 40% ownership interest in LLC and H owns the remaining 60% ownership interest. G will sell its share of energy produced by the facility in a manner designed to generate applicable credits under section 45(a) and will make an election under section 6417(a) with respect thereto. LLC makes a valid election under section 761(a) to be excluded from subchapter K.
(B) Analysis. G will be entitled to any credits under section 45(a) generated by its sale of energy produced by LLC that G has the right to take in kind or dispose of (which, under the joint operating agreement, is 40% of the energy produced by LLC). Assuming all other requirements are met, G will be able to make an elective payment election under section 6417 for the applicable credits determined with respect to its ownership share of the solar energy property.
(ii) Example 2—(A) Facts. T is an Indian Tribal government as defined in § 1.6417-1(k) and an applicable entity. Through a limited liability company organized under T's Tribal law (TLLC), T and Y own and operate applicable credit property that will generate electricity the sale of which will generate applicable credits under section 45(a). TLLC is not treated as an association taxable as a corporation for Federal tax purposes and no election under § 301.7701-3 of this chapter has been made to treat TLLC as such. T and Y enter into a joint operating agreement with respect to the ownership and operation of the applicable credit property in which each of T and Y reserve the right separately to take in kind or dispose of their pro rata shares of property produced, extracted, or used and any associated renewable energy credits or similar credits. TLLC is formed exclusively to own and operate an applicable credit property with respect to which section 45(a) credits will be determined. On January 1st of year 1, T and Y enter into delegation agreements with Q that delegate T's and Y's authority to Q to sell the electricity generated by T's and Y's shares of the applicable credit property. The term of the delegation agreements is one year, which does not exceed the minimum needs of the industry. On June 1st of year 1, Q enters into a power purchase agreement with Utility on T's and Y's behalf that commits T and Y to sell the electricity produced from their shares of the applicable credit property to Utility for a term of 15 years. At the end of the day on December 31st of year 1, the delegation agreements terminate.
(B) Analysis. Because T and Y did not delegate authority for a period of more than one year to sell the output from their shares of the applicable credit property, the requirements of paragraph (a)(3)(iii) of this section (as modified by paragraph (a)(4)(iii)(B) of this section) are met. Assuming that TLLC otherwise qualifies as an applicable unincorporated organization, TLLC is an organization described in paragraph (a)(4)(iii)(A) of this section and can make an election under paragraphs (b) and (e) of this section to be excluded from the application of all of subchapter K under section 761(a). As such, T can make an elective payment election for the applicable credits determined with respect to its share of the applicable credit property held by TLLC, assuming the requirements of section 6417 are otherwise met. The analysis in this example would be the same whether Y is also an Indian Tribal government, another applicable entity, or some other person.
(iii) Example 3—(A) Facts. The facts are the same as in paragraph (a)(5)(ii)(A) of this section (Example 2), except that at the end of the day on December 31, T and Y each agree, in writing, to a new agent delegation agreement with Q with substantively identical terms as the agent delegation agreement in effect during year 1.
(B) Analysis. Because each of T and Y have agreed, in writing, to engage Q in an agency relationship lasting no longer than one year, the results are the same as in paragraph (a)(5)(ii)(B) of this section (Example 2). In contrast, if the agent delegation agreement renewed automatically, T and Y have effectively entered into an agent delegation agreement lasting longer than one year and have violated the requirements of paragraph (a)(4)(iii)(B) of this section. In that case, TLLC would not be eligible to make or maintain an election under section 761(a). As such, T could not make an elective payment election for the applicable credits determined with respect to its share of the applicable credit property held through TLLC.
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Treas. Reg. §1.761-3Certain option holders treated as partners
(a) Noncompensatory option treated as a partnership interest—(1) General rule. A noncompensatory option (as defined in paragraph (b)(2) of this section) is treated as a partnership interest for all Federal tax purposes if, on the date of a measurement event (as defined in paragraph (c) of this section) with respect to the option—
(i) The noncompensatory option (and any agreements associated with it) provides the option holder with rights that are substantially similar to the rights afforded a partner (as determined under paragraph (d) of this section); and
(ii) There is a strong likelihood that the failure to treat the holder of the noncompensatory option as a partner would result in a substantial reduction in the present value of the partners' and noncompensatory option holder's aggregate Federal tax liabilities (as determined under paragraph (e) of this section).
(2) Continuing applicability of general principles of law. The fact that an option is not treated as a partnership interest under this section does not prevent the option from being treated as a partnership interest under general principles of Federal tax law.
(3) Timing of characterization. If a noncompensatory option is treated under this section as a partnership interest, that treatment applies, as the case may be, upon the issuance of the option, or immediately before any other measurement event that gave rise to the characterization under paragraph (a)(1) of this section.
(4) Effect of characterization. If a noncompensatory option is treated as a partnership interest under this section or under general principles of law, the option holder will be treated as a partner with respect to the partnership interest and will receive a distributive share of the partnership's income, gain, loss, deduction, or credit (or items thereof), as determined in accordance with that partner's interest in the partnership (taking into account all facts and circumstances) in accordance with § 1.704-1(b)(3). Once a noncompensatory option is treated as a partnership interest, in no event may it be characterized as an option thereafter.
(b) Definitions. For purposes of this section:
(1) Look-through entity. Look-through entity means an entity described in § 1.704-1(b)(2)(iii)(d)(2).
(2) Noncompensatory option. Noncompensatory option means an option (as defined in paragraph (b)(3) of this section) issued by a partnership, other than an option issued in connection with the performance of services. For purposes of applying this section, an option that would be a noncompensatory option under this paragraph if it had been issued by a partnership is a noncompensatory option if the option was issued by an eligible entity (as defined in § 301.7701-3(a)) that would become a partnership under § 301.7701-3(f)(2) if the noncompensatory option holder were treated as a partner. Also for purposes of applying this section, if a noncompensatory option is issued by such an eligible entity, then the eligible entity is treated as a partnership.
(3) Option. An option is a contractual right to acquire an interest in the issuing partnership, including a call option, warrant, or other similar arrangement. 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)). To achieve the purposes of this section, the Commissioner can treat other contractual agreements, including a forward contract, a futures contract, or a notional principal contract, as an option. A contract that otherwise constitutes an option will not fail to be treated as an option for purposes of this section merely because it may or must be settled in cash or property other than a partnership interest.
(4) Underlying partnership interest. Underlying partnership interest means the interest in the issuing partnership that would be acquired by the noncompensatory option holder upon exercise of the noncompensatory option.
(c) Measurement event—(1) General rule. Except as provided in paragraph (c)(2) of this section, a measurement event with respect to a noncompensatory option is any of the following events:
(i) Issuance of the noncompensatory option;
(ii) An adjustment of the terms (modification) of the noncompensatory option or of the underlying partnership interest (as defined in paragraph (b)(4) of this section) (including an adjustment pursuant to the terms of the noncompensatory option or the underlying partnership interest);
(iii) Transfer of the noncompensatory option if either:
(A) The option may be exercised (or settled) more than 12 months after its issuance, or
(B) The transfer is pursuant to a plan in existence at the time of the issuance or modification of the noncompensatory option that has as a principal purpose the substantial reduction of the present value of the aggregate Federal tax liabilities of the partners and the noncompensatory option holder (under paragraph (a)(1)(ii) of this section);
(2) Events not treated as measurement events. A measurement event does not include the following events:
(i) A transfer of the noncompensatory option at death, between spouses or former spouses under section 1041, or in a transaction that is disregarded for Federal tax purposes;
(ii) A modification that neither materially increases the likelihood that the noncompensatory option will be exercised (as described in paragraph (d)(2) of this section) nor provides the noncompensatory option holder with partner attributes (as described in paragraph (d)(3) of this section);
(iii) A change in the strike price of a noncompensatory option or in the interests in the issuing partnership that may be issued or transferred pursuant to the noncompensatory option, made pursuant to a bona fide, reasonable adjustment formula that has the intended effect of preventing dilution of the interests of the noncompensatory option holder;
(iv) Any other event as provided in guidance published in the Internal Revenue Bulletin.
(d) Rights substantially similar to partner rights—(1) In general. A noncompensatory option provides the holder with rights that are substantially similar to the rights afforded to a partner if either the option is reasonably certain to be exercised or the option holder possesses partner attributes.
(2) Reasonable certainty of exercise—(i) General rule. The determination of whether a noncompensatory option is reasonably certain to be exercised at the time of a measurement event is based on all the facts and circumstances, including—
(A) The fair market value of the partnership interest that is the subject of the noncompensatory option;
(B) The strike price of the noncompensatory option;
(C) The term of the noncompensatory option;
(D) The volatility of the value or income of the issuing partnership or the underlying partnership interest;
(E) Anticipated distributions by the partnership during the term of the noncompensatory option;
(F) Any other special option features, such as a strike price that fluctuates;
(G) The existence of related options, including reciprocal options; and
(H) Any other arrangements affecting or undertaken with a principal purpose of affecting the likelihood that the noncompensatory option will be exercised.
(ii) Safe harbors—(A) General rule. Except as provided in paragraph (d)(2)(ii)(C) of this section, a noncompensatory option is not considered reasonably certain to be exercised if, as of the date of a measurement event with respect to the noncompensatory option—
(1) The option may be exercised no more than 24 months after the date of the measurement event and the strike price is equal to or greater than 110 percent of the fair market value of the underlying partnership interest on the date of the measurement event; or
(2) The terms of the option provide that the strike price of the option is equal to or greater than the fair market value of the underlying partnership interest on the exercise date.
(B) Options exercisable at fair market value. For purposes of paragraph (d)(2)(ii)(A) of this section, an option whose strike price is determined by a formula is considered to have a strike price equal to or greater than the fair market value of the underlying partnership interest on the exercise date if the formula is agreed upon by the parties when the option is issued in a bona fide attempt to arrive at the fair market value on the exercise date and is to be applied based on the facts and circumstances in existence on the exercise date.
(C) Exception. The safe harbors of paragraph (d)(2)(ii)(A) of this section do not apply if the parties to the noncompensatory option had a principal purpose described in paragraph (c)(1)(iii)(B) of this section with respect to a measurement event for that option (or, if multiple options were issued pursuant to a plan, a measurement event with respect to any option issued pursuant to that plan).
(D) Failure to satisfy safe harbor. Failure of an option to satisfy one of the safe harbors of paragraph (d)(2)(ii)(A) does not affect the determination of whether an option is treated as reasonably certain to be exercised.
(3) Partner attributes—(i) General rule. The determination of whether a holder of a noncompensatory option possesses partner attributes is based on all the facts and circumstances, including whether the option holder, directly or indirectly, through the option agreement or a related agreement, is provided with voting rights or managerial rights in the partnership.
(ii) Certain factors that conclusively establish partner attributes. For purposes of this section, a noncompensatory option holder has partner attributes if, based on all the facts and circumstances—
(A) The option holder is provided with rights (through the option agreement or a related agreement) that are similar to rights ordinarily afforded to a partner to participate in partnership profits through present possessory rights to share in current operating or liquidating distributions with respect to the underlying partnership interests; or
(B) The option holder, directly or indirectly, undertakes obligations (through the option agreement or a related agreement) that are similar to obligations undertaken by a partner to bear partnership losses.
(iii) Special rules. The following rules apply for purposes of paragraphs (d)(3)(i) and (d)(3)(ii) of this section:
(A) Rights in the issuing partnership possessed by a noncompensatory option holder solely by virtue of owning an interest in the issuing partnership are not taken into account, provided that those rights are no greater than the rights granted to other partners owning substantially similar interests in the partnership and who do not hold noncompensatory options in the partnership.
(B) If all of the partners owning substantially similar interests in the issuing partnership also hold noncompensatory options in the partnership, or if none of the other partners owns substantially similar interests in the partnership, then all facts and circumstances will be considered in determining whether the rights in the partnership possessed by the option holder are possessed solely by virtue of owning a partnership interest. If those rights are possessed solely by virtue of owning a partnership interest, they are not taken into account.
(C) A noncompensatory option holder will not ordinarily be considered to possess partner attributes solely because the noncompensatory option agreement significantly controls or restricts, or the noncompensatory option holder has the ability to significantly control or restrict, a partnership decision that could substantially affect the value of the underlying partnership interest. In particular, the following abilities of the option holder will not be treated as partner attributes:
(1) The ability to impose reasonable restrictions on partnership distributions or dilutive issuances of partnership equity or options while the noncompensatory option is outstanding.
(2) The ability to choose the partnership's section 704(c) method for partnership properties.
(D) When the applicable measurement event is a transfer described in paragraph (c)(1) of this section, the partner attributes of the transferee, not the transferor, are taken into account.
(E) The option holder will be treated as owning all partnership interests and noncompensatory options issued by the partnership that are owned by any person related to the option holder. For purposes of the preceding sentence, a person related to the option holder is defined as any person bearing a relationship to the option holder described in section 267(b) or 707(b).
(e) Substantial tax reduction requirement—(1) General rule. The determination of whether there is a strong likelihood that the failure to treat a noncompensatory option holder as a partner would result in a substantial reduction in the present value of the partners' and the noncompensatory option holder's aggregate Federal tax liabilities is based on all the facts and circumstances, including—
(i) The interaction of the allocations of the issuing partnership and the partners' and noncompensatory option holder's Federal tax attributes (taking into account tax consequences that result from the interaction of the allocations with the partners' and noncompensatory option holder's Federal tax attributes that are unrelated to the partnership);
(ii) The absolute amount of the Federal tax reduction;
(iii) The amount of the reduction relative to overall Federal tax liability; and
(iv) The timing of items of income and deductions.
(2) Special rules. For purposes of applying paragraph (e)(1) of this section to a partner or noncompensatory option holder that is—
(i) A look-through entity (as defined in paragraph (b)(1) of this section), the Federal tax consequences that result from the interaction of allocations of the partnership and the Federal tax attributes of any person that is an owner, or in the case of a trust or estate, the beneficiary, of an interest in such a partner or noncompensatory option holder, whether directly, or indirectly through one or more look-through entities, must be taken into account; or
(ii) A member of a consolidated group (within the meaning of § 1.1502-1(h)), the tax consequences that result from the interaction of the issuing partnership's allocations and the tax attributes of the consolidated group and the tax attributes of another member with respect to a separate return year must be taken into account.
(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:
(g) Effective/applicability date. This section applies to noncompensatory options issued on or after February 5, 2013.
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Treas. Reg. §1.761-3(a)Noncompensatory option treated as a partnership interest—(1) General rule.
Noncompensatory option treated as a partnership interest—(1) General rule. A noncompensatory option (as defined in paragraph (b)(2) of this section) is treated as a partnership interest for all Federal tax purposes if, on the date of a measurement event (as defined in paragraph (c) of this section) with respect to the option—
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Treas. Reg. §1.761-3(b)Definitions.
Definitions. For purposes of this section:
(1) Look-through entity. Look-through entity means an entity described in § 1.704-1(b)(2)(iii)(d)(2).
(2) Noncompensatory option. Noncompensatory option means an option (as defined in paragraph (b)(3) of this section) issued by a partnership, other than an option issued in connection with the performance of services. For purposes of applying this section, an option that would be a noncompensatory option under this paragraph if it had been issued by a partnership is a noncompensatory option if the option was issued by an eligible entity (as defined in § 301.7701-3(a)) that would become a partnership under § 301.7701-3(f)(2) if the noncompensatory option holder were treated as a partner. Also for purposes of applying this section, if a noncompensatory option is issued by such an eligible entity, then the eligible entity is treated as a partnership.
(3) Option. An option is a contractual right to acquire an interest in the issuing partnership, including a call option, warrant, or other similar arrangement. 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)). To achieve the purposes of this section, the Commissioner can treat other contractual agreements, including a forward contract, a futures contract, or a notional principal contract, as an option. A contract that otherwise constitutes an option will not fail to be treated as an option for purposes of this section merely because it may or must be settled in cash or property other than a partnership interest.
(4) Underlying partnership interest. Underlying partnership interest means the interest in the issuing partnership that would be acquired by the noncompensatory option holder upon exercise of the noncompensatory option.
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Treas. Reg. §1.761-3(c)Measurement event—(1) General rule.
Measurement event—(1) General rule. Except as provided in paragraph (c)(2) of this section, a measurement event with respect to a noncompensatory option is any of the following events:
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Treas. Reg. §1.761-3(d)Rights substantially similar to partner rights—(1) In general.
Rights substantially similar to partner rights—(1) In general. A noncompensatory option provides the holder with rights that are substantially similar to the rights afforded to a partner if either the option is reasonably certain to be exercised or the option holder possesses partner attributes.
(2) Reasonable certainty of exercise—(i) General rule. The determination of whether a noncompensatory option is reasonably certain to be exercised at the time of a measurement event is based on all the facts and circumstances, including—
(A) The fair market value of the partnership interest that is the subject of the noncompensatory option;
(B) The strike price of the noncompensatory option;
(C) The term of the noncompensatory option;
(D) The volatility of the value or income of the issuing partnership or the underlying partnership interest;
(E) Anticipated distributions by the partnership during the term of the noncompensatory option;
(F) Any other special option features, such as a strike price that fluctuates;
(G) The existence of related options, including reciprocal options; and
(H) Any other arrangements affecting or undertaken with a principal purpose of affecting the likelihood that the noncompensatory option will be exercised.
(ii) Safe harbors—(A) General rule. Except as provided in paragraph (d)(2)(ii)(C) of this section, a noncompensatory option is not considered reasonably certain to be exercised if, as of the date of a measurement event with respect to the noncompensatory option—
(1) The option may be exercised no more than 24 months after the date of the measurement event and the strike price is equal to or greater than 110 percent of the fair market value of the underlying partnership interest on the date of the measurement event; or
(2) The terms of the option provide that the strike price of the option is equal to or greater than the fair market value of the underlying partnership interest on the exercise date.
(B) Options exercisable at fair market value. For purposes of paragraph (d)(2)(ii)(A) of this section, an option whose strike price is determined by a formula is considered to have a strike price equal to or greater than the fair market value of the underlying partnership interest on the exercise date if the formula is agreed upon by the parties when the option is issued in a bona fide attempt to arrive at the fair market value on the exercise date and is to be applied based on the facts and circumstances in existence on the exercise date.
(C) Exception. The safe harbors of paragraph (d)(2)(ii)(A) of this section do not apply if the parties to the noncompensatory option had a principal purpose described in paragraph (c)(1)(iii)(B) of this section with respect to a measurement event for that option (or, if multiple options were issued pursuant to a plan, a measurement event with respect to any option issued pursuant to that plan).
(D) Failure to satisfy safe harbor. Failure of an option to satisfy one of the safe harbors of paragraph (d)(2)(ii)(A) does not affect the determination of whether an option is treated as reasonably certain to be exercised.
(3) Partner attributes—(i) General rule. The determination of whether a holder of a noncompensatory option possesses partner attributes is based on all the facts and circumstances, including whether the option holder, directly or indirectly, through the option agreement or a related agreement, is provided with voting rights or managerial rights in the partnership.
(ii) Certain factors that conclusively establish partner attributes. For purposes of this section, a noncompensatory option holder has partner attributes if, based on all the facts and circumstances—
(A) The option holder is provided with rights (through the option agreement or a related agreement) that are similar to rights ordinarily afforded to a partner to participate in partnership profits through present possessory rights to share in current operating or liquidating distributions with respect to the underlying partnership interests; or
(B) The option holder, directly or indirectly, undertakes obligations (through the option agreement or a related agreement) that are similar to obligations undertaken by a partner to bear partnership losses.
(iii) Special rules. The following rules apply for purposes of paragraphs (d)(3)(i) and (d)(3)(ii) of this section:
(A) Rights in the issuing partnership possessed by a noncompensatory option holder solely by virtue of owning an interest in the issuing partnership are not taken into account, provided that those rights are no greater than the rights granted to other partners owning substantially similar interests in the partnership and who do not hold noncompensatory options in the partnership.
(B) If all of the partners owning substantially similar interests in the issuing partnership also hold noncompensatory options in the partnership, or if none of the other partners owns substantially similar interests in the partnership, then all facts and circumstances will be considered in determining whether the rights in the partnership possessed by the option holder are possessed solely by virtue of owning a partnership interest. If those rights are possessed solely by virtue of owning a partnership interest, they are not taken into account.
(C) A noncompensatory option holder will not ordinarily be considered to possess partner attributes solely because the noncompensatory option agreement significantly controls or restricts, or the noncompensatory option holder has the ability to significantly control or restrict, a partnership decision that could substantially affect the value of the underlying partnership interest. In particular, the following abilities of the option holder will not be treated as partner attributes:
(1) The ability to impose reasonable restrictions on partnership distributions or dilutive issuances of partnership equity or options while the noncompensatory option is outstanding.
(2) The ability to choose the partnership's section 704(c) method for partnership properties.
(D) When the applicable measurement event is a transfer described in paragraph (c)(1) of this section, the partner attributes of the transferee, not the transferor, are taken into account.
(E) The option holder will be treated as owning all partnership interests and noncompensatory options issued by the partnership that are owned by any person related to the option holder. For purposes of the preceding sentence, a person related to the option holder is defined as any person bearing a relationship to the option holder described in section 267(b) or 707(b).
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Treas. Reg. §1.761-3(e)Substantial tax reduction requirement—(1) General rule.
Substantial tax reduction requirement—(1) General rule. The determination of whether there is a strong likelihood that the failure to treat a noncompensatory option holder as a partner would result in a substantial reduction in the present value of the partners' and the noncompensatory option holder's aggregate Federal tax liabilities is based on all the facts and circumstances, including—
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Treas. Reg. §1.761-3(f)Example.
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:
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Treas. Reg. §1.761-3(g)Effective/applicability date.
Effective/applicability date. This section applies to noncompensatory options issued on or after February 5, 2013.
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Treas. Reg. §1.761-3(i)§1.761-3(i)
A look-through entity (as defined in paragraph (b)(1) of this section), the Federal tax consequences that result from the interaction of allocations of the partnership and the Federal tax attributes of any person that is an owner, or in the case of a trust or estate, the beneficiary, of an interest in such a partner or noncompensatory option holder, whether directly, or indirectly through one or more look-through entities, must be taken into account; or
(ii) A member of a consolidated group (within the meaning of § 1.1502-1(h)), the tax consequences that result from the interaction of the issuing partnership's allocations and the tax attributes of the consolidated group and the tax attributes of another member with respect to a separate return year must be taken into account.
30 Citing Cases
733 (1949); see also - 27 - Connors v.
And so--because there is no genuine issue of fact that 7050 continued to hold that account in its name until 2003--we hold that Schechter's partnership interest was not liquidated through 7050's termination in 2001 .
761.4(c) (2000); 16 Encyclopedia Americana, supra at 147. Also located on Johnston Island is Johnston Atoll Chemical Agent Disposal System (JACADS), a facility for incinerating U.S. chemical weapons stockpiles. Greenpeace USA v. Stone, 748 F. Supp. 749, 752-753 (D. Haw. 1990); Environmental Assessment, supra at 9278. Johnston Atoll is not a pa
761.4(c) (2000); 16 Encyclopedia Americana, supra at 147. Also located on Johnston Island is Johnston Atoll Chemical Agent Disposal System (JACADS), a facility for incinerating U.S. chemical weapons stockpiles. Greenpeace USA v. Stone, 748 F. Supp. 749, 752-753 (D. Haw. 1990); Environmental Assessment, supra at 9278. Johnston Atoll is not a pa
ional Commodity & Barter Association v. United States, 843 F. Supp. 655, 659, 661 (D. Colo. 1993), affd. without published opinion 42 F.3d 1406 (10th Cir. 1994), an entity that was organized largely to resist taxes was treated as a partnership under section 761. Petitioners cite certain court opinions out of context. In Commissioner v. Culbertson, 337 U.S. 733, 740 (1949), the Supreme Court stated that a partnership constitutes an organization for - 12 - production of income to which each partne
The term "partnership" is broadly defined in section 761 as a "syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on," but is not a corporation, trust, or estate.
Section 761 of the Code defines the term "partnership" as follows: (a) PARTNERSHIP.--For purposes of this sub- title, the term "partnership" includes a syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the mean
Section 761 of the Code defines the term "partnership" as follows: (a) PARTNERSHIP.--For purposes of this sub- title, the term "partnership" includes a syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, within the mean
ional Commodity & Barter Association v. United States, 843 F. Supp. 655, 659, 661 (D. Colo. 1993), affd. without published opinion 42 F.3d 1406 (10th Cir. 1994), an entity that was organized largely to resist taxes was treated as a partnership under section 761. Petitioners cite certain court opinions out of context. In Commissioner v. Culbertson, 337 U.S. 733, 740 (1949), the Supreme Court stated that a partnership constitutes an organization for - 12 - production of income to which each partne
ership return.16 Petitioners argue that the definitions of partnership agreement and amendment of the partnership agreement are much more expansive, for the purpose of determining distributive shares of gain under section 704(b), than they are under section 761. Compare sec. 1.761-1(c), Income Tax Regs., with sec. 1.704- 1 (b)(2)(ii)(h), Income Tax Regs. The regulation under section 704(b) states: Partnership agreement defined. For purposes of this paragraph, the partnership agreement includes a