Determining and analyzing the partnership tax year of least aggregate deferral.

Facts: After being rescued from a desert island, a group of former castaways are forming a production company, GI Screen Partners, to make a television series about their adventures. The three partners in the joint venture will be Howell Enterprises (a corporation with a June 30 year-end), Gilligan Co. (an S corporation with a calendar year-end) and Island Tours, Inc. (a corporation with a February 28 year-end). Proposed ownership of the joint venture is as follows:

Partner                 Year-end       Interest in profits

Howell Enterprises      June 30               35%
Gilligan Co.            December 31           25%
Island Tours, Inc.      February 28           40%

Issue: What is the required year-end for GI Screen Partners? What alternatives do the partners have if they do not wish to adopt the required year-end?

Analysis

The general rule is that a partnership must adopt the year-end of its majority partners (Sec. 706(b)(1) (B) (i)). As no partner or group of partners owning more than 50% in partnership capital and profits has the same yearend, GI Screen Partners cannot determine a year-end based on the general rule. Under Sec. 706(b) (1) (B) (ii), the partnership must then adopt the tax year-end of all of its principal partners. A principal partner is one with a 50%-or-more interest in profits or capital. Because all of the principal partners in GI Screen Partners have different yearends, the partnership cannot determine its required year-end under this method either. After failing to determine a required year-end under either of these two provisions, Temp, Regs. Sec. 1.706-IT(a)(1) provides that the partnership must adopt the tax year of least aggregate deferral.

The tax year of least aggregate deferral is the year-end that generates the least total amount of deferral to all the partners. It can be the year-end of any partner. For test purposes, the number of months of deferral are counted from the partnership test year-end through each partner's year-end. GI Screen Partner's tax year of least aggregate deferral can be determined as follows:

1. Test of June 30 year-end

                              Months of   Interest in    Test
Partner                       deferral      profits     amount

Howell                            0           35%          0
Gilligan                          6           25%        1.5
Island Tours                      8           40%        3.2
Aggregate deferral                                       4.7

2. Test of December 31 year-end

                              Months of   Interest in    Test
Partner                       deferral      profits     amount

Howell                            6           35%        2.1
Gilligan                          0           25%          0
Island Tours                      2           40%        0.8
Aggregate deferral                                       2.9

3. Test of February 28 year-end

                              Months of   Interest in    Test
Partner                       deferral      profits     amount

Howell                            4           35%        1.4
Gilligan                         10           25%        2.5
Island Tours                      0           40%          0
Aggregate deferral                                       3.9

Under this fact pattern, GI Screen Partners' required year-end is December 31, the year-end that results in the amount of least aggregate deferral.

If the partners do not wish to use the required calendar year-end, they have two other options:

1. If the partnership can support a business purpose for adopting a year-end other than the required year-end, it can apply for a change in accounting period on Form 1128, Application To Adopt, Change, or Retain a Tax Year.

2. If the partnership cannot satisfy the business-purpose test, the partnership can apply for a September 30, October 31 or November 30 year-end, under Sec. 444, on Form 8716, Election To Have a Tax Year Other Than a Required Tax Year.

Conclusion

GI Screen Partners must adopt a December 31 year-end under the least aggregate deferral rules, as it cannot comply with the "majority partner" or "principal partners" tests. If GI does not wish to adopt the December 31 year-end, it can request a change in accounting period under the business-purpose rules or the Sec. 444 three-month deferral rules.

Variation

For partnerships already in operation, a special de minimis rule applies in determining the year-end of least aggregate deferral. Temp. Regs. Sec. 1.706-1T(a)(4) states that when the computed year-end of least aggregate deferral results in an aggregate deferral of less than 0.5 when compared to the aggregate deferral of the partnership's current tax year, the IRS will not permit the partnership to change its tax year.

Correction

The publication referenced in the December 2000 issue of TTA, p. 890, as Guidelines for Tax Practice Review, should have appeared as Guidelines for Voluntary Tax Practice Review. To order this publication, please call Member Satisfaction 888-777-7077 and request product number 061065. AICPA member price is $63, nonmember is $79. (Does not include sales tax or shipping and handling.)

Editor's note: This case study has been adapted from PPC Tax Planning Guide--Partnerships, 14th edition, by Grover A. Cleveland, James A. Keller, William D. Klein, Terry W. Lovelace, Sara S. McMurrian and Linda A. Markwood, published by Practitioners Publishing Company, Fort Worth, Tex. 2000.

Editor: Albert B. Ellentuck, Esq. Of Counsel King and Nordlinger, L.L.P. Arlington, VA