Final regulations define publicly traded status for partnerships.

Recent issued final regulations define when a partnership is "publicly traded" under Sec. 7704, and thus generally taxed as a corporation. (Even if it is taxed as a partnership, the income or loss from a publicly traded partnership's (PTP's) passive activities are subject to special limitations under Sec. 469(k).) The final regulations significantly relax the definition of publicly traded found in the May 1995 proposed regulations, but still define publicly traded more restrictively than does Notice 88-75. The regulations are generally effective for tax years beginning after 1995. However, certain existing partnerships qualify to use the less restrictive provisions of Notice 88-75 for a 10-year transition period.

The structure of the final regulations is basically the same as Notice 88-75 and the proposed regulations. The regulations specifically describe situations in which a partnership is automatically treated as publicly traded and situations in which a partnership is safe-harbored, i.e., not treated as publicly traded. The final regulations clarify that a facts-and-circumstances determination must be made in all other situations to determine if a partnership is publicly traded for these purposes. Closely held partnerships typically should not be concerned about these new rules absent extraordinary circumstances (such as interests in the partnership being offered on an interdealer quotation system).

Automatically Publicly Traded

A partnership is automatically treated as publicly traded if its interests are traded on an "established securities market." As in previous guidance, this term includes a national exchange (e.g., New York Stock Exchange), a foreign exchange (e.g., Tokyo Stock Exchange) and a regional or local exchange. However, Regs. Sec. 1.7704-1(b)(5) also provides that an "interdealer quotation system" that regularly disseminates "firm buy or sell quotations" by identified brokers or dealers represents an established securities market for this purpose.

Safe Harbors 

If interests in a partnership are not traded through an interdealer quotation system or other established securities market (as described), the partnership may qualify for one of the following safe harbors. In all other situations, a facts-and-circumstances test must be applied to determine if interests in the partnership are traded on a secondary market or the substantial equivalent thereof. * Private placement safe harbor: As in Notice 88-75 and the proposed regulations, "private placement partnerships" are generally safe-harbored. The final regulations define a "private placement" more generously than the proposed regulations; the sole criterion for qualification under Regs. Sec. 1.7704-1(h)(1)(i) is that all interests in the partnership were issued in transactions not required to be registered under the Securities Act of 1933 (assuming the offering takes place in the U.S.) and the partnership does not have more than 100 partners at my time during the tax year (subject to lookthrough rules for certain tiered partnerships). * Private transfers safe harbor: As in previous guidance, "private transfers" are disregarded in determining if a partnership is publicly traded. Private transfers include transfers between family members, certain block transfers, certain substituted-basis transactions, distributions from certain retirement plans and certain redemption transactions, etc. Thus, a partnership that limits the transferability of its interests to such "private transfers" is generally safe-harbored. * Qualified matching service safe harbor: Regs. Sec. 1.7704-1(g) leaves intact a safe-harbor rule relating to transfers through a "qualified matching service." Thus, in addition to allowing private transfers, a partnership can allow up to 10% of its interests to be transferred through such a service, but must determine that each of the requirements of the "qualified matching service" safe-harbor rules (e.g., bid or offer prices are not firm quotes, a minimum waiting period must exist between the offer and acceptance and settlement dates, etc.) has been met before admitting the transferee of interests acquired through such means. A third party, a partner or the underwriter that handled the issuance of the interests, but apparently not the partnership itself, can serve as a qualified matching service. * Two percent de minimis trading activity safe harbor: As in the proposed regulations, Regs. Sec. 1.7704-1(j) contains a de minimis trading activity safe harbor, under which a partnership is not publicly traded if the sum of all interests transferred (other than through private transfers) during a tax year (determined on a monthly basis) does not exceed 2% of the total interests in partnership profits or capital (excluding the general partner's interest if it exceeds 10% of the total of such interests).

Preventing a Partnership From

Inadvertently Becoming Publicly

Traded

To avoid the possibility that a partnership could become publicly traded without its knowledge or assent, the regulations provide that a partnership can be publicly traded only if the partnership participates in the creation of a market for the substantial equivalent thereof) for its interests or recognizes transfers made in such a "market" (e.g., by using such a "market" to redeem a partner's interest in the partnership or by admitting the transferee of an interest acquired in such a "market"). (The foregoing exception does not apply to interests traded on an established securities market other than an interdealer quotation system, trading in those exchanges requires the partnership's participation.) To avoid PTP status, a partnership subject to the regulations must determine that a transferee of its interests has not acquired such interests through an established securities market (or the substantial equivalent thereof) before admitting the transferee as a partner or recognizing the transferee's rights as an assignee.

Effective Dates and

Transition Rules

The final regulations generally apply to partnership tax years beginning after 1995. However, for partnerships engaged in a business as of Dec. 5, 1995 (the date of publication of the final regulations), Regs. Sec. 1.7704-1(1)(2) generally applies only to tax years beginning after 2005. During the interim 10-year period, the rules of Notice apply to such partnerships. However, an "existing partnership" that adds a substantial new line of business (as defined in Regs. Sec. 1.7704-2) during this 10-year transition period will become subject to the final regulations in the tax year following the addition of such new line of business.