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Foreign Partnerships - You Do If I Do

Years ago in west Texas, we used to watch in eager anticipation any of the sixteen Dean Martin and Jerry Lewis movies that came out during their ten year career together.  They were highly successful comedic partners who at one time were regarded as the hottest stars in the world.  In one of their last movies, the duo sang some silly song about being partners, and so we were delighted that they would continue to entertain us for years to come.  What we didn't know was that in the last ten months of their partnership, they barely spoke to each other.

As it turns out, a partnership is the most complicated of legal entities to perpetuate.  In fact, accounting for partnerships involves an entire set of rules that is at times conflicting, sometimes unclear, but always challenging.  For tax purposes, the partners must show their share of partnership income, gains, losses, credits, and deductions on their personal income tax returns.  Partners' bases in a partnership must account for the capital account, the inside basis, the outside basis and the at risk basis.  Debts are separated between recourse and non-recourse.  A partnership agreement should define each partner's share of capital, losses and profits.  Complex elections must be discussed and decided.

Some advantages accrue to partnership entities such as an unlimited number of partners, avoidance of gain recognition for contributed and distributed property, and special profit and loss allocations.  But operating a partnership basically means defining and then monitoring what each partner does or agrees to do.

Whenever one or more U.S. persons set up a foreign partnership, they are subject to complex reporting requirements.  Internal Revenue Code Section 6046 mandates that such U.S. persons file Form 8865 - Return of U.S. Persons with Respect to Certain Foreign Partnerships - whenever they have a reportable event during the tax years.  Reportable events include acquisitions, dispositions or changes in proportional interests of at least 10% in a foreign partnership.

Code Section 6038 requires that U.S. persons having a controlling interest in the foreign partnership file Form 8865 annually.  Control implies direct or indirect interest of at least 50%.  Form 8865, which is an information and not a tax return, requires reporting 1) taxpayer identifying details, 2) ownership interest, 3) foreign entities owned by the partnership, 4) details of reportable events, 5) fair market value of interests acquired or disposed, 6) other ownership interests of the partnership, 7) income and balance sheet details in U.S. currency, 8) other essential information.

In determining exactly what should be included in the 10 pages of Form 8865, filers have to decide between four reporting categories.  Category1 is a U.S. person who controlled the foreign partnership at any time during the partnership's tax year.  Category 2 is a U.S. person who at any time during the tax year of the foreign partnership owned a 10% or greater interest in the partnership while it was controlled.  Category 3 is a U.S. person who contributed property during that person's tax year to the foreign partnership.  Category 4 is a U.S. person that had a reportable event during the tax year.  Multiple categories can also apply.

Naturally the Internal Revenue Service can penalize those who fail to comply with Form 8865 filing requirements.  Category 1, 2 or 4 filers are subject to a $10,000 penalty for each tax year of non-compliance.  Additional penalties can apply for further delays once a taxpayer is notified by IRS.  Category 3 filers may be subject to as much as a $100,000 penalty.

Dean Martin and Jerry Lewis each had their own vision of their careers, and so separated in 1956 after ten highly successful years of entertaining as a team.  Afterward they only saw each other publicly three times:  The Eddie Fisher Show in 1958, the MDS Telethon in 1976, and Las Vegas in 1989.  Their partnership, like a marriage gone sour, could not be sustained by any form of agreement or understanding.  Both decided in the end and in the years ahead that I do as he does.