What Is IRC 708 and How Does It Impact Partnerships?

IRC Section 708 determines whether a partnership continues or terminates for tax purposes. This affects how income, deductions, and other tax attributes are reported, potentially leading to significant financial and operational consequences.

Understanding IRC 708 is critical for partnerships, as it influences tax filings, partner basis calculations, and liability allocations.

Continuation Criteria

A partnership continues under IRC 708 if it maintains business operations with at least one original partner. Changes in ownership percentages or new partners joining do not automatically disrupt continuity. If at least one original partner remains and the business continues, the partnership retains its Employer Identification Number (EIN), tax elections, and accounting methods, avoiding the administrative burden of reestablishing these elements.

For example, if a partnership originally had four partners and three sell their interests to new individuals, the presence of the remaining partner ensures continuity. Changes in profit-sharing arrangements or capital contributions do not necessarily impact continuity. However, if the restructuring fundamentally alters the business—such as shifting from a service-based operation to manufacturing—the IRS may scrutinize whether the partnership has effectively become a new entity.

Events Triggering Termination

A partnership terminates under IRC 708 when it ceases operations or undergoes a complete transfer of ownership. If a partnership liquidates its assets, settles liabilities, and distributes remaining funds, it is no longer recognized as an active entity for tax purposes. The IRS treats this as a final tax year, requiring a short-period return to report all income, deductions, and capital gains up to the termination date.

Termination also occurs if 100% of partnership interests are sold or exchanged within a short period. In this case, the original partnership ceases to exist, and a new one is formed. The new partnership must obtain a fresh EIN and make new tax elections. Depreciation schedules and other tax attributes do not automatically carry over, potentially altering asset tax treatment.

If a partnership converts into another entity type, such as a corporation, it also terminates. Under IRC Section 351, assets and liabilities transfer to the new corporation in exchange for stock. This can trigger tax consequences, including recognition of built-in gains or losses depending on the adjusted basis of contributed assets. The partners become shareholders, and the business is subject to corporate tax rules.

Mergers and Divisions

When partnerships merge or split, tax treatment depends on how assets and liabilities are distributed. In a merger, two or more partnerships combine into a single entity, consolidating operations and financial positions. Assets and liabilities transfer from one partnership to another, often in exchange for ownership interests in the surviving entity. The IRS does not treat a merger as a taxable event if the contributing partnerships continue as part of the combined business. However, basis allocation in transferred assets and the treatment of pre-existing tax attributes, such as suspended losses and depreciation schedules, must be carefully managed.

Divisions occur when a partnership splits into two or more entities, distributing assets and liabilities among them. This can happen due to strategic objectives, regulatory requirements, or internal disputes. Depending on the structure, the IRS may treat it as a continuation of the original partnership or a complete termination. If one resulting partnership retains a significant portion of the original business, it may be considered the successor, while newly formed partnerships may require new tax registrations and elections.

Partner Basis and Liabilities Adjustments

A partner’s basis in a partnership interest fluctuates based on capital contributions, distributions, and allocation of income, deductions, and liabilities. Basis determines the ability to deduct losses, the taxability of distributions, and gain or loss upon disposition of the partnership interest. IRC Section 705 governs basis adjustments to reflect economic investment and tax attributes over time.

Liability allocations affect basis calculations. Under IRC Section 752, liabilities are classified as recourse or nonrecourse. Recourse liabilities, where a partner has personal repayment obligations, are assigned based on economic risk of loss. Nonrecourse liabilities, where no partner bears personal responsibility, are allocated according to profit-sharing ratios. These adjustments impact a partner’s ability to deduct losses, as basis must be sufficient to absorb allocated deductions under at-risk and passive activity rules.

Documentation Requirements

Maintaining accurate records ensures compliance with IRC 708 and other tax regulations. Proper documentation supports tax positions and provides transparency in audits.

Partnership agreements should clearly outline ownership percentages, capital contributions, and profit-sharing arrangements, as these impact tax reporting and partner basis calculations. Amendments must be documented whenever membership or financial structure changes. Additionally, maintaining records of capital accounts, debt allocations, and distributions is necessary to track each partner’s basis and ensure compliance. Failure to maintain adequate documentation can result in penalties, disallowed deductions, or disputes with tax authorities over the partnership’s classification and tax treatment.