Transfer Of Partnership Interest Recast Under Substance-Over-Form Doctrine

In a chief counsel advice memorandum (CCA 201507018), the IRS concluded that a transaction involving a partner's transfer of his partnership interest to a corporation through an organization seeking tax-exempt status should be recast under the substance-over-form doctrine as a direct transfer of the partnership interest by the partner to the corporation. The IRS explained that the tax-exempt organization was never a bona-fide partner because it was entitled only to distributions related to the transferred units in the partnership, while the transferor partner retained all other rights to the units in the partnership.

The partnership was formed as a limited liability company and treated as a partnership for U.S. federal income tax purposes. The partner was one of the founding members of the partnership and also served as its manager and tax matters partner. The interest in the partnership held by the partner had a high fair market value and a nominal basis.

The partner formed a trust that was intended to be a qualified medical research organization described in Section 170(b)(1)(A)(iii). The partner claimed the trust owned all the shares of the corporation that were used to execute the transaction. However, the IRS found there had been "no meaningful change" in the partner's control over the assets of the trust, and, thus, the trust should not be respected as a separate taxable entity. Therefore, the partner was treated as owning the assets of the trust, including all of the shares of the corporation.

The partner entered an agreement to assign some of his units in the partnership to the tax-exempt organization. On the following day, the partner executed another agreement in which the corporation purchased the interests in the partnership from the tax-exempt organization in exchange for a 20-year promissory note with some additional earn-out potential. The latter agreement also provided that the partnership "shall make a section 754 election with...