7728 / How is a publicly traded partnership taxed?

A publicly traded partnership is taxed as a corporation unless 90 percent of the partnership’s income is passive-type income and has been passive-type income for all taxable years beginning after 1987 during which the partnership (or any predecessor) was in existence. For this purpose, a partnership (or a predecessor) is not treated as being in existence until the taxable year in which it is first publicly traded.¹ On the first day that a publicly traded partnership is treated as a corporation under these rules, the partnership is treated as having transferred all of its assets (subject to its liabilities) to a new corporation in exchange for stock of the corporation, followed by a distribution of the stock to its partners in liquidation of their partnership interests.² A publicly traded partnership is a partnership that is (1) traded on an established securities market, or (2) is readily tradable on a secondary market or the substantial equivalent thereof (discussed in Q 7730).³ In general, “passive-type income” for this purpose includes interest, dividends, real property rents, gain from the sale of real property, income and gain from certain mineral or natural resource activities, and gain from the sale of a capital or IRC Section 1231 asset.⁴ (“Passive-type income” should therefore be distinguished from income from a passive activity under the passive activity loss rules.)

The passive-type income exception is not available to a publicly traded partnership that would be treated as a regulated investment company (RIC, see Q 7922) as described in IRC Section 851(a) if the partnership were a domestic corporation. Regulations may provide otherwise if the principal activity of the partnership involves certain commodity transactions.⁵

A partnership that fails to meet the passive-type income requirement may be treated as continuing to meet the requirement if: (1) the Service determines that the failure was inadvertent; (2) no later than a reasonable time after the discovery of the failure, steps are taken so that the partnership once more meets the passive-type income requirement; and (3) the partnership and each individual holder agree to make whatever adjustments or pay whatever amounts as may be required by the Service with respect to the period in which the partnership inadvertently failed to meet the requirement.⁶

A grandfather rule provided that partnerships that were publicly traded, or for which registrations were filed with certain regulatory agencies, on December 17, 1987 (“existing partnerships”), were exempt from treatment as a corporation until taxable years beginning after 1997. (See Q 7730 for treatment of electing 1987 partnerships after 1997.) However, the addition of a substantial line of business to an existing partnership after December 17, 1987, would terminate such an exemption. For purposes of the 90 percent passive-type income requirement above, an existing partnership is not treated as being in existence before the earlier of (1) the first taxable year beginning after 1997 or (2) such a termination of exemption due to the addition of a substantial new line of business. In other words, an existing partnership need not meet the 90 percent requirement while it was exempt under the transitional rules in order to meet the 90 percent requirement when its exemption has expired.⁷