This letter summarizes concerns with new IRS regulations regarding bottom-dollar payment obligations (BDPOs) under section 752 of the tax code. The new regulations broadly classify most guarantees as BDPOs not recognized for allocating partnership debt, contrary to congressional intent. This leads to inconsistent and uncertain results compared to prior regulations. The letter provides two examples where the same guarantee is treated differently under the new rules. It proposes alternatives, such as a bright-line rule recognizing guarantees above a debt threshold to balance compliance and congressional intent. The letter urges the IRS to reconsider the new BDPO regulations.

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• Associated Firm
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Advogados
Baker & McKenzie LLP
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January 03, 2017
CC:PA:LPD:PR (REG-122855-15) By certified mail
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington,D.C. 20044
Re: Comments on theNew Regulations Addressing Bottom-Dollar Payment Obligations
Dear Sir/Madam:
We are writing to you regarding a specific aspect of the temporary regulations issued on
October 5, 2016 (T.D. 9788), and that also serve as the contemporaneously issued
proposed regulations (REG-122855-15). Treas. Reg. Section 1.752-2T over-broadly
lumps most guarantees, indemnities, and similar arrangements into the bucket of
"bottom-dollar payment obligations" ("BDPOs") that are expressly not recognized under
Section 752 for purposes of determining whether a partner has economic risk of loss
("EROL") with respect to a partnership liability for allocation of partnership debt for tax
purposes (the "New BDPORegulations").
The New BDPO Regulations do not appear to arise from an improved framework for
partnership debt allocation for federal income tax purposes. TheNew BDPO Regulations
are conceptually flawed, result in odd and inconsistent answers, and present inappropriate
traps for the unwary. Indeed, the New BDPO Regulations are directly contrary to
Congressional intent and legislative history. See Pub. L. No. 98-369, § 79, 98 Stat. 494
(1984) and HR Rep.No. 861, 98th Cong., 2d Sess. 869 (1984). For this reason alone, the
New BDPO Regulations should be revoked, amended, and re-issued only in proposed
form for public notice and comment.
BackgroundandContext
Prior to the issuance of the New BDPO Regulations, the regulations concerning
allocation of partnership debt for tax purposes followed Congress' basic mandate, issued
in response to the decision in Raphan v. U.S., 52 AFTR 2d 83-5987 (C1. Ct. 1983), that
debt should be allocated by a partnership to the partners who bear the EROL with respect
to such debt. A partner generally bears the EROL for a partnership liability to the extent
the partner, or a related person, would be obligated to make a payment if the
partnership's assets were worthless and the liability became due and payable. This
ultimate liability test allocates an otherwise nonrecourse partnership liability to a partner
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that guarantees the obligation even ifthe lender and partnership reasonably anticipate the
partnership will be able to satisfy the liability.
The prior regulations carefully and appropriately followed Congress' mandate by using
EROL to determine whether a debt was a recourse liability or a nonrecourse liability.
The prior regulations were conceptually consistent and resulted in predictable results,
which facilitated tax compliance,including the reporting required by each partnership of
the manner in which its liabilities are allocated to its partners. This theoretically-
consistent approach under the prior regulations stands in stark contrast to the new BDPO
Regulations, which lead to inconsistent results and which will result in substantial
uncertainty.
The New BDPORegulations
Under the New BDPO Regulations all guarantees are, subject to limited exceptions,
treated as BDPOs which do not create EROL unless the partner or related person is liable
up to the full amount ofsuch partner's or related person's payment obligation if, and to
the extent that, any amount of the partnership liability is not otherwise satisfied. A
payment obligation is not within the scope ofthe BDPO definition merely because(i)a
maximum amount is placed on the partner's or related person's payment obligation (i.e.,
a cap on an otherwise respected BDPO is permissible),(ii)a partner's or related person's
payment obligation is stated as a fixed percentage of every dollar of the partnership
liability to which such obligation relates(i.e., vertical slice obligations),or(iii)there is a
right of proportionate contribution running between partners or related persons who are
co-obligors with respect to a payment obligation for which each ofthem is jointly and
severally liable. A BDPO is still recognized as creating EROL if a partner or related
person has a payment obligation that would be recognized under these new rules, but for
the effect ofan indemnity,reimbursement agreement,or similar arrangement,and,taking
into account such indemnity, reimbursement agreement, or similar arrangement, the
partner or related person is liable for at least 90 percent of such partner's or related
person's initial payment obligation.
Under the New BDPO Regulations, Congress' mandate that EROL determine how a
liability is to be allocated is ignored. Instead, every liability is treated as a nonrecourse
liability —even if a partner bears real EROL —unless the liability fits into a limited
exception provided in these new regulations. Partnerships will be required to allocate
liabilities based on partner's share ofthe profits, which is highly uncertain in situations in
which there are layers of profit allocation within a partnership. The New BDPO
Regulations replace certainty in debt allocation with massive uncertainty —the exact
opposite ofsound tax administration.
Two Examples in the New BDPD Regulations Illustrate One o,fthe Conceptual Flaws in
the New BDPO Regulations
In Example 10 ofthe New BDPO Regulations, A,B,and C are equal members of ABC
limited liability company that is treated as a partnership for federal income tax purposes.
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ABC borrows $1,000 from Bank. A guarantees payment ofup to $300 ifany amount of
the liability is not recovered by Bank. B guarantees payment of up to $200, but only if
Bank otherwise recovers less than $200. Both A and B waive their rights ofcontribution
against each other. Under the New BDPO Regulations, A's guarantee is not a BDPO
because A is obligated to pay up to $300 without any conditions. B's guarantee is a
BDPO because B is only required to pay ifless than $200 is recovered by the Bank. In
this fact set,$300 ofthe liability is allocated to A,and the remaining $700 is allocated to
A,B,and C under the allocation rules for nonrecourse liabilities.
In Example 11 of the New BDPO Regulations, the same facts occur except that, in
addition, C agrees to indemnify A up to $100 that A pays on its guarantee and to fully
indemnify B for any amount B pays on its guarantee. The New BDPO Regulations
provide that an indemnity will be recognized only ifthe indemnitee's underlying payment
obligation is recognized and is not itself a BDPO. Accordingly, the determination
whether C's indemnity is recognized is made without regard to whether C's indemnity,
itself, causes A's guarantee not to be recognized. Because A's obligation would be
recognized but for the effect ofC's indemnity,and C is obligated to pay A up to the full
amountofC's indemnity ifA pays on its guarantee,C's$100 indemnity ofA's guarantee
is not a BDPO and is recognized. Now,since C's indemnity is recognized,A's guarantee
is a BDPO and is not recognized. This is the case since A is obligated for $200 only to
the extent an amount beyond $100 is not satisfied. Since B's guarantee is not
independently recognized,C's indemnity ofB's guarantee is not recognized. In this fact
set, $100 ofthe liability is allocated to C,and the remaining $900 is allocated to A,B,
and C underthe allocation rulesfor nonrecourse liabilities.
Notwithstanding that$300ofthe same first-dollars ofthe $1,000 partnership liability was
guaranteed by partners ofthe partnership in both examples,the New BDPO Regulations
give rise to the incongruous results noted above. In Example 10,$300 ofthe EROL is
recognized and allocated; whereas,in Example 1l only $100 is recognized and allocated.
This is erroneous. Such incongruous results between these two examples means that
similar economics are being treated differently taxwise, which illustrates one of the
conceptual flaws in the treatment ofBDPOs under the New BDPO Regulations. The full
$300 ofEROL in Example 11 would have been recognized and allocated under the New
BDPO Regulations ifmade by only one partner,but splitting it acrosstwo partners causes
$200 ofthe EROL to be ignored. A conceptually consistent result in Example I1 would
have been for A and C to split the $300 EROL, with $200 allocated to A and $100
allocated to C.
The One Wav Anti-Abuse Rule SkewedAgainst Taxnavers
There is also aone-way anti-abuse rule in the New BDPO Regulations,applicable only at
the discretion of the Commissioner, in which a partner is considered to bear EROL
notwithstanding BDPO characterization. One can infer that the IRS is concerned that it
does not understand the broad impactofits regulations. This kind of"heads theIRS wins,
tails the taxpayer loses" regulation is improper for a number of reasons, primarily
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because it hoists a Sword of Damocles over taxpayers that snuffs out certainty of
treatment. It also has detrimental consequences to the integrity ofthe tax system.
For example,assume that Todd,Pat,and Steve form the TPS partnership. A lender to the
TPS partnership asks Todd to guarantee the bottom 60% ofthe debt;the lender is willing
to accept risk on the top 40%,but does not wantto bear catastrophic risk. Todd agrees to
do so, but under the New BDPO Regulations, his guarantee would be a BDPO that is
disregarded. Accordingly, the liability would be allocated to the partners in accordance
with their interests in partnership profits.
This result does not change ifTodd guarantees the bottom 70% ofthe debt,or the bottom
80% ofthe debt —failure to guarantee the entire debt,or at least a vertical slice thereof—
means that the guarantee is completely disregarded. For purposes of preparing its tax
returns,the partnership must disregard every BDPO for purposes ofdetermining EROL,
even ifboth the partnership and its paMnerS are convinces Thal the guaranteeing partner is
bearing real risk of economic loss. This result is the opposite of what Congress
envisioned when it instructed the IRS to issue regulations overruling the Raphan decision.
But, there is no assurance of this treatment in such a murky and vague regime. Now,
under the New BDPO Regulations,the taxpayer is subject to the whim ofthe IRS ifthere
is an arrangement the IRS does not like. Ifthe IRS determines it prefers a different result,
the obligation could be treated as a recourse loan to Todd. As a result,the partners would
never have any certainty as to the tax consequences of their partnership and its
borrowings. It is wrong for the IRS to set forth an uncertain set ofrules regarding debt
allocation,yet give themselves broad powerto attack whatthey arbitrarily do not like.
Alternatives
We understand that the IRS was unhappy with the results which could be obtained under
the prior regulations, in which a partner could be allocated debt while practically taking
no economic risk. For example,ifa partnership had $500 million ofdebt,and a partner
wanted to be allocated $1 million ofdebt to permit atax-deferred distribution,the partner
could guarantee the bottom 0.2% ofthe debt ofthe partnership. As a practical matter,
that partner is taking no risk of loss, because the assets ofthe partnership would always
be worth $1 million,even assuming an economic catastrophe.
However, the New BDPO Regulations address this situation the wrong way, treating
every payment obligation that is not "first dollar" or "vertical slice" as a BDPO,even if
there is real risk ofloss to the person who entered into the payment obligation. The New
BDPO Regulations also ensure uncertainty in determining how partnership debts are
allocated, which is contrary to sound tax administration. For these reasons alone, these
regulations need to be completely reconsidered.
We believe that the prior regulations were consistent with Congressional intent and
should be retained —the concern addressed by the New BDPO Regulations is a relatively-
minor problem that did not upset the integrity ofthe tax system to the same extent as the
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New BDPO Regulations. However, if the IRS is concerned about bottom-dollar
obligations that it believes lacks economic reality, we propose that the New BDPO
Regulations be replaced with abright-line rule in which a BDPO that guarantees only
debt below a specified threshold is not recognized. For example, regulations could
provide that any BDPO that is limited to the bottom l/3 of a debt obligation is not
recognized, but any BDPO that includes debt above the bottom 1/3 ofa debt obligation is
recognized in full because ofthe risk being undertaken by the guarantor. This approach,
which is more consistent with the Congressional mandate, will allow certainty and
consistency in application, which is the opposite of the result under the New BDPO
Regulations. We urge the IRS to re-think the New BDPO Regulations and adopt a
bright-line approach that will aid compliance while being consistent with the intent of
Section 752ofthe Code.
We thank you for your consideration ofour above comments.
Respectfiully submitted,
Richard M.Lipton
Samuel P. Grilli
~,-.
f
Nicole D.Renchen
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