IRS Regulation Brings Clarity to Apportioning Income for Partnerships with Changing Interests

August 10, 2015

By Jeff Winland, tax partner, and Tage Kelkar, tax associate

The IRS has recently released a new set of regulations, NPRM REG-109370-10, under Code Sec. 706(d), which set forth new choices for income allocations for partnerships with changing interests. The regulations create the varying interests rule, which recognizes that the annual income and expenses allocated to partners need to take into account changes in ownership during the year. The varying interests rule does not apply to most partnerships with changes to sharing ratios caused by agreements among partners that were partners for the entire partnership tax year. Certain service partnerships are also excluded.

The varying interests rule permits partnerships to employ either the interim-closing-of-the-books, “interim method,” or the proration method as their allocation method. The interim method is generally the default method. In this method, the partnership divides the year into segments based on the dates partnership interests changed. Partnership interests remain constant within each segment. Partnerships using the interim method may employ several conventions to determine the testing interval to determine whether an ownership change requiring an allocation change has occurred. If a variation occurs in the first half of a convention period, it is considered to occur at the beginning of the convention period. If the variation occurs in the second half, it is considered to happen at the end of the period.

The proration method may be selected if the partners agree. Under it, the partnership will divide its tax year into separate periods called “proration periods.”  Once these periods have been created, the partnership will prorate its tax items based on these periods. The proration method is less precise but also less cumbersome. The partnership’s items are prorated throughout the year.

The interim and proration methods are designed to make reporting easier. However, those methods do not lend themselves well to certain extraordinary items, such as a sale of capital assets. Under the Regulations, extraordinary items must be specifically allocated to the partners according to their interest at the time the item occurs. All items may be ratably allocated if the sum of all extraordinary items is less than $10 million and less than five percent of gross income. When the varying interest rule is applied to tiered partnerships, the daily allocation method is generally required for all of the tiers. This requirement can be waived if each upper-tier partnership owns less than 10 percent of the lower-tier partnership and the sum of upper-tier partnership ownership is less than 30 percent.

These regulations should assist in clarifying how income and deductions are allocated among partners by instilling some certainty into the proration process.

For questions or more information, contact Jeff Winland at or 770-353-3108.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.

Stay informed with Aprio.
Get industry news and leading insights delivered straight to your inbox.

Recent Articles

About the Author