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 respect to both the original purchase of the interest as well as for any additional amounts paid by [the corporation]” under an earn-out.

In reporting this transaction, the partner claimed a charitable deduction under Section 170 on his individual tax return. The partnership increased the transferee-corporation’s share of the inside basis of the partnership’s assets under Section 743(b), allowing the corporation to take an amortization deduction. Additionally, the corporation claimed an interest deduction related to the promissory note it had issued in connection with the transaction. No party to the transaction reported any gain upon the transfers of the interest in the partnership.

The IRS said the substance of the transaction is that the tax-exempt organization never received an interest in partnership, because it never held any rights in the partnership other than the mere distribution rights for the one day it held the partnership interest. Thus, the partner wasn’t entitled to claim the charitable deduction under Section 170 and was treated as transferring the interest directly or indirectly through the trust to the corporation.

Additionally, because the tax-exempt organization never held an interest or share of the partnership property, it never entered into a sale of the interest to the corporation that would entitle the partnership to adjust its basis under Section 743(b). Therefore, the corporation wasn’t entitled to the amortization deductions it had claimed on its tax return.