Publicly Traded Partnerships
By Section 7704 provides a partnership is a publicly traded partnership if interests in the partnership are (1) traded on an established securities market or (2) readily tradable on a secondary market or the substantial equivalent thereof. A publicly traded partnership is generally taxed as a C corporation. That means it is subject to corporate taxes rather than being a pass-through entity like other partnerships.
The first test about whether the interests of a partnership are traded on an established securities market is fairly easy to apply. The second test is less clear and requires a facts and circumstances analysis. The regulations provide a number of safe harbors for avoiding publicly traded status.
One commonly relied on safe harbor is the private placement exception of Reg. § 1.7704-1(h)(1). It states a partnership’s interests are not considered readily tradable (and therefore will not fall within the second test) if (1) all partnership interests are issued in transactions that are not required to be registered under the Securities Act of 1933 (i.e., private placements), and (2) the partnership does not have more than 100 partners at any time during the partnership taxable year. Under Reg. § 1.7704-1(h)(3), a look-through approach applies for certain pass-through entities to prevent a partnership from avoiding the 100-partner limit by using tiered pass-through entities. This safe harbor provides comfort to most partnerships.
Reg. § 1.7704-1(c)(1) defines “readily tradable on a secondary market or a substantial equivalent” to mean if “taking into account all of the facts and circumstances, the partners are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on an established securities market.” Reg. § 1.7704-1(c)(2) provides examples of when interests are considered readily tradable, including if (1) any person, such as a broker or dealer, making a market in the interests regularly quotes interests in the partnership; (2) any person regularly makes available to the public, including customers or subscribers, bid or offer quotes with respect to interests in the partnership and stands ready to affect buy or sell transactions at the quoted prices for itself or on behalf of others; (3) the holder of an interest in the partnership has a readily available, regular, and ongoing opportunity to sell or exchange the interest through a public means of obtaining or providing information of offers to buy, sell, or exchange interests in the partnership; or (4) prospective buyers and sellers otherwise have the opportunity to buy, sell, or exchange interests in the partnership in a time frame and with the regularity and continuity that is comparable to that described in the previous three circumstances.
In addition to the private placement exception, the regulations provide exemptions for (1) issuances of interests by, or on behalf of, the partnership in exchange for cash, property or services pursuant to Reg. § 1.7704-1(e)(1)(iv) and (2) de minimis trading during the year that does not exceed 2% of the total interests in capital or profits of the partnership pursuant to Reg. § 1.7704-1(j).
Finally, even if the tests are met for the partnership to be treated as a publicly traded partnership, 7704(c) provides for an exception for partnerships where 90% or more of its income is from interest, dividends, real property, rents, and certain other passive sources.
John G. Hodnette is a partner with Fox Rothschild, LLP in Charlotte.