If your business is a partnership, the I.R.S. will require the partnership to pick a tax year. A partnership’s tax year is determined by the partners. However, picking a tax year can be difficult. Partnerships may have partners who disagree on which tax year to use. One partner may want a tax year ending on April 1 while another may want a tax year ending on December 31. I.R.C. § 706(b)(1)(B) provides a solution to this dilemma. Under I.R.C. § 706(b)(1)(B), the following method determines a partnership’s tax year:

- A partnership must use the taxable year of its partners who hold more than a 50% interest in the partnership profits and capital.
- If the partners owning more than a 50% interest in the partnership do not have the same taxable year, the partnership must use the taxable year of all the principal partners of the partnership. Principal partners are those who own 5% or more of the partnership’s profits or capital.
- If neither of the two rules above apply, the partnership must use the “least aggregate deferral” test to determine the partnership’s taxable year.

The “least aggregate deferral” test works like this. Imagine D is a partnership with X, Y, and Z as partners. All the partners agree that X will receive 30% of the partnership’s profits, Y will receive 40%, and Z will receive 30%. But, X, Y, and Z all want different tax years as shown in the graph below.

Partners | % of the profits | Desired Tax Year |

X | 30% | 6/30 |

Y | 40% | 8/30 |

Z | 30% | 12/31 |

To determine the “least aggregate deferral,” we first test how many months the other partners are deferred if we chose X’s date of 6/30/2019. Then we multiply each partner’s percentage of profits by their respective deferral months. Finally, we add up the results to determine the aggregate deferral number as seen below.

Partner | Desired Taxable Year | % of the profits | Months of Deferral | Interest X Deferral |

X | 6/30/2019 | 30% | 0 | 0 |

Y | 8/31/2019 | 40% | 2 | 40% x 2 = 0.8 |

Z | 12/31/2019 | 30% | 6 | 30% x 6 = 1.8 |

Aggregate Deferral | 0.8 + 1.8 = 2.6 |

However, this does not end our inquiry. The remaining partners (Y and Z) must also determine their aggregate deferral numbers by employing the same formula used for X. Once that is done the partner with the lowest aggregate deferral number is the partnership’s tax year

by Reymond Huang

Krogh & Decker, LLP, Business Attorneys (916) 498-9000 or www.kroghdecker.com/contact