[Federal Register Volume 60, Number 84 (Tuesday, May 2, 1995)]
[Proposed Rules]
[Pages 21475-21482]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10765]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[PS-013-88]
RIN 1545-AL57


Certain Publicly Traded Partnerships Treated as Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
classification of certain publicly traded partnerships as corporations. 
These proposed regulations would provide guidance needed by taxpayers 
to comply with changes to the law made [[Page 21476]] by the Omnibus 
Budget Reconciliation Act of 1987. The regulations would affect the 
classification of certain partnerships for federal tax purposes.

DATES: Written comments must be received by July 31, 1995. Requests to 
speak (with outlines of oral comments) at a public hearing scheduled 
for July 31, 1995, at 10 a.m. must be received by July 31, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (PS-013-88), room 5228, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. In the alternative, submissions may be hand delivered between 
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (PS-013-88), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, 
Washington, DC. The public hearing has been scheduled to be held in the 
Auditorium, Internal Revenue Building, 1111 Constitution Avenue NW, 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, 
Christopher T. Kelley, (202) 622-3080; concerning submissions and the 
hearing, Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Introduction

    This document proposes to add Sec. 1.7704-1 to the Income Tax 
Regulations (26 CFR part 1) relating to the definition of a publicly 
traded partnership under section 7704(b) of the Internal Revenue Code 
(Code).

Background

    Section 7704 was added to the Code by section 10211(a) of the 
Omnibus Budget Reconciliation Act of 1987 (Pub. L. 100-203), as amended 
by sections 2004(f)(1)-(5) of the Technical and Miscellaneous Revenue 
Act of 1988 (Pub. L. 100-647). Section 7704(a) provides that a publicly 
traded partnership is treated as a corporation for federal tax purposes 
unless the partnership meets the 90 percent qualifying income test of 
section 7704(c) or qualifies as an existing partnership. The term 
existing partnership is defined in Sec. 1.7704-2. Under section 
7704(b), a partnership is a publicly traded partnership if interests in 
the partnership are traded on an established securities market or are 
readily tradable on a secondary market or the substantial equivalent 
thereof. Section 7704 applies to all domestic and foreign entities 
treated as partnerships under section 7701, including limited liability 
companies and other entities treated as partnerships for federal tax 
purposes.
    No regulations have been issued regarding the circumstances under 
which interests in a partnership are treated as publicly traded under 
section 7704(b). Notice 8875, 1988-2 C.B. 386, however, provides 
guidance on the definition of a publicly traded partnership. Notice 88-
75 provides that interests in a partnership are not treated as readily 
tradable on a secondary market or the substantial equivalent thereof 
for purposes of section 7704(b)(2) if the interests are: (1) issued in 
certain private placements; (2) transferred pursuant to transfers not 
involving trading; (3) traded in amounts that meet the requirements of 
a 5 percent or 2 percent safe harbor; (4) transferred through a 
matching service that meets certain requirements; or (5) transferred 
pursuant to a qualifying redemption or repurchase agreement. Notice 88-
75 does not address when partnership interests are treated as traded on 
an established securities market for purposes of section 7704(b)(1).

Explanation of Provisions

Definitions

    The proposed regulations define the terms established securities 
market, secondary market, and the substantial equivalent of a secondary 
market for purposes of section 7704(b). These definitions reflect 
congressional intent as articulated in the legislative history to 
section 7704. See H.R. Conf. Rep. No. 495, 100th Cong., 1st Sess. 947-
50 (1987) (Conference Report).
    Under the proposed regulations, an established securities market 
for purposes of section 7704(b)(1) includes: (1) A national securities 
exchange registered under the Securities Exchange Act of 1934; (2) a 
national securities exchange exempt from registration because of the 
limited volume of transactions; (3) a foreign securities exchange; (4) 
a regional or local exchange; and (5) an interdealer quotation system 
that regularly disseminates firm buy or sell quotations by identified 
brokers or dealers by electronic means or otherwise.
    Under the proposed regulations, interests in a partnership that are 
not traded on an established securities market are readily tradable on 
a secondary market or the substantial equivalent of a secondary market 
for purposes of section 7704(b)(2) if 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. The proposed regulations further provide that interests in a 
partnership are readily tradable on a secondary market if: (1) 
Interests in the partnership are regularly quoted by any person, such 
as a broker or dealer, making a market in the interest, or (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 effect buy or sell transactions at the 
quoted prices for itself or on behalf of others. This provision 
clarifies that a secondary market exists whenever interests in the 
partnership are subject to firm-quote trading.
    The proposed regulations also provide that, if there is no 
secondary market, interests in a partnership are readily tradable on 
the substantial equivalent of a secondary market if: (1) 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, or (2) prospective buyers and sellers have the 
opportunity to buy, sell, or exchange interests in a time frame and 
with the regularity and continuity that the existence of a secondary 
market would provide.
    The proposed regulations define an interest in a partnership for 
purposes of section 7704(b) as any interest in the capital or profits 
of the partnership (including any right to partnership distributions) 
and any financial instrument or contract the value of which is 
determined in whole or in part by reference to the partnership 
(including the amount of partnership distributions, the value of 
partnership assets, or the results of partnership operations). This 
definition is intended to prevent the avoidance of section 7704(b) 
through the creation and transfer of interests other than traditional 
partnership interests, such as the creation and transfer of derivative 
partnership interests. The proposed regulations also provide several 
exceptions to the definition of an interest in the partnership. Under 
these exceptions, an interest in the partnership does not include non-
convertible debt or an interest in a partnership or a corporation that 
holds an interest in a lower-tier partnership. For example, an interest 
in a regulated investment company that holds an interest in a 
partnership is not treated as an interest in the partnership.
    The proposed regulations also define a transfer of an interest in a 
partnership to include a transfer in any form, including a redemption 
by the partnership or the entering into of a [[Page 21477]] financial 
instrument or contract described above. This provision applies only for 
purposes of determining when a transaction is treated as a transfer for 
purposes of section 7704(b) and does not apply in determining any other 
federal tax consequences of a transaction, including whether the 
transaction is a sale or exchange or whether the transferee is a 
partner of the partnership for any purpose other than section 7704(b).
    The proposed regulations also provide that a transfer of an 
interest in a partnership is taken into account for purposes of section 
7704(b) only if: (1) The partnership redeems the interest; (2) the 
transferee is admitted as a partner; or (3) the partnership otherwise 
recognizes any rights of the transferee, such as a right of the 
transferee to partnership distributions (directly or indirectly) or the 
right of the transferee to acquire an interest in the capital or 
profits of the partnership. For example, if a partner enters into a 
financial contract providing for a payment by the partner in an amount 
calculated by reference to the amount of partnership distributions, the 
financial contract is treated as an interest in the partnership and the 
entering into the contract is treated as a transfer of an interest for 
purposes of section 7704. The transfer is not taken into account, 
however, unless the partnership admits the transferee as a partner or 
otherwise recognizes the rights of the transferee to partnership 
distributions by, for example, making distributions directly to the 
transferee or to a third party on behalf of the transferee. This 
provision is intended to limit transfers for purposes of section 
7704(b) to transfers that the partnership is aware of and has 
recognized, thereby preventing a partnership from becoming publicly 
traded without the knowledge or participation of the partnership.

Transfers That Do Not Create Public Trading

    As discussed above, guidance issued in Notice 88-75 provided 
certain exclusions for purposes of section 7704(b)(2). The proposed 
regulations generally adopt these exclusions with certain 
modifications. The modifications are necessary to more appropriately 
implement congressional intent and to ensure that any partnership in 
which interests are subject to firm-quote trading is treated as a 
publicly traded partnership under section 7704. As in Notice 88-75, 
none of these exclusions apply in determining whether interests in a 
partnership are traded on an established securities market.
    The proposed regulations adopt the exclusion in section II.A of 
Notice 88-75 for partnership interests issued in certain private 
placements with four modifications. First, the proposed regulations 
provide that the exclusion applies only for purposes of determining 
whether interests in a partnership are readily tradable on the 
substantial equivalent of a secondary market. Unlike Notice 88-75, this 
exclusion does not apply for purposes of determining whether the 
interests are readily tradable on a secondary market. As a result, a 
private placement partnership is treated as a publicly traded 
partnership if the interests in the partnership are readily tradable on 
a secondary market. This modification was made to ensure that, 
consistent with the purpose of section 7704(b), all partnerships, 
including private placement partnerships, are treated as publicly 
traded if interests in the partnership are subject to firm-quote 
trading.
    Secondly, the proposed regulations provide that the private 
placement exclusion does not apply if the partnership has more than 50 
partners at any time during its taxable year and the sum of the 
percentage interests in partnership capital or profits transferred 
during the taxable year of the partnership (other than in private 
transfers described in paragraph (d) of this section) exceeds 10 
percent of the total interests in partnership capital or profits. This 
modification was made because transfers in excess of 10 percent 
indicate the existence of the type of market that section 7704(b) 
intended to treat as public trading. This modification does not apply 
to partnerships with 50 or fewer partners because such partnerships are 
unlikely to develop any public trading.
    Thirdly, as in Notice 88-75, the private placement exclusion 
applies only if the partnership does not have more than 500 partners or 
the initial offering price of each unit of partnership interest is at 
least $20,000. The proposed regulations clarify that a partnership 
satisfies the 500 partner requirement only if the partnership does not 
have more than 500 partners at any time during the taxable year of the 
partnership. Finally, the proposed regulations provide that the 
indirect ownership rule for determining the number of partners in a 
partnership does not apply to persons owning interests in a partnership 
through a regulated investment company (as defined in section 851) or a 
real estate investment trust (as defined in section 865).
    The proposed regulations adopt, with two additions, the exclusion 
contained in section II.B of Notice 88-75 for transfers not involving 
trading (private transfers). Under the proposed regulations, private 
transfers include all of the transfers described in section II.B of 
Notice 88-75 plus: (1) distributions from an individual retirement 
account, and (2) transfers by one or more partners of interests 
representing more than 50 percent of the total interests in partnership 
capital and profits in one transaction or a series of related 
transactions. The proposed regulations also provide that a block 
transfer means the transfer by a partner in one or more transactions 
during any 30 calendar day period of partnership interests representing 
in the aggregate more than 2 percent of the total interests in 
partnership capital or profits, rather than 5 percent as in Notice 88-
75.
    In lieu of the 5 percent and 2 percent safe harbors contained in 
section II.C of Notice 88-75, the proposed regulations provide a more 
limited de minimis trading exclusion. The percentage safe harbors in 
Notice 88-75 applied in determining whether interests in a partnership 
were readily tradable on a secondary market or the substantial 
equivalent thereof. The Conference Report, however, gives no indication 
that a de minimis level of trading on a secondary market should be 
permitted, and the IRS and Treasury do not believe that a broad-based 
de minimis rule that allows firm-quote trading on a secondary market is 
appropriate. Furthermore, the percentage safe harbors contained in 
Notice 88-75 apparently have encouraged the type of firm-quote trading 
that Congress intended to prohibit by enacting section 7704.
    Accordingly, the proposed regulations provide that interests in a 
partnership are not readily tradable on a substantial equivalent of a 
secondary market if the sum of the percentage interests in partnership 
capital or profits transferred during the taxable year of the 
partnership does not exceed 2 percent of the total interests in 
partnership capital or profits. All transfers of an interest in a 
partnership (including redemptions) are taken into account for purposes 
of this 2 percent rule, except for: (1) Private transfers; (2) 
transfers pursuant to redemption and repurchase agreements meeting 
certain requirements as specified in the regulations; and (3) transfers 
pursuant to a qualified matching service, discussed below. The 2 
percent rule differs from the percentage safe harbors in Notice 88-75 
because the 2 percent rule applies only for purposes of determining 
[[Page 21478]] whether interests in a partnership are readily tradable 
on the substantial equivalent of a secondary market. As a result, the 2 
percent rule does not apply in determining whether interests are 
readily tradable on a secondary market and thus does not apply to 
partnerships with interests subject to firm quote trading.
    The proposed regulations contain a qualified matching service 
exclusion similar to the matching service exclusion contained in 
section II.D of Notice 88-75. The proposed regulations, however, 
contain certain modifications designed to prevent a qualified matching 
service from operating as a secondary market or the substantial 
equivalent thereof. For example, the matching service can display only 
nonfirm quotes or nonbinding indications of interest and cannot provide 
firm quotes or two-sided quotes. The selling partner cannot enter into 
a binding agreement to sell an interest until the 15th calendar day 
after the date information regarding the offering of an interest for 
sale is made available to potential buyers, and closing of the sale 
cannot occur prior to the 30th calendar day after the first day that 
the seller can enter into a binding agreement to sell the interest. The 
matching service must obtain written representations from any 
subscribers that the subscribers and their customers will not act as 
market makers for any partnership interest listed on the matching 
service and that the subscriber, acting on its own account or on behalf 
of the same investor, will not enter offers for interests in the same 
partnership more than once in any 15 calendar day period.
    As in Notice 88-75, this matching service exclusion does not apply 
if more than 10 percent of the total percentage interests in 
partnership capital or profits is transferred during the taxable year. 
For purposes of this 10 percent limitation, all transfers (other than 
private transfers) are considered, including transfers that do not take 
place on the matching service and transfers that are eligible for 
another exclusion under the proposed regulations. For example, if 1 
percent of the total partnership interests in capital or profits is 
transferred on a nonqualified matching service, the amount of interests 
that can be transferred pursuant to a qualified matching service and 
still qualify for the matching service exclusion is reduced to 9 
percent.
    The proposed regulations clarify that certain activities will not 
prevent a matching service from qualifying for the exclusion. Under the 
proposed regulations, a qualifying matching service may provide: (1) 
Prior pricing information, including information regarding resales of 
interests and actual prices paid for interests; (2) a description of 
the business of the partnership; and (3) financial and reporting 
information from the partnership's financial statements and reports. 
The operator of the matching service may also assist with the transfer 
documentation necessary to transfer the partnership interest. The 
operator may receive and deliver funds for completed transactions, and 
its fee may be a flat fee for use of the service, a fee based on 
completed transactions, or any combination thereof. While these 
activities may allow the operator of the matching service to assist in 
the completion of the transfer, the activities should not, by 
themselves, result in the type of activity that would cause the 
matching service to be a secondary market or the substantial equivalent 
thereof under section 7704(b)(2).
    The proposed regulations adopt the exclusions for redemption and 
repurchase agreements contained in section II.E of Notice 88-75 with no 
significant modifications.
    The IRS and Treasury request comments on the proposed regulations. 
In particular, comments are requested concerning: (1) Whether 
transitional relief is necessary for partnerships that qualified for an 
exclusion contained in Notice 88-75, but do not qualify for an 
exclusion contained in the proposed regulations and, if so, what type 
of relief would be appropriate; (2) whether further modifications to 
the private placement exclusion are necessary in light of developments 
in the securities laws since the issuance of Notice 88-75, including 
the issuance of Rule 144A (17 CFR 230.144A) and Regulation S (17 CFR 
230.901); and (3) which members in a limited liability company or other 
entity that is treated as a partnership for federal tax purposes should 
be treated as general partners for purposes of determining the 
percentage interests in partnership capital or profits transferred 
during the taxable year of the partnership under paragraph (j)(1) of 
the proposed regulations.

Proposed Effective Date

    These regulations are proposed to apply for taxable years of a 
partnership beginning on or after the date the final regulations are 
published in the Federal Register. The provisions of Notice 88-75 
regarding the definition of readily tradable on a secondary market or 
the substantial equivalent thereof for purposes of section 7704(b) will 
continue to apply until these regulations are effective.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations and, therefore, a Regulatory Flexibility 
Analysis is not required. Pursuant to section 7805(f) of the Internal 
Revenue Code, this notice of proposed rulemaking will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for July 31, 1995, at 10 a.m. 
in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue 
NW, Washington, DC. Because of access restrictions, visitors will not 
be admitted beyond the Internal Revenue Building lobby more than 15 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments and an outline of the topics to be discussed (a 
signed original and eight (8) copies) by July 31, 1995.
    A period of 10 minutes will be allotted for each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

    Drafting Information: The principal author of these regulations 
is Christopher T. Kelley, Office of Chief Counsel (Passthroughs and 
Special Industries). However, other personnel from the IRS and 
Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements. 
[[Page 21479]] 

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *.

    Par. 2. Section 1.7704-1 is added to read as follows:


Sec. 1.7704-1  Publicly traded partnerships.

    (a) In general--(1) Publicly traded partnership. A domestic or 
foreign partnership is a publicly traded partnership for purposes of 
section 7704(b) and this section if--
    (i) Interests in the partnership are traded on an established 
securities market; or
    (ii) Interests in the partnership are readily tradable on a 
secondary market or the substantial equivalent thereof.
    (2) Partnership interest--(i) In general. For purposes of section 
7704(b) and this section, an interest in a partnership includes--
    (A) Any interest in the capital or profits of the partnership 
(including the right to partnership distributions); and
    (B) Any financial instrument or contract the value of which is 
determined in whole or in part by reference to the partnership 
(including the amount of partnership distributions, the value of 
partnership assets, or the results of partnership operations).
    (ii) Exception for non-convertible debt. For purposes of section 
7704(b) and this section, an interest in a partnership does not include 
any financial instrument or contract that--
    (A) Is treated as debt for federal tax purposes; and
    (B) Is not convertible into or exchangeable for an interest in the 
capital or profits of the partnership and does not provide for a 
payment of equivalent value.
    (iii) Exception for tiered entities. For purposes of section 
7704(b) and this section, an interest in a partnership or a corporation 
(including a regulated investment company as defined in section 851 or 
a real estate investment trust as defined in section 856) that holds an 
interest in a partnership (lower-tier partnership) is not considered an 
interest in the lower-tier partnership.
    (3) Definition of transfer. For purposes of section 7704(b) and 
this section, a transfer of an interest in a partnership means a 
transfer in any form, including a redemption by the partnership or the 
entering into of a financial instrument or contract described in 
paragraph (a)(2)(i)(B) of this section.
    (4) Transfers taken into account. For purposes of section 7704(b) 
and this section, a transfer of an interest in a partnership is taken 
into account only if--
    (i) The transferee is admitted as a partner;
    (ii) The partnership otherwise recognizes any rights of the 
transferee, such as a right of the transferee to partnership 
distributions (directly or indirectly) or the right of the transferee 
to acquire an interest in the capital or profits of the partnership; or
    (iii) The partnership redeems or repurchases the interest.
    (b) Established securities market. For purposes of section 7704(b) 
and this section, an established securities market includes--
    (1) A national securities exchange registered under section 6 of 
the Securities Exchange Act of 1934 (15 U.S.C. 78f);
    (2) A national securities exchange exempt from registration under 
section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) 
because of the limited volume of transactions;
    (3) A foreign securities exchange that, under the law of the 
jurisdiction where it is organized, satisfies regulatory requirements 
that are analogous to the regulatory requirements under the Securities 
Exchange Act of 1934 described in paragraph (b)(1) or (2) of this 
section (such as the London International Financial Futures Exchange; 
the Marche a Terme International de France; the International Stock 
Exchange of the United Kingdom and the Republic of Ireland, Limited; 
the Frankfurt Stock Exchange; and the Tokyo Stock Exchange);
    (4) A regional or local exchange; and
    (5) An interdealer quotation system that regularly disseminates 
firm buy or sell quotations by identified brokers or dealers by 
electronic means or otherwise.
    (c) Readily tradable on a secondary market or the substantial 
equivalent thereof--(1) In general. For purposes of section 7704(b) and 
this section, interests in a partnership that are not traded on an 
established securities market (within the meaning of section 7704(b) 
and paragraph (b) of this section) are readily tradable on a secondary 
market or the substantial equivalent thereof if 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.
    (2) Secondary market. For purposes of paragraph (c)(1) of this 
section, interests in a partnership are readily tradable on a secondary 
market if-(i) Interests in the partnership are regularly quoted by any 
person, such as a broker or dealer, making a market in the interests; 
or
    (ii) 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 effect buy or sell transactions 
at the quoted prices for itself or on behalf of others.
    (3) Substantial equivalent of a secondary market. For purposes of 
paragraph (c)(1) of this section, interests that are not readily 
tradable on a secondary market are readily tradable on the substantial 
equivalent of a secondary market if--
    (i) 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
    (ii) Prospective buyers and sellers have the opportunity to buy, 
sell, or exchange interests in the partnership in a time frame and with 
the regularity and continuity that the existence of a secondary market 
would provide.
    (d) Transfers not involving trading--(1) In general. For purposes 
of section 7704(b) and this section, the following transfers (private 
transfers) are disregarded in determining whether interests in a 
partnership are readily tradable on a secondary market or the 
substantial equivalent thereof--
    (i) Transfers in which the basis of the partnership interest in the 
hands of the transferee is determined, in whole or in part, by 
reference to its basis in the hands of the transferor or is determined 
under section 732;
    (ii) Transfers at death;
    (iii) Transfers between members of a family (as defined in section 
267(c)(4));
    (iv) Transfers involving the issuance of interests by (or on behalf 
of) the partnership in exchange for cash, property, or services;
    (v) Transfers involving distributions from a retirement plan 
qualified under section 401(a) or an individual retirement account;
    (vi) Block transfers (as defined in paragraph (d)(2) of this 
section);
    (vii) Transfers pursuant to a right under a redemption or 
repurchase agreement (as defined in paragraph (d)(3) of this section) 
that is exercisable only-- [[Page 21480]] 
    (A) Upon the death, disability, or mental incompetence of the 
partner; or
    (B) Upon the retirement or termination of the performance of 
services of an individual who actively participated in the management 
of, or performed services on a full-time basis for, the partnership;
    (viii) Transfers pursuant to a closed end redemption plan (as 
defined in paragraph (d)(4) of this section); and
    (ix) Transfers by one or more partners of interests representing 
more than 50 percent of the total interests in partnership capital and 
profits in one transaction or a series of related transactions.
    (2) Block transfers. For purposes of paragraph (d)(1)(vi) of this 
section, a block transfer means the transfer by a partner in one or 
more transactions during any 30 calendar day period of partnership 
interests representing in the aggregate more than 2 percent of the 
total interests in partnership capital or profits.
    (3) Redemption or repurchase agreement. For purposes of section 
7704(b) and this section, a redemption or repurchase agreement means a 
plan of redemption or repurchase maintained by a partnership whereby 
the partners may tender their partnership interests for purchase by the 
partnership, another partner, or a person related to another partner 
(within the meaning of section 267(b) or section 707(b)(1)).
    (4) Closed end redemption plan. For purposes of paragraph 
(d)(1)(viii) of this section, a redemption or repurchase agreement (as 
defined in paragraph (d)(3) of this section) is a closed end redemption 
plan if--
    (i) The partnership does not issue any interest after the initial 
offering (other than the issuance of additional interests prior to 
August 5, 1988); and
    (ii) No partner or person related to any partner (within the 
meaning of section 267(b) or 707(b)(1)) provides contemporaneous 
opportunities to acquire interests in similar or related partnerships 
which represent substantially identical investments.
    (e) Redemption and repurchase agreements. For purposes of section 
7704(b) and this section, the transfer of an interest in a partnership 
pursuant to a redemption or repurchase agreement (as defined in 
paragraph (d)(3) of this section) that is not described in paragraph 
(d)(1) (vii) or (viii) of this section is disregarded in determining 
whether interests in the partnership are readily tradable on a 
secondary market or the substantial equivalent thereof only if--
    (1) The redemption or repurchase agreement requires receipt of 
written notification from the transferor partner by the partnership or 
a partner (or an agent thereof) at least 60 calendar days before the 
redemption or repurchase date of such partner's intention to exercise 
the redemption or repurchase right;
    (2) Either--
    (i) The redemption or repurchase agreement requires that the 
redemption or repurchase price not be established until at least 60 
calendar days after receipt of such notification by the partnership or 
the partner; or
    (ii) The redemption or repurchase price is established not more 
than 4 times during the partnership's taxable year; and
    (3) The sum of the percentage interests in partnership capital or 
profits transferred during the taxable year of the partnership (other 
than in private transfers described in paragraph (d) of this section) 
does not exceed 10 percent of the total interests in partnership 
capital or profits.
    (f) Qualified matching services--(1) In general. For purposes of 
section 7704(b) and this section, the transfer of an interest in a 
partnership through a qualified matching service is disregarded in 
determining whether interests in the partnership are readily tradable 
on a secondary market or the substantial equivalent thereof.
    (2) Requirements. A matching service is a qualified matching 
service only if--
    (i) The matching service consists of a computerized or printed 
listing system that lists customers' bid and/or ask prices in order to 
match partners who want to sell their interests in a partnership (the 
selling partner) with persons who want to buy those interests;
    (ii) Matching occurs either by matching the list of interested 
buyers with the list of interested sellers or through a bid and ask 
process that allows interested buyers to bid on the listed interest;
    (iii) The selling partner cannot enter into a binding agreement to 
sell the interest until the 15th calendar day after the date 
information regarding the offering of the interest for sale is made 
available to potential buyers and such time period is established by 
contemporaneous records maintained by the operator at a central 
location;
    (iv) The closing of the sale effected by virtue of the matching 
service does not occur prior to the 30th calendar day after the first 
day that the selling partner can enter into a binding agreement to sell 
the interest (as specified in paragraph (f)(2)(iii) of this section) 
and such time period is established by contemporaneous records 
maintained by the operator at a central location;
    (v) The matching service displays only quotes that do not commit 
any person to buy or sell a partnership interest (nonfirm price quotes) 
or quotes that express interest in a partnership interest without an 
accompanying price (nonbinding indications of interest) and does not 
display quotes at which any person is committed to buy or sell a 
partnership interest (firm quotes) or two-sided quotes;
    (vi) The operator of the matching service (or any person related to 
the operator within the meaning of section 267(b) or section 707(b)(1)) 
does not quote prices at which the operator (or a related person) 
stands ready to buy or sell partnership interests for itself or on 
behalf of others, make such quotes available to the public (or 
customers or subscribers), or buy or sell interests for itself or on 
behalf of others;
    (vii) The matching service obtains written representations from any 
subscribers to the service that--
    (A) The subscriber and its customers will not create or facilitate 
a secondary market (within the meaning of paragraph (c)(2) of this 
section) for any partnership interest listed on the matching service; 
and
    (B) The subscriber, acting for its own account or on behalf of the 
same investor, will not enter offers for interests in the same 
partnership more than once in any 15 calendar day period;
    (viii) The selling partner's information is removed from the 
matching service within 120 calendar days after the date information 
regarding the offering of the interest for sale is made available to 
potential buyers and, following any removal (other than removal by 
reason of a sale of any part of such interest) of the selling partner's 
information from the matching service, no interest in the partnership 
is entered into the matching service by the selling partner for at 
least 60 calendar days; and
    (ix) The sum of the percentage interests in partnership capital or 
profits transferred during the taxable year of the partnership (other 
than in private transfers described in paragraph (d) of this section) 
does not exceed 10 percent of the total interests in partnership 
capital or profits.
    (3) Closing. For purposes of paragraph (f)(2)(iv) of this section, 
the closing of a sale occurs no later than the earlier of--
    (i) The passage of title to the partnership interest;
    (ii) The payment of the purchase price; or
    (iii) The date, if any, that the operator of the matching service 
(or any person [[Page 21481]] related to the operator within the 
meaning of section 267(b) or section 707(b)(1)) loans, advances, or 
otherwise arranges for funds to be available to the seller in 
anticipation of the payment of the purchase price.
    (4) Optional features. A qualified matching service may be 
sponsored or operated by a partner of the partnership (either formally 
or informally), the underwriter that handled the issuance of the 
partnership interests, or an unrelated third party. In addition, a 
qualified matching service may offer the following features--
    (i) The matching service may provide prior pricing information, 
including information regarding resales of interests and actual prices 
paid for interests; a description of the business of the partnership; 
financial and reporting information from the partnership's financial 
statements and reports; and information regarding material events 
involving the partnership, including special distributions, capital 
distributions, and refinancings or sales of significant portions of 
partnership assets;
    (ii) The operator may assist with the transfer documentation 
necessary to transfer the partnership interest;
    (iii) The operator may receive and deliver funds for completed 
transactions; and
    (iv) The operator's fee may consist of a flat fee for use of the 
service, a fee based on completed transactions, or any combination 
thereof.
    (g) Private placements--(1) In general. For purposes of section 
7704(b) and this section, interests in a partnership are not readily 
tradable on the substantial equivalent of a secondary market if--
    (i) All interests in the partnership were issued in a transaction 
(or transactions) that was not required to be registered under the 
Securities Act of 1933;
    (ii) Either--
    (A) The partnership does not have more than 500 partners at any 
time during the taxable year of the partnership; or
    (B) The initial offering price of each unit of partnership interest 
is at least $20,000 and the partnership agreement provides that no unit 
of partnership interest may be subdivided for resale into units smaller 
than a unit the initial offering price of which would have been at 
least $20,000; and
    (iii) If the partnership has more than 50 partners at any time 
during the taxable year of the partnership, the sum of the percentage 
interests in partnership capital or profits transferred during the 
taxable year of the partnership (other than in private transfers 
described in paragraph (d) of this section) does not exceed 10 percent 
of the total interests in partnership capital or profits.
    (2) Number of partners. For purposes of determining the number of 
partners under paragraph (g)(1) of this section--
    (i) Each person indirectly owning an interest in the partnership 
through another partnership, a grantor trust, or an S corporation (but 
not through a regulated investment company, as defined in section 851, 
or a real estate investment trust, as defined in section 865) is 
treated as a partner; and
    (ii) Partnerships are aggregated when they jointly operate one or 
more businesses, or the operations of the partnerships are 
interrelated, and a principal purpose for the use of multiple 
partnerships is to permit any of the partnerships to qualify for the 
rule provided under this paragraph (g).
    (h) Lack of actual trading--(1) General rule. For purposes of 
section 7704(b) and this section, interests in a partnership are not 
readily tradable on the substantial equivalent of a secondary market if 
the sum of the percentage interests in partnership capital or profits 
transferred during the taxable year of the partnership (other than in 
transfers described in paragraph (d), (e), or (f) of this section) does 
not exceed 2 percent of the total interests in partnership capital or 
profits.

    (2) Examples. The following examples illustrate the rules of 
this paragraph (h).
    Example 1. Calculation of percentage interest transferred. (i) 
ABC, a calendar year limited partnership formed in 1995, has 9,000 
units of limited partnership interests outstanding at all times 
during 1996, representing in the aggregate 95 percent of the total 
interests in capital and profits of ABC.
    (ii) During 1996, the following transactions occur with respect 
to the units of ABC's limited partnership interests--
    (A) 800 units are sold through the use of a qualified matching 
service that meets the requirements of paragraph (f) of this 
section;
    (B) 50 units are sold through the use of a matching service that 
does not meet the requirements of paragraph (f) of this section; and
    (C) 500 units are transferred as a result of private transfers 
described in paragraph (d) of this section.
    (iii) The private transfers of 500 units and the sale of 800 
units through a qualified matching service are disregarded under 
paragraph (h)(1) of this section for purposes of applying the 2 
percent rule. As a result, the total percentage interests in 
partnership capital and profits transferred for purposes of the 2 
percent rule is .528 percent, determined by--
    (A) Dividing the number of units sold through a matching service 
that did not meet the requirements of paragraph (f) of this section 
(50) by the total number of outstanding limited partnership units 
(9,000); and
    (B) Multiplying the result by the percentage of total interests 
represented by limited partnership units (95 percent) ([50/9,000] x 
.95 = .528 percent).
    Example 2. Application of the 2 percent rule. (i) ABC operates a 
service consisting of computerized video display screens on which 
subscribers view and publish quotes that do not commit any person to 
buy or sell a partnership interest and quotes that express interest 
in a partnership interest without an accompanying price. The ABC 
service does not provide two-sided quotes or quotes at which any 
person (including the operator of the service) is committed to buy 
or sell a partnership interest. Subscribers are limited to broker-
dealers registered with the National Association of Securities 
Dealers.
    (ii) The ABC service is not an established securities market for 
purposes of section 7704(b)(1) and this section because the service 
does not satisfy any of the definitions of an established securities 
market in paragraph (b) of this section. The ABC service also is not 
a secondary market because the service does not provide two-sided 
quotes or quotes at which any person (including the operator of the 
service) is committed to buy or sell a partnership interest. 
Therefore, partnerships whose interests are listed and transferred 
on the ABC service are not publicly traded for purposes of section 
7704(b) and this section as a result of such listing or transfers if 
the sum of the percentage interests in partnership capital or 
profits transferred during the taxable year of the partnership 
(other than in transfers described in paragraph (d), (e), or (f)) 
does not exceed 2 percent of the total interests in partnership 
capital or profits. In addition, assuming the ABC service complies 
with the necessary requirements, the service may qualify as a 
matching service described in paragraph (f) of this section.
    Example 3. Effect of firm quotes. Assume the same facts as in 
Example 2, except that, in addition to operating the matching 
service, ABC regularly quotes prices at which it stands ready to buy 
interests in certain partnerships listed on the service. As a result 
of the regular quotes, interests in the quoted partnerships are 
readily tradable on a secondary market under paragraph (c)(2) of 
this section. The quoted partnerships are therefore publicly traded 
partnerships for purposes of section 7704 and this section, 
regardless of whether the sum of the percentage interests in 
partnership capital or profits transferred during the taxable year 
of the partnership exceeds 2 percent of the total interests in 
partnership capital or profits.

    (i) [Reserved].
    (j) Percentage interests in partnership capital or profits--(1) 
Interests considered--(i) General rule. Except as otherwise provided in 
this paragraph (j), for purposes of this section, the total interests 
in partnership capital or profits are determined by reference to all 
outstanding interests in the partnership.
    (ii) Exceptions--(A) General partner with greater than 10 percent 
interest. If [[Page 21482]] the general partners and any person related 
to the general partners (within the meaning of section 267(b) or 
section 707(b)(1)) own, in the aggregate, more than 10 percent of the 
outstanding interests in partnership capital or profits at any one time 
during the taxable year of the partnership, the total interests in 
partnership capital or profits are determined without reference to the 
interests owned by such persons.
    (B) Derivative interests. Any partnership interests described in 
paragraph (a)(2)(ii) of this section are taken into account for 
purposes of determining the total interest in partnership capital or 
profits only as and to the extent that the transfer of the interest is 
taken into account under paragraph (a)(4) of this section.
    (2) Monthly determination. For purposes of this section, except in 
the case of block transfers (as defined in paragraph (d)(2) of this 
section), the percentage interests in partnership capital or profits 
represented by partnership interests that are transferred during a 
taxable year of the partnership is equal to the sum of the percentage 
interests transferred for each calendar month during the taxable year 
of the partnership in which a transfer of a partnership interest occurs 
(other than a private transfer as described in paragraph (d) of this 
section). The percentage interests in capital or profits of interests 
transferred during a calendar month is determined by reference to the 
partnership interests outstanding during that month.
    (3) Monthly conventions. For purposes of paragraph (j)(2) of this 
section, a partnership may use any reasonable convention in determining 
the interests outstanding for a month, provided the convention is 
consistently used by the partnership from month to month during a 
taxable year and from year to year. Reasonable conventions include, but 
are not limited to, a determination by reference to the interests 
outstanding at the beginning of the month, on the 15th day of the 
month, or at the end of the month.
    (4) Block transfers. For purposes of paragraph (d)(2) of this 
section (defining block transfers), the partnership must determine the 
percentage interests in capital or profits for each transfer of an 
interest during the 30 calendar day period by reference to the 
partnership interests outstanding immediately prior to such transfer.
    (5) Example. The following example illustrates the rules of this 
paragraph (j).

    Example. Conventions. (i) ABC limited partnership, a calendar 
year partnership formed in 1995, has 1,000 units of limited 
partnership interests outstanding on January 1, 1996, representing 
in the aggregate 95 percent of the total interests in capital and 
profits of ABC. The remaining 5 percent is held by the general 
partner.
    (ii) The following transfers take place during 1996--
    (A) On January 15, 10 units of limited partnership interests are 
sold in a transaction that is not a private transfer;
    (B) On July 10, 1,000 additional units of limited partnership 
interests are issued by the partnership (the general partner's 
percentage interest is unchanged); and
    (C) On July 20, 15 units of limited partnership interests are 
sold in a transaction that is not a private transfer.
    (iii) For purposes of determining the sum of the percentage 
interests in partnership capital or profits transferred, ABC chooses 
to use the end of the month convention. The percentage interests in 
partnership capital and profits transferred during January is .95 
percent, determined by dividing the number of transferred units (10) 
by the total number of limited partnership units (1,000) and 
multiplying the result by the percentage of total interests 
represented by limited partnership units ([10/1,000] x .95). The 
percentage interests in partnership capital and profits transferred 
during July is .7125 percent ([15/2,000] x .95). ABC is not required 
to make determinations for the other months during the year because 
no transfers of partnership interests occurred during such months. 
ABC may qualify for the 2 percent rule for its 1996 taxable year 
because less than 2 percent (.95 percent+.7125 percent=1.6625 
percent) of its total interests in partnership capital and profits 
was transferred during that year.
    (iv) If ABC had chosen to use the beginning of the month 
convention, the interests in capital or profits sold during July 
would have been 1.425 percent [(15/1,000] x .95) and ABC would not 
have satisfied the 2 percent rule for its 1996 taxable year because 
2.375 percent (.95+1.425) of ABC's interests in partnership capital 
and profits was transferred during that year.

    (k) Effective date. This section applies for taxable years of a 
partnership beginning on or after the date final regulations are 
published in the Federal Register.
Margaret Milner Richardson,
Commissioner of Internal Revenue.

[FR Doc. 95-10765 Filed 5-1-95; 8:45 am]
BILLING CODE 4830-01-U