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Partnership Preferred Returns: Identifying Capital Shifts and Recharacterization Risks

Recording of a 110-minute CPE webinar with Q&A

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Conducted on Thursday, December 12, 2019

Recorded event now available

or call 1-800-926-7926

This course will provide partnership advisers and tax professionals with a thorough guide to the allocation and reporting challenges of partnerships with preferred return provisions in their operating agreements. The panel will discuss the tax risks to individual partners with preferred returns, describe the tax consequences of guaranteed payment treatment and capital shifts, and provide planning tools on how to navigate preferred returns in the absence of definitive IRS guidance.


The most critical task for tax counsel drafting partnership agreements is ensuring that the allocations in the operating documents reflect the partners' business intent while complying with IRS regulations. Target allocation provisions, which are increasingly popular in partnership agreements, present many issues. One of these issues is the risk that partnership preferred returns may be recharacterized as guaranteed payments or may require recognition of income without an associated partnership distribution. The guidance from the IRS is unclear as to the character and timing of including preferred returns as taxable income.

In partnership agreements where preferred returns are accrued but unpaid, there can be an implied shift of capital from subordinated partners to the partners entitled to the preferred return. The preferred partners may be required to recognize ordinary income with respect to the implied capital shift, which can generate a costly and often unforeseen current year tax. Because preferred returns are favored in certain types of partnerships, many partnership agreements contain allocations involving preferred returns that can create an unrecognized tax risk. Proper planning and drafting may mitigate the potential dangers of IRS challenges to the intended character and timing of income associated with preferred returns.

Listen as our experienced panel provides a thorough and practical guide to meeting the planning and reporting challenges involved in partnership agreements with preferred returns.



  1. Target allocations and preferred returns
  2. Risk of preferred returns being characterized as guaranteed payments
  3. Capital account liquidation analysis and capital shifts
  4. Tools to protect the intended tax treatment of preferred returns


The panel will discuss these and other important issues:

  • The risks of having a preferred interest recharacterized as a guaranteed payment
  • Current year tax consequences of noncompensatory capital shifts
  • Determining whether a capital shift has occurred under the capital account liquidation rules


Mandarino, Joseph
Joseph C. Mandarino

Smith Gambrell & Russell

Mr. Mandarino's practice focuses on corporate, tax and finance law. He is involved with a wide variety of...  |  Read More

Moorefield, Crawford
Crawford Moorefield

Clark Hill

Mr. Moorefield provides counsel with regard to federal income taxation and structuring complex business transactions...  |  Read More

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