Rev. Rul. 68-48

The Internal Revenue Service has been asked to discuss the procedural and substantive responsibilities which fall upon the trustee in bankruptcy of a bankrupt partnership.

The first question in this area is the nature of the entity created by bankruptcy and the kind of return the trustee should file.

This question was considered under the Internal Revenue Code of 1939 in G.C.M. 24617, C.B. 1945, 235. G.C.M. 24617 held that income of a bankrupt partnership's estate, like that of a bankrupt individual's estate, should be taxed as income of an estate under section 161 of the Internal Revenue Code of 1939 (predecessor of section 641 of the Internal Revenue Code of 1954) and the returns of such estates should be made on Form 1041 (U.S. Fiduciary Income Tax Return). The basis for this conclusion is that the intervention of the status of bankruptcy into the affairs of both an individual and a partnership creates an entity separate and apart from the individual or partnership bankrupt. See In re Loehr , 98 F.Supp. 402 (1950). The foregoing is equally applicable under section 641 of the 1954 Code.

The second question often raised in cases of bankrupt partnerships is whether net ordinary income and net capital gain of the bankrupt estate are taxable to the estate or to the individual partners.

In this situation, both ordinary and capital gain income are taxable to the estate of the bankrupt partnership. See In re Loehr , above; In re Mid America Co. , 31 F.Supp. 601, 606 (1939); and State of Missouri v. Harry S. Gleick , 135 F.2d 134, 137 (1943). Cases which appear to hold otherwise have involved receivers who held only part of the bankrupt's property, rather than trustees in bankruptcy. See, in this connection, In re Lister , 177 F.Supp. 372 (1959); M. G. Stoller , et ux. v. United States , 320 F.2d 340 (1963); and Selma Heasley v. Commissioner , 45 T.C. 448 (1966). As noted in G.C.M. 24617, above, a receiver, although somewhat similar in function, is not identical to a trustee in bankruptcy for Federal income tax purposes.

The third question concerns the deductibility of certain expenses incurred by the trustee in bankruptcy of the bankrupt partnership estate.

Where the trustee does not operate the partnership business, compensation of attorneys and accountants retained by the trustee are deductible expenses of the estate under section 212 of the Code. These expenses are deductible if, and to the extent that, they are paid for services rendered for the production or collection of income, for the management, conservation, or maintenance of property held for the production of income, or in connection with the determination, collection, or refund of any tax for the estate in bankruptcy. For example, the trustee may deduct the usual costs of administration, including the referee's compensation, statutory compensation for the trustee and for the bankrupt's attorney, the trustee's bond premium, and charges of court reporting and transcripts. Filing costs originally paid by petitioning creditors and compensation for the attorneys of petitioning creditors may be deducted by the trustee to the extent the estate is able to reimburse the creditors for these expenses, because the estate is statutorily liable to reimburse creditors wherever its assets are sufficient to allow it to do so.

The fourth question frequently raised concerns the tax treatment of the gain or loss on sale or exchange, the bases, and the holding periods, of various assets held by the trustee in bankruptcy.

The tax treatment of the gain or loss on the sale or exchange of each asset depends upon the nature of the asset in the hands of the bankrupt. For example, if the bankrupt held certain assets for sale to customers in the ordinary course of business, the sale of these assets by the trustee would give rise to ordinary income or loss. Conversely, the sale of assets which were capital assets in the bankrupt's hands would generate capital gain or loss income when sold by the trustee in bankruptcy.

A trustee in bankruptcy must use the bankrupt's adjusted basis when computing gain or loss on the sale of assets for the benefit of the estate in bankruptcy. Accordingly, the trustee in bankruptcy must use the same adjusted basis in computing gain or loss as the bankrupt partnership would have had to use had it sold or exchanged its assets. See In re Loehr , above. Section 1012 of the Code states the general rule that the basis of property shall be its cost, except as otherwise provided.

Section 1223(2) of the Code provides that in determining the period for which a taxpayer has held property, however acquired, there shall be included the period for which the property was held by any other person, if the property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in his hands as it would have in the hands of the other person. Similarly, since the trustee in bankruptcy takes a carry-over basis from the bankrupt, the holding period of the trustee includes the period the bankrupt held the asset.

The fifth question raised is whether the estate in bankruptcy may take a deduction for distributions of income, in excess of expenses, to its creditors under either section 651 or 661 of the Code.

Section 651 of the Code provides for a deduction in the case of trusts distributing current income only. Section 1.651(a)-5 of the Income Tax Regulations provides that section 651 of the Code has no application to an estate. As held in reply to the first question above, the trustee in bankruptcy is taxed as an estate, rather than as a trust. Accordingly, the trustee may take no deductions under section 651 of the Code for the amount by which the estate's income exceeds its expenses, which amount is distributed to creditors of the estate.

Section 661 of the Code provides a deduction for estates and trusts which may accumulate income or distribute corpus. Section 1.661(a)-2 of the regulations limits the deductions allowable under section 661 of the Code to certain distributions to `beneficiaries' of the estate. The term `beneficiary,' for purposes of part I, subchapter J, of the Code, is defined in section 643(c) of the Code to include heirs, legatees and devisees of an estate. Creditors of the estate do not fall within this definition. Therefore, amounts received by the bankrupt's estate which are includible in its income are not deductible under section 661 of the Code when distributed to creditors. See Trust Estate of Thomas Lonergan v. Commissioner , 6 T.C. 715, 719 (1946).

Section 641(b) of the Code provides in part that the taxable income of an estate shall be computed in the same manner as in the case of an individual, except as otherwise provided in subchapter J. Exceptions to the general rule, exclusive of subpart E, appear in sections 651 and 661 of the Code. As stated above, neither section is applicable in the case of an estate in bankruptcy. Accordingly, such deductions as are allowable to the trustee in bankruptcy are those allowable under section 641(b) of the Code.

The sixth and final question most frequently raised in this area concerns the applicability of the concept of `distributable net income' in relation to the treatment of net capital gains by an estate in bankruptcy.

Under section 643 of the Code, as implemented by section 1.643 (a)-0 of the regulations, the term `distributable net income' has no application except in the taxation of estates and trusts and their beneficiaries. It limits the deductions allowable to estates and trusts for amounts paid, credited, or required to be distributed , and is used to determine how much of an amount paid, credited, or required to be distributed, to a beneficiary will be includible in his gross income. Since it has been concluded that there are no income beneficiaries or remaindermen concerned with the administration of a bankrupt partnership, the concept of distributable net income is not applicable. Accordingly, net capital gains of an estate in bankruptcy are includible in its gross income in the manner and to the extent provided by section 641(b) of the Code and other provisions of the Code made applicable to estates by that section.