Question

When a partner performs services to a partnership in return for an immediate receipt of a capital interest where the capital interest is not immediately vested but is contingent until three years of services are performed:
a- The partner must include the fair market value of the capital interest as income in the year the capital interest is received
b- The partner can elect pursuant to IRC section 83(b) to report the future value of the capital interest as ordinary income in the year the interest is received.
c- The partner can elect pursuant to IRC section 83(b) to report the current value of the capital interest as capital gain in the year the interest is received.
d- The partner can elect pursuant to IRC section 83(b) to report the current value of the capital interest as ordinary income in the year the interest is received.
e- None of the above

Answer 1

Answer: a- The partner must include the fair market value of the capital interest as income in the year the capital interest is received.

As per IRC Section 83

The following discussion helps in understanding the rules that currently govern the receipt of a partnership interest in exchange for services. In the given question partner receiving interest in exchange for services to be performed for a period of three years.

The issue of value is always important when Sec. 83 applies to a transfer of property—including a partnership interest transfer to a service partner. Indeed, the problem of valuation is especially tricky when the property is a partnership interest.

Valuing Capital Interests

If the transferred partnership interest is a capital interest, the liquidation value is often assumed to establish the interest's fair market value (FMV). While this is certainly a convenient rule of thumb and may often establish an appropriate value consistent with the overall tax treatment of the transaction.

The time at which the interest is valued may be an issue. In Johnston, T.C. Memo. 1995-140, the Tax Court found that the taxpayer (the general partner in a limited partnership) had to recognize taxable income when he received a 1% interest in partnership capital.

Accordingly as per the above explanation, capital interest needs to be recorded at fair market value as income in the year in which it is received.

Hope the question has been properly clarified