Revenue Ruling 77-137: Asset Protection and Partnership Agreements

Revenue Ruling 77-137, issued by the IRS in 1977, holds significant implications for individuals holding limited partnership interests, particularly concerning asset protection. The ruling addresses the tax responsibilities of an assignee who acquires substantially all of the dominion and control over a limited partnership interest, effectively treating them as a substituted limited partner for tax purposes. This article explores the rule’s impact, the importance of incorporating its language into partnership agreements, and how pairing this with a Bridge Trust can enhance asset protection.

Understanding Revenue Ruling 77-137
Revenue Ruling 77-137 establishes that when an assignee of a limited partnership interest acquires substantially all of the dominion and control, they become responsible for the partnership’s income, gains, losses, deductions, and credits, regardless of whether they receive actual distributions. This classification hinges on whether the assignee’s rights resemble those of a limited partner, including voting and management rights.

Impact on Charging Orders
One of the key applications of this ruling arises when a creditor obtains a charging order against a debtor’s partnership interest. A charging order allows the creditor to receive any distributions due to the debtor but does not confer voting or management rights. Consequently, under Rev. Rul. 77-137, the creditor is not deemed to have substantial dominion and control, leaving the debtor-partner liable for taxes on the income attributed to their partnership share.

However, if a creditor forecloses on the interest and gains full rights, they may be considered to hold substantial control and, thus, tax liability. This distinction underscores the importance of clearly delineating the rights associated with partnership interests within the partnership agreement.

The Role of Partnership Agreements
To fully leverage the protective aspects of Rev. Rul. 77-137, it is crucial for partnership agreements to explicitly include language consistent with the ruling. By stating that an assignee must possess substantial control and rights equivalent to those of a limited partner to assume tax liability, the agreement helps reinforce the separation between ownership and control. This strategic drafting not only aids in maintaining the original partner’s tax obligations but also serves as a deterrent to creditors seeking to assume such interests through charging orders.

Bridge Trust Pairing for Enhanced Protection
The Bridge Trust is an advanced asset protection tool that combines elements of domestic and offshore trusts. When combined with a well-drafted partnership agreement reflecting Rev. Rul. 77-137, it offers a formidable layer of protection. The partnership agreement language ensures that control does not automatically pass to a creditor, while the Bridge Trust acts as a robust safeguard by shifting the jurisdiction of assets if needed. This combination minimizes the risk of creditor control and maintains tax obligations with the original partner.

Lodmell & Lodmell, PC is one of the nations leading Asset Protection Law Firms and the creators of The Bridge Trust®.  L&L serves clients nationwide and may be reached at [e-mail] or 602-230-2014.