As part of the Internal Revenue Code of 1954 Congress enacted section 736. This section specifies the tax treatment of the various types of payments that a partnership may make to a withdrawing partner. It introduced the concept of a liquidation of a partnership interest by the partnership itself, as opposed to the sale of that interest to an outsider or to the continuing partners. In some instances it provides tax consequences for continuing and withdrawing partners which are different from those attendant to a sale. It was designed to make the law concerning disposition of partnership interests simpler and to provide flexibility to the parties in fixing the federal tax consequences thereof.
After over thirty-year's experience with section 736 it is time to acknowledge that it has not worked very well. The creation of the concept of a "liquidation" of a partnership interest, with consequences that differ from those of a sale, has not simplified the tax law in this area; it has complicated it unnecessarily. Further, while section 736 has provided flexibility to the parties to withdrawals from partnerships, this flexibility has been purchased at the expense of significant federal taxation policy. This Article examines those two propositions and advocates abrogating section 736 and the disparity it created between the tax attributes accompanying liquidations and sales of partnership interests. It proposes that all withdrawals from a partnership, whether accomplished by a sale to outsiders or to the continuing partners on one hand, or by liquidation of the interest by the partnership on the other, be treated similarly for tax purposes.
Taxation of the Disposition of Partnership Issues: Time to Repeal I.R.C. Section 736, 65 Neb. L. Rev. 450 (1986)