## Facts

- Three brothers (Edward, William, and Jack Pratt) and their spouses were petitioners; their cases were consolidated.
- The brothers formed two limited partnerships to develop and operate shopping centers; they served as general partners managing the partnerships under partnership agreements.
- The partnerships used the accrual method; the Pratts reported individual income on the cash method.
- The partnership agreements provided “management fees” to the general partners calculated as a percentage of rental proceeds.
- For tax years 1967–1969, the partnerships accrued and deducted the management fees but did not pay them; the Pratts did not report the unpaid amounts as income.
- The Pratts also loaned money to the partnerships; the partnerships accrued and deducted interest on the loans but did not pay it; the Pratts did not report the unpaid interest as income.
- The Commissioner determined deficiencies, challenging the partnerships’ deductions and the timing/character of income to the Pratts.

## Issues

1. Whether management fees calculated as a percentage of partnership rental income and accrued (but unpaid) were “guaranteed payments” under I.R.C. § 707(c), deductible by the partnerships and includible by the Pratts when accrued despite their cash method.
2. Whether accrued (but unpaid) interest on partner loans was a “guaranteed payment” under I.R.C. § 707(c), deductible by the partnerships and includible by the Pratts when accrued despite their cash method.

## Decision

- The Tax Court held the management fees were not § 707(c) guaranteed payments because they were determined by reference to partnership income; they were treated as part of the partners’ distributive shares and not separately deductible as guaranteed payments.
- The Tax Court held the interest on the partner loans was a § 707(c) guaranteed payment for the use of capital because it was determined without regard to partnership income.
- The partnerships could deduct the interest when accrued, and the Pratts had to include the interest in income in the year the partnerships accrued and deducted it, notwithstanding nonpayment and the Pratts’ cash method.
- The Commissioner was sustained in part and rejected in part, with adjustments consistent with these characterizations for 1967–1969.

## Legal Principles

- A payment to a partner is a § 707(c) guaranteed payment only if it is determined without regard to partnership income.
- Amounts computed as a percentage of partnership income (including rental proceeds) are not § 707(c) guaranteed payments; they are treated as allocations of distributive share under Subchapter K.
- Interest paid to a partner for the use of capital may constitute a § 707(c) guaranteed payment when it is not contingent on partnership income.
- For § 707(c) guaranteed payments, the partner’s income inclusion aligns with the partnership’s deduction year (via §§ 707(c) and 706), even if the partner uses the cash method and does not receive payment in that year.

## Conclusion

Management fees contingent on partnership income were treated as distributive shares rather than deductible guaranteed payments, while partner-loan interest qualified as a guaranteed payment, producing an accrual-year deduction to the partnership and accrual-year income to the partner.


Pratt v. Commissioner, 64 T.C. 203 (1975)