BUSINESS - PARTNERSHIPS Flashcards
Who pays taxes in a Partnership?
The partnership does not pay income taxes.
The income of the partnership flows to the individual partners and the individual partners pay taxes on it.
Partnership Tax Year
Partnership tax year is the same as the partner’s who own a majority.
If no majority owners have same tax year, look at the principal partners (owning more than 5%).
A partnership can select a tax year that is different from what is required, but only if the selected tax year is no more than three months different from the tax year that should be used.
Partnership Accounting Decisions
Most major tax accounting decisions will be made at the partnership level.
Depreciation Method
How to account for Inventory
Etc
Organization and Syndication Costs
Organization costs are those costs to actually establish the existence of the partnership.
Attorney’s Fees
Filing Costs
Etc
Up to $5,000 of organization costs may be deducted in the year incurred (this deduction is phased out by $1 for each $1 of organizational costs in excess of $50,000).
Any remaining organizational costs must be capitalized and amortized over 15 years (180 months).
Syndication costs are those costs associated with selling the partnership interests to partners.
These are not deductible for federal income tax purposes at all.
Filing Partnership Return
The partnership tax return is due by the 15th day of the 3rd month following the date its tax year ended.
The tax return (Form 1065) is an information return only.
Schedule K is attached to the partnership return and on Schedule K will be the summary of how the partnership reports its taxable items of income, deduction, credit, etc.
Schedule K is then divided into “baby” schedules known as K-1s.
Partnership Income
This income flows through to the Partners, who pay taxes on their individual Tax Returns.
However, not all income flows together to the partners.
Partnership Income - Separately Stated Items
These are separately stated because the treatment of these items may be different based on the individual tax situations of each of the individual Partners.
They are:
1. Long-term and short-term capital gains and losses
- Charitable contributions
- Dividends, interest (including tax-exempt) and royalty income
- Section 179 deductions (accelerated depreciation)
- Passive losses from rental activities
- Section 1231 gains and losses
- Unrecaptured Section 1250 gains and losses
- Foreign taxes paid
- Interest expense on investment indebtedness
- Tax-exempt income.
Sharing Distributable Income/Items
Income shared as per partnership agreement.
If agreement is silent, gains shared equally.
Losses can be shared in any way – and differently than income.
If partnership agreement is silent, then shared as gains are shared.
Guaranteed Payments
A payment that is made to a partner that is not dependent upon the profit or loss or results of the partnership.
Guaranteed payments are like a salary and are treated differently from a distribution of partnership income.
Guaranteed payments are generally deductible by the partnership in the calculation of ordinary partnership taxable income.
Classified as Self-Employment income on the partner’s personal return.
Initial Basis of a Partner
The initial basis that the partner will have and the how it will be recorded depends on what the partner contributed to the partnership in return for their partnership share.
The basis is usually valued at what was contributed.
Partner’s Contributions to the Partnership
Contribution of services
Contribution of property
Contribution of services and property
Assumption of partnership liabilities
Contribution of Services
When services are contributed for a partnership interest, the contributing partner must recognize ordinary income equal to the fair market value of the partnership interest minus any cash that was also paid for the interest (if any).
The new partner’s interest will be recorded as a portion the FMV of the partnership.
So, if the FMV of the Partnership is $60K and the Partner is given 25% capital interest, his compensation will be $15K. ($60K x 25% = $15K).
Admitting A New Partner
A new partner can only be admitted with the unanimous consent of all partners.
Any new partner can only be held liable for the future debts of the partnership not in existence at the time of his/her inclusion in the partnership.
Withdrawal of a Partner
When a partner withdraws or leaves the partnership, there may be an agreement by which the partnership will not hold the departing partner liable for any past, present or future liabilities of the partnership.
Thought the Partnership agrees not to hold the Partner liable, this does NOT mean the creditors aren’t allowed to go after the departed partner.
Dissolution of Partnership
If there is a specified term, it is dissolved at the end of the term.
If no specified term, there are different ways it can be dissolved.
Dissolution of Partnership-At-Will
If a partnership agreement is silent as to duration of partnership, then the partnership is “at-will” and any of the partners can terminate at any time without incurring liability.
Rightful / Wrongful Dissolution
The partnership agreement determines if it is Rightful Dissolution or not.
Rightful Dissolution – If the departure does not violate any terms of the partnership agreement. The departing partner incurs no additional liability as a result of departure.
Wrongful Dissolution – If, by leaving, the partner violates the partnership agreement, then he or she is liable to the other partners for any resulting damages that result from their departure.
Dissolution by Operation of Law
Any of the partners die
The partnership or any individual partner is adjudicated bankrupt, or
There is subsequent illegality regarding the subject matter or composition of the partnership. (e.g. It was legal when we started, but no longer)
Dissolution Through Court Order
A court may order the dissolution of a partnership under equity.
Since it was court ordered, there is no liability for partners.
Notification of Dissolution
A dissolved partnership, unless it dissolved as an operation of law, notify all third parties with whom the partners have dealt in order to sever the apparent authority of the partners or other agents.
Winding Up the Partnership
After dissolution, a partnership continues in existence long enough to settle all outstanding debts and complete unfinished transactions. This is called the winding up process.
Distribution of Partnership Assets
MARSHALLING OF ASSETS RULE - Partnership creditors have first claim on partnership assets before proceeding against an individual partner’s personal assets.
Claims of general creditors. Creditors are paid FIRST.
Debts owed to individual partners through items as a loan to the partnership.
Any remaining sums are distributed based on the final capital balances of the partners’ contributions.
Any payments to partners in respect to profits.
Continuation of Partnership
An existing partnership shall be considered as continuing if it is not terminated.
A Partnership is considered Terminated only if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners.
Sale of Partnership Interest
When a partner sells his partnership interest, they may have a capital gain or loss or an ordinary gain.
Cold Assets and Hot Assets
Capital assets are called cold assets.
The sale of cold assets leads to a capital gain or loss.
Unrealized receivables and substantially appreciated inventory are hot assets.
The sale of hot assets leads to an ordinary gain or loss.