Ch 9 Part 2 Flashcards
Contribution to partnership: 3 exceptions for when recognition of gain loss or income is taxable for property
1 liabilities assumed by partnership exceed partner’s
predistribution basis
2 partnership formed is investment partnership
3 contribution followed by distribution is treated as sale
Contribution to Partnership - recognition of gain, loss or income by partner: property
Usually nontaxable
Contribution to partnership - recognition of gain, loss or income of partner: services
Taxable to partner
Equal to FMV of partnership interest received in exchange for
Services
Contribution to partnership - basis of partnership interest: property basis equation
Basis of partnership interest for contributed property =
Substituted basis from contributed property
+ share of partnership liabilities assumed
- partner’s liabilities assumed by partnership
+ (gain recognized if investment company)
Contribution to partnership - basis of partnership interest for services equation
Basis of partnership interest for services =
Amount of income recognized
+ share of partnership liabilities assumed by partner
- partner’s liabilities assumed by partnership
Contribution to partnership - gain or loss recognized by partnership for property
No gain or loss recognized by partnership
Contribution to partnership - gain or loss recognized by partnership for services 2 things
1 deduction or capitalized expense is created depending on
Type of service rendered
2 gain or loss recognized equals difference between FMV of
Portion of assets used to pay service partner and basis of
Portion of assets
Contribution to a partnership - basis of assets to the partnership for property: 3 things (basis in formation, assumption of partner’s liabilities, sale transaction)
Carryover basis used, only increased by partner’s gain
Recognized if gain results from formation of investment company
No basis adjustment when assumption of partner’s liabilities
Results in partner’s gain recognition
In sale transaction assets take cost basis
Contribution to partnership - basis of assets to the partnership for services
Increased or decreased to reflect FMV of assets paid to the
Service partner
Majority partners define, what does section 706 restrict
Have aggregate interest in partnership profits and capital
Exceeding 50%
Sec. 706: Partnership must have same tax year as one or more
Majority partner
Principal partner define, section 706 restriction
Partner who owns 5% or more interest in capital or profits
Sec. 706: partnership must use tax year concurrent with principal
Partners, if they don’t share tax year, must use tax year with least
Aggregate tax deferral of months
If a partnership has a business purpose for using some tax year other than year prescribed in rules…
The IRS must approve use of another tax year beacause
Acceptable business purpose
Section 444 provides an election that permits a partnership to…
Use year end results in a deferral of lesser of current deferral
Period or 3 months
Deferral period sec. 444
Time from beginning of partnership’s fiscal year to close of
First required tax year ending December 31
Section 444 election is available to both…
New partnerships making initial tax year election or existing
Partnerships that are changing tax years
When is sec. 444 election not needed?
When partnership satisfies sec. 706 requirements or
Has an established business purpose
Mandatory required payment from making section 444’election
Required payment assesses tax on partnership’s deferred income
At highest individual marginal tax rate + 1%
What does section 703 require a partnership to do?
Requires partnership make all elections that can affect computation
Of taxable income derived from partnership
3 elections reserved to individual partners that relate to income
1 discharge of indebtedness
2 deduction and recapture of certain mining exploration
expenditures
3 deducting or crediting foreign income taxes
3 elections partnership makes at entity level
1 accounting method
2 inventory method
3 depreciation method
Section 706 requires that a partnership select the highest ranked tax year end from ranking the following 3 items
1 tax year end used by partners who own majority interest in
Partnership capital and profits
2 tax year end used by all principal partners
3 tax year end determined by least aggregate deferral test
The IRS may grant permission for the partnership to use a fiscal year end if the partnership has a natural business year. If the partnership doesn’t have natural business year, it must either… 2 things
1 use tax yearned required by sec. 706
Or
2 elect fiscal year end under sec. 444 and make required payment
Required payment under Sec. 444
Approximates tax due on deferred income
Why does that IRC require a partnership to calculate partnership taxable income even though a partnership is not a taxable entity?
In order to adjust partners’ basis in their partnership interest
Partnership taxable income is calculated similarly to taxable income for individuals, what are some differences? 2
1 taxable income divided into separately stated items and ordinary
Income or loss
2 section 703 specifies list of deductions available to individuals
That can’t be claimed by partnership
What are 4 forbidden deductions to partnerships .
1 taxes paid/accrued to foreign country or US possession
2 charitable contributions
3 oil and gas depletion
4 NOL carry backs and carry forwards
3 separately stated items for partnerships?
1 taxes paid/accrued to foreign country or US possession
2 charitable contributions
3 oil and gas depletion
When are NOLs used
Used at partner level without any regard to partnership entity
10 common separately stated items
1 net ST and LT capital gains/losses 2 Sec. 1231 gains/losses 3 Unrecaptured sec. 1250 gains 4 sec. 179 expense 5 charitable contributions 6 dividends and interest income 7 taxes paid or accrued to foreign country or US possession 8 tax exempt/partial tax exempt interest 9 investment income and expenses 10 any items subject to special allocations
As a general rule, an item must be separately stated if The income tax liability of any partner that would result from Treating item separately is…
different from liability that would result if item were included in
Partnership ordinary income
Once partnership separately states each item and allocates distributive share to each partners, the partners report separately stated items on their tax returns as…
If the partnership entity did not exist
Partnership ordinary income or loss
All taxable items of income, gain, loss or deduction that don’t have
To be separately stated and are combined into total
Partnership taxable income equation
Partnership taxable income =
separately stated items + partnership ordinary income or loss
4 common items included in determining partnership’s ordinary income
1 gross profit on sales
2 administrative expenses
3 employee salaries
4 sec. 1245 depreciation recapture
Where is partnership ordinary income allocated and reported in a partnership tax return?
Corporate tax return?
Partnership: schedules K and K-1 form 1065
Corporate partner: other income category Form 1120
Where does an individual partner report his or her share of ordinary income or deductible distribution share of ordinary loss?
Schedule E form 1040
Partner’s distributive share
Portion of partnership taxable and nontaxable income that
Partner has agreed to report for other tax purposes
A partnership agreement may describe either…
1 a partner’s distributive share by indicating partner’s profits
And loss interest
Or
2 it may indicate separate profits and loss interests
If a partner has a 20% profits interest and 30% loss interest, when is the loss interest calculated?
A partner’s loss percentage is only used in years when the
Partnership has a net loss
Varying interest rule
If partnership’s ownership interest changes during partnership
Tax year, the income or loss allocation takes into account
Partner’s varying interest
Calculations applied on pro rata basis
What do special allocations allow?
Flexibility in sharing specific items of income or loss among
Partners
2 categories of special allocations
1 Sec 704 requires certain special allocations with respect to
Contributed property
2 special allocations that meet tests in Treasury Regulations
For having substantial economic benefit
Section 704 requires precontribution gains or losses to be…
Allocated to contributing partner
The allocation of depreciation is another common example of…
The special deduction allocation related to contributed property
under Sec. 704 where the allocation has economic effect if it meets all 3 criteria
1 allocation results in appropriate increase/decrease in partner’s
Capital account
2 proceeds if any liquidation at any time in partnership’s life
Cycle are distributed in accordance with positive capital acct.
Balances
3 partners must make up negative capital acct. balances upon
Liquidation of partnership
partners must make up negative capital acct. balances upon
Liquidation of partnership
These contributions are used to pay partnership debts or are
Allocated to partners having positive capital account balances
Allocations: shifting (occurs when 2 conditions are present)
1 net change in partner’s capital accounts will be same for normal
Allocation and special allocation
2 total tax liability of partners will be less with special allocation
Than with normal allocation
A partner can acquire partnership interest by methods others than…
Contributing property or services to partnership
If a person purchases a partnership interest from an existing partner, what is the new partner’s basis
New partner’s basis =
(price paid for partnership interest)
+ (assumption of partnership liabilities
If a person inherits the partnership interest, what is the heir’s basis?
Heir’s basis = FMV of partnership interest on decedent’s date of death
Or alternative valuation date but not less than liabilities assumed
If person receives partnership interest as a gift, what is the donee’s basis?
Donee’s basis = donor’s basis + portion of gift tax paid by donor
What 2 changes in partner’s liabilities are considered contribution of cash by the partner to the partnership?
1 increase in partner’s share of partnership liabilities
2 have partner assume partnership liabilities in his individual
Capacity
Equation for partner’s basis in partnership interest based on changes in liabilities
Partner’s basis in partnership interest =
Partner’s basis before changes in liabilities
+ increases in share of partnership liabilities
- decreases in share of partnership liabilities
+ partnership liabilities assumed by this partner
- this partner’s liabilities assumed by partnership
Recourse loan
Usual kind of loan that borrower remains liable for until loan is
Paid
Nonrecourse loan
Loan where lender may sell property used as security if loan
Isn’t paid, but no partner is liable for any deficiency
Recourse debt increases a limited partner’s basis only to extent that the partner has…
Risk of economic loss
Non recourse debts increase limited partner’s basis based primarily on…
The profit ratio
