Chapter 21 Flashcards
Partnership Definition
• An association of two or more persons to carry on a trade or business – Contribute money, property, labor – Expect to share in profit and losses • For tax purposes, includes: – Syndicate – Group – Pool – Joint venture, etc • Partners can be individuals, corporations, etc.
Entities Taxed as Partnerships (slide 1 of 4)
• General partnership
– Consists of at least 2 general partners
– Partners are jointly and severally liable
• Creditors can collect from both partnership and partners’ personal assets
• General partner’s assets are at risk for malpractice of other partners even if not personally involved in malpractice
Entities Taxed as Partnerships(slide 2 of 4)
• Limited liability company (LLC)
– Combines the corporate benefit of limited liability with benefits of partnership taxation
• Unlike corporations, income is subject to tax only once
• Special allocations of income, losses, and cash flow are available
– Owners are “members,” not partners, but if properly structured will receive partnership tax treatment
Entities Taxed as Partnerships (slide 3 of 4)
• Limited partnership
– Has at least one general partner
• One or more limited partners
– Only general partner(s) are personally liable to creditors
• Limited partners’ loss is limited to equity investment
Entities Taxed as Partnerships (slide 4 of 4)
• Limited liability partnership (LLP)
– Used primarily by service entities
– An LLP partner is not personally liable for malpractice committed by other partners
– Popular organizational form for large accounting firms
Key Concepts in Partnership Taxation (slide 1 of 3)
• Partnership is not a taxable entity
– Flow through entity
• Income taxed to owners, not entity
• Partners report their share of partnership income or loss on their own tax return
Key Concepts in Partnership Taxation (slide 2 of 3)
• Involves 2 legal concepts:
– Aggregate (or conduit) concept – Treats partnership as a channel with income, expense, gains, etc. flowing through to partners
• Concept is reflected by the imposition of tax on the partners, not the partnership
Key Concepts in Partnership Taxation (slide 3 of 3)
• Involves 2 legal concepts (cont’d):
– Entity concept – Treats partners and partnerships as separate and is reflected by:
• Partnership requirement to file its own information return
• Treating partners as separate from the partnership in certain transactions between the two
Partnership Taxation
• Generally, the calculation of partnership income is a 2-step approach
– Step 1: Net ordinary income and expenses related to the trade or business of the partnership
– Step 2: Segregate and report “separately stated items”
– If an item of income, expense, gain or loss might affect any 2 partners’ tax liabilities differently, it is separately stated
– e.g., Charitable contributions
Partner’s Ownership Interest
• Each owner normally has a:
– Capital interest
• Measured by capital sharing ratio
– Partner’s percentage ownership of capital
– Profits (loss) interest
• Partner’s % allocation of partnership ordinary income (loss) and separately stated items
• Certain items may be “specially allocated”
– Specified in the partnership agreement
Inside and Outside Bases
• Inside basis
– Refers to the partnership’s adjusted basis for each asset it owns
– Each partner “owns” a share of the partnership’s inside basis for all its assets
• Outside basis
– Represents each partner’s basis in the partnership interest
– All partners should maintain a record of their respective outside bases
Partnership Reporting(slide 1 of 2)
• Partnership files Form 1065, an information return
– No tax is calculated or paid with the return
• This return is due by the fifteenth day of the third month following the end of the tax year
• For calendar year partnerships, the return is due March 15 of the following year
Partnership Reporting(slide 2 of 2)
• Partnership files Form 1065, an information return
– On page 1 of Form 1065, partnership reports ordinary income or loss from its trade or business activities
– Schedule K accumulates information to be reported to partners
• Provides ordinary income (loss) and separately stated items in total
– Each partner (and the IRS) receives a Schedule K-1
• Reports each partner’s share of ordinary income (loss) and separately stated items
Tax Consequences of Partnership Formation (slide 1 of 2)
• Usually, no gain or loss is recognized by a partner or partnership on the contribution of money or property in exchange for a partnership interest
• Gain (loss) is deferred until taxable disposition of:
– Property by partnership, or
– Partnership interest by partner
Tax Consequences of Partnership Formation(slide 2 of 2)
• Partner’s basis in partnership interest = basis of contributed property
– If partner contributes capital assets and § 1231 assets, holding period of partnership interest includes holding period of assets contributed
– For other assets including cash, holding period begins on date partnership interest is acquired
– If multiple assets are contributed, partnership interest is apportioned and separate holding period applies to each portion
Exceptions to Tax-Free Treatment on Partnership Formation (slide 1 of 4)
• Transfers of appreciated stock to investment partnership
– Gain will be recognized by contributing partner
– Prevents multiple investors from diversifying their portfolios tax-free
Exceptions to Tax-Free Treatment on Partnership Formation (slide 2 of 4)
• If transaction is essentially a taxable exchange of properties, gain will be recognized
– e.g., Individual A contributes land and Individual B contributes equipment to a new partnership; shortly thereafter, the partnership distributes the land to B and the equipment to A; Partnership liquidates
– IRS will disregard transfer to partnership and treat as taxable exchange between A & B
Exceptions to Tax-Free Treatment on Partnership Formation (slide 3 of 4)
• Disguised Sale
– e.g., Partner contributes property to a partnership; Shortly thereafter, partner receives a distribution from the partnership
• Distribution may be viewed as a purchase of the property by the partnership
Exceptions to Tax-Free Treatment on Partnership Formation (slide 4 of 4)
•Receipt of fully vested interest in partnership capital in exchange for services is generally taxable to the partner
•When partner receives fully vested interest in partnership’s future profits in exchange for services rendered, the partner is not typically required to recognize any income at the time of receipt
•Partnership may deduct the amount included in the service partner’s income if the services are of a deductible nature
–If the services are not deductible by the partnership, they must be capitalized to an asset account
–Any deduction is allocated to the OTHER partners
Tax Issues Relative to Contributed Property (slide 1 of 4)
• Contributions of depreciable property and intangible assets
– Partnership “steps into shoes” of contributing partner
• Continues the same cost recovery and amortization calculations
• Cannot expense contributed depreciable property under § 179
Tax Issues Relative to Contributed Property (slide 2 of 4)
• Gain or loss is ordinary when partnership disposes of:
– Contributed unrealized receivables
– Contributed property that was inventory in contributor’s hands, if disposed of within 5 years of contribution
• Inventory includes all tangible property except capital assets and real or depreciable business assets
Tax Issues Relative to Contributed Property (slide 3 of 4)
• If contributed property is disposed of at a loss and the property had a ‘‘built-in’’ capital loss on the contribution date
– Loss is treated as a capital loss if disposed of within 5 years of the contribution
– Capital loss is limited to amount of ‘‘built-in’’ loss on date of contribution
Tax Issues Relative to Contributed Property (slide 4 of 4)
• Special allocations must be made relative to contributed property that is appreciated or depreciated
– The partnership’s income and losses must be allocated under § 704(c) to ensure that the inherent gain or loss is not shifted away from the contributing partner
– Discussed later in the chapter
Elections Made by Partnership(slide 1 of 2)
• Inventory method • Accounting method – Cash, accrual or hybrid • Depreciation method • Tax year • Organizational cost amortization • Start-up expense amortization