Partnership Taxation

Question 1

How do tax rules differ for limited partnerships and general partnerships?

Answer 1

They are the same

Question 2

How are limited liability companies treated for tax purposes?

Answer 2

They are treated as partnerships unless conditions obtain that make them taxable as a corporation (or if they decide to be taxed as one)

Question 3

What must partnerships file?

Answer 3

Form 1065, an informational tax return, as well as Schedule K-1 for each partner, which explains his share

Question 4

What is the taxable year for a partnership?

Answer 4

The same one used by the partners with a majority interest, though a different one can be elected if justified by a business purpose (and if the deferral period would not exceed 3 months)

Question 5

What is a partnership’s taxable year if partners with a majority interest do not have the same taxable year?

Answer 5

Then the partnership uses the taxable year of its “principal partners,” i.e. its partners with a 5% or greater interest in the firm’s profits or capital

Question 6

What is a partnership’s taxable year if its principals partners do not have the same taxable year?

Answer 6

The calendar year

Question 7

What is a partner’s distributive share?

Answer 7

What a partner is entitled to receive from the partnership, and thus what he is taxed on, whether or not he actually receives any distribution

Question 8

How are partners’ distributive shares determined?

Answer 8

Usually by the partnership agreement, but if any arrangement mentioned in the agreement does not have “substantial economic effect,” then the distribution corresponds to the partners’ interests in the partnership

If there is simply no arrangement, then it corresponds to the allocation for profits and losses

Question 9

When does a partnership distributive share allocation have “substantial economic effect”?

Answer 9

If it could affect the dollar amount of partners’ distributive shares irrespective of tax consequences

Question 10

What is the maximum limit for deductions from a partner’s distributive share?

Answer 10

The same as for S corporation stockholders: it is limited by (1) his basis in the partnership, (2) at-risk rules, and (3) passive loss rules

Question 11

How are fixed/guaranteed payments to partners by the partnership treated?

Answer 11

As if they were payments to an outside person – can be deducted from partnership income and included in the partner’s personal income

Question 12

Under what circumstances can gains and losses from sales of property between a partner and his partnership be forbidden?

Answer 12

Any losses from sales of property between the partnership and a controlling partner (with >50% interest) are forbidden, though gains on such sales are included in ordinary income

Question 13

Are gains and losses recognized when partners contribute property in exchange for a partnership interest?

Answer 13

No

This rule does not apply when services are contributed, however

Question 14

How is the holding period for a partnership interest calculated?

Answer 14

It includes the holding period of the property exchanged for the partnership interest, if that property is a capital asset or otherwise used in the business

Otherwise the holding period begins when the interest is acquired

Question 15

If property is given to partners in a nonliquidating distribution, what is the partner’s basis in the property?

Answer 15

The lesser of

(1) the partnership’s basis immediately before distribution or
(2) the basis of the partner’s interest minus any cash distributed

Question 16

If property is given to partners in a liquidating distribution, what is the partner’s basis in the property?

Answer 16

The basis of the partner’s interest minus any cash distributed

Question 17

If a partner acquires another partner’s interest in the partnership, what is the acquirer’s basis in the interest?

Answer 17

The FMV of the consideration given

Question 18

How do distributive shares affect a partner’s basis in his partnership interest?

Answer 18

Distributive shares of income increase, losses decrease it

Question 19

How do partnership liabilities affect a partner’s basis in his partnership interest?

Answer 19

Any assumption of liabilities increases the partner’s basis

Likewise, any decrease in assuming liabilities counts as a distribution to that partner, thus reducing his basis

Question 20

When is a gain or loss recognized by the partnership when distributing money or property to a partner?

Answer 20

Ordinarily it is not recognized, but:

(1) a gain can be recognized inasmuch as distributed money exceeds partner’s basis in the partnership
(2) a loss can be recognized for a liquidating distribution if the property consists only of money, unrealized receivables, and inventory

Question 21

What are “hot assets”?

Answer 21

Partnership assets that produce income – have different rules related to their distribution

Two kinds: unrealized receivables and appreciated inventory items

Question 22

As regards hot assets, what all is included in “appreciated inventory”?

Answer 22

Any assets besides cash, Section 1231 assets, or capital

Their FMV must be >120% of their basis in order to be sufficiently appreciated

Question 23

What occurs if, in a distribution, a partner does not receive a share in hot assets proportionate to his share in the partnership?

Answer 23

The distribution is understood as two separate events:

(1) a proportionate distribution of the assets
(2) the partner’s sale of such assets to the partnership

Question 24

What is an electing large partnership (ELP)?

Answer 24

A partnership which has at least 100 members and elects a simpler reporting process

The election can be revoked in the future only if the IRS consents

Question 25

What kind of partnerships cannot be ELPs?

Answer 25

Service partnerships or commodity-trading partnerships

Question 26

What is the simplified way of calculating taxable income for ELPs?

Answer 26

It is just like individual taxable income, but with a few modifications

Also, certain items have to be stated separately

Question 27

What modifications are made to the calculation of taxable income for ELPs?

Answer 27

The personal-exemption deduction, the NOL deduction, and some itemized deductions are forbidden

Question 28

What causes a partnership to terminate?

Answer 28

If either (a) none of the business is carried on or (b) at least 50% of the partnership interests are sold within a 12-month period

(b) is not a reason for termination in the case of ELPs, however

Question 29

Do mergers or divisions cause a partnership to terminate?

Answer 29

Mergers do not, since the new partnership includes the partners who had at least a 50% interest

Divisions can, if the new partnership includes the partner who had at least a 50% interest

Question 30

What kind of gains/losses are transactions involving partnership interests?

Answer 30

Capital gains

Question 31

Which kinds of distributions give rise to ordinary gains or losses?

Answer 31

Distributions of unrealized receivables or inventory

Question 32

What is peculiar about distributions for ordinary income items?

Answer 32

Such distributions must be pro rata to each partner, based on his interest

If they are not, they must be construed as (1) a pro rata distribution and (2) a (taxable) transaction to result in the disproportionate distribution