Partnership Taxation

Question 1

True or false? Partnerships are a taxable entity.

Answer 1

False.

Income and expenses flow through to the partner to be taxed via a Form K-1.

Question 3

When exchanging property for a partnership interest; how is gain or loss recognized?

Answer 3

Neither gain nor loss is recognized in an exchange of property for a partnership interest. It is a non-taxable event.

Question 4

When services are exchanged for a partnership interest; how is this treated for tax purposes?

Answer 4

It is a taxable event; treated the same as compensation for the services. The taxable income equals the % of partnership interest received times the FMV of the partnership.

i.e. the FMV of the interest received is the taxable income for the service provider. In addition, this amount becomes the basis for the partner.

Question 5

What is a partner’s basis in partnership property?

Answer 5

Initial basis for partnership property is the basis of the property that was contributed or exchanged for the partnership interest.

Question 6

What is the partner’s basis in a partnership when they provide a service in exchange for the interest?

Answer 6

The basis in the partnership interest is the amount of taxable service revenue provided by service provider.

Question 7

What deductions are subtracted from gross revenues to arrive at partnership income?

Answer 7

1. COGS
2. Wages - except for partners
3. Guaranteed payments to partners
4. Business bad debt (if on accrual basis)
5. Interest paid
6. Depreciation (except section 179)
7. Amortization (Startup costs; goodwill; etc)

Note: All items are deductions shown on the partnership return - Form 1065

Question 8

What is the holding period of an asset that has been contributed to a partnership?

Answer 8

The partnership inherits the holding period of the asset contributed.

The exception of inventory- the holding period begins when contributed.

Question 9

What is the tax treatment of startup costs for a partnership?

Answer 9

Tax treatment is the same as that of an individual taxpayer.

However syndication fees are not deductible or amortized.

Question 10

How are partnership losses taken on an individual’s return?

Answer 10

Losses cannot be taken beyond a partner’s basis in the partnership

Losses in excess of basis are carried forward until basis is available

Question 11

How is net self-employment income from a partnership interest calculated?

Answer 11

Partner’s % share of ordinary income from partner’s K-1

+ Guaranteed payments
- Partner’s % share of section 179 expense from K-1

= Self-employment income (subject to SE tax)

Note: This is calculated and shown on the partner K-1

Question 12

When are guaranteed payments to a partner includable in taxable income?

Answer 12

They appear in partner’s income during the year in which the partnership’s fiscal year CLOSES.

Question 13

Which items are NOT deductible on Schedule K of form 1065?

Answer 13

1. Foreign tax paid
2. Investment interest expense
3. Section 179 expense
4. Charitable contributions

Mnemonic: IFC179

Note: All of these items are listed in the partner K-1

Question 14

Which items are NOT counted as income on Schedule K of form 1065?

Answer 14

1. Passive Income
2. Portfolio Income
3. 1231 Gain or Loss

Mnemonic: PP1231

Note: All of these items are listed in the partner K-1

Question 15

How are partner benefits paid by the partnership treated?

Answer 15

Health insurance; life insurance and other benefits paid on behalf of the partner are treated as guaranteed payments and are includable as self-employment income.

Question 16

What items INCREASES partnership basis?

Answer 16

1. Partnership getting a loan
2. Capital contributions
3. Ordinary income - partner’s share
4. Capital gains
5. Tax-exempt income

Question 17

How is adjusted partnership basis calculated?

Answer 17

Beginning partnership basis

+ Capital contributions

+ Share of ordinary partnership income

+ Capital gains

+ Tax-exempt partnership income (DON’T FORGET!)

= Ending partnership basis

Question 18

What items DECREASE partnership basis?

Answer 18

1. Money distributed
2. Adjusted basis of property distributed
3. Partner’s share of ordinary losses
4. Partnership is relieved of a liability (considered a distribution)

Question 19

In general; what is a partner’s basis in partnership property purchased?

Answer 19

Partner’s basis is basis of goods exchanged or for services exchanged is FMV of partnership interest received.

If purchased; purchase price less liabilities incurred = basis.

For a gifted interest in a partnership; gift basis rules apply.

Question 20

How do guaranteed payments affect partnership basis?

Answer 20

They do NOT affect basis- they are already included in ordinary income; which affects basis.

Question 21

How do liabilities either INCURRED or RELIEVED affect a partner’s basis in a partnership?

Answer 21

If the partnership gets a loan; this INCREASES basis.

If partnership is relieved of a liability; this DECREASES basis.

Question 22

What is the order in which basis is adjusted in a partnership?

Answer 22

1. Increase basis (all items; including tax-exempt income)
2. Distributions
3. Losses (limited to basis)

Question 23

How is the taxable year of a partnership determined?

Answer 23

It must be the same as 50% of the partners and use the same tax year for 3 years once adopted.

Question 24

How does death of a partner affect the partnership’s taxable year?

Answer 24

The taxable year closes with respect to the decedent partner’s interest ONLY.

Question 25

When CAN’T a partnership use cash basis?

Answer 25

1. They have inventories
2. Partnership is a tax shelter
3. Has a corporate partner
4. Gross receipts are $5 Million or more

Exception: If gross receipts are $1 Million or LESS and Partnership maintains inventories; Cash method is ok.

Question 26

When does a partnership terminate?

Answer 26

When there is less than 2 partners (only one partner)

When 50% of the partnership interests sell within a 12 month period- partnership IMMEDIATELY terminates.

Question 27

How is gain or loss on sale of a partnership interest calculated?

Answer 27

Gain or Loss = Amount realized on sale - basis in partnership interest

Question 28

What is the new basis of a partnership interest sold?

Answer 28

Basis = Capital account + Liabilities assumed

Question 29

How is a partner’s share of an ordinary gain calculated?

Answer 29

FMV of Assets (non-capital)
- Adjusted basis of assets
= Ordinary gain

x Partner’s % interest
= Partner’s share of gain

Note: No gain or loss will be recognized by a partnership upon distribution of property.

Question 30

How is the sale of non-capital partnership property treated?

Answer 30

As ordinary gain/loss.

Items that fall into non-capital category would be unrealized receivables; appreciated inventory; and similar.

Question 31

Can a gain or loss be recognized by a partner in a COMPLETE LIQUIDATION of their partnership interest (liquidating distribution)?

Answer 31

Generally, NO gain or loss is recognized upon the complete liquidation of a partner’s partnership interest…

However, a loss CAN be recognized if the liquidating distribution consist of ONLY:

1. Cash
2. Receivables
3. Inventory

Note: Liquidating distribution is when partner is getting out of partnership 100%

Question 32

When can a LOSS occur in a partnership distribution?

Answer 32

Only in a LIQUIDATING DISTRIBUTION.

The things that cause a loss are:

1. The receipt of cash
2. Unrealized receivables
3. Inventory

Note: If property OTHER than money, unrealizable receivables or inventory is distributed in a complete liquidation (liquidating distribution) of a partner’s interest, NO LOSS can be recognized

Note: Liquidating distribution is when partner is getting out of partnership 100%

Question 33

When can a LOSS occur in a partnership distribution?

Answer 33

Only in a LIQUIDATING DISTRIBUTION.

Note: Liquidating distribution is when partner is getting out of partnership 100%

Question 34

What is the order of basis reductions for distributions from a partnership?

Answer 34

1. Money distributed
2. Adjusted basis of unrealized receivables and inventory
3. Adjusted basis of other property

Note: Only MONEY distributions will trigger a gain in a partnership distribution.

Question 35

What are the effects of NON-LIQUIDATING distributions to a partnership?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 35

Generally no GAIN or LOSS recognized by partnership UNLESS distribution is disproportionate and Sec. 751 applies

Question 36

What are the effects of NON-LIQUIDATING distributions to a partnership?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 36

Generally no GAIN or LOSS recognized by partnership UNLESS distribution is disproportionate and Sec. 751 applies

Question 37

Question: R, W and M are equal partners in RWM partnership. R’s basis in the partnership is $60,000. R receives a LIQUIDATING distribution of $61,000 cash and land (FMV= $14,000, Basis = $12,000)

What gain must R recognize upon the liquidation of his partnership interest?

Answer 37

Note: In the case of a partnerships distribution, ONLY the receipt of money can result in gain recognition to the distribute

If both cash and noncash property are received in a LIQUIDATING DISTRIBUTION, the basis for the partner’s partnership interest is first reduced by the cash, before being reduced by noncash property

This is important because a distributee partner MUST recognize gain to the extent that the cash received exceeds the basis of the partnership interest

Recognized gain =

61,000 cash
- 60,000 basis
= 1,000 recognized gain

Note: The basis for the land that Reid received will be zero

Question 38

What are the effects of Non-liquidating distributions to a partner (owner) in a partnership?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 38

Generally, NON-LIQUIDATING distributions are nontaxable to partners, but GAIN recognized if money or FMV of securities received by partner EXCEED the partner’s basis for partnership interest

Noncash property distributions generally measured by partnership’s basis for the distributed property; property will generally have a transferred basis to the distribute partner

Question 39

What are the rules regarding pro-rata distributions from a partnership?

Answer 39

1. Partnership recognizes NO gain or loss on a distribution
2. If a single distribution consists of multiple items of property, the distributed property reduces the partner’s basis for the partnership interest in the following order
   a. Money
   b. Adjusted basis of unrealized receivables and inventory
   c. Adjusted basis of other property

Question 40

When would a partner recognize a GAIN in a pro-rata distribution from a partnership?

Answer 40

Partner recognizes gain ONLY to the extent MONEY received EXCEEDS the partner’s partnership basis

1. Relief from liabilities is deemed a distribution of property
2. Gain is capital EXCEPT for gain attributable to unrealized receivables and substantially appreciated inventory - in this cash it would be ordinary
3. If property OTHER than MONEY is received, gain is NOT recognized until disposition of the property

Example: Casey had a basis of $9,000 for his partnership interest at the time that he received a NON-LIQUIDATING distribution consisting of $5,000 cash and other property with a basis of $3,000 and a FMV of $8,000

No gain is recognized by Casey since the cash received did NOT exceed his partnership basis. Casey’s $9,000 basis for his partnership interest is first reduced by the $5,000 cash, and then reduced by the $3,000 basis of other property to $1,000

Casey will have a basis for the other property received of $3,000

Question 41

When does a partner recognize a LOSS in a partnership distribution?

Answer 41

Partner recognizes LOSS ONLY upon COMPLETE LIQUIDATION (Liquidating Distribution) of a partnership interest through receipt of money, unrealized receivables or inventory

The amount of loss is the basis for the partner’s partnership interest LESS the money and the partnership’s basis in the unrealized receivables and inventory received by the partner

The loss is generally treated as a capital loss

If property other than money, unrealized receivables or inventory is distributed in COMPLETE LIQUIDATION of a partner’s interest, NO LOSS can be recognized

Example 1: Day had a basis of $20,000 for his partnership interest before receiving a distribution in complete liquidation of his interest

The liquidating distribution consisted of $6,000 cash and inventory with a basis of $11,000. Since Day’s liquidating distribution consisted of ONLY money and inventory, Day will recognize a loss on the liquidation of his partnership interest

The amount of loss is the $3,000 difference between the $20,000 basis for his partnership interest and the $6,000 cash and the $11,000 basis for the inventory received. Day will have an $11,000 basis for the inventory

Example 2: Assume the same facts as in example 1, EXCEPT that Day’s liquidating distribution consists of $6,000 cash and a parcel of land with a basis of $11,000

Since the liquidating distribution now includes property other than money, receivables and inventory, NO LOSS can be recognized on the liquidation of Day’s partnership interest

The basis for Day’s partnership interest is first reduced by the $6,000 cash to $14,000. Since no loss can be recognized, the parcel of land must absorb all of Day’s unrecovered partnership basis. As a result, the land will have a basis of $14,000

Question 42

Is a gain or loss recognized when a partner contributes Property in exchange for a partnership interest?

Answer 42

Generally, no gain or loss is recognized on the contribution of property in exchange for a partnership interest

Note: If a partner just contributes money for property, then there is NO gain or loss to the partnership or partner; EXCEPT, when property has a liability that EXCEEDS basis - which would be a capital gain

Question 43

How do partnerships operate?

Answer 43

Partnerships are pass-through entities

Pay no entity level income taxes

Income, deduction, loss and credit items retain their characteristics when passed through to be reported on partner returns (similar to S corporations)

Question 44

How does the holding period differ between a partner who contributed a section 1231 or capital asset vs. inventory to the partnership?

Answer 44

When a partner transfers (contributes) a section 1231 or capital asset, the holding period of the asset start when they first purchased it to when the partnership sell it

When a partner transfers (contributes) inventory (or a NON section 1231 or capital asset), then the holding period starts when the partner enters the partnership to when the partnership sells it

So.., section 1231 and capital asset contributed property will have a longer holding period to the partnership than other contributed property

Question 45

What are partnership syndication fees? Are they deductible?

Answer 45

Partnership syndication fees are expenses related to selling partnership interests

For example: Accounting fees to prepare the representations in offering materials. These are offering materials related to selling the partnership interest; thus NOT an organizational expense

Other examples of syndication fees include costs connected with the issuing and marketing of partnership interests such as:

1. Commissions,
2. Professional fees
3. Printing costs

All of these costs must be capitalized

There are NEITHER deductible nor amortizable

Question 46

What type of income is reported on Form 1065 - U.S. Return of Partnership Income?

Answer 46

Ordinary income is the ONLY type of income that is reported on the partnership return

For example, dividends from foreign corporations and net income are shown on the partnership return, as these items are shown separately on Schedule K

Question 47

How do you calculate a partner’s basis in a Partnership?

Answer 47

Partner’s basis in a Partnership is as follows:

Beginning Basis
+ Partner ordinary income
+ Partner share of capital gain
+ Partner share of tax-exempt interest income
- Withdrawal of Assets
+ Share of liabilities of partnership which partner is liable for (Recourse debts only)

= Total Basis

Note: Whenever you have multiple withdrawals of assets, remember that money decreases basis first

Question 48

How are a partner’s fringe benefits treated?

Answer 48

Any fringe benefits for the partner, such as the Partnership paying health insurance, accident insurance premiums, they are considered as guaranteed payment (deductible by partnership to arrive at ordinary income) and also the guaranteed payments will go on Schedule K and the partner’s share of those guaranteed payments will go on the Partner’s K-1

A partner’s fringe benefits are DEDUCTIBLE by the PARTNERSHIP as guaranteed payments and must be included in a partner’s gross income

Guaranteed payments = Ordinary income to partner

Question 49

What is Ordinary gain section 751?

Answer 49

Ordinary gain Section 751 is the portion of appreciated A/R and inventory that is attributable to a partner when they sell their partnership interest to an outsider

In problems, appreciated A/R would be denoted as the FMV of “unrealized accounts receivable”

Basically, the partners ownership % times appreciated A/R and inventory = Ordinary gain section 751

Note: Although the sale of a partnership interest results in a capital gain or loss, ORDINARY income must be recognized to the extent of the selling partner’s share of UNREALIZED RECEIVABLES and APPRECIATED INVENTORY. The remaining gain would be capital

Question 50

How is a Current Distribution characterized?

Answer 50

Current distribution is when a partner is withdrawing assets, but NOT getting out of the partnership

Question 51

How is a Liquidating Distribution characterized?

Answer 51

Liquidating distribution is when partner is getting out of partnership 100%

Question 52

What needs to occur in order for a gain to be recognized in a NON-LIQUIDATING distribution?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 52

In order for there to be a gain recognized in a non-liquidating transaction where partner receives a cash non-liquidating distribution, the cash distribution has to EXCEED the basis

Question 53

In a NON-LIQUIDATING distribution, what is the rule regarding partner’s basis in the distributed property?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 53

In non-liquidating distributions, a partner’s basis in distributed property is generally the same as the partnership’s former basis in the property, but is LIMITED to the basis for the partner’s partnership interest LESS any CASH received

Question 54

Are losses recognized on NON-LIQUIDATING distributions?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 54

There is NO loss on a NON-LIQUIDATING distribution

Note: There is no loss recognition in a non-liquidating distribution (never!)

Question 55

When a partner takes out property out of the partnership, what will their basis be?

Non-Liquidating distribution = Withdrawal of Assets = Current distributions

Answer 55

When a partner takes out property out of the partnership, their basis will be the LESSOR of their beginning basis LESS cash distribution or the Partnership property basis

To summarize, in a Non-liquidating distribution, the basis is going to be the LESSOR of the partner basis and the basis of the Partnership basis

Question 56

How are Section 1231 losses shown on Form 1065 - Partnership return and Schedule K?

Answer 56

Section 1231 LOSSES are ordinary and they are shown on the front of Form 1065 and Schedule K (in full amount)

Question 57

Should Section 179 deduction be reported on Form 1065 - Partnership return?

Answer 57

No, section 179 deduction amount should NOT be shown on Form 1065- Partnership return

Instead, the section 179 deduction amount should be shown in FULL on the Schedule K and the partner’s percent of the deduction should be shown on their K-1

Question 58

In general, are partnership items having special tax characteristics shown on partnership Form 1065 return?

Answer 58

NO, Partnership items having special tax characteristics (i.e. passive activity income, deductions subject to dollar or percentage limitations) must be separately and shown on Schedules K and K-1 so that their special characteristics are preserved when reported on partners’ tax returns

In contrast, partnership ordinary income and deduction items having NO special tax characteristics can be netted together in the computation of a partnership’s ordinary income and deductions from trade or business activities on page 1 of Form 1065

Question 59

Are salaries and wages paid to employees reported on Form 1065, Schedule K and K-1?

Answer 59

Salaries and wages ARE reported on Form 1065 as these are deductible in the computation of ordinary income, plus, they do not require adjustment

Salaries and wages are NOT reported on Schedule K or K-1

Note: If there is an qualifying work opportunity credit; then salaries and wages are reduced by this amount and the net is shown on Form 1065. Only the credit (full amount) would be shown on Schedule K and the partner’s % of it would be shown on their K-1

Question 60

Are guaranteed payments paid to partners reported on Form 1065, Schedule K and K-1?

Answer 60

Guaranteed payments in their full amount are reported on Form 1065 and Schedule K. The partner % of the guaranteed payments are shown on their K-1

Guaranteed payments are deductible in the computation of ordinary income

Note: Guaranteed payments would be increased by the health insurance premiums paid on behalf of partners

Question 61

Are health insurance premiums paid by partnership on behalf of its partners reported on Form 1065, Schedule K and K-1?

Answer 61

Health insurance premiums paid by the partnership on behalf of its partners are treated as guaranteed payments. As such, they are deductible in computing partnership ordinary income and are includible in partners’ gross income as ordinary

These are reported in Form 1065 and Schedule K in their full amount. Partner’s % of these are reported in their K-1

Question 62

Are contributions to a defined benefit (Keogh) pension plan reported on Form 1065, Schedule K and K-1?

Answer 62

The total amount of contributions to a defined benefit pension plan must be REDUCED by any amount paid on behalf of partners for the benefit of employees that is deductible in computing partnership ordinary income. The net amount would be reported on Form 1065

The amount paid on behalf of partners is separately shown on Schedule K and partner % is reported on the K-1

Question 63

Are charitable contributions of a partnership reported on Form 1065, Schedule K and K-1?

Answer 63

Charitable contributions are NOT deductible in the computation of a partnership income; thus, they are NOT reported on Form 1065

Instead, they are separately shown on a partnership’s Schedule K and a partner’s Schedule K-1 so that the appropriate percentage limitations can be applied to partners’ returns

Note: If the stock was NOT held for more than 1 year; then it DOESN’T qualify as capital gain property; thus the amount of contribution is limited to the stock’s adjusted basis