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Tax 2 > Partnerships > Flashcards

Partnerships Flashcards

1
Q

Partnership:

What is a partnership?

A

An association of two or more persons to carry on a trade or business, with each contributing money, property, labor, or skill, and with all expecting to share in profits and losses.

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2
Q

Partnership:

Are partnerships subject do Federal Income Tax?

A

No!

Partnerships are not subject to a Federal income tax.

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3
Q

Partnership:

What form do partnerships file and why?

A

• They file informational returns (Form 1065), which merely report the results of a partnership’s activities.

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4
Q

Partnership:

How is the partnership’s income and expenses calculated?

A

Business income and expense items are aggregated in computing the ordinary business income (loss) of the partnership.

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5
Q

Partnership:

How is profit and loss allocated among/to partners?

A

Partnership ordinary business income (loss) and separately reported items are allocated to partners as per their profit and loss sharing ratios.

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6
Q

Partnership:

What is a K1 and who receives it?

A

The K-1 reports the partner’s share of partnership ordinary business income (loss) and separately stated items.

Each partner receives a K1

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7
Q

Partnership:

Who can receive a qualified business income deduction?

A

Individual partners can claim the deduction for qualified business income on their own Form 1040.

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8
Q

Partnership:

With respect to a partnership, who can act as a “person”?

A 
A “person” can be:
• Individual.
• Trust.
• Estate.
• Corporation.
• Association.
• Another partnership
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9
Q

Partnership:

[True/False] The entity must be unincorporated and cannot be otherwise classified as a corporation, trust, or estate.

A

True.

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10
Q

Partnership:

What are the 2 characteristics for a general partner?

A

General partners can:

(1) participate in managing the entity and
(2) can be legally required to repay a partnership’s recourse debt.

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11
Q

Partnership:

What are the 2 characteristics for a limited partner?

A

Limited partners are:
(1) typically not permitted to participate in entity
management and
(2) they are not liable for partnership debts

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12
Q

General Partnership:

(1) What type and (2) how many partners are required to form a “General Partnership”?

A

Consists of at least two general partners and no limited partners.

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13
Q

General Partnership:

Can a “General Partnership” have any limited partners?

A

No!

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14
Q

General Partnership:

How does liability work with a “General Partnership”?

A

Partners are jointly and severally liable.

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15
Q

General Partnership:

What assets can creditors access from the “General Partnership”?

A

Creditors can collect from both partnership and partners’ personal assets.

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16
Q

Limited Partnership:

How is a “Limited Partnership” formed?

A

Formed with at least one general partner and one or more limited partners.

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17
Q

Limited Partnership:

Which type of partners (general or limited) are liable to creditors?

A

Only general partners are personally liable to creditors.

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18
Q

Limited Partnership:

Which type of entity is often the general partner?

A

General partners are often entities that have limited liability, such as C corporations or LLCs

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19
Q

Limited Partnership:

What is the maximum loss that a limited investor can sustain?

A

Limited partners’ loss is limited to equity investment.

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20
Q

Limited Liability Company:

Owners are treated as ______ (general or limited) members with respect to an LLC’s debt?

A

Answer: Limited

They are treated as limited partners with respect to the LLC’s debts, but they generally participate in management.

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21
Q

Limited Liability Partnership:

Which industry typically uses LLP’s?

A

Used primarily by service entities.

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22
Q

Limited Liability Partnership:

Why are LLP’s advantageous for service folks?

A

An LLP partner is not personally liable for malpractice committed by other partners

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23
Q

Partnerships:

What type of document is created to form a partnership?

A

A “Partnership Agreement”

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24
Q

Partnerships:

What does the “Partnership Agreement” outline?

A

A partnership agreement is signed by each partner, that outlines:
• Rights and obligations of the partners.
• Allocations, deductions, and cash flows.
• Initial and future capital contribution requirements.
• Conditions for terminating the partnership.

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25
Q

Limited Liability Company:

What type of document is created to form an LLC?

A

An “Operating Agreement”

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26
Q

Partnership:

What is the purpose of the K1?

A

Schedule K-1 shows the partner’s share of partnership items.

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27
Q

Partnership:

What is “inside basis”?

A

“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 of its assets.

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28
Q

Partnership:

What is “outside basis”?

A

“Outside Basis” represents each partner’s basis in the partnership interest.

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29
Q

Partnership:

(1) What is a “capital interest”?
(2) How is it measured?

A

(1) The partner’s percentage ownership of the capital of the partnership.
(2) Capital interest is measured by the partner’s capital sharing ratio

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30
Q

Partnership:

(1) What is a “profit interest”?
(2) How is it measured?

A

(1) The partner’s percentage share of the partnership’s operating results.
(2) Profit (loss) interest is measured by the partner’s profit and loss sharing ratio

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31
Q

Partnership:

How is “partnership interest” created when a partnership is formed?

A

Partners contribute cash and other property in exchange for the partnership interest.

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32
Q

Partnership Example:

Roy transfers a capital asset with an adjusted basis of $10,000 and a fair market value of $30,000 for a one-third interest in AFC Richmond Partnership.

(1) What is Roy’s realized and recognized gain
in the transaction?

(2) What is Roy’s outside basis in the partnership?
(3) What is AFC Richmond’s inside basis in the capital asset?

A

(1) Roy’s realized gain is $20,000 ($30,000 - $10,000) and his recognized gain is $0.
(2) Roy’s basis in the partnership is a substituted basis of $10,000.
(3) AFC Richmond’s basis in the capital asset is a carryover basis of $10,000.

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33
Q

Partner Contributes Asset to Partnership:

If a partner contributes an asset with an [original price of X] and a [market price of Y], what is the partnerships basis for the contributed asset it receives?

A

Answer: X

The partnership takes a carryover basis in the contributed assets it receives (i.e., the partner’s basis in the asset carries over to become the partnership’s inside basis in the asset).

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34
Q

Partner Contributes Asset to Partnership:

How is (1) cost recover and (2) amortization calculated when a partner contributes depreciable property?

A

If a partner contributes depreciable property or intangible assets, the partnership “steps into the shoes” of the contributing partner and continues to use the same cost recovery and amortization calculations

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35
Q

Partnerships:

(1) What are “syndication costs” and (2) how are they treated?

A

(1) Syndication costs include expenditures incurred for promoting and marketing partnership interest such as:
• Brokerage fees.
• Registration fees.
• Legal fees.
• Accounting fees related to the offering materials.
• Printing costs of the prospectus and other selling materials.

(2) Syndication costs are capitalized, but no amortization election is available.

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36
Q

Partnerships:

What method of accounting can a partnership use?

A. Cash
B. Accrual
C. Hybrid

A

New partnerships may adopt cash, accrual or hybrid method

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37
Q

Partnerships:

What is the “gross receipts test”?

A

A partnership meets the $26 million gross receipts test if it does not have average annual gross receipts of more than $26 million.

• “Average annual gross receipts” is the average of gross receipts for the three tax years ending with the tax period prior to the tax year in question.

38
Q

Partnerships:

When is the Form 1065 due?

A

This return is due by the fifteenth day of the third month following the end of the tax year.

39
Q

Partnerships:

What is the two-step approach for calculating partnership income?

A

(1) Calculate partnership Net Ordinary Income

2) Calculate Separately-Stated Items (which are items that effect two people differently

40
Q

Partnerships Allocations:

Why was the “economic effect test” created?

A

(1) To prevent tax evasion
(2) The economic effect test was put in place to ensure that allocations do not result in undue tax revenue losses to the Treasury.

41
Q

Partnerships Allocations:

What are the 3 requirements of the “economic effect test”?

A
  1. Capital accounts must reflect contributions and distributions at their fair market values
  2. When a partnership interest is liquidated, a partner with a positive capital account must receive assets with a fair market value equal to the positive balance.
  3. When a partnership interest is liquidated, a partner with a negative capital account must
    restore that account upon liquidation, generally by contributing cash.
42
Q

Partnerships Allocations:

(1) For property contributed to a partnership, the difference between fair market value and basis at the contribution date is a ______________.
(2) What is special about this difference?

A

(1) Precontribution gain or loss.

(2) These precontribution gains and losses must be allocated to the contributing partner.

43
Q

Partnerships Allocations:

Keeley, a 40% partner in West Ham Partnership, contributed land with a fair market value of $800,000 and a basis of $600,000 when forming the partnership. Eventually, West Ham sells the property for $1,100,000.

(1) What is the pre-contribution gain or loss to Keeley and
(2) How much gain or loss does she recognize when West Ham sells the property?

A

(1) Precontribution gain is $800,000 fair market value - $600,000 basis = $200,000
(2) Keeley’s gain is $200,000 precontribution gain + $120,000 ($300,000 appreciation of land when owned by West Ham x 40% partnership interest) = $320,000

44
Q

Partnership Basis:

What is the relevance of a partner’s outside basis?

A

Outside basis is required for determining the treatment of distributions from the partnership to the partner and for establishing the deductibility of partnership losses.

45
Q

Partnership Basis:

Is a partner’s basis reflected on the Schedule K–1?

A

No.

A partner’s basis is not reflected anywhere on the Schedule K–1.

46
Q

Partnership Basis:

Where is the partner’s basis recorded?

A

Answer: The Partnership Interest document

The partner must maintain a record of their basis in the partnership interest

47
Q

Partnership Basis:

For new partners, what is the partner’s basis equal to?

A

For new partnerships, partner’s basis generally equals the adjusted basis of property contributed by the partner in exchange for partnership interest plus the fair market value of any services performed by the partner in exchange for partnership interest (i.e., the amount reported as ordinary income from services).

48
Q

Partnership Basis:

How do each of the following affect the partner’s basis [Increase/Decrease/No] :

(1) Initial Basis
(2) Subsequent Contributions (includes debt)
(3) Partner’s share of partnership
(4) Distribution to Partnership
(5) Withdraws from Partnership
(6) Reduction in share of partnership debt
(7) Partner’s share of partnership

A

(1) Initial Basis = NONE
(2) Subsequent Contributions = INCREASE
(3) Partner’s share of partnership = INCREASE
(4) Distribution to Partnership = DECREASE
(5) Withdraws from Partnership = DECREASE
(6) Reduction in share of partnership debt = DECREASE
(7) Partner’s share of partnership = DECREASE

49
Q

Partnership Basis:

An increase in partner’s share of liabilities is equivalent to:

A. Treated as a cash distribution to the partner
B. Treated as a cash contribution to the partnership

A

B. Treated as a cash contribution to the partnership

50
Q

Partnership Basis:

A decrease in partner’s share of liabilities is equivalent to:

A. Treated as a cash distribution to the partner
B. Treated as a cash contribution to the partnership

A

A. Treated as a cash distribution to the partner

51
Q

Partnership Basis:

An increase in partner’s share of liabilities:

A. Increases partner’s adjusted basis
B. Decreases partner’s adjusted basis

A

A. Increases partner’s adjusted basis

52
Q

Partnership Basis:

A decrease in partner’s share of liabilities:

A. Increases partner’s adjusted basis
B. Decreases partner’s adjusted basis

A

B. Decreases partner’s adjusted basis

53
Q

Partnership Liabilities:

What are the two types of partnership debt?

A

(1) Recourse Debt

(2) Non-recourse debt

54
Q

Partnership Liabilities:

What is recourse debt?

A

Recourse debt is partnership debt where the partnership or at least one partner is personally liable.

55
Q

Partnership Liabilities:

What is non-recourse debt? How is it allocated?

A

(1) Nonrecourse debt is partnership debt for which no partner is personally liable.
(2) Nonrecourse debt is allocated based on profit sharing ratios.

56
Q

Partner’s Capital Account:

How is the partner’s capital account measured?

A

The partner’s capital account measures the partner’s share of the net liquidation value of all partnership assets.

57
Q

Partner’s Returns:

Who do partnership losses flow to?

A

Partnership losses flow through to partners for use on their tax returns.

58
Q

Partner’s Returns:

Is a general partner subject to self-employment income tax?

A

Yes.

Self-employment income includes a general partner’s distributive share of income from a partnership’s trade or business.

59
Q

Partner’s Returns:

Is a limited partner subject to self-employment income tax?

A

Yes - if partner is not only an investor (no if he is investor)

includes the distributive share allocated to a “limited partner” that is “in the nature of compensation” for services performed for or on behalf of the partnership

60
Q

Self-Employment Tax:

What are “Guaranteed Payments”

A

Guaranteed payments are payments from the partnership to a partner for the use of capital or for services provided to the partnership.

61
Q

Self-Employment Tax:

Which type of partners are subject to the self-employment taxes on any guaranteed payments for services?

A

Both General AND Limited partners

62
Q

Tax Benefits:

What is the tax benefit of a partnership loss to a partner?

A

The entity can generate net taxable losses and/or valuable tax credits, which will be of use to the partners.

63
Q

Tax Benefits:

Why is Qualified Business Income deduction a benefit?

A

The QBI reduces tax burden.

64
Q

Tax Benefits:

What is the tax benefit of receiving income from a partnership (as opposed to C corp)?

A

No double taxation.

65
Q

Tax Benefits:

What is the tax benefit for a passive partner?

A

Self Employment taxes will be minimized.

66
Q

Tax Disadvantages:

Is it possible for partners to be taxed at a higher rate than they would be taxed with a C Corp?

A

Yes.

The tax paid by the individual owners of a partnership is potentially greater than the tax the entity would pay if it were a C corporation.

67
Q

Tax Disadvantages:

Is it possible for a partnership to generate net taxable income without distributing cash to owners?

A

Yes.

The entity is generating net taxable income potentially without distributing any cash to the owners

68
Q

Liability Disadvantages:

Why is a partnership not advantageous to an LLC from the perspective of liability?

A

Partners have less protection for their personal liability.

69
Q

Distributions:

What is a “Partnership Distribution”?

A

A distribution is a payment from a partnership to a partner with respect to the partner’s ownership interest in the partnership.

70
Q

Distributions:

Are all payments to a partner considered a distribution?

A

Answer: No!

Not all payments from a partnership to a partner are treated as a distribution.

71
Q

Distributions:

When does a liquidating distribution occur?

A

A liquidating distribution occurs when either:

• A partnership itself liquidates and distributes all its property to the partners,

or

• An ongoing partnership redeems interest of one of its partners; for example, when a partner retires.

72
Q

Distributions:

What is a current distribution?

A

Any distribution that is not a liquidating distribution

73
Q

Distributions:

Is a guaranteed payment considered a distribution?

A

No!

74
Q

Ordinary Income Preservation Concept:

What is the “ordinary income preservation concept”?

A

Ordinary income treatment must be preserved and allocated to the partner to whom that income accrued.

75
Q

Hot Assets:

(1) What are hot assets?
(2) What are some examples of ‘hot’ assets?

A

(1) Ordinary Income-Producing Assets

(2) receivables and inventory

76
Q

Distributions:

What are the two categories of distributions?

A

(1) Proportionate

(2) Disproportionate

77
Q

Distributions:

What is a proportionate distribution?

A

In a Proportionate distribution, a partner receives the appropriate share of the partnership’s hot assets.

78
Q

Distributions:

What is a disproportionate distribution?

A

A disproportionate distribution occurs when a partnership distributes cash or property to a partner and that distribution increases or decreases the partner’s share of ordinary income-producing assets
(hot assets).

79
Q

Distributions Example:

Jack owns a 25% interest in Reacher LLC.

His basis in the LLC interest is $40,000 and the fair market value is $70,000.

The LLC distributes $25,000 cash to Jack and land with an adjusted basis of $13,000 and a fair market value of $30,000.

After the distribution:

(1) What is Jack’s basis in the LLC interest?
(2) What is his basis in the land?
(3) What is the fair market value of his interest in the LLC?

A

(1) Basis in the LLC is $40,000 starting basis - $25,000 cash distribution - $13,000 basis of land distributed = $2,000.
(2) Basis in the land is $13,000 carryover basis.
(3) Fair market value of interest in the LLC is $70,000 starting FMV - $25,000 cash distribution - $30,000 fair market value of land = $15,000.

80
Q

Distributions:

Is a gain recognized on a property distribution?

A

In general, no gain is recognized on a property distribution whether the distribution is current or liquidating.

81
Q

Distributions Example:

Roscoe has a $50,000 basis in Kliner LLC. The LLC distributes land to Roscoe with a basis of $60,000 and a fair market value of $100,000.

(1a) Does Roscoe recognize gain on the distribution?
(1b) What is Roscoe’s basis in the property?

(2) What is Roscoe’s basis in the LLC?
(3) What is the outcome if Roscoe turns around and sells the property for $100,000?

A

(1a) Roscoe does not recognize a gain on the distribution.
(1b) Roscoe’s basis in the property is $50,000 substituted basis

(2) Roscoe’s basis in the LLC interest is $50,000 starting basis - $50,000 basis in land received = $0.
(3) Roscoe recognizes a gain on the sale of $100,000 sales price - $50,000 substituted basis = $50,000.

82
Q

Distributions:

What is the assumed order of assets distributed from the partnership (when multiple assets are distributed)?

  • Inventory
  • Property
  • Cash
  • Unrealized Receivables
  • All Other Assets
A

When multiple assets are distributed from a partnership, they are deemed distributed in the following order:
• Cash.
• Unrealized receivables and inventory.
• All other assets.

83
Q

Distributions Example:

When Finlay’s outside basis is $40,000, he receives a liquidating distribution of $7,000 cash and a proportionate share of inventory with a basis of $3,000 and a fair market value of $10,000.

(1) What amount and type of gain or loss does Finlay recognize on the liquidating distribution?

A

Finlay recognizes a capital loss of $30,000.

$40,000 starting basis - $7,000 cash distribution -$3,000 inventory basis = $30,000 capital loss.

84
Q

One of the key differences between capital accounts and outside basis is the effect of ____________.

A

partnership liabilities

85
Q

Contributions to partnership:

Do they increase or decrease the following accounts:

(A) Capital Account
(B) Outside Basis

A

Contributions to partnership – Increases capital account and outside basis.

86
Q

Distributions:

Do they increase or decrease the following accounts:

(A) Capital Account
(B) Outside Basis

A

Decreases capital account and outside basis

87
Q

Distributive share of income and loss:

Do they increase or decrease the following accounts:

(A) Capital Account
(B) Outside Basis

A

Increases/decreases capital account and outside basis.

88
Q

Partnership Liabilities:

Do they increase or decrease the following accounts:

(A) Capital Account
(B) Outside Basis

A

Does not affect capital account

Increases/decreases outside basis.

89
Q

What does a partner’s “capital account” measure?

A

The partner’s “capital account” measures the partner’s equity investment in the partnership.

90
Q

What does a partner’s “outside basis” measure?

A

The “outside basis” measures the adjusted basis of the partner’s partnership interest.

Tax 2 (12 decks)

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