REG 4 - Partnership Taxation

Question 1

Partnership (1065)

Answer 1

An arrangement, which may be formal or informal, in which two or more parties agree to operate a business as co-owners for profit. All partners have unlimited liability.

• Files an Information Tax Return since it is a flow-through entity.
  
  • Form 1065, due 4/15 in a calendar year
  • Automatic 5 month extension
  • Tax yearmust be the same asmajority of partners
• Accounting is similar to S corporations
• Informal creation since all partners have unlimited liability (everything is “at risk”)

Question 2

Partnership Basis

Formation

Answer 2

Accounting is similar to S corporations.

• Cash or Property (not subjected to 80% rule)
  
  • Tax free exchange
  • Carryover basis (NOT FMV)
  • Carryover holding period
    
    • Means the time the partner held the asset is the same time the partnership technically held the asset.
• Services
  
  • Taxable at FMV of services provided

NOTE: Liabilities assumed by the partnership results in an increase in basis for each partner proprtional to their percentage of ownership in the partnership.

Question 3

Basic Partnership Terms:

Outside Basis

Inside Basis

Basis in Asset Received

Guaranteed Payment

Answer 3

• Outside Basis - partner basis in the partnership
  
  • Contributed plus distributions
• Inside Basis - Partnership’s basis in the partner’s asset.
  
  • Only contributed asset
• Basis in Asset Received from P/S distribution
• Guaranteed Payment - Like a salary in an S corp, not based on profit or income.
  
  • Taxable to the partner receiving payment & subject to Self-Emplyement Tax
  • Deductible to P/S as an Ordinary expense.
    
    • NOT separately stated item on the K-schedule, but Separately Stated on the K-1.
  • NOT based on Income, should be for services or use of capital. (NOT based on percentage income profits)

Question 4

Operation of Partnership

Answer 4

Initial Outside Basis

+/- Income/Loss

+ Muni Bond Int

+/- Separately Stated Items

• Distributions rec’d from P/S

+ % of P/S * Liabilities Contributed

• Liabilities contributed to P/S

= Ending Outside Basis

Question 5

Partnership Basis

Inrease & Deacrease

Answer 5

A partner’s basis increases as a result of each of the following:

• Contributions of assets
• Borrowings & other debts incurred by the partnership
• Allocation of partnership income (distributive share) to the partner

A partner’s basis deacrease as a result of each of the following:

• Distributions of assets from the partnership to the partner
• Allocation of partnership losses (distributive share to the partner
• Repayments & other reductions of debts to the partnership

Question 6

Parnership Basis

Property Contribution to Partnership (w/ Liability)

Answer 6

When a partner contributes property, their basis is increased by the partner’s tax basis in the contributed asset.

If an asset being contributed is subject to liability,

• Each partner’s basis is increased based on their individual ownership percentage multiplied by the liability amount that partnership has assumed.
  
  • Increase = % Partnership x Liability Assumed
• The partner, who contributed an asset with a liability, will have a basis equal to the asset, less the liability plus the increase percentage.
  
  • Basis = Asset - Liab + (% P/S x Liab Assumed)

Question 7

Partnership Basis

At 0 or below 0

Answer 7

• A partner’s basis NEVER declines below $0
  
  • Loss reducing basis below $0 is NOT deductible
  • Cash (only) distribution exceeding basis results in a gain for the partner receiving the distribution
  • Contributed asset subject to higher liability results in a capital gain.

Example: Partner gets 20% interest contributing an asset with a basis of $4K & subject to a $6 liability. Results in an $800 captial gain.

Question 8

Partnership - Organizational Costs

Answer 8

A partnership may deduct up to $5K of organizational expenditures for the tax year in which the partnership begins business, with any remaining expenditures deducted ratably over the 180-month period beginning with the month in which the partnership begins business. These expenditures includes:

• Partnership filing fees
• Legal & accounting
• Start-up costs such as training, advertising, testing

NOTE: “Accounting fees to prepare the representations in offering materials” are NOT start-up costs.

Question 9

Separately Stated Items (7)

Answer 9

Items that are reported separately on the tax return of a Partnership (1165) because of their tax treatments, enabling shareholders to each recognize their proportionate share of each item & handle it properly on their tax returns. Any amount that can hit a limit on your individual tax return:

• Capital Gains/Losses (on sale of securities)
  
  • Limit on deductibility of net capital losses, $3K limit
• Charitable Contributions
  
  • Must itemize to deduct/ up to 50% of AGI
• Secton 179 Depreciation Deduction
  
  • Dollar limit on use of election per year
• Section 1231 Gains/Losses
  
  • Classification of net gain as capital
  • Losses only offset capital gains
• Tax Credits (Foreign)
  
  • Limited to tax liability
• Passive Income/Activities (Rents)
  
  • Passive acivity loss limitations, $25K threshold
• Dividends & Interest Income (Portfolio Income)
  
  • Need for investment interest limitation

Question 10

Partnership Distribution

Non-Liquidating

(Cash vs. Property)

Answer 10

A non-liquidating distribution (current distribution) reduces the partner’s basis in the partnership by the tax basis of the distributed asset in the partnership. (FMV of distributed asset is IGNORED)

Non-Liquidating (Current) Distributions: (Cash first, then Prop)

• Cash Distributions
  
  • Record at the dollar amount received
  • Capital Gain if get more than Outside Basis
• Property Distributions
  
  • Record at the lower of Outside or Inside Basis
  • NEVER recognize gain or loss on Property Distribution

Question 11

Partnership Distribution

Liquidating

Answer 11

In a liquidating distribution, a partner’s basis must be reduced to $0 in all cases.

Liquidating Distributions:

• Cash Distributions
  
  • Record at the dollar amount
  • Capital Gain/Loss if get more/less than Outside Basis
• Property Distributions
  
  • ALWAYS record at Outside Basis (reduce to 0)
  • NEVER a gain or loss on Property Distribution

NOTE: If receive both cash & property, do cash first, the remainder is allocated to property.

Question 12

Partnership Termination

(What is the amount realized by the Partner?)

Answer 12

When a partner wishes to sell their interest to another party, the amount realized is the sum of:

• Cash & Property Received
• + Relief from Debt

NOTE: When a partner sells their interest, the amount the buyer is willing to pay is based on the FMV of the assets & liabilities. Therefore, for the partner selling:

• Ordinary Gain/Loss on Inventory/Receivables
  
  • Example: On termination, partner’s basis on A/R is 10, but FMV is 100, the 90 gain will be considered as ordinary.
• Capital Gain for everything else

Question 13

Partnership Termination

(P/S Terminates for Tax Purposes If any of 3 Reasons)

Answer 13

Other than for electing termination for large partnerships (over 100 partners), a Partnership terminates for tax purposes when any of the following occurs:

1. Business & financial operations are discontinued
2. Business is reduced to one partner
3. 50% or more of P/S interests change hands within a 12-month period

Question 14

Limited Liability Company (LLC)

6

Answer 14

Limited Liability Company (LLC)

• Formal Creation
• Greater/Equal than 1 Person
• Limited Liability for contracts & debts up to investment
• Unlimited Liability for malpractice or negligence of the partnership
• Agents/Members
• Taxed as a P/S (or Corp or Sch C)

Question 15

Limited Liability Partnership (LLP)

6

Answer 15

• Formal Creation
• Greater/Equal than 2 people
• Limited Liability for malpractice or negligence of copartners
• Unlimited Liability for contracts & debts of the LLP
• Agents
• Taxed as a P/S (or Corp)

Question 16

Liquidating Distribution

Gain or Not?

Answer 16

Correct! When a partner receives a liquidating distribution, the partner only recognizes gain to the extent that the cash received exceeds the partner’s basis in the partnership. Hoben does not receive any cash, so Hoben does not recognize any gain or loss.

Question 17

Liquidating Distribution

Answer 17

Correct! In a liquidating distribution, the total basis of the distributed assets is always equal to the partner’s basis in the partnership before the distribution. However, if both cash and property are distributed, the cash reduces the partner’s basis first.

Correct! When a partner receives a liquidating distribution, the partner only recognizes gain to the extent that money received exceeds the partner’s basis in the partnership. Baker does not receive any cash, so Baker does not recognize any gain or loss.

Question 18

Built-in Gain

Answer 18

Correct! Acre contributed appreciated property (the FMV of the property is greater than the tax basis), resulting in a “built in gain” of $40,000 ($100,000 FMV- $60,000 tax basis). This built-in gain of $40,000 will be allocated to Acre, since he contributed the built in gain property to the partnership, and the remaining $60,000 gain ($160,000 selling price less the $60,000 of tax basis) will be recognized by the partnership and allocated to all partners in proportion to their equitable shares in the partnership.

Question 19

Curry’s sale of her partnership interest causes a partnership termination. The partnership’s business and financial operations are continued by the other members. What is (are) the effect(s) of the termination?

I. There is a deemed distribution of assets to the remaining partners and the purchaser.

II. There is a hypothetical recontribution of assets to a new partnership.

Answer 19

Correct! When a partnership terminates for tax purposes, but the business continues, it is treated as a total distribution of the assets to the partners followed by a recontribution of all the assets to a new partnership.

Question 20

Section 444 of the Internal Revenue Code

Selecting a Tax Year

Answer 20

Correct! When a partnership is given permission to elect a tax year other than the generally required one, the Internal Revenue Code limits the choice of alternative year-end to the three months preceding the generally required one (or no greater than the 3 months preceeding). General and limited partnerships may be granted permission for the alternative year-end, the structure of the partnership is not important, and the number of partners is not a bar to electing an alternative year-end.