Topic 5 & 6 (Tax Treatment for Partnerships and Special)

Question 1

The term “outside basis” refers to the partnership’s basis in its assets; whereas, the term “inside basis” refers an individual partner’s basis in her partnership interest.

Answer 1

False
The term “outside basis” actually refers to a partner’s basis in her partnership interest, and the term “inside basis” refers to the partnership’s basis in its assets.

Question 2

Partners must generally treat the value of profits interests they receive in exchange for services as ordinary income.

Answer 2

False
Partners must treat the value of capital interests they receive in exchange for services as ordinary income. Because there is no immediate liquidation value associated with a profits interest, the partner providing the services will not recognize income.

Question 3

Tax elections are rarely made at the partnership level.

Answer 3

False
In formulating partnership tax law, Congress adopted an entity and aggregate approach. Most tax elections for a partnership are made at the partnership level. The requirement that partnerships make most tax elections represents the entity concept.

Question 4

The least aggregate deferral test uses the profit percentage of each partner to determine the minimum amount of tax deferral for the partner group as a whole in determining the permissible tax year-end of a partnership.

Answer 4

True

Question 5

Gerald received a one-third capital and profit (loss) interest in XYZ Limited Partnership (LP). In exchange for this interest, Gerald contributed a building with a FMV of $30,000. His adjusted basis in the building was $15,000. In addition, the building was encumbered with a $9,000 nonrecourse mortgage that XYZ, LP assumed at the time the property was contributed. What is Gerald’s outside basis immediately after his contribution?

1. $6,000.
2. $9,000
3. $21,000.
4. $24,000.

Answer 5

$9,000
A partner’s outside basis consists of the basis of the contributed property less any debt relief the property received plus the portion of debt the partner assumes based upon the partner’s interest in the partnership. In this case, the nonrecourse mortgage is allocated to the partners strictly according to their profit sharing ratios because the mortgage does not exceed the basis in the contributed property. [$15,000 − $9,000 + ($9,000 × 33%)].

Question 6

Under general circumstances, debt is allocated from the partnership to each partner in the following manner:

1. Recourse - profit sharing ratios; nonrecourse - profit sharing ratios.
2. Recourse - capital ratios; nonrecourse - capital ratios.
3. Recourse - to partners with the ultimate responsibility for paying the debt; nonrecourse - profit sharing ratios.
4. Recourse - profit sharing ratios; nonrecourse - to partners with the ultimate responsibility for paying the debt.

Answer 6

Recourse - to partners with the ultimate responsibility for paying the debt; nonrecourse - profit sharing ratios.
Partners are allocated any debt the partner is personally responsible for. This method corresponds with the economic risk of loss concept. If none of the partners is personally responsible for the debt, then the partnership will allocate this debt according to profit sharing ratios found in the partnership agreement.

Question 7

Which of the following statements regarding capital and profit interests received for services contributed to a partnership is false?

1. The holding period of a capital or profits interest begins on the date the interest is received.
2. Partners receiving capital interests must recognize the liquidation value of their capital interests as capital gain.
3. Partners receiving only profits interests generally don’t recognize income when the profits interest is received.
4. Partners receiving only profits interests include their share of partnership debt in the tax basis of their partnership interest.

Answer 7

Partners receiving capital interests must recognize the liquidation value of their capital interests as capital gain.
Partners receiving capital interests must recognize the liquidation value of these interests as ordinary income.

Question 8

In what order should the tests to determine a partnership’s year end be applied?

1. majority interest taxable year - least aggregate deferral - principal partners test.
2. principal partners test - majority interest taxable year - least aggregate deferral.
3. principal partners test - least aggregate deferral - majority interest taxable year.
4. majority interest taxable year - principal partners test - least aggregate deferral.

Answer 8

majority interest taxable year - principal partners test - least aggregate deferral.
A partnership should consider three tests in the following order to determine its appropriate year end: 1st - majority interest taxable year, 2nd - principal partners test, and 3rd - least aggregate deferral.

Question 9

What is the rationale for the specific rules partnerships must follow in determining a partnership’s taxable year-end?

1. To increase the amount of aggregate tax deferral partners receive.
2. To minimize the amount of aggregate tax deferral partners receive.
3. To align the year-end of the partnership with the year-end of a majority of the partners.
4. To spread the workload of tax practitioners more evenly over the year.
5. Both to minimize the amount of aggregate tax deferral partners receive and to align the year-end of the partnership with the year-end of a majority of the partners.

Answer 9

Both to minimize the amount of aggregate tax deferral partners receive and to align the year-end of the partnership with the year-end of a majority of the partners.