Chapter 10: Partnerships- Formation, Operation, and Basis
syndication costs
Incurred in promoting and marketing partnership interests for sale to investors. Examples include legal and accounting fees, printing costs for prospectus and placement documents, and state registration fees. These items are capitalized by the partnership as incurred, with no amortization thereof allowed.
profit and loss sharing ratios
Specified in the partnership agreement and used to determine each partner's allocation of ordinary taxable income and separately stated items. Profits and losses can be shared in different ratios. The ratios can be changed by amending the partnership agreement. § 704(a).
Partnerships are governed by
Subchapter K of Internal Rev Code
guaranteed payment
a payment to a partner for services performed by the partners or for the use of the partner's capital (salary or interest payments of other businesses)- reported as ordinary income
Each partner typically owns both a capital interest and
a profits (loss) interest in the partnership
partnership agreement
a written agreement among all partners, outlines rights and obligations of partners
partnership debt doesn't include
accounts payable of a cash basis partnership
treatment of partners and partnerships traced to two legal concepts
aggregate (conduit) concept, and entity concept
All partnership debt is allocated
among the partners and included in the partner's bases
Partnerships is defined as
an association formed by 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. (person can be individual, trust, estate, corporation, trust, or estate)
disadvantage of partnerships
any general partners may be liable for entity debts. If partnership can operate as LLC or LLP, the owners' liability is minimized. general partners could be structured as LLCs
generally, neither partner or partnership recognizes
any realized g/l arising on contribution of property to a partnership (realized g/l is deferred)
newly formed partnership may adopt either
cash or accrual method of accounting or hybrid of these two methods
ordinary business income
consists of any income or expenses that aren't required to be separately stated
general partnership (GP)
consists of two or more general partners who may participate in management; there are no limited partners. Often used for operating activities and corp join ventures
partner's holding period in the partnership interest
depends on type of contributed assets. (capital and S1231 assets holding period is same as partner's holding period) (cash or noncapital/S1231 assets, holding period in interest starts on date partnership interest is acquired)
Generally a partner can't make an election individually if partner fails to do it. Some exceptions
each partner required to make a specific election for the following tax issues: 1) whether to reduce the basis of depreciable property first when excluding income from discharge of indebtedness 2) whether to claim cost or percentage depletion for oil and gas wells 3) whether to take a deduction or credit for paid to non- US jurisdictions
partnership organizational and startup costs are the same as corps
each type of cost category can be deducted up to $5000 immediately. Excess is amortized over 180 months, beginning with the month in which the partnership begins business. Elected by deducting the proper amts on the tax return
required taxable year rule prevents
excess deferral of tax on the partnership's income
partner isn't treated as an employee for
federal income tax purposes - certain types of partnership income allocated may be considered net earnings from self employment or net investment income
partnership taxable income
flows through to each partner at the end of the partnership's taxable year
cash method may not be adopted by partnership that
has one or more C corp partners or is a tax shelter
Partnership files Form 1065
includes a Schedule K-1 for each partner
partner's taxable income
includes distributive share of partnership income for any partnership taxable yr that ends during the partner's tax year
if using accrual method
income must be reported no later than the date that income would be reported on the partnership's "applicable financial statement" or other similar financial statement
Limited Partnership (LP)
is a partnership with at least one general partner and one more limited partners
partner's capital account
isn't the same as basis. it's an accounting calculation of the partner's ownership in the entity
partnership's interest expense reporting rules
it must be allocated among the partnerships various activities, generally based on how and why the underlying debt arose
separately stated items
items that could differently affect two partners' tax situations
special allocations
items that the partnerships doesn't allocate using profit/loss interests
partnership debt includes any partnership
obligation that creates an asset, results in an expense to the partnership, or results in a nondeductible, noncapitalizable item at the partnership level
partnership measures and reports two kinds of income
ordinary business income and separately stated items
partners report their distributive share of
partner's income or loss on their tax returns and pay any tax due.
partner's capital account measures
partner's share of the net liquidation value of all partnership assets
Recourse debt
partnership debt for which the partnership or at least one of the partners is personally liable (allocated among general partners only)
guaranteed pmt can't be calculated based on
partnership income
for income tax purposes, a partnership is a
tax reporting, rather than a taxpaying entity
partnership return is generally due by
the fifteenth day of the third month following the tax yr. end (Mar 15 for calendar yr. partnership)
Limited Liability Company (LLC)
the owners are a hybrid type of partner. Combines the corp benefit of limited liability for owners with the benefits of partnership taxation, including the single level of tax
partner's initial outside basis generally equals
the partner's basis in contributed assets
when income or gain flows through partner from partnership
the partner's outside basis in the partnership interest is increased
If partnership receives any contributed assets,
the partnership takes a carryover basis (carries over to become the partnership's inside basis in the asset), then the partner takes a substituted basis in partnership interest (partner's basis in contributed asset transfers over to become the partner's outside basis in the partnership interest)
partnerships holding period in assets includes
the period during which the partner owned the asset
the partnership basis rules- an aggregate concept- ensures the partnership's total inside basis in all assets equals
the sum of the outside basis of all partners' partnership interests
partners basis is important for determining
the treatment of distributions from the partnership to the partner and establishing the deductibility of partnership losses
when partner receives fully vested interest in partnership capital in exchange for services
the value of the interest is generally taxable to the partner as ordinary compensation income
disguised sale
transaction appears to be a sale or exchange of property instead of a contribution, S721 can't be used to defer g/l
Limited Liability Partnership (LLP)
treated similarly to a general partnerhsip/ LLP partner isn't personally liable for any malpractice from other partners
economic effect test-
used to ensure there aren't undue tax revenue losses to the Treasury resulted from Partnership manipulation of tax benefits. There are three general requirements
tax shelter
a partnership whose interests have been sold in a registered offering, a partnership in which 35% of the losses are allocated to limited partners, or a partnership with a significant purpose to avoid or evade fed income tax
a partnership is not
a taxable entity
separately stated items
any item with tax attributes that might affect any two partner's tax liabilities in different ways
capital interest is measured by a partner's
capital sharing ratio
types partnerships generally are based on classification of partners:
general partners, limited partners, types of businesses
If no yr. end can be determined under first two rules, the partnership determines a yr under the
least aggregate deferral rule as outlines in the Regulations for S706
partner's tax basis
measures the amt the partner can receive relaive to the partnership interest without paying additional tax
the basis of a partner's interest can never be
negative
Qualified nonrecourse financing
nonrecourse debt secured by real property from a commercial lender unrelated to the borrower.
Partnership Formation and Initial Basis Computation is on page
10-2c
Nonrecourse debt
Debt for which no partner is personally liable (allocated among all partners (in accordance with profit sharing ratios))
operating agreement
In a limited liability company, an agreement in which the members set forth the details of how the business will be managed and operated. (Governing agreement)
(Exceptions to the General Rule of S721) Nonrecognition principles don't apply in situations:
Appreciated stocks are contributed to an investment partnership, transaction is essentially a disguised sale or exchange of properties, partnership interest is received in exchange for services rendered to the partnership by the partner
A partnership isn't allowed to claim the following deductions:
NOLs, Depletion of oil and gas interests, dividends received deductions, deductions taken by individuals
precontribution gain or loss
Partnerships allow for a variety of special allocations of gain or loss among the partners, but gain or loss that is "built in" on an asset contributed to the partnership is assigned specifically to the contributing partner. § 704(c)(1)(A). ---- the difference btwn fmv and basis at the contribution date (for property contributed to a partnership)