TAX FINAL - chapters 9 and 10

interest in a partnership

1. capital interests - partner's interest in the assets of the partnership 2. profits (and loss) interest - partner's interest in the earnings of the partnership a partner's profit and loss interest may be different than their capital interest capital interest received in exchange for services is taxable as value is readily determinable special allocation - pre-contribution gains or losses are allocated to the contributing partner on subsequent disposition

termination of a partnership

1. no business operated as partnership - to avoid termination, a partnership must maintain both partners and business activity 2. sale or exchange of at least a 50% interest - a partnership terminates if there is a sale or exchange of at least 50% of the total capital and profits interests within a 12-month period

effects of termination of a partnership

1. tax year is closed: partners include their share earnings for the short-period 2. pro rata liquidating distribution deemed to have been made to all partners, resulting in gain or loss by partners (basis of assets deemed distributed must be adjusted) 3. if business continues, a deemed contribution of property to the new partnership follows the deemed distribution 4. new elections must be made (period, methods)

751 "hot assets"

751 assets are property that is likely to generate ordinary income when sold or collected 1. unrealized receivables are certain rights to payments to be received by a partnership that have not already been recognized as income, including most potential OI recapture items 2. inventory - a. items held for sale in the normal course of business, b. other property that is not a capital or 1231 asset to the partnership, and c. property that, in the hands of the distributee partner, is inventory or not 1231 or capital asset put simply, cash, capital assets and 1231 assets are the only non-inventory property

publicly traded partnerships

taxed as corporations partnership whose interests are either traded on an established securities exchange or are traded on a secondary market or the equivalent thereof

organizational expenditures

the costs of organizing a partnership are treated as capital expenditures; partnership can elect to deduct the first $5000 of these expenditures in the tax year it begins business, reduced by the amount by which total organizational expenditures exceed $50,000, but not below $0 any remaining organizational expenditures are amortized over a period of 180 months beginning the month the partnership commences business

overview of partnerships

not a tax-paying entity; each partner reports their share of partnership income, gain, loss, deduction and credit on her own tax return; partner's basis in partnership is increased by their share of partnerships income and decreased by their share of loss. distributions from partnership are generally non-taxable because they have already been taxed; distributions reduce partner's basis and thus represent a return of capital; basis can never be negative; any distribution in excess of the basis is taxable gain

liquidating distribution

one or a series of distributions that terminates a partner's entire interest in the partnership; gain is recognized only if the money distributed exceeds the partner's pre-distribution outside basis loss recognized only if: 1. distribution consists of money, unrealized receivables, and inventory, but no other property AND 2. partner's outside basis exceeds the total basis of these distributed properties liability relief is deemed cash payment partnership recognizes no gain or loss on a liquidating distribution to its partners

sale of a partnership interest

partner recognizes capital gain or loss as if corporate stock were sold; upon sale, partner is relieved of her share of partnership liabilities amount realized includes the seller's share of the partnership liabilities assumed by the purchaser generally, sale of interest has no effect on partnership unless partnership is terminated, infra

contribution of services - compensation income

partner who receives a partnership interest in exchange for services has been compensated and recognizes ordinary income service partner's basis in her partnership interest is increased by the amount of income recognized for services (FMV of interest received)

retirement or death of a partner

typically, a partner or deceased partner's assignee transfers the interest to the partnership in exchange for payments a. payments of property - arm's length valuation; taxed under the liquidating distribution rules except unrealized receivables and certain goodwill are taxed as OI; property payments are not deductible by the P'ship b. other payments - payments made to a retiring partner or to a deceased partner's successor in excess of the value of the partner's share of partnership property are taxed either as a distributive share (payment is a function of partnership income) or a guaranteed payment (payment is determined without regard to partnership income); guaranteed payment is OI and deductible by p'ship

mergers/consolidations

when two or more partnerships merge, an old partnership, whose partners own more than 50% of the profits and capital interests of the new partnership, is considered to be continued as the new partnership the new partnership continues with the tax year and accounting methods and elections of the old partnership all the other old partnerships are considered terminated when two or more partnerships meet the more than 50% of profits and capital interests requirement, the partnership that is considered contributing the greater dollar value of assets to the new partnership is considered the continuing partnership if no partnership contributed the requisite amount, all of the partnerships terminate and the new entity can make its own tax year and accounting method elections

basis effects of nonliquidating distribution

partner's basis in property distributed by the partnership carries over from the partnership partner's outside basis is reduced by the amount of money received and basis claimed of distributed property, but not below zero total basis of all distributed property in the partner's hands are limited to the partner's pre-distribution basis in his partnership interest plus G recognized partner's outside basis and partnership's inside basis of pre-contributed property, infra, is increased immediately before the distribution by the amount of gain recognized by parter (increased inside basis carries over to recipient partner) HP tacks

outside basis

partner's initial basis in her partnership interest equals: carryover basis from money or property contributed - liabilities assumed by partnership + liabilities assumed by the partner if interest is purchased, basis is purchase price if inherited, FMV on date of death or AVD if received by gift, basis is generally donor's basis increased by the portion of any gift tax paid by the donor that relates to appreciation in the partnership interest

at-risk loss limitations

partnership losses that can be taken as deductions are limited to the at-risk basis at-risk basis is essentially the same amount as the regular partnership basis with the exception that liabilities increase the at-risk basis only if the partner is at-risk with respect to the amount

754 election

partnership may elect adjustment to its inside basis only with respect to the new partner; if substantial built-in loss in partnership assets and partnership interest is sold, basis adjustment may be mandatory

contribution of services - recognition

partnership recognizes G/L in the proportionate share of assets deemed to be transferred to the service partner; basis in each asset having G/L will be adjusted up or down by the amount G/L recognized

inside basis

partnership's initial basis in contributed property is: partner's basis in the property contributed + any gain recognized by the partner on formation

electing large partnerships

partnerships that qualify as "large partnerships" may elect to be taxed under a simplified reporting arrangement cannot be a partnership that performs professional services

contribution of services - corresponding deduction

payments for services made by the partnership in the form of a partnership interest are generally deductible as an expense matching - timing of the partnership's expense deduction matches partner's inclusion allocation - deduction is allocated among the partners other than the service partner

444 election

permits partnership to use a year-end that results in a deferral period not to exceed 3 months requires payment that has effect of assessing deferred income at highest individual rate plus 1%

exception to 751 "hot assets"

portion of the gain recognized on the sale or exchange of a partnership interest attributable to "unrealized receivables" or "inventory" will be taxed as ordinary income; hypothetical sale of partner's interest in partnership assets; three step process; amount realize includes liability relief

substantial effect

reasonable possibility the allocation will affect the dollar amounts to be received independent of tax consequences; if a special allocation does not alter capital accounts but reduces a partners' total tax liability, then shifting occurs and there is no substantial economic effect

precontribution gain or loss

recognized if within seven years of the contribution date: 1. contributed property is distributed to any partner (other than contributing partner); recognize basis as if property sold for FMV (AR over inside basis) OR 2. contributing partner receives a distribution with a FMV in excess of his adjusted basis in his partnership interest; G recognized is the lesser of remaining pre-contribution gain or amount FMV is in excess of partner's outside basis; character of gain determined by contributed property; partnership increased basis in contributed property by gain recognized by contributing partner

contribution of unrealized receivables

result in ordinary income or loss for partnership on subsequent collection or disposition, regardless of its character in the hands of the partnership

estimated taxes

a partnership pays no income taxes so they partnership makes no estimated tax payments partners must make estimated tax payments based on their separate tax positions including their distributive share of partnership income or loss for the current year

nonliquidating distribution

all other distributions; partners recognize gain only if they receive money in excess of basis; for distribution purposes, money includes cash, deemed cash from reductions in a partner's share of liabilities and the fair market value of marketable securities (liability relief is a deemed cash payment)

holding period of property for partnership

always tack partner's holding period

economic effect

appropriate increase or decrease in capital account capital account represents each partner's equity; generally, FMV of contributions + profits - losses - distributions; maintained using book value (ie not the same as tax basis and can be negative) proceeds on liquidation are distributed according to capital accounts partners must restore any negative balance in capital accounts on liquidation

transactions between a partner and partnerships - sale of property

no loss on the sale or exchange between a partnership and a more than 50% partner (capital or profits interests) gain on sale of capital asset between partnership and controlling partner is ordinary if it is not a capital asset int he buyer's hands

syndication expenditures

capitalized; neither expenses nor amortized

transactions between a partner and partnerships - guaranteed payments

compensation for services and interest payments to partners; generally a partner is not an employee of the partnership, but may work for it in a similar capacity (most fringe benefits are disallowed for partners) distinct from distributive share guaranteed payments are ordinary income to the recipient partnership treats payments as if made to third-party

754 basis adjustments

context: 1. new partner purchases a partnership interest and takes an outside basis equal to the cost + liabilities assumed 2. this basis may be different from the partner's share of partnership assets and liabilities 3. as a result, timing and character of future gains from partnership may be affected

reporting of income

each partner reports their distributive share of income 1. separately stated items - if item has the potential to receive different tax treatment at the partner level, it must be passed through separately 2. ordinary income (loss) - all items that are not separately stated are combined into a single amount called partnership ordinary income or loss

compliance

form 1065 is due the fifteenth day of the third month after tax year end; automatic six-month extension for time to file using form 7004

contribution of inventory

gain or loss from sale of contributed inventory is ordinary for five years beginning on the date of contribution, regardless of its character for the partnership

passive activity limitations

generally, losses of a non-corporate partner from a passive activity cannot be used to offset either active income or portfolio income

contribution of property

generally, no gain or loss is recognized by the partner or the partnership when property (not services) is exchanged for a partnership interest. exceptions: contribution of property followed by a distribution that resembles a sale; liabilities assumed by partnership are greater than available basis (no negative basis)

varying interest rule

if a partner's ownership interest changes during the year, income or loss allocation takes into account the varying interest on a daily basis

holding period of partner's interest in partnership

if capital asset or 1231 property contributed - tacked otherwise, new holding period starts day after contribution

outside basis increases/decreases

increased by: distributive share of separately stated items and ordinary income (includes tax-exempt income) decreased (but not below zero) by: distributions from the partnership; distributive share of losses (both separately stated items and ordinary loss) - losses in excess of basis are carried forward until partner has positive basis; expenditures that are not deductible for tax purposes and that are not capital expenditures

partnership taxable year

last day of the partnership's taxable year is the day the income, loss, credits, etc flow-through to partner to limit opportunity for tax deferral: 1. use same tax year as those partners who have an aggregate interest in partnership profits and capital in excess of 50% ("majority partners") 2. if not applicable, then tax year of all of its principal partners (5% or more ownership in capital or profits) 3. if no common tax year, then tax year that provides the "least aggregate deferral" is used

special allocations

may be made between partners providing one partner with more or less income, gain, loss or deduction; permitted as long as they have substantial economic effect