Chapter 20: Forming and Operating Partnerships

Recourse

___ debt - Allocate to partners ultimately responsible E.g, payables (unsecured)

Nonrecourse

___ debt -Allocate according to profit-sharing ratios e.g., mortgages (secured)

None

What if: Suppose Chanzz Inc. contributed equipment with a fair market value of $120,000 and a tax basis of $220,000 to CCS. What amount of the gain or loss would Chanzz Inc. recognize on the contribution? Answer: ___. Chanzz Inc. would not recognize any of the $100,000 built-in loss on the equipment. However, if Chanzz Inc. sold the property to an unrelated party and contributed $120,000 in cash instead of the equipment, it could recognize the $100,000 built-in tax loss. If, for some reason, the equipment Chanzz planned to contribute was uniquely suited to CCS's operations, Chanzz could obtain the same result by selling the equipment to Sarah, who would then contribute the equipment to CCS rather than her planned $120,000 cash contribution.

entity, aggregate

When Congress adopted Subchapter K in 1954, it had to decide whether to follow an ___ approach and treat tax partnerships as entities separate from their partners, or to apply an ____ approach and treat partnerships simply as an aggregation of the partners' separate interests in the assets and liabilities of the partnership.

partnership interest, economic rights

When a partnership is formed, and afterwards, partners may transfer cash, other tangible or intangible property, and services to it in exchange for an equity interest called a ___ ___. Partnership interests represent the bundle of ___ ___ granted to partners under the partnership agreement (or operating agreement for an LLC)

capital asset, acquired

Because a partnership interest is a ___ ___, its holding period determines whether gains or losses from the disposition of the partnership interest are short-term or long-term capital gains or losses. The length of a partner's holding period for a partnership interest acquired by contributing property depends on the nature of the assets the partner contributed. When partners contribute capital assets or §1231 assets (assets used in a trade or business and held for more than one year), the holding period of the contributed property "tacks on" to the partnership interest.20 Otherwise, it begins on the day the partnership interest is ___.

capital account

Besides satisfying bookkeeping requirements, a partnership's tax basis balance sheet can provide useful tax-related information. For example, we can calculate each partner's share of the inside basis of partnership assets by adding the partner's share of debt to her ___ ___

ordinary business

Calculate and characterize a partnership's ___ ___ income or loss and its separately stated items, and demonstrate how to report these items to partners.

formation, no gain, loss, services, exceeds

Contributions of Property Tax consequences reflect underlying rationale for corporate ___ General rule - ___ ___ or ___ for partner or partnership Exceptions to general rule for: Contribution of ___ and Debt relief ___ tax basis in partnership interest [later]

entity level, allocated, once

Income earned by flow-through entities is usually not taxed at the ___ ___. Instead, the owners of flow-through entities are taxed on the share of entity-level income ___ to them. Thus, unlike income earned by C corporations, income from flow-though entities is taxed only ___—when it "flows through" to owners of these entities

property, services

It is quite common for partners contributing ___ to receive both capital and profits interests in the exchange. Partners who contribute ___ instead of property frequently receive only profits interests. The distinction between capital and profits interests is important because the tax rules for partnerships are sometimes applied to them differently.

carries over

Like the adjusted basis of contributed property, the holding period of contributed assets also ___ ___ to the partnership

taxed, entity, aggregate

Determine whether a flow-through entity is ___ as a partnership or S corporation, and distinguish the ___ approach from the ___ approach for taxing partnerships.

debt, equivalent

Determining a partner's initial tax basis in a partnership interest acquired by contributing property and/or cash is relatively straightforward if the partnership doesn't have any ___. Partners will simply have a basis in their partnership interest ___ to the tax basis of the property and cash they contributed

importance, adjustments

Explain the ___ of a partner's tax basis and the ___ that affect it

without

From a practical perspective, the tax rules in this area allow entrepreneurs to organize their businesses ___ having to pay taxes.

profit-sharing ratio

Nonrecourse - allocated according to partners' ___ ___ ___.

mortgages, profit-sharing ratios

Nonrecourse debts, in contrast, don't provide creditors the same level of legal recourse against partners. Nonrecourse debts such as ___ are typically secured by real property and only give lenders the right to obtain the secured property in the event the partnership defaults on the debt. Because partners are responsible for paying nonrecourse debts only to the extent the partnership generates sufficient profits, such debts are generally allocated according to partners' ___ ___ ___.

not, allocated

Overview Flow-though entity is ___ taxed at entity level Owners are taxed on share of entity-level income ___

gain, loss, contributed property, type

PROPERTY CONTRIBUTIONS Partners don't generally recognize ___ or ___ when they contribute property to partnerships. Initial tax basis for partners contributing property = basis of ___ ___ − debt securing contributed property + partnership debt allocated to contributing partner + gain recognized. Contributing partner's holding period in a partnership interest depends on the ___ of property contributed.

increase, decrease, negative

Partner's Basis Adjustments A partner will ___ the tax basis in her partnership interest for: Contributions Share of ordinary business income Separately stated income/gain items Tax-exempt income A partner will ___ the tax basis in her partnership interest for: Cash distributions Share of nondeductible expenses Share of ordinary business loss Separately stated expense/loss items A partner's tax basis may not be ____.

partnership, debt, equals, type

Partner's Outside Tax Basis Outside basis refers to partner's tax basis in ___ interest If no partnership ___, outside basis ___ basis of property contributed If partnership has debt, impact on basis depends on ___ of debt: 1.) Recourse debt 2.) Nonrecourse debt

assets, contributed property

Partnership's Inside Tax Basis Inside basis refers to partnership's basis in its ___ Equals contributing partner's basis in ___ ___.

differs

Partnerships may have either recourse debt or nonrecourse debt or both, and the specific approach to allocating partnership debt to individual partners ___ for each.

partners

Recourse - Allocated to ___ with ultimate responsibility for paying debt

economic, own funds, payables, responsible

Recourse debts are those for which partners have ___ risk of loss—that is, they may have to legally satisfy the debt with their ___ ___. For example, the unsecured debts of general partnerships, such as ___, are recourse debt because general partners are legally ___ for the debts of the partnership. Recourse debt is usually allocated to the partners who will ultimately be responsible for paying it. The partners must consider their partner guarantees, other agreements, and state partnership or LLC statutes in making this determination.

reducing

Relief of debt is treated as cash distribution from partnership ___ partner's outside basis

taxpaying, 1065, K-1, separately, differ

Reporting Partnership Operations Not ___ entities (must file information return only) Form ___ and Schedule ___ Required to ___ state special items for allocation to partners Separately stated if item could cause any partner's income tax liability to ___ from the liability computed if the partner did not separately account for it e.g., net capital gains (losses), charitable contributions, dividends, etc.

formations, recognition, tax basis

Resolve tax issues applicable to partnership ___ and other acquisitions of partnership interests, including gain ___ to partners and ___ ___ for partners and partnerships

legal

The fundamental difference between the two types of debt lies in the ___ responsibility partners assume for ultimately paying the debt

gains, losses

The general rule facilitates contributions of property with built-in ___ (fair market value is greater than tax basis) but discourages contributions of property with built-in ___ (fair market value is less than tax basis). In fact, partners holding property with built-in losses are usually better off selling the property, recognizing the related tax loss, and contributing the cash from the sale to the partnership so it can acquire property elsewhere.

protected

The legal structure of entities taxed as partnerships also influences the way partners characterize and allocate partnership debt. Recourse debts in limited partnerships are typically allocated only to general partners, because, as we discuss in Chapter 15, limited partners are legally ___ from a limited partnership's recourse debt holders.

defer realized gains

The rationale for permitting taxpayers to ___ ___ ___ or losses on property contributed to partnerships is identical to the rationale for permitting tax deferral when corporations are formed

share, net assets, capital, profits

These rights include the right to receive a ___ of the partnership ___ ___ if the partnership were to liquidate, called a ___ interest, and the right or obligation to receive a share of future profits or future losses, called a ___ interest.

services

This applies to property contributions when a partnership is initially formed and to subsequent property contributions. In this context, the term property is defined broadly to include a wide variety of both tangible and intangible assets but not ___.

gains, losses, deferred

This rule ensures that realized ___ and ___ on contributed property are merely ___ until either the contributing partner sells her partnership interest or the partnership sells the contributed property.

equal

To ensure built-in gains and losses on contributed property are ultimately recognized if partnerships sell contributed property, partnerships generally take a basis in the property ___ to the contributing partner's basis in the property at the time of the contribution

general partnerships, limited partnerships, limited liability companies

Unincorporated business entities such as ___ ___, ___ ___, and ___ ___ ___ (LLC) are generally treated as partnerships under the rules provided in Subchapter K of the Internal Revenue Code

long-term

What if: Assume Nicole contributed land (no cash) that she had held for five years in exchange for her partnership interest. One month after contributing the property, she sold her partnership interest and recognized a capital gain. Is the gain long-term or short-term? Answer: The gain is ___ ___ because the five-year holding period of the land is tacked on to Nicole's holding period for her partnership interest. She is treated as though she held the partnership interest for five years and one month at the time she sold it.

20000

What if: Assume Nicole contributed land with a fair market value of $120,000 and an adjusted basis of $20,000 and CCS had no liabilities. What is Nicole's initial tax basis in CCS? Answer: Nicole's basis is $___, the basis of the property she contributed to CCS. If Nicole immediately sold her interest in CCS for $120,000 (the value of the land she contributed), she would recognize gain of $100,000—exactly the amount she would have recognized if she had sold the land instead of contributing it to CCS.

None, built-in gain

What if: Assume Nicole contributes land to CCS with a fair market value of $120,000 and an adjusted basis of $20,000. What amount of gain or loss would she recognize on the contribution? Answer: ___. Under the general rule for contributions of appreciated property, Nicole will not recognize any of the $100,000 ___ __ ___ from her land

120000

What if: Assume that Sarah contributed $120,000 in cash to CCS in exchange for her partnership interest and that CCS had no liabilities. What is Sarah's outside basis in her partnership interest after the contribution? Answer: Sarah's basis is $____, the amount of cash she contributed to CCS.

140000

What if: Assuming the $60,000 bank loan is CCS's only debt, what is Sarah's initial basis in her CCS interest after taking her share of CCS's bank debt into account? Answer: Sarah's basis is $___ ($120,000 + $20,000) and consists of her cash contribution plus her share of CCS's $60,000 bank loan.

debt of the partner, cash distribution

Another step is needed to determine a partner's outside basis when the partnership assumes ___ ___ ___ ___ secured by property the partner contributes to the partnership. Essentially, the contributing partner must treat her debt relief as a deemed ___ ___ from the partnership that reduces her outside basis.

contribute property

As a general rule, neither partnerships nor partners recognize gain or loss when they ___ ___ to partnerships

increasing

Assumption of debt (or other increase in partner's share of partnership debt) is treated as cash contribution to partnership ___ partner's outside basis

don't pay, aggregate

In the end, Congress decided to apply both concepts in formulating partnership tax law. For instance, one of the most basic tenets of partnership tax law—that partnerships ___ ___ taxes—reflects the ___ approach.

flow-through entity

In this chapter, we review the options for operating a business with multiple owners as a ___ ___ ___.

excess, allocated solely, recognized

Amount of nonrecourse debt (secured by property) in ___ of basis of contributed property is ___ ___ to contributing partner; remaining debt allocated to partners per profit-sharing ratios If deemed cash distribution exceeds contributing partner's outside tax basis in partnership interest prior to distribution, gain is ___

distributions, nondeductible expenses, loss, expense/loss

A partner will decrease the tax basis in her partnership interest for: Cash ___ Share of ___ ___ Share of ordinary business ___ Separately stated ___ ___ items.

Contributions, ordinary, separately, tax-exempt

A partner will increase the tax basis in her partnership interest for : ____ Share of ___ business income. ___ stated income/gain items. ___ ___ income.

outside, inside

A partner's tax basis in her partnership interest is her ___ basis. In contrast, the partnership's basis in its assets is its ___ basis.

negative

A partner's tax basis may not be ___.

only if, exceeds, tax basis

Although in many instances partners don't recognize gains on property contributions, there is an important exception to the general rule that may apply when property secured by debt is contributed to a partnership. In these situations, the contributing partner recognizes gain ___ ___ the cash deemed to have been received from a partnership distribution ___ the contributing partner's ___ ___ in her partnership interest prior to the deemed distribution. Any gain recognized is generally treated as capital gain

entity

However, Congress also adopted other partnership tax rules that fall more squarely on the side of the entity approach. For example, the requirement that partnerships, rather than partners, make most tax elections represents the ___ concept.

in excess of the basis

If the debt securing the contributed property is nonrecourse debt, the amount of the debt ___ ___ ___ ___ ___ of the contributed property is allocated solely to the contributing partner, and the remaining debt is allocated to all partners according to their profit-sharing ratios

aggregate

In addition, these rules follow the ___ theory of partnership taxation because they recognize that partners contributing property to a partnership still own the contributed property, albeit a smaller percentage, since other partners will also indirectly own the contributed property through their partnership interests.

Subchapter S

In contrast, corporations whose owners elect to treat them as flow-through entities are classified as such under the rules in ___ ___. These corporations are called S Corporations.

character

In fact, the only tax attribute of contributed property that doesn't carry over to the partnership is the ___ of contributed property. Whether gains or losses on dispositions of contributed property are capital or ordinary usually depends on the manner in which the partnership uses contributed property

20000

In reality, Sarah and Chanzz Inc. initially each contributed $120,000 and CCS borrowed $60,000 from a bank when CCS was formed. The bank required Nicole, Sarah, and Chanzz Inc. to personally guarantee the bank loan. The terms were structured so the members would each be responsible for a portion of the debt equal to the percentage of CCS losses allocated to each member (one-third Page 20-6each) and would have no right of reimbursement from either CCS or the other members of CCS. How much of the $60,000 bank debt was allocated to each member? Answer: Each member was allocated $____. The debt is treated as recourse debt because the members are personally guaranteeing it. Because each guarantees one-third of the debt, the $60,000 debt is allocated equally among them.

organization costs, syndication, start-up

When partnerships are formed, they typically incur some costs that must be capitalized rather than expensed for tax purposes, because they will benefit the partnership over its entire lifespan. This category of expenses includes ___ ___ associated with legally forming a partnership (such as attorneys' and accountants' fees), syndication costs to promote and sell partnership interests, and start-up costs that would normally be deducted as operating expenses except that they are incurred before the start of active trade or business. However, with the exception of syndication costs,33 which are not Page 20-13deductible, the partnership may elect to amortize these costs. Chapter 10 provides additional detail about immediately expensing or amortizing business organization and start-up costs.

debt, share

When partnerships have ___, a few additional steps are required to determine a partner's tax basis in her partnership interest. First, each partner must include her ___ of the partnership's debt in calculating the tax basis in her partnership interest because partnership tax law treats each partner as borrowing her proportionate share of the partnership's debt and then contributing the borrowed cash to acquire her partnership interest. You can understand the necessity for this basis increase by recalling that the basis of any purchased asset increases by the amount of any borrowed funds used to purchase it.