Taxes: Chap 10 Partnership taxation

At Risk Limitations

Partners cannot deduct losses from activities in excess of their investment - losses limited to amounts at risk (AAR) in those activities A "nonrecourse liability" is a debt for which the borrower is not personally liable and doesn't count towards AAR "Encumbered property" is the property pledged for a liability and the adjusted basis is includable in AAR (only if partner is personally liable for repayment of debt) -Taxpayers are at-risk for an amount equal to Cash and property contributed to partnership + Liabilities on encumbered properties (recourse debt) + Liabilities for which taxpayer is personally liable (recourse debt) + Retained profits in activity -Taxpayer allowed a loss deduction allocable to business activity to the extent of: -Income received or accrued from activity without regard to amount at risk or -Taxpayer's amount at risk at the end of the tax year

current distributions

Partnerships may make distributions of money or other property to partners - A current distribution is one that does not completely terminate a partner's interest - No gain is recognized by the partner, unless the partner's basis in partnership has reached zero Then, only the portion of the current distribution that is in excess of partner's basis is taxed

At risk rules and real estate

Real estate acquired before 1987 is not subject to at-risk rules For real estate acquired after 1986, the amount of "qualified nonrecourse financing" is considered to be the amount at risk This is defined as debt secured by real estate and borrowed from person who regularly engages in the lending of money Does not apply to financing from seller or promoter

Partnership Income Reporting

- Partnerships do not pay tax - All information flows through to be reported by the partners - Tax return is due by the 15th of the third month following close of partnership tax year Schedule K-1 shows allocable partnership income/expenses for each partner, based upon the individual ownership percentage - Ordinary income/loss - Special income/deduction items such as charitable deductions, interest, capital gains/losses On the individual partner's tax return the deductible losses from partnership activities are limited to the basis in partnership interest: - Cannot reduce basis below zero - Carry forward any unused losses to subsequent years (when there may be additional basis with which to absorb loss!)

Partnership Formation

When forming a partnership, individuals contribute assets to partnership in exchange for a partnership interest - No gain/loss is usually recognized - Exceptions include: 1. When services are performed in exchange for partnership interest 2. When property is contributed with liabilities in excess of basis, then The contributor must recognize a gain of the portion of the Liabilities Allocable to Other Partners - Adjusted Basis of Property Contributed

Guaranteed payments

Amount that a partner receives for services rendered or use of partner's capital is called a guaranteed payment - Guaranteed payments are made regardless of income/loss situation of partnership - Guaranteed payments are subtracted before partnership taxable income/loss is allocated to partners (so loss can be generated) - Guaranteed payments are taxable ordinary income to partner and deductible by partnership

Form 1099-K

Banks and online payments networks (like PayPal) are required to send 1099-Ks to all merchants with more than $20,000 of sales and more than 200 transactions

Partners basis in partnership interest

Cash contributed + Basis of property transferred to partnership + Gain recognized (from prior screen) - Liabilities allocable to other partners = Partner's initial basis in partnership

Changes in partners interest

Changes occur to partner's basis due to subsequent activities! Beginning Basis + Additional Contributions + Share of Net Ordinary Taxable Income + Share of Capital Gains/Other Income - Distributions of Property or Cash - Share of Net Loss from Operations* - Share of Capital Losses/Other Deductions +/- Increase/Decrease in Liabilities

What form do partners file

Form 1065 -Partnership itself does not pay tax; rather, income/expenses 'flow through' to partners -Partnership income taxable to partner, even if he/she does not receive cash!!

Transactions between partners

Generally, transactions between partners and the partnership are not regarded as related party transactions However, if a partner with more than 50% direct or indirect ownership* sells assets to the partnership (or two partnerships with > 50% ownership by same partners engage in a transaction) And a gain results: it is taxed as ordinary income And a loss results: the loss is disallowed and any gain on future sale of asset by the partnership is reduced by the deferred loss

Tax Years and Partnerships

IRS establishes rigid rules pertaining to tax years as follows: - Unless it can show bona fide business purpose for adopting another fiscal year-end, the partnership must adopt the same tax year as the majority of the partners - If this is not possible, it must adopt same tax year as majority of the principal partners - If neither of these work, partnership must use the least aggregate deferral method See IRS Publication 538 for more information

LLC's

Limited Liability Companies (LLCs) have attributes of both partnerships and corporations Advantages of LLCs are numerous Taxable income/loss passes through to owners No general partner requirement Owners can participate in management Owners have limited liability LLC ownership interest is not a security (helps avoid many legal/accounting reporting requirements). Tax attributes pass through to owners Offer greater tax flexibility than S corporations (single member LLCs are very common) Disadvantages of LLCs Because of newness, limited amount of case law dealing with limited liability companies States are not uniform in treatment of LLCs, so potential for confusion if LLC is operating in more than one state Single member LLCs are treated as a disregarded entity for tax purposes (directly reported on member's Schedule C, not on a Form 1065)