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)