EA: Business SU 10.1 Partnership Operations and Partner's Taxable Income
Partnership items of income, gain, deduction, loss, or credit that must be separately stated are:
- Section 1231 gains/losses - Net STCG and net LTCG or loss from the sale or exchange of capital assets - Tax-exempt income and related expenses - Rental activities, portfolio income, and related expenses - Recovery items (eg, prior taxes, bad debts) - Charitable contributions - Foreign income taxes paid or accrued - Depletion on oil and gas wells - Section 179 deductions
Partners' Capital Accounts
A capital account is maintained for each partner at the partnership level. A partner's initial capital account balance is the FMV of the assets (net of liabilities) contributed to the partnership. It is separate from the partner's adjusted basis in their partnership interest.
Recourse liabilities
A liability is a recourse liability if the creditor has a claim against the partnership or any partner for payment if the partnership defaults. Partners generally share recourse liabilities based on their ratio for sharing losses. If property that is subject to recourse debt is cancelled, ordinary income and capital gain/loss can result.
Consistent Treatment Rules
The partner's treatment of partnership items must be consistent with the treatment of that item by the partnership in all respects, including the amount, timing, and characterization of the item. If a partner files a return that is not consistent with the partnership, the partner must inform the IRS of the inconsistency. If the partner has treated a partnership item inconsistently with the partnership and fails to notify the IRS of the inconsistent treatment, the tax attributable to the inconsistent treatment can be directly assessed by the computational adjustment if the computation is purely mathematical. The partner may also be subject to a negligence penalty.
Inheritance
The tax year of a partnership closes with respect to a partner whose entire interest in the partnership terminates, whether by death, liquidation, or otherwise. The partnership tax year does not close with respect to the other partners.
Ordinary Income
This is all taxable items of income, gain, loss, or deduction that are not separately stated. Ordinary income is different from taxable income, which is the sum of all taxable items, including separately stated items and the partnership ordinary income or loss. Ordinary income includes such items such as gross profit, administrative expenses, and employee salaries.
Precontribution Gain or Loss
To the extent of gain not recognized on contribution of property to the partnership, gain or loss subsequently recognized on the sale or exchange of an asset by the partnership must be allocated to the contributing partner. Postcontribution gain or loss is allocated among partners distributive shares, ie, as any gain or loss. Accounting for variation between the property's FMV and adjusted basis immediately before contribution also applies to related deductions. For example, depreciation must be apportioned and allocated. A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. The character of the gain is determined by reference to the character of the net precontribution gain.
Partner's death
When a partner dies, their distributive share of self-employment income is figured through the end of the month in which the death occurs. This is true even though the decedent's estate or heirs may succeed to rights in the partnership. The partnership income (or loss) for the years is treated as though it was earned in equal amounts each month.
Partner's Taxable Income
A partner reports their distributive share of partnership items for the partnership's tax year that ends with or within the partner's tax year. Examples of taxable income include their distributive share of partnership income and separately state items; sale of their partnership interest; and dealings with the partnership (guaranteed payments).
At-Risk Rules
Each partner may deduct only a partnership ordinary loss to the extent they are at risk with respect to the partnership. The amount of a partnership loss currently deductible (up to an amount for which the partnership bears economic risk of loss with respect to each partnership activity) is allocated to partners as a deductible distributive share. Only partnership liabilities for which a partner is personally liable can be considered in a partner's at-risk limit. A limited partner is at risk in the partnership to the extent of contributions and their share of qualified nonrecourse financing, that is, the amount the partner would lose if the partnership suddenly became worthless. Passive activity losses are deductible in the current tax year only to the extent of gains from passive activities (in the aggregate). Partnership ordinary loss is generally passive to a partner unless the partner materially participates in the partnership activity.
QBI Reporting Consistency
Each partner must report their share of items consistently with their treatment on the partnership return, unless the partner identifies inconsistency on a filed statement or the partnership has no more than 10 partners and no estate or nonresident alien is a partner.
Elections by Partners
Elections made on the individual income tax return: deduction or credit of foreign income taxes paid (the amount is limited to the partner's distributive share from the partnership); treatment of mining and exploration expenditures; basis reduction following discharge of indebtedness
Syndication fees
Costs of issuing and marketing partnership interests. Examples are prospectus and preparation costs and commissions on sales of limited partnership interests. These costs are not amortizable. They might alter the amount of gain or loss when the partnership is terminated.
Bipartisan Budget Act of 2015
Created a new centralized partnership audit regime. In general, the audit regime assesses and collects tax at the partnership level rather than from the partners. Therefore, any adjustments, including penalties and interest, uncovered during an audit are paid by the partnership and not the partners individually.
Partnership Taxable Income
Determined the same way as for individuals except that certain deductions are not allowed for a partnership, and other items are required to be separately stated.
Canceled Debt Exclusions from ordinary income
Exclusions: - debt canceled due to a Title 11 bankruptcy case - debt canceled to the extent insolvent - cancellation of qualified farm indebtedness - cancellation of qualified real property business indebtedness The amount excluded reduces certain tax attributes (certain credits and carryover, losses and carryover, basis of assets, etc.) (but not below zero) by the amount excluded.
Gift of Partnership Interest
Generally, no gain is recognized upon the gift. However, if the partnership liabilities allocable to the gifted interest exceed the AB of the partnership interest, the donor must recognize gain. No loss is recognized on the gift. The donee's basis in the interest is the donor's basis after adjustment for the donor's distributive share of partnership items up to the date of the gift. For purposes of computing a loss on a subsequent sale of the interest by the donee, the FMV of the interest immediately prior to the gift is used.
Reporting for QBID
In a partnership, QBI deduction is determined at the partner level. To allow partners to correctly figure the deduction on the partner's Form 1040 return, the partnership must report the following on the partner's Sch. K-1 or separate statement (if multiple trade or businesses): - each trade or business and identify each that is a SSTB - the QBI (eg, income, gain, deduction, and loss) from the partnership's trade or businesses - the W-2 wage totals paid to each employees by each trade or business - the unadjusted basis of all tangible property subject to depreciation and whose depreciable period has not ended. The amount is based on all qualified assets immediately after acquisition - Real Estate Investment Trust dividends and Publicly Traded Partnership income
Adjusted basis in partnership interest equation
Initial basis + subsequent contributions of capital +/- distributive share of partnership taxable income (loss) + separately stated taxable and nontaxable income - separately stated deductible and nondeductible expenditures + increase in allocable share of partnership liabilities - decrease in allocable share of partnership liabilities - current-year excess business interest expense - share of the adjusted basis of charitable property contributions and foreign taxes paid or accrued - distributions from partnership = adjusted basis in partnership interest
Elections by Partnership
Methods of accounting, computing depreciation, installment method election, and expensing intangible drilling and development costs. These elections apply equally amongst all partners; however, no election made by a partnership has any force or effect with respect to any partner's nonpartnership interest.
Penalties on late returns of Small Businesses (Gross Receipts less than $5 million)
Not more than 30 days late: $50 per return/$194,500 max 31 days late - Aug. 1: $110 per return/$556,500 max After Aug. 1 or not at all: $270 per return/$1,113,000 max Intentional disregard: $550 per return/no limitation
Penalties on late returns of Large Businesses (Gross Receipts $5 million+)
Not more than 30 days late: $50 per return/$556,000 max 31 days late - Aug. 1: $110 per return/$1,669,500 max After Aug. 1 or not at all: $270 per return/$3,339,000 max Intentional disregard: $550 per return/no limitation
Contributions to Employee Retirement Accounts
Contributions made by a partnership for its employers under a qualified SEP, SIMPLE IRA, pension, profit sharing plan, annuity plan, or another deferred compensation plan may be deducted subject to limitations. Contributions to an employee's IRA are included in the employee's salaries and wages.
Basis Limit
A partner's distributive share of a partnership ordinary loss is allowable as a deduction to the partner only to the extent of the partner's AB in their interest in the partnership at the end of the year. Excess loss is deductible in a subsequent year in which the AB is greater then zero. To recognize a loss beyond the partner's AB in their interest in the partnership, the distribution must also liquidate the partner's entire interest in the partnership and be made in the form of money, unrealized receivables, or inventory items.
Partner's Distributive Share
A partner's distributive share of any partnership item is allocated by the partnership agreement as long as the allocation has substantial economic effect, which means the allocation is not for tax avoidance. Each partner is taxed on their share of partnership income whether or not it is distributed. The partnership agreement includes modifications up to the partnership return due date (without extensions). If the partnership agreement does not allocate a partnership item or the agreement lacks substantial economic effect, the item must be allocated to partners according to their interests in the partnership.
Organization fees
A partnership on the cash basis of accounting is not allowed a deduction for organization expenses until the expenses are actually paid. Examples are legal fees for drafting partnership agreement, costs of state filings, and cost of required notice publications.
Reporting Requirements of a Partnership
A partnership, as a conduit, is not subject to federal income tax. But it must report information that includes partnership items of income, loss, deduction, and credit to the IRS. Information is filed on Form 1065. A partnership is required to file an initial return for the first year in which it receives income or incurs expenditures treated as deductions for federal income tax purposes. A Schedule K-1 is prepared for each partner and contains the partner's distributive share of partnership income and separately stated items to be reported on the partner's tax return. A partnership return is due (postmark date) on or before the 15th day of the 3rd month following the close of the partnership's tax year.
Partnership Representative
All partnerships must designate a partnership representative who may be partner in the partnership, must have a substantial presence in the US, and has sole authority to act on behalf of the partnership for purposes of the new rules. The partnership representative's exclusive authority also includes acting on the partnership's behalf in all matters involving examination of the partnership's tax return, conducting administrative practice before the IRS, and conducting matters of litigation regarding disputed tax adjustments. A partner other than the designated partnership representative is designated annually on the partnership's tax return, and the effective date is the date of filing the return. A partnership with 100 or fewer qualifying partners may opt out of having a partnership representative. Qualifying partners are individuals, estates of deceased partners, and corporations (C and S corps). If the partnership elects to opt out, the IRS will proceed with an audit of each individual partner.
Deductions
Certain deductions, eg, charitable contributions, are disallowed in computing partnership taxable income. These are items that must be separately stated by the partnership. Each partner may be entitled to a deduction for their distributive share of these items in computing their personal tax liability.
Partnership Cancellation of Debt
If debt is canceled, forgiven, or discharged for less than the amount the taxpayer must pay, the amount of the canceled debt is taxable and the taxpayer must report the canceled debt on the tax return for the year the cancellation occurs. Canceled debt is not taxable if the law specifically allows the taxpayer to exclude it from ordinary income (see exclusions notecard).
Substantial economic effect (partner's distributive share)
Substantial economic effect is present for any allocation that may substantially affect the amount of the partners' shares of total partnership income or loss independently of tax consequences of the allocation.
Adjustments to basis
The basis of a partner's interest in a partnership is adjusted each year for subsequent contributions of capital, partnership taxable income (loss), separately stated items, variations in the partner's share of partnership liabilities, and distributions from the partnership to the partner.
Character
The character of distributive shares of partnership items is generally determined at the partnership level. If the size of a partner's interest in the partnership varies (eg, by sale, purchase, exchange, liquidation) during a partnership tax year, the distributive shares of partnership items must be apportioned on a daily basis. The partnership may change profit and loss ratios up to the date of the return. However, certain items (such as cash-paid interest) must be allocated based on the number of days of ownership.
Nonrecourse liabilities
The creditor has no claim against the partnership or any partners. At most, the creditor has a claim against a particular secured item of partnership property. All partners share in nonrecourse liabilities based on their ratio for sharing profits. If property that is subject to nonrecourse debt, capital gain/loss can result.