M12, Ch 14: Partnerships: Formation and Operation

When is a corporation's income taxed?

A corporation's income is taxed twice: when earned and again when conveyed as a dividend.

General Partner

An owner (partner) who has unlimited liability and is active in managing the firm. [This is Quizlet's definition]

Noncash contributions such as inventory or land are entered into the partnership's accounting records at

Fair value

T/F: LLC partners can lose everything if things go wrong

False. Depends on state law, but owners usually only risk their own investments

Because income is taxable to the partners as the business earns it, any operating losses can be used to ____.

Reduce their personal taxable income directly

Mutual Agency

Right each partner has to incur liabilities in the name of the partnership. The ability of partners in a partnership to commit other partners and the business to a contract.

T/F: A corporation's Paid-in Capital is shown separately from earned capital and OCI 633

True

T/F: partners acting within the normal scope of the business have the power to obligate the company for any amount. If the partnership fails to pay these debts, creditors can seek satisfactory remuneration from any partner that they choose.

True

Advantages of Partnership

Two or more owners Availability of capital and credit Easy to start Income taxed once as personal income Personal interest Combined business skills and knowledge Retention of profits No special taxes Share work and share risks "The principal advantage of partnerships is the ability to make virtually any arrangements defining their relationship to each other that the partners desire. There is no necessity, as there is in a corporation, to have the ownership interest in capital and profits proportionate to the investment made; and losses can be allocated on a different basis from profits" 630

Disadvantages of Partnership

Unlimited liability Management disagreements Lack of continuity Frozen investment

Largest disadvantage of partnership

Unlimited liability that each partner automatically incurs

How many classes of stock can a Sub S Corp have?

1

How many stockholders can a Sub S Corp have?

100

corporation has the ability to carry back any net operating losses and reduce previously taxed income (usually for the ___ prior years) and carry forward remaining losses to decrease future taxable income (for up to ___ years).

2 20

Uniform Partnership Act (UPA)

A model act that codifies partnership law. Most states have adopted the UPA in whole or in part.

Subchapter S Corporation

A type of corporation that is limited to 100 or fewer shareholders, has limited shareholder liability, and requires little financial reporting; taxed as a partnership; also known as an "S" corporation A Subchapter S corporation (often referred to as an S corporation ) is created as a corporation and, therefore, has all of the legal characteristics of that form. According to the U.S. tax laws, if the corporation meets certain regulations, it will be taxed in virtually the same way as a partnership. Thus, the Subchapter S corporation pays no income taxes although any income (and losses) pass directly through to the taxable income of the individual owners. This form avoids double taxation, and the owners do not face unlimited liability. Unless a corporation qualifies as a Subchapter S corporation or some other legal variation, it is referred to as a Subchapter C corporation. Therefore, a vast majority of all businesses are C corporations. 632 Chapter 14 To qualify, the business can have only one class of stock and is limited to 100 stockholders. All owners must be individuals, estates, certain tax-exempt entities, or certain types of trusts. The most significant problem associated with this business form is that its growth potential is limited because of the restriction on the number and type of owners.

The bonus method recognizes only ______. The capital accounts are then aligned to indicate the balances negotiated by the partners. According to the goodwill approach, all contributions (even those of a nebulous nature such as expertise) are ____ and ____, often as goodwill.

Identifiable assets Valued Recorded

The 4 largest accounting firms are [type of partnership]

LLP

LLP vs General Partnership

The limited liability partnership has most of the characteristics of a general partnership except that it significantly reduces the partners' liability

When is a partnership's income taxed?

When business initially earns it

In making a transfer of ownership, a partner can actually convey only three rights

1. The right of co-ownership in the business property. This right justifies the partner's periodic drawings from the business as well as the distribution settlement paid at liquidation or at the time of a partner's withdrawal. 2. The right to share in profits and losses as specified in the articles of partnership. 3. The right to participate in the management of the business.

Limited Liability Company (LLC)

A company similar to an S corporation but without the special eligibility requirements. / Corporation with the benefits of a sole proprietorship, and not many disadvantages. The limited liability company is a new type of organization in the United States although it has long been used in Europe and other areas of the world. It is classified as a partnership for tax purposes. However, depending on state laws, the owners risk only their own investments. In contrast to a Subchapter S corporation, the number of owners is not usually restricted so that growth is easier to accomplish.

In forming a partnership, the partners' contributions need not be limited to tangible assets. A particular line of expertise possessed by a partner and an established clientele are attributes that can have a significant value to a partnership. Two methods of recording this type of investment are found in practice.

The bonus method recognizes only identifiable assets. The capital accounts are then aligned to indicate the balances negotiated by the partners. According to the goodwill approach, all contributions (even those of a nebulous nature such as expertise) are valued and recorded, often as goodwill.

How do partnerships avoid double taxation?

Thus, partnership revenue and expense items (as defined by the tax laws) must be assigned directly each year to the individual partners who pay the income taxes. Passing income balances through to the partners in this manner avoids double taxation of the profits that are earned by a business and then distributed to its owners. A corporation's income is taxed twice: when earned and again when conveyed as a dividend. A partnership's income is taxed only at the time that the business initially earns it.

Limited Partnership (LP)

A partnership in which one or more partners have limited liability as long as at least one partner (the general partner) has unlimited liability. The limited partners are passive investors that cannot take an active role in the firm's management. / partnership in which only one partner is required to be a general partner A limited partnership is a type of investment designed primarily for individuals who want the tax benefits of a partnership but who do not wish to work in a partnership or have unlimited liability. In such organizations, a number of limited partners invest money as owners but are not allowed to participate in the company's management. These partners can still incur a loss on their investment, but the amount is restricted to what has been contributed. To protect the creditors of a limited partnership, one or more general partners must be designated to assume responsibility for all obligations created in the name of the business. Buckeye Partners, L.P. is an example of a limited partnership that trades on the New York Stock Exchange. Buckeye's December 31, 2012, balance sheet reported capital of $2.4 billion for its limited partners. Many limited partnerships were originally formed as tax shelters to create immediate losses (to reduce the taxable income of the partners) with profits spread out into the future. As mentioned earlier, tax laws limit the deduction of passive activity losses, and this significantly reduced the formation of limited partnerships. DO NOT CONFUSE WITH LLPS LP are limited partnerships LLPs are limited liability partnerships

Articles of partnership (partnership agreement)

• Name and address of each partner. • Business location. • Description of the nature of the business. • Rights and responsibilities of each partner. • Initial contribution to be made by each partner and the method to be used for valuation. • Specific method by which profits and losses are to be allocated. • Periodic withdrawal of assets by each partner. • Procedure for admitting new partners. • Method for arbitrating partnership disputes. • Life insurance provisions enabling remaining partners to acquire the interest of any deceased partner. • Method for settling a partner's share in the business upon withdrawal, retirement, or death.

T/F: From an accounting perspective, the assignment of income and the setting of withdrawal limits are two separate decisions.

True

partnership

"an association of two or more persons to carry on a business as coowners for profit." This form of business organization exists throughout the U.S. economy ranging in size from small, part-time operations to international enterprises. The partnership format is popular for many reasons, including the ease of creation and the avoidance of the double taxation that is inherent in corporate ownership. However, the unlimited liability incurred by each general partner normally restricts the growth potential of most partnerships. Thus, although the number of partnerships in the United States is large, the size of each tends to be small.

T/F: Partners in a LP are allowed to participate in company's management

False

T/F: From an accounting perspective, the assignment of income and the setting of withdrawal limits is 1 decision

False. From an accounting perspective, the assignment of income and the setting of withdrawal limits are two separate decisions.

T/F: LLC have restricted number of owners

False. Unless a Sub S Corp, the number of owners isn't usually restricted

T/F: Unless a corporation qualifies as a Subchapter C corporation or some other legal variation, it is referred to as a Subchapter S corporation

False. Unless a corporation qualifies as a Subchapter S corporation or some other legal variation, it is referred to as a Subchapter C corporation. Therefore, a vast majority of all businesses are C corporations

T/F: If a partner retires, dies, or new partners are added, then the existing partnership can go on

False; Over time, changes occur in the makeup of a partnership because of death or retirement or because of the admission of new partners. Such changes dissolve the existing partnership, although the business frequently continues uninterrupted through a newly formed partnership. If, for example, a new partner is admitted by the acquisition of a present interest, the capital balances can simply be reclassified to reflect the change in ownership. As an alternative, the purchase price may be viewed as evidence of the underlying value of the organization as a whole. Based on this calculation, asset and liability balances are adjusted to fair value, and any residual goodwill is recognized.

Bonus Method

The old partnership capital plus the new partner's asset contribution is equal to the new partnership capital. This method records an increase in the partnership's total capital only for the capital amount invested by the new partner, in accordance with GAAP. bonus method - to existing partners (new partner pay more) ; to new partner - to new partner (new partner pay less) bonuses are adjusted between old and new partner's capital accounts and do not affect partnership assets Bonus To be received by New Cap= (Old Partner Capital + New PArtner Capital )/ ratio of interest. Amount to be received - Contributed by New Cap = Bonus If new cap paid more Cash Dr Old Capital Cr Old Capital Cr New Capital Cr If new cap paid less Cash Dr Old Capital Dr Old Capital Dr New Capital Cr The Bonus Method The bonus method assumes that a specialization such as Joyce's artistic abilities does not constitute a recordable partnership asset with a measurable cost. Hence, this approach recognizes only the assets that are physically transferred to the business (such as cash, patents, inventory). Although these contributions determine total partnership capital, the establishment of specific capital balances is viewed as an independent process based solely on the partners' agreement. Because the initial equity figures result from negotiation, they do not need to correspond directly with the individual investments.

Goodwill Method

The old partnership capital plus the new partner's asset contribution is not equal to the new partnership capital. Goodwill is recognized based upon total value of partnership implied by new partner's contribution Compute new net assets before Goodwill after admitting new or paying old partner Implied value = New Cap * ratio of interest (if 1/3, then 3) Total Capital = Old Cap + New Cap Goodwill = Implied - Total Capital Cash Dr ( Same as New Cap) Goodwill Dr (calculation) Old Capital Cr (Ratio) Old Capital Cr (Ratio) New Capital Cr (Same as cash) Based on the assumption that an implied value can be calculated mathematically and recorded for any intangible contribution made by a partner.

T/F: LLCs are classified as partnerships for tax purposes

True

T/F: Partnership law specifies that ANY partner can be held personally liable for ALL debts of the business

True

T/F: The implied value of a partnership as a whole cannot be determined directly from the amount distributed to a withdrawing partner

True

T/F: Unless a corporation qualifies as a Subchapter S corporation or some other legal variation, it is referred to as a Subchapter C corporation. Therefore, a vast majority of all businesses are C corporations

True

T/F:if a corporation is newly formed or has not been profitable, operating losses provide no immediate benefit to a corporation or its owners as losses do for a partnership.

True

Limited Liability Partnerships (LLPs)

partnerships in which all partners in the business are limited partners, giving them the advantage of limited liability for the partnership's debts The limited liability partnership has most of the characteristics of a general partnership except that it significantly reduces the partners' liability. Partners may lose their investment in the business and are responsible for the contractual debts of the business. The advantage here is created in connection with any liability resulting from damages. In such cases, the partners are responsible for only their own acts or omissions plus the acts and omissions of individuals under their supervision. As Section 306(c) of the Uniform Partnership Act notes, An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner. Thus, a partner in the Houston office of a public accounting firm would probably not be held liable for a poor audit performed by that firm's San Francisco office. Not surprisingly, limited liability partnerships have become very popular with professional service organizations that have multiple offices. For example, all of the four largest accounting firms are LLPs