Partnerships - 27% Of the exam

Formation of a partnership requires legal documentation filed with the Secretary of State.

False

Financial Accounting Income

Financial accounting income includes all of a​ company's financial transactions. This​ "book" income reflects all​ income, expenses, gains and losses.

Liquidating Distribution

Gain: Only to the extent cash is received. Loss: Only if money, unrealized receivables, or inventory are received and if the basis of the assets received is less than his adjusted basis.

General Partners

General partners can participate in management and have joint and several liability for the partnerships debts. Unlimited Liability. All partnerships must have at least one general partner.

Proportionate Non Liquidating Distribution

In general, neither partner nor partnership recognizes gain or loss on proportionate non liquidating distributions. The partner usually takes a carryover basis in assets distributed Their basis in the partnership is reduced by amount of cash and basis of property distributed In some circumstances the partner may recognize a gain to extent cash received exceeds their basis (outside basis) in partnership

Individual A joins a partnership and contributes a piece of land with a fair market value of $40,000 to the partnership. Individual A's cost basis for the land is $5,000. Three years later, the land now has a fair market value of $60,000 and is distributed to individual B. What is the tax treatment for each partner?

Individual A has a $35,000 pre-contribution gain, while individual B recognizes no gain.

Limited Partners

Limited partners are only liable to to their investment, but they cannot participate in management without losing their limited liability status.

Taxable Income for Partnerships

Net Income from Operations + Long-Term Capital Gains

Technical Termination

Occurs when there is a sale or exchange of at least 50% interest in both capital and profits within a consecutive 12-month period

Non-Liquidating Distribution

Recognize gain only to the extent cash (or the liability assumed) distributed exceeds the adjusted basis.

Explain the conditions under which Sec. 751 has an impact on nonliquidating​ (current) distributions.

Sec. 751 affects current distributions when the distributing partnership has both Sec. 751 assets andSe ​ non-Sec. 751 assets. The distribution must also be disproportionate.

Items considered to be inventory for purposes of Sec. 751

Supplies Inventory Notes Receivable Lots held for sale

When a Partner contributes Property

The general rule of Sec.​ 721(a) provides that neither the partner or partnership recognize a gain or loss when partners contribute property in exchange for a partnership interest. Services provided by the partner to the partnership for a portion of partnership interest is specifically excluded from the definition of​ property, so any services contributed is a taxable transaction.

What are some consequences when services are provided by a partner in exchange for an interest in the partnership?

The partnership could be required to capitalize the payment. The partner will have to recognize it as income.

Fringe Benefits

The value of a partners fringe benefits are deductible by the partnership as guaranteed payments and must be included in a partners gross income.

Recourse Debt

Where the partnership or at least one partner is *personally* liable. Usually only allocated among *general* partners. Guaranteed debt is treated as recourse with respect to the guarantor.

Are Gains Recognized on the Sale of Property between a Partnership and a more than 50% Partner?

Yes

Can a partner recognize gain AND loss on a liquidating distribution?

Yes

Can a partner recognize both a gain and a loss on the sale of a partnership​ interest? If​ so, under what​ conditions?

​Yes, when a partner sells his or her partnership​ interest, the partnership is deemed to sell all its assets in a hypothetical sale for their FMVs. The selling partner is allocated his or her share of the ordinary income or loss from the sale of Sec. 751 and​ non-Sec. 751​ assets, and the​ partner's residual gain or loss on the sale is capital gain or loss.

Partnerships file form

1065

LLC

A limited liability company is a form of business entity that combines the legal benefits of the corporate form with the tax benefits of the partnership form.

Partnership Losses

A partner can deduct partnership losses on her tax return only to the extent of her basis in her partnership interest

Economic Effect

For a special allocation to be accepted under Treasury Regulations as having substantial economic​ effect, a reasonable possibility must exist that the allocation will substantially affect the dollar amounts to be received by the partners independent of tax consequences.​

The amount and character of any​ gains/losses is determined at

the partnership level.

Two questions to ask yourself anytime you see a distribution:

Is it a current distribution (partner is going to continue)? Or a liquidating distribution (partnership is ending or partner is retiring)?

What is a publicly traded​ partnership?

A PTP is defined as a partnership whose interests are either traded on an established securities exchange or are traded in a secondary market or the equivalent thereof.

Capital Loss

A capital loss results when you sell a capital asset, such as stocks and bonds, for less than your cost.

What conditions are required for a partner to recognize a loss upon receipt of a distribution from a​ partnership?

A partner can recognize a loss on a distribution only if it is a liquidating distribution consisting of​ money, unrealized​ receivables, and/or inventory and the sum of these amounts is less than the​ partner's predistribution basis in his or her partnership interest.

Can a General Partner have a Passive Loss?

A partnership Loss may be a passive loss to a general partner depending upon whether the partner meets the material participation test.

The definition of Unrealized Receivable includes:

A right to payment for services performed by a CASH-basis tax payer Recapture potential on Sec. 1245 Property Recapture potential on Sec. 1250 Property

Disadvantages of a Partnership

All the partnership's profits are taxed to the partners when earned, even if not distributed. A partner's tax rate could be higher than a corporation's tax rate for the same level of taxable income. A partner is not considered to be an employee of the partnership. Therefore, he or she must pay the full amount of self-employment taxes on his or her share of partnership income. Some tax-exempt fringe benefits (e.g., premiums for group term life insurance) are not available to partners. Partners generally cannot defer income by choosing a fiscal year for the partnership that differs from the tax year of the principal partner (s). However, if the partnership demonstrates a business purpose, or if it makes a special election, it may use a fiscal year in general.

What are the advantages of a firm being formed as an LLC instead of as a LLP?

An LLC provides its owners with limited liability for debts of the firm and an LLC with more than one owner can choose to be treated as either a partnership or a corporation

Electing Large Partnership

An electing large partnership is a partnership that is not a service partnership, is not engaged in commodity​ trading, has at least 100​ partners, and files an election to be taxed as an electing large partnership.

What is a valid reason for making a 754 election?

An incoming partner pays more for a partnership interest than his proportional share of partnership assets

Ordinary Loss

An ordinary loss occurs from the normal operations of a business when expenses exceed income. An ordinary loss can also occur as a result of a net section 1231 loss.

A partnership terminates for tax purposes when

At least 50% of the total interest in partnership capital and profits changes hands by sale or exchange within twelve consecutive months

Three Hurdles Must Be Cleared for a Loss to be Deducted

Basis in Partnership Interest (can only be taken to zero) At-Risk Amount (basis less share of non recourse debt) Passive Income (if the loss is passive)

For purposes of Sec. 751, inventory does NOT include

Capital Assets or 1231 Property

Separately Stated Items

Capital Gains and Losses Section 1231 Gains and Losses Charitable Contribution Foreign Income Tax Section 179 Expense Deduction Interest, Dividend and Royalty Income Interest Expense on Investment Net Income or Loss from Rental Real Estate Tax Exempt Income

Partnership Holding Period

Capital or section 1242 tacks on to partnership interest. For other assists like income assets the holding period starts over.

The partnership nor any partner recognizes gain or loss when partners contribute property in exchange for a partnership interest. Three exceptions to this general rule may require a partner to recognize a gain upon the contribution of property to a partnership in exchange for a partnership interest:

Contribution of property to a partnership that would be treated as an investment company if it were incorporated Contribution of property followed by a distribution in an arrangement that may be considered a sale rather than a contribution Contribution of property to a partnership along with the​ partnership's assumption of the​ partner's liabilities​ if, as a​ result, the​ partner's share of partnership liabilities exceeds his or her basis in the partnership.

Can a recourse debt of a partnership increase the basis of a limited​ partner's partnership​ interest? Explain.

Even though limited partners are not liabile to pay partnership debts beyond their originial contribution, a recourse debt of a partnership increases a limited partners basis to the limited partner has a risk of economic loss.

When the land is​ distributed, the​ partnership's basis in the land immediately before distribution is increased by

FMV - Basis

Rules for Liquidating Distribution

Generally the same as the non-liquidating rules but with two exceptions: Loss is recognized if: The partner receives only cash, unrealized receivables, and inventory The inside basis of the assets is less than the partners outside basis in the partnership immediately before the distribution The partners basis MUST be reduced to zero

A Partnership is considering two compensation schemes for​ Tracy, the partner who runs the business on a daily basis. Tracy can be given a​ $10,000 guaranteed​ payment, or she can be given a comparably larger distributive share​ (and distribution) so that she receives about​ $10,000 more each year. From the standpoint of when the income must be reported in​ Tracy's tax​ return, are these two compensation alternatives the​ same?

Guaranteed payment must be included in income for the recipients tax year in which the partnerships year ends and partnership deducts or capitalizes the payments. Hence, from the standpoint of when the incomes must be reported, the two methods are the same.

Non-Recourse Debt

No partner is personally liable. Secured by collateral. Allocated among *all* partners.

Outside Basis

Outside basis represents each partner's basis in the partnership interest. Each partner "owns" a share of the partnership's inside basis for all of its assets, and all partners should maintain a record of their respective outside bases. Typically, when a partner contributes assets to a partnership, the basis carries over from the asset basis (inside basis) to the partnership interest basis (outside basis). Moreover, when a partner contributes property to the partnership, the partnership's basis in the contributed property is equal to its fair market value (FMV). However, the outside basis of the partner increases only by the amount of the basis that the partner had in the property.

Initial Basis Increased by:

Partners share of taxable and non taxable income Increases in the partners share of partnership debt Additional contributions the partner makes to the partnership

Which schedule or form attendant to the Form 1040 should be used to report an individual partner's share of ordinary income?

Schedule E

Sec. 704(d) Loss Limitation

Sec. 704(d) provides that a partner's distributive share of loss is allowable to the extent of the partner's adjusted tax basis in his interest in the partnership at the end of the partnership year in which the loss occurred. Any losses in excess of the partner's tax basis are disallowed pro rata (Regs. Sec. 1.704-1(d)) and are carried forward indefinitely for as long as the partner remains in the partnership.

Least aggregate deferral of income.

The tax year that results in the least aggregate deferral of income is determined as follows. Figure the number of months of deferral for each partner using one partner's tax year. Count the months from the end of that tax year forward to the end of each other partner's tax year. Multiply each partner's months of deferral figured in step (1) by that partner's interest in the partnership profits for the year used in step (1). Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. The partner's tax year that results in the lowest number in step (3) above is the tax year that must be used by the partnership.

Sam wants to help his​ brother, Lou, start a new business. Lou is a capable auto mechanic but has little business​ sense, so he needs Sam to help him make business decisions. Should this partnership be arranged as a general partnership or a limited​ partnership? Why? Should they consider any other form for structuring their​ business?

This would be a general partnership because Sam wants to help Lou make business decisions. In a limited partnership, the limited partner has no right to be active in the Parnership's management. On the other hand, if they only want one person to assume the role of a general partner, they may structure their business as an LLP to avoid personal liability.

Recourse Liabilities

Those that any partner bears the economic risk of loss with respect to the liability. This economic risk of loss is present only if any partner or any persona related to the partner would be obligated to make a payment to the

Pre-contribution Gain or Loss

Two different distribution events may trigger recognition of precontribution gain or loss: First, the contributing partner must recognize the precontribution gain or loss when the partnership distributes the property to any other partner within seven years of the contribution.​ Second if the FMV of the distributed property exceeds the​ partner's basis in his or her partnership interest before the distribution.

754 Election

Under section 754, a partnership may elect to adjust the basis of partnership property when property is distributed or when a partnership interest is transferred. The purpose of a Section 754 election is to reconcile a new partner's outside and inside basis in the partnership.

What are the tax implications of his receiving only a profits interest versus his receiving a capital and profits​ interest?

Whether a person receives a profits interest or a capital and profits interest, he theoretically should report the value of the property he receives for services as ordinary income.

Can a partnership recognize a gain or loss on a current distribution?

Yes

Formation of a Partnership

A partner will not recognize gain or loss from contribution of property in exchange for a partnership interest.

For purposes of Sec. 751, inventory includes all of the following:

Accounts Receivable Items held for sale in the ordinary course of business

Adjusted Basis in Partnership

Adjusted each year to reflect results of operations.

Distribution of Partnership Income

Distribution of partnership income in the form of cash to partners is generally​ tax-free to the partners and the partnership.

Is a partnership a taxable entity?

No

Are all publicly traded partnerships taxed as​ corporations?

No. Partnerships that have​ 90% or more of their gross income being​ "qualified income" are taxed as partnerships. A publicly traded partnership that existed on December​ 17, 1987, and which has not added a substantial new line of​ business, was not taxed as a corproation until tax years beginning after December​ 31, 1997. These​ partnerships, which were grandfathered under the 1987 law for ten​ years, were granted a new election in the Taxpayer Relief Act of 1997.

The total bases of all distributed property in the​ partner's hands following a nonliquidating distribution is limited to

the​ partner's predistribution basis in his partnership interest.

Not Seperately Stated (Goes into Bucket)

Sales Wages, Rent Expense, Bad Debts Deduction for Guaranteed Payments Depreciation

A partners Basis is adjusted in the following order

Increased for all income items (including tax-exempt income) Decreased for distributions Decreased by deductions and losses (including non deductible items not charged to capital)

If a partner dies, his tax year closes

On the date of death

What are the advantages and disadvantages to the partnership and its partners when a partnership termination is caused by a sale of at least a​ 50% capital and profits​ interest?

Termination of tax accounting elections. Possibility of an accelerated loss flow through when the terminated​ partnership's year closes. The transfer of assets does not create a basis change under the Treasury Regulations.

2 Categories of Special Allocations

Special allocations are unique to partnerships​ (and LLCs treated as​ partnerships). They allow tremendous flexibility in sharing specific items of income and loss among the partners. Special allocations can provide a specified partner with more or less of an item of​ income, gain,​ loss, or deduction than would be available using the​ partner's regular distributive share.

Elective Large Partnerships

A partnership generally qualifies to make an ELP Election if it had 100 or more partners in the partnership's preceding taxable year, and will be subject to the ELP Rules if it affirmatively elects on its tax return to do so. A large partnership must not be a service partnership. A large partnership is subject to a different set of audits. Must not be engaged in commodity trading.

Partnership

A partnership includes​ "a syndicate,​ group, pool, joint​ venture, or other unincorporated​ organization" that carries on a business or financial operation or venture. Formation of a partnership requires no legal​ documentation, just two partners working together to carry on any​ business, and the partner can be an​ individual, trust,​ estate, or corporation. The only restriction is a partnership requires at least two partners.

Shifting

The net change in the​ partner's capital accounts will be the same for a normal allocation and the special allocation. AND The total tax liability of the partners will be less with the special allocation than with a normal allocation.

Basis

The partner takes a substituted basis in his partnership interest (the basis they had in the property transferred) and the partnership takes a carryover basis.

Limited Partners Self Employment Income

Their Guaranteed Payments

Section 1231 Assets

1231 Property is a category of property defined in section 1231 of the U.S. Internal Revenue Code. 1231 property includes depreciable property and real property (e.g. buildings and equipment) used in a trade or business and held for more than one year.

What is the required tax​ year-end for the partnership​ (if no Sec. 444 election is​ made)?

A partnership generally must conform its tax year to its partners' tax years. The rules for determining the required tax year are as follows. Majority interest tax year. If one or more partners having the same tax year own an interest in partnership profits and capital of more than 50% (a majority interest), the partnership must use the tax year of those partners. Testing day. The partnership determines if there is a majority interest tax year on the testing day, which is usually the first day of the partnership's current tax year. Change in tax year. If a partnership's majority interest tax year changes, it will not be required to change to another tax year for 2 years following the year of change. Principal partner. If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Least aggregate deferral of income. If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners

If a Partnership is not a taxable entity why do they still need to compute taxable income?

Although the partnership is not a taxable​ entity, the IRC requires that the partnership calculate partnership taxable income for various computational​ reasons, such as adjusting the​ partners' basis in their partnership interests.

Doug contributes services but no property to the CD Partnership upon its formation. What are the tax implications of his receiving only a profits interest versus his receiving a capital and profits​ interest?

Capital interests are taxable under the tax rule. If Doug recieves a capital and profits interest, then his capital interest will be taxed according to the rules. On the other hand, profit interests are rights to future income taxable to the partners. Income tax is not levied on the profits interests separately. Only the partnership profits that pass through to the partner are taxed under the normal rules of partnership taxation.

In a non-liquidating distribution, assets are always deemed to be distributed in the following order:

Cash Unrealized Receivables and Inventory Capital Assets and Section 1231 Assets

Initial Outside Basis

Cash Contributed + Basis of property contributed + Gain or income recognized - Partner's liabilities assumed by partnership = Basis of Partnership Interest received by Partner

Advantages of Partnerships

Flexibility Single Taxation Partners can usually get into and out of a partnership without recognizing a gain.

Guaranteed Payments

Guaranteed payments are determined without regard to partnership income and are paid to the partner in his or her role as partner (like a salary). Guaranteed payments are taxable as ordinary income to the partner and are deductible by the partnership. Subject to Self Employment Tax Always taxed as if they were paid on the last day of the partnerships taxable year.

Hot Assets

Hot assets" are "unrealized receivables" and "inventory items" as defined under IRC Section 751. These are basically ordinary income producing assets, such as accounts receivable not already recognized as income, LIFO reserves, appreciated inventory, and depreciation recapture.

Built-In Gains/Losses

If a partnership disposed of an asset that was contributed by a partner and at the time of contribution the asset had a BI Gain or Loss, they recognized gain or loss is allocated back to the contributing partner to the extent of the built-in gain/loss.

Inside Basis

Inside basis refers to the adjusted basis of each partnership asset, as determined from the partnership's tax accounts. Inside basis usually comes from partner contributions, but may also come from purchases the partnership makes with partnership funds. This determines the partner's tax basis according to the individual assets contributed to the operation of the business.

Related Party Losses

Losses are disallowed between a partnership and person owning more than 50% of Capital or Profits interest Losses disallowed between two partnerships if same person owns more than 50% of Capital or profits interest

Can you recognize gain on a partnership distribution of PROPERTY?

No - the only time a gain is recognized on a non-liquidating distribution is when the CASH received exceeds the Partner's basis in the partnership. If you have an excess of property basis because of a distribution, your basis in the land will be the lower number of either the Partnerships basis in the land OR the partners interest that was left after the cash distribution.

The ABC Partnership has a non-recourse liability that it incurred by borrowing from an unrelated bank. It is secured by an apartment building owned and managed by the partnership. The liability is not convertible into an equity interest. How does this liability affect the​ at-risk basis of general partner Anna and limited partner​ Bob?

Non-recourse debts increase a limited partner's basis based on it's profit ratio. In a similar manner, non recourse liability for a general partner is also determined by the partners profit ratio. Both partners are qualified to be considered as at-risk. Hence, the liability increases the at-risk basis of the partners.

Partnership Loss - Limited Partner

Passive Loss

Things that increase a Partner's Basis

The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. The partner's distributive share of taxable and nontaxable partnership income. The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners.

Things that decrease a Partner's Basis

The partner's basis is decreased (but never below zero) by the following items: The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. The partner's distributive share of the partnership losses (including capital losses). The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner.

Advantages of a Partnership

The partnership as an entity pays no tax. Rather, the income of the partnership passes through to the separate returns of the partners and is taxed directly to them. A partner's tax rate may be lower than a corporation's tax rate for the same level of taxable income. Partnership income is not subject to double taxation. Although partnership profits are accounted for at the partnership level, they are taxed only at the partner level. Additional taxes generally are not imposed on distributions to the partners. With limited exceptions, partners can contribute money or property to, or withdraw money or property from, the partnership without recognizing gain or loss. Subject to limitations, partners can use losses to offset income from other sources. A partner's basis in a partnership interest is increased by his or her share of partnership income. This basis adjustment reduces the amount of gain recognized when the partner sells his or her partnership interest, thereby avoiding double taxation.

Disadvantages of partnership terminations:

The transfer of assets does not create a basis change under the Treasury Regulations. Termination of tax accounting elections. Loss of a favorable tax year and the possible bunching of income into one year for the partners due to a​ short-period tax return.

Under Sec.​ 751, unrealized receivables include potential Section 1245 or 1250 recapture on the​ partnership's depreciable property.

True