UCF School of Accounting Tax 5015

1
UCF School of AccountingTax 5015

• Partnerships
• Formations and Operations
• Chapter Ten

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Learning Objectives

• Explain the tax results of a contribution of
  property or services in exchange for a
  partnership interest
• Differentiate between items that must be
  separately stated and those that are included in
  ordinary income or loss
• Calculate a partners distributive share of
  partnership income, gain, loss deduction or
  credit items
• Calculate a partners basis in a partnership
  interest
• Determine the limitations on a partners
  deduction of partnership losses
• Determine the tax consequences of a guaranteed
  payment

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Partnership Definitions

• Tax definition
• a syndicate, group, pool, joint venture or other
  unincorporated organization that carries on a
  business
• Not an estate, trust or corporation.
• Individuals, estates, trusts and corporations can
  all be partners.
• General partnership two or more partners with no
  specific restriction on duties.
• Limited partnership
• Two classes of partners at least one general
  partner
• one or more limited partners who have
  restrictions on both duties and liabilities of
  the partnership
• Other Entities Taxed As Partnerships
• Check the Box Regulations
• LLP
• LLC

4
Taxation Process

• Partnership files an information return on Form
  1065 with no tax due
• Partners receive a Form K-1 explaining the income
  or loss and separately reported items
• Partners include the profit or loss and separate
  items on their tax return (e.g. Form 1040 for
  individuals)
• Individual partners guaranteed payments and
  distributive share of ordinary income (if
  material participant) are subject to
  self-employment tax
• Partners basis in partnership is important
  concept

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Partners Ownership Interest

• Each owner normally has a
• Capital interest
• Measured by capital sharing ratio
• Partners percentage ownership of capital
• Profits(loss) interest
• Partners allocation of partnership ordinary
  income (loss) and separately stated items
• Certain items may be specially allocated
• Specified in the partnership agreement

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Formation of a Partnership - Contribution of
Property

• Section 721 - No gain or loss recognized by
  partner or partnership on transfer of property to
  partnership in exchange for partnership interest
• Applies to contributions made by new or existing
  partners to new or existing partnerships
• 3 exceptions (for gain recognition)
• Appreciated stocks contributed to investment
  partnership
• Transaction is essentially a taxable exchange or
  a disguised sale (substance over form)
• Partnership interest received in exchange for
  services rendered to the partnership

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Partners Basis in Partnership Interest

• Partners beginning basis in Partnership interest
  is equal to
• Amount of Money Contributed
• Adjusted Basis of Property Contributed
• FMV of Services provided in exchange for pship
  interest
• - Partners liabilities assumed by partnership
• Partners share of partnership liabilities
• Hold. Period for Pship Interest
• includes holding period of contributed property
  if property was a capital or Sec 1231 asset.
• Begins on the day after contribution if property
  was an ordinary income asset, or if partnership
  interest received in exchange for cash or
  services

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Partnerships Basis in Contributed Property

• Partnerships Basis Propertys Basis in hands
  of contributing partner
• Character
• Ordinary Income Property (unrealized receivables,
  inventory) - character always remains ordinary
• Capital Loss Property - to the extent loss exists
  at time of contribution, character remains
  capital for 5 years
• Sec 1245 and Sec 1250 Recapture potential carries
  over to pship
• Holding Period Includes Partners HP

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Partnership Elections

• Tax year important because determines which year
  partner recognizes pship income. Choices are
  restricted
• Overall accounting method
• Elections Reserved for Partners
• Foreign Tax Credit/Deduction
• Percentage Depletion
• Income from discharge of indebtedness
• Deduction and recapture of certain mining and
  exploration expenditures

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Initial Costs of Partnership

• Sec. Type of cost Treatment
• 709 Organization expense 15 yr. amort
• 709 Syndication costs Capitalized
• 195 Pre-operating expense 15 year amort
• 162 Ordinary/Necessary Exp. Deduction
• 167 Acquisition of property Depreciated
• 197 197 Intangible 15 yr. Amort.
• 167 Other Intangible assets Amort. over useful
  life
• 5,000 immediate first-year deduction allowed
  (2004 AJCT)

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Partnership Taxable Income

• Separately Reported Items
• Net ST and LT capital gains and losses
• Sec. 1231 gains and losses
• Charitable contributions
• Portfolio Items (dividends, interest, royalties,
  expenses)
• Sec 179 Write-offs
• Recovery of Items Previously deducted
• AMT preference and adjustment items
• Self-employment income
• Passive activity items
• Intangible Drilling and development costs
• Foreign or possession taxes
• Non business and personal items
• Partnership Ordinary Income all items not
  separately stated.

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Partner Distributive Share

• The share is normally determined by the terms of
  the partnership agreement.
• It is the portion of partnership taxable and
  nontaxable income that the partner has agreed to
  report for tax purposes.
• The partners can agree to share profits
  differently than losses (total partnership
  taxable income determines which applies in
  given year).
• The amount is not related to the actual amounts
  distributed to a partner in a particular year.

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Special Allocations

• Pre-contribution gains or losses must be
  allocated to the contributing partner.
• Allocations not related to contributed property
  must produce substantial economic effects.
• Result in appropriate /- in partners capital
  account
• proceeds of liquidation distributed in accordance
  with positive capital account balances
• Partners must make up negative balances in their
  capital accounts upon liquidation

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Partners Basis

• Beginning Basis determined by method used to
  acquire partnership interest
• subsequent contributions
• partners share of
• debt increase
• Taxable income items
• Exempt income items
• - Partners Distributions and withdrawals
• - partners share of
• Debt decrease
• Nondeductible items not charged to capital
• Loss items

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Partnership Liabilities

• Affect partners adjusted basis
• Increase in partners share of liabilities
• Treated as a cash contribution to the partnership
• Increases partners adjusted basis
• Decrease in partners share of liabilities
• Treated as a cash distribution to the partner
• Decreases partners adjusted basis
• Two types of partnership debt
• Recourse debt - At least one partner is
  personally liable
• Allocate to partners using a Constructive
  Liquidation Scenario
• Non-recourse debt - No partner is personally
  liable
• Allocate to partners using a three-tiered
  allocation

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Constructive Liquidation Scenario

• 1.Partnership assets deemed to be worthless
• 2.Assets deemed sold at 0 losses determined
• 3.Losses allocated to partners under partnership
  agreement
• 4.Partners with negative capital accounts deemed
  to contribute cash
• 5.Deemed contributed cash would repay partnership
  debt
• 6.Partnership deemed to liquidate
• Partners share of recourse debt Cash
  contribution
• used to repay debt (Step 4 and 5)
• Note as long as capital accounts are
  proportional to ownership , this calculation
  implies equal sharing of liabilities.

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Simple Example Part I

• Partnership has two assets cash 9,000, and Land
  with a basis of 40,000. The partnership has a
  mortgage of 25,000, and two equal partners with
  capital accounts of 12,000 each.
• Step One assets deemed worthless.
• Step Two Partnership sustains 49,000 loss.
• Step Three losses allocated equally to
  partners, therefore their capital accounts
  decrease to (12,500).
• Step Four Partners each contribute 12,500 to
  restore capital accounts to 0.
• Step Five and Six Partnership repays mortgage
  and liquidates.
• Thus, each partners share of the mortgage is
  12,500, and if inside and outside bases are
  equal, their bases will each be 24,500.

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Simple Example Part II

• Partnership has two assets cash 9,000, and Land
  with a basis of 40,000. The partnership has a
  mortgage of 25,000, and two equal partners.
  Partner As capital account is 10,000, Partner
  Bs capital account is 14,000.
• Step One assets deemed worthless.
• Step Two Partnership sustains 49,000 loss.
• Step Three losses allocated equally to
  partners, therefore Partner As capital account
  is (14,500) 10,000-24,500 and Partner Bs
  capital account is (10,500) 14,000-24,500
• Step Four Partner A contributes 14,500 and
  Partner B contributes 10,500, to restore their
  capital accounts to 0.
• Step Five and Six Partnership repays mortgage
  and liquidates.
• Thus, Partner As share of liabilities is 14,500
  (and his basis is 24,500) and Partner Bs share
  of liabilities is 10,500 (and his basis is
  24,500).

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Non-recourse Debt Allocation

• Three step allocation - the first two steps are
  complex and only occur when debt is greater than
  book and/or tax basis of assets.
• Any remaining debt after steps one and two, is
  allocated per partnership agreement, usually
  based on profit sharing ratios.
• We will assume all nonrecourse debt is allocated
  based on profit sharing ratios.

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Loss Limitations

• Sec 704 (d) Limitation Losses deductible up to
  basis for Partnership interest (after positive
  adjustments distributions are accounted for).
• Special Limitations
• At Risk Basis - includes only liabilities for
  which partner is at risk
• Passive Activity Limits - passive losses are
  deductible only against passive income. Passive
  loss rules are applied at the partner level.
• Note all three of these limitations apply
  simultaneously.

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Partner/Partnership Transactions

• Sale of Loss Property
• Losses disallowed between a partnership and a
  person who owns (directly or indirectly) more
  than 50 of partnership capital and profits
• Disallowed losses reduce subsequently recognized
  gains
• Sale of Gain Property
• Ordinary income recognized when capital asset
  sold between partnership and more than 50
  partner asset not a capital asset in
  purchasers hands

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Guaranteed Payments

• Payment to partner for use of capital or for
  services provided to partnership
• Not determined by reference to partnership income
• Usually expressed as a fixed dollar amount or as
  a of capital
• May be deducted or capitalized by partnership
  depending on the nature of the payment
• Deductible by partnership if meets ordinary and
  necessary business expense test
• May create partnership loss
• Includable in income of partner at time
  partnership records payment
• Treated as if received on last day of partnership
  tax year
• Character is ordinary income to recipient partner

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Limited Liability Companies

• Effectively treated as limited partnership with
  no general partners
• However members who materially participate are
  still subject to self-employment tax.
• Liabilities are allocated to members based on
  non-recourse liability rules, since LLC members
  are not personally liable for entity debts
• Losses are subject to at-risk and passive loss
  rules