Chapter 9: Partnership Formation and Operation

1
Chapter 9Partnership Formation and Operation
Chapter 9 Partnership Formation Operation
2
PARTNERSHIP FORMATION OPERATION (1 of 2)

• Partnership definitions
• Overview of partnership taxation
• Contributions of property
• Partnership elections
• Ordinary income/loss vs. separately stated items
• Partners distributive share of items

3
PARTNERSHIP FORMATION OPERATION (2 of 2)

• Special allocations
• Partners basis in partnership interest
• Special loss limitations
• Transactions between partner partnership
• Guaranteed payments
• Family partnerships
• Self-employment income

4
Partnership Definitions

• Tax definition of a partnership
• General partnership
• Limited partnership
• Limited liability companies (LLCs)
• Limited liability partnerships (LLPs)
• Electing large partnership (ELP)

5
Tax Definition of a Partnership

• Syndicate, group, pool, joint venture or other
  unincorporated organization that carries on a
  business

6
General Partnership

• Two or more partners
• All partners are general partners
• May participate in management
• May make commitments on behalf of partnership
• Unlimited liability for partnership debts

7
Limited Partnership

• One or more general partners and
• One of more limited partners
• Cannot participate in management
• Cannot make commitments for partnership
• Liability generally limited to amount invested in
  partnership

8
Limited Liability Companies (LLC)

• May be taxed as a partnership or a corporation
  (using check-the-box Regs)
• When taxed as a partnership, entity obtains
  flow-through and flexibility of partnership
  allocations while maintaining limited liability
  of a corp

9
Limited Liability Partnerships Electing Large
Partnerships

• Limited liability partnerships (LLPs)
• Used by many professional organizations
• May be taxed as a partnership or a corporation
  (using check-the-box Regs)
• Partners not liable for failures in work of other
  partners or people supervised by other partners
• Electing large partnership (ELP)
• Non-service partnerships of ?100 ptrs

10
Overview of Partnership Taxation

• Partnership profits and losses
• Partners Basis
• Partnership distributions

11
Partnership Profits and Losses (1 of 2)

• Partnership files Form 1065
• Information return with no tax due
• Partners receive a Form K-1
• Reports partners share of income or loss and
  separately reported items

12
Partnership Profits and Losses (2 of 2)

• Partners include profit or loss and separate
  items on their individual return (Form 1040 for
  individuals)
• Loss limitation
• Partners losses limited to his/her basis in the
  partnership
• At-risk rules and passive loss rules also apply

13
Partners Basis(1 of 2)

• Items that increase basis
• Partners share of partnership earnings,
  additional contributions, additional assumption
  of partnership debt
• Increase in basis for earnings prevents double
  taxation of earnings upon subsequent distribution

14
Partners Basis(2 of 2)

• Items that decrease basis
• Partners share of losses, distributions,
  reduction in partnership debt

15
Partnership Distributions

• Payment of money to partner usually tax-free
  because earnings previously taxed
• If distributions exceed the partners basis, gain
  may be recognized

16
Contributions of Property

• General rule
• Exceptions to nonrecogntion rule
• Effects of liabilities
• Contributions of services
• Basis
• Organizational syndication costs
• See Topic Review C9-1 for summary

17
General Rule

• General rule for property contributions in
  exchange for partnership interest
• No gain or loss
• 721 similar to 351

18
Exceptions toNonrecognition Rule

• Gain recognition at time of property contribution
  if
• Partnership would be investment company if it
  were incorporated,
• Contribution followed by a distribution
  resulting in a deemed sale, or
• Liabilities assumed by partnership in excess of
  partners basis

19
Effects of Liabilities

• Two effects of liabilities contributed by a
  partner to a partnership
• Basis of each partner (including contributing
  partner) is increased by her share of
  liabilities, AND
• Contributing partner treated as if partnership
  made cash distribution to the partner, decreasing
  partners basis
• Gain would be recognized if deemed distribution
  exceeds partners basis

20
Contributions of Services(1 of 2)

• Contribution of services in exchange for
  partnership interest
• Income is FMV of services contributed

21
Contributions of Services(2 of 2)

• Partnership deducts or capitalizes FMV of
  services, depending on the nature of the expense
• Partnership recognizes gain or loss
• FMV of services less basis in assets allocated to
  service partner

22
Basis

• Partners basis in partnership equal to money
  contributed plus partners basis in contributed
  property plus gain recognized on contribution
• Partnerships basis in property is partners old
  basis before contribution
• Holding period also carries over

23
Organizational and Syndication Costs

• Organization costs are capital expenditures
• May immediately expense 5K and amortize the rest
  over 180 months
• 5K immediate expense reduced for for
  cumulative organization costs gt50K

24
Partnership Elections

• Tax year
• Must be same as majority partner or partners with
  a 50 or more interest
• See Topic Review C9-2
• Overall accounting method
• Inventory valuation method
• Depreciation method

25
Ordinary Income/Loss vs. Separately Stated Items
(1 of 2)

• Separately stated items include
• Net S-T capital gains and losses
• Net L-T capital gains and losses
• 1231 gains and losses
• Charitable contributions
• Dividends eligible for DRD
• Foreign or possession taxes

26
Ordinary Income/Loss vs. Separately Stated Items
(2 of 2)

• Separately stated items (continued)
• Tax-exempt interest
• Portfolio activities
• Passive activities
• U.S. production activities deduction
• Any items subject to special allocation
• Partnership ordinary income/loss
• All items not separately stated

27
Partners Distributive Share of Items

• Normally determined by terms of partnership
  agreement
• Portion of partnership taxable and nontaxable
  income partner agreed to report for tax purposes
• Amount not necessarily same as actual amounts
  distributed to partner in a particular year

28
Special Allocations

• Pre-contribution gains or losses must be
  allocated to contributing partner
• Allocations not related to contributed property
  must have substantial economic effect
• Allocations affect partners capital accounts,
  and
• Partners must make up deficit in capital account
  upon liquidation of partnership

29
Partners Basis in Partnership Interest (1 of 2)

• Beginning basis
• Amount paid for interest OR
• Basis of property/ services contributed
• Additions to basis
• Additional contributions, earnings or assumption
  of liabilities
• Reductions result from withdrawals, losses or
  decrease in share of liabilities

30
Partners Basis in Partnership Interest (2 of 2)

• Effect of liabilities on partner basis
• Partners basis before liabs
• Increases in share of ptrshp liabs
• - Decreases in share of ptrshp liabs
• Ptrshp liabs assumed by this partner
• - This partners liabs assumed by ptrshp
• Partners basis in the ptrshp interest
• See Topic Review C9-3

31
Special Loss Limitations(1 of 2)

• Loss recognition limitations
• Partners basis in partnership interest
• Portion of partners basis not at risk
• At risk definition amount partner would lose
  should the partnership suddenly become worthless.

32
Special Loss Limitations(2 of 2)

• Loss recognition limitations (continued)
• Designation of partnership interest as a passive
  activity
• Passive losses can only be used to offset
  passive income.
• Disallowed losses are suspended, and can be used
  to offset future passive income, or when the
  passive activity is sold

33
Transactions Between Partner Partnership

• Loss sales
• No loss deducted on sale of property between a
  partnership and a gt 50 owner (direct or
  indirect)
• Gain sales
• Gains on sale of property involving a gt50 owner
  produce ordinary income unless property will be a
  capital asset in hands of new owner

34
Guaranteed Payments

• Always ordinary income to recipient
• Partner treats payment as if made to an outsider
• Deduct or capitalize
• If deductible, GP reduces partnership ordinary
  income, which is allocated based on partnership
  agreement

35
Family Partnerships(1 of 2)

• Safe-harbor rule under 704(e) for family
  partnerships
• Interest must be a capital interest,
• Partner has right to receive assets if
  partnership liquidates immediately
• Capital must be a material income producing
  factor, AND
• Family member must be true owner

36
Family Partnerships(2 of 2)

• Donor-donee allocations of income
• Donor must be allocated reasonable compensation
  for services rendered to partnership
• Remaining partnership income must be allocated
  based on relative capital interest

37
Self-Employment Income

• Individuals who are partners must pay SE tax on
  the following income from a partnership
• Guaranteed payments
• Partnership ordinary income or loss
• All separately stated items, except
• Capital and 1231 gains/losses, interest,
  dividends, and rental income

38
End of Chapter 9
Comments or questions about PowerPoint
Slides?Contact Dr. Richard Newmark atUniversity
of Northern ColoradosKenneth W. Monfort College
of Businessrichard.newmark_at_PhDuh.com