Income Tax Fundamentals 2010 Gerald E. Whittenburg Martha Altus- Buller Student’s Copy

1. Chapter 10Partnership Taxation Income Tax Fundamentals 2010 Gerald E. Whittenburg Martha Altus-Buller Student’s Copy 2010 Cengage Learning

2. What is a Partnership? • A partnership is a syndicate, group, pool, joint venture or other unincorporated organization through which any business, financial operation or venture is carried on • Simply co-owning property does not constitute a partnership • Note: many co-owners of real estate choose to operate as a limited partnership or limited liability company 2010 Cengage Learning

3. Partnership Formation • When forming a partnership, individuals contribute assets to partnership in exchange for a partnership interest • No gain/loss is usually recognized • Exceptions include • When services are performed in exchange for partnership interest • When property is contributed with liabilities in excess of basis, then Recognized Gain = Liabilities Allocable to Others – Adjusted Basis of Property Contributed 2010 Cengage Learning

4. Partnership Formation • Partner’s basis in partnership interest Cash contributed plus: Basis of property transferred to partnership plus: Gain recognized (from prior screen) less: Liabilities allocable to other partners Equals: Partner’s initial basis in partnership 2010 Cengage Learning

5. Changes occur to partner’s basis due to subsequent activities Beginning Basis + Additional Contributions + Share of Net Ordinary Taxable Income + Share of Capital Gains/Other Income - Distributions of Property or $ - Share of Net Loss from Operations* - Share of Capital Losses/Other Deductions +/- Increase/Decrease in Liabilities Basis in Partnership Interest *Note: Can’t take basis below 0 and must comply with at-risk limitations Changes in Partner’s Basis 2010 Cengage Learning

6. Partnership Income Reporting • Partnerships do not pay tax • All information flows through to be reported by the partners • Tax return is due by 15th of 4th month following close of partnership tax year • Must report each element of income and expense separately on Form 1065 (Partnership Tax Return) • Schedule K-1 shows allocable partnership income/expenses for each partner based upon the individual ownership percentage • Ordinary income/loss • Special income/deduction items such as charitable deductions, interest, capital gains/losses 2010 Cengage Learning

7. At-Risk Limitations • Partners cannot deduct losses from activities in excess of their investment • Losses limited to amounts at risk (AAR) in those activities • Definitions • A “nonrecourse liability” is a debt for which the borrower is not personally liable • “Encumbered property” is the property pledged for a liability • Taxpayers are at-risk for an amount equal to Cash and property contributed to partnership + Liabilities on encumbered properties (recourse debt) + Liabilities for which taxpayer is personally liable (recourse debt) + Retained profits in activity 2010 Cengage Learning

8. Limited Liability Companies • Limited Liability Companies (LLCs) are a cross between a partnership and a corporation • Treated generally as a partnership for tax purposes • Each owner has limited liability (similar to a corporation) • Advantages of LLCs are numerous • Taxable income/loss passes through to owners • No general partner requirement • Owners can participate in management • Owners have limited liability • LLC ownership interest is not a security • Tax attributes pass through to owners • Offer greater tax flexibility than S corporations 2010 Cengage Learning

9. Limited Liability Companies • Disadvantages • Because of newness, limited amount of case law dealing with limited liability companies • States are not uniform in treatment of LLCs, so potential for confusion if LLC operating in more than one state Note: Limited Liability Companies quickly becoming a major form of business organization in the U.S. 2010 Cengage Learning