Chapter 9: Partnership Formation and Operation

1. Chapter 9:Partnership 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 • Partner’s basis in partnership interest • Special loss limitations • Guaranteed payments • Transactions between partner & partnership • Family partnerships

4. Partnership Definitions(1 of 5) • Tax definition of a partnership • Syndicate, group, pool, joint venture or other unincorporated organization that carries on a business

5. Partnership Definitions(2 of 5) • General partnership • Two or more partners • All partners are general partners • May participate in mgmt • May make commitments on behalf of partnership • Unlimited liability for partnership debts

6. Partnership Definitions(3 of 5) • 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

7. Partnership Definitions(4 of 5) • Limited liability companies (LLCs) • May be taxed as a partnership or a corp (using check-the-box regs) • Allows entity to obtain flow-through and flexibility of partnership allocations while maintaining limited liability of a corp.

8. Partnership Definitions(5 of 5) • Limited liability partnerships(LLPs) • Used by many professional organizations • May be taxed as a partnership or a corp (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 w/ 100 ptrs

9. Overview of Partnership Taxation • Partnership profits and losses • Partner’s Basis • Partnership distributions

10. Partnership Profits and Losses (1 of 2) • Partnership files Form 1065 • Information return with no tax due • Partners receive a Form K-1 • Reports partner’s share of income or loss and separately reported items

11. 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 • Partner’s losses limited to his/her basis in the partnership • At-risk rules and passive loss rules also apply

12. Partner’s Basis • Partner’s basis increased by share of partnership earnings, additional contributions, & additional assumption of partnership debt • Partner’s basis decreased by losses, distributions, & reduction in partnership debt

13. Partnership Distributions • Payment of money to partner usually tax-free because earnings previously taxed • If distributions exceed the partner’s basis, gain may be recognized

14. Contributions of Property • General rule • Exceptions to nonrecogntion rule • Contributions of services • Basis • See Topic Review C9-1 for summary

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

16. Exceptions toNonrecognition Rule • Gains recognition at time of property contribution • Partnership would be investment company if it were incorporated • Contribution followed by a distribution resulting in a deemed sale • Liabilities assumed by partnership in excess of partner’s basis

17. Contributions of Services(1 of 2) • Contribution of services in exchange for partnership interest • Income is FMV of services contributed

18. 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 – basis in assets allocated to service partner

19. Basis • Partner’s basis in partnership equal to money contributed plus partner’s basis in contributed property plus gain recognized on contribution • Partnership’s basis in property is partner’s old basis before contribution • Holding period also carries over

20. 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

21. Ordinary Income/Loss vs. Separately Stated Items (1 of 2) • Separately stated items • Net S-T capital gains and losses • Net L-T capital gains and losses • §1231 gains and losses • Charitable contributions • Dividends eligible for DRD

22. Ordinary Income/Loss vs. Separately Stated Items (2 of 2) • Separately stated items (continued) • Foreign or possession taxes • Tax-exempt interest • Any items subject to special allocation • Partnership ordinary income/loss • All items not separately stated

23. 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

24. Special Allocations(1 of 2) • Pre-contribution gains or losses must be allocated to contributing partner for contributions

25. Special Allocations(2 of 2) • 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

26. Partner’s 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 transfer of liabilities

27. Partner’s Basis in Partnership Interest (2 of 2) • Affect of liabilities on partner basis Partner’s basis before liabs + Increases in share of ptrshp liabs - Decreases in share of ptrshp liabs + Ptrshp liabs assumed by this partner - This partner’sliabs assumed by ptrshp = Partner’s basis in the ptrshp interest

28. Special Loss Limitations(1 of 2) • Loss recognition limitations • Partner’s basis in partnership interest • Portion of partner’s basis not “at risk” • Amount partner would lose should the partnership suddenly become worthless.

29. 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

30. Transactions Between Partner & Partnership • Loss sales • No loss deducted on sale of property between a partnership and a  50% owner (direct or indirect) • Gain sales • Gains on sale of property involving a  50% owner produce ordinary income unless property will be a capital asset in hands of new owner

31. Guaranteed Payments • Always ordinary income to recipient • Deductible by the partnership from ordinary income • Losses due to guaranteed payments allocated among partners

32. Family Partnerships(1 of 2) • Interest must be a capital interest • Partner has right to receive assets if partnership liquidates immediately • Capital must be a material income producing factor • Family member must be true owner

33. 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

34. 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

35. Comments or questions about PowerPoint Slides?Email Richard Newmark at richard.newmark@PhDuh.com End of Chapter 9