2011 Pearson Education Inc Publishing as Prentice Hall

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© 2011 Pearson Education, Inc. Publishing as Prentice Hall 9 -1

© 2011 Pearson Education, Inc. Publishing as Prentice Hall 9 -1

PARTNERSHIP FORMATION & OPERATION (1 of 2) ® Partnership definitions ® Overview of partnership

PARTNERSHIP FORMATION & OPERATION (1 of 2) ® Partnership definitions ® Overview of partnership taxation ® Partnership formation ® Partnership elections ® Partnership reporting of income ® Partner reporting of income © 2011 Pearson Education, Inc. Publishing as Prentice 9 -2

PARTNERSHIP FORMATION & OPERATION (2 of 2) ® Basis for partnership interest ® Special

PARTNERSHIP FORMATION & OPERATION (2 of 2) ® Basis for partnership interest ® Special loss limitations ® Partnership-partner transactions ® Family partnerships ® Tax planning considerations ® Compliance and procedural considerations © 2011 Pearson Education, Inc. Publishing as Prentice 9 -3

Partnership Definitions ® Tax definition of a partnership ® General partnership ® Limited liability

Partnership Definitions ® Tax definition of a partnership ® General partnership ® Limited liability limited partnership ® Limited liability companies (LLCs) ® Limited liability partnerships (LLPs) ® Electing large partnership (ELP) © 2011 Pearson Education, Inc. Publishing as Prentice 9 -4

Tax Definition of a Partnership ® Syndicate, group, pool, joint venture or other unincorporated

Tax Definition of a Partnership ® Syndicate, group, pool, joint venture or other unincorporated organization that carries on a business © 2011 Pearson Education, Inc. Publishing as Prentice 9 -5

General Partnership ® Two or more partners ® All partners are general partners May

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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -6

Limited Partnership ® One or more general partners AND ® One of more limited

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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -7

Limited Liability Limited Partnership ® Formed under state’s limited partnership laws ® General partners

Limited Liability Limited Partnership ® Formed under state’s limited partnership laws ® General partners have limited liability © 2011 Pearson Education, Inc. Publishing as Prentice 9 -8

Limited Liability Companies (LLC) ® May be taxed as a partnership or a corp

Limited Liability Companies (LLC) ® May be taxed as a partnership or a corp (using check-the-box Regs) ® When taxed as a partnership, entity obtains pass-through and flexibility of partnership allocations while maintaining limited liability of a corp ® 59% of all partnerships in 2007 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -9

Limited Liability Partnerships (LLP) ® Used by many professional organizations ® May be taxed

Limited Liability Partnerships (LLP) ® 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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -10

Electing Large Partnerships (ELP) ® May elect to have simplified set of reporting rules

Electing Large Partnerships (ELP) ® May elect to have simplified set of reporting rules apply if Non-service partnership, and 100 partners © 2011 Pearson Education, Inc. Publishing as Prentice 9 -11

Overview of Partnership Taxation ® Partnership profits and losses ® Partner’s Basis ® Partnership

Overview of Partnership Taxation ® Partnership profits and losses ® Partner’s Basis ® Partnership distributions © 2011 Pearson Education, Inc. Publishing as Prentice 9 -12

Partnership Profits and Losses (1 of 2) ® Partnership Information ® Partners files Form

Partnership Profits and Losses (1 of 2) ® Partnership Information ® Partners files Form 1065 return with no tax due receive a Form K-1 Reports partner’s share of income or loss and separately reported items © 2011 Pearson Education, Inc. Publishing as Prentice 9 -13

Partnership Profits and Losses (2 of 2) ® Partners include profit or loss and

Partnership Profits and Losses (2 of 2) ® Partners include profit or loss and separate items on their entity’s return Form ® Loss 1040 for individuals limitation Partner’s losses limited to entity’s basis in the partnership At-risk rules and passive loss rules 9 -14 also apply © 2011 Pearson Education, Inc. Publishing as Prentice

Partner’s Basis (1 of 2) ® Items that increase basis Partner’s share of partnership

Partner’s Basis (1 of 2) ® Items that increase basis Partner’s share of partnership earnings, additional contributions, & additional assumption of partnership debt ¬Increase in basis for earnings prevents double taxation of earnings upon subsequent distribution © 2011 Pearson Education, Inc. Publishing as Prentice 9 -15

Partner’s Basis (2 of 2) ® Items that decrease basis Partner’s share of losses

Partner’s Basis (2 of 2) ® Items that decrease basis Partner’s share of losses Distributions Reduction in partnership debt © 2011 Pearson Education, Inc. Publishing as Prentice 9 -16

Partnership Distributions ® Generally nontaxable ® Return of previously taxed earnings Earnings increased partner’s

Partnership Distributions ® Generally nontaxable ® Return of previously taxed earnings Earnings increased partner’s basis Distributions reduce partner’s basis ® Distributions in excess of basis are generally recognized as taxable gain © 2011 Pearson Education, Inc. Publishing as Prentice 9 -17

Partnership Formation ® Contribution of property ® Contributions of services ® Organizational & syndication

Partnership Formation ® Contribution of property ® Contributions of services ® Organizational & syndication costs ® See Topic Review 1 for summary © 2011 Pearson Education, Inc. Publishing as Prentice 9 -18

Contribution of Property ® General nonrecognition rule ® Exceptions to nonrecognition rule ® Effect

Contribution of Property ® General nonrecognition rule ® Exceptions to nonrecognition rule ® Effect of liabilities ® Basis © 2011 Pearson Education, Inc. Publishing as Prentice 9 -19

General Nonrecognition Rule ® Property contributions general rule No gain or loss § 721

General Nonrecognition Rule ® Property contributions general rule No gain or loss § 721 similar to § 351 Partner has substituted basis in partnership interest Partnership gets carryover basis Holding period tacks on for partner and partnership © 2011 Pearson Education, Inc. Publishing as Prentice 9 -20

Exceptions to Nonrecognition Rule ® Gain recognition at time of property contribution if Partnership

Exceptions to Nonrecognition 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 partner’s basis © 2011 Pearson Education, Inc. Publishing as Prentice 9 -21

Effect of Liabilities Contributed by Partner to Partnership ® Basis of each partner (including

Effect of Liabilities Contributed by Partner to Partnership ® Basis of each partner (including contributing partner) increased by her share of liabilities, AND ® Contributing partner treated as if partnership made cash distribution to partner, decreasing partner’s basis Gain would be recognized if deemed distribution exceeds partner’s basis © 2011 Pearson Education, Inc. Publishing as Prentice 9 -22

Basis Money contributed + Partner’s basis in contributed prop + Gain recognized on contribution

Basis Money contributed + Partner’s basis in contributed prop + Gain recognized on contribution Partner’s (outside)basis in partnership ® Partnership’s basis in property Partner’s old basis before contribution Depr Recap potential transfers to ptrshp 9 -23 © 2011 Pearson Education, Inc. Publishing as Prentice

Contributions of Services (1 of 2) ® Contribution of services in exchange for partnership

Contributions of Services (1 of 2) ® Contribution of services in exchange for partnership interest Income ® Partner’s is FMV of services contributed basis = FMV of services provided © 2011 Pearson Education, Inc. Publishing as Prentice 9 -24

Contributions of Services (2 of 2) ® Partnership deducts or capitalizes FMV of services,

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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -25

Organizational and Syndication Costs ® Organization costs are capital expenditures May immediately expense $5

Organizational and Syndication Costs ® Organization costs are capital expenditures May immediately expense $5 K and amortize the rest over 180 months ¬§ 709 expense election deemed to be made for org costs incurred after 9/8/2008 $5 K immediate expense reduced $ for cumulative organization costs >$50 K © 2011 Pearson Education, Inc. Publishing as Prentice 9 -26

Partnership Elections ® Tax year Must be same as majority partner or partners with

Partnership Elections ® Tax year Must be same as majority partner or partners with a 50% or more interest See Topic Review 2 ® Overall accounting method ® Inventory valuation method ® Depreciation method © 2011 Pearson Education, Inc. Publishing as Prentice 9 -27

Partnership Reporting of Income (1 of 2) ® Separately stated items include: Net S-T

Partnership Reporting of Income (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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -28

Partnership Reporting of Income (2 of 2) ® Separately stated items (continued) Tax-exempt interest

Partnership Reporting of Income (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 All ordinary income/loss items not separately stated © 2011 Pearson Education, Inc. Publishing as Prentice 9 -29

Partner Reporting of Income Partner’s Distributive Share ® Normally determined by terms of partnership

Partner Reporting of Income Partner’s Distributive Share ® 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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -30

Partner Reporting of Income Special Allocations ® Pre-contribution gains or losses must be allocated

Partner Reporting of Income Special Allocations ® Pre-contribution gains or losses must be allocated to contributing partner ® Allocations unrelated to contrib prop must have substantial economic effect Allocations affect partners’ capital accounts, AND Partners must make up deficit in capital account upon liquidation of partnership © 2011 Pearson Education, Inc. Publishing as Prentice 9 -31

Basis for Partnership Interest (1 of 2) ® Beginning basis Amount paid for interest

Basis for 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 9 -32 liabilities © 2011 Pearson Education, Inc. Publishing as Prentice

Basis for Partnership Interest (2 of 2) ® Effect of liabilities on partner basis

Basis for Partnership Interest (2 of 2) ® Effect 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’s liabs assumed by ptrshp = Partner’s basis in the ptrshp interest © 2011 Pearson Education, Inc. Publishing as Prentice 9 -33

Special Loss Limitations (1 of 2) ® Loss recognition limitations Partner’s basis in partnership

Special Loss Limitations (1 of 2) ® Loss recognition limitations Partner’s basis in partnership interest Portion of partner’s basis not “at risk” ¬At risk definition: amount partner would lose should the partnership suddenly become worthless © 2011 Pearson Education, Inc. Publishing as Prentice 9 -34

Special Loss Limitations (2 of 2) ® Loss recognition limitations (continued) Designation of partnership

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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -35

Partnership-Partner Transactions (Related Party Issues) ® Loss sales No loss deducted on sale of

Partnership-Partner Transactions (Related Party Issues) ® 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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -36

Partnership-Partner Transactions (Guaranteed Payments) ® Always ordinary income to recipient ® Partner treats payment

Partnership-Partner Transactions (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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -37

Family Partnerships (1 of 2) ® Safe-harbor rule under § 704(e) for family partnerships

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 ¬Kiddie tax may apply © 2011 Pearson Education, Inc. Publishing as Prentice 9 -38

Family Partnerships (2 of 2) ® Donor-donee allocations of income Donor must be allocated

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 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -39

Tax Planning Considerations ® Timing of loss recognition Accelerate personal income to absorb partnership

Tax Planning Considerations ® Timing of loss recognition Accelerate personal income to absorb partnership losses Delay personal income recognition to use anticipated future partnership losses © 2011 Pearson Education, Inc. Publishing as Prentice 9 -40

Compliance and Procedural Considerations (1 of 2) ® Forms Form 1065 for partnership Form

Compliance and Procedural Considerations (1 of 2) ® Forms Form 1065 for partnership Form K-1 for each partner May file for automatic 5 mo. extension ® Schedule M-3 required instead of M 1 for large partnerships ® Sec. 444 election – use Form 8716 © 2011 Pearson Education, Inc. Publishing as Prentice 9 -41

Compliance and Procedural Considerations (2 of 2) ® Self-employment income Individuals who are partners

Compliance and Procedural Considerations (2 of 2) ® 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 ªCapital and § 1231 gains/losses, interest, dividends, and rental income © 2011 Pearson Education, Inc. Publishing as Prentice 9 -42

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. [email protected] Duh. com © 2011 Pearson Education, Inc. Publishing as Prentice Hall 9 -43