Chapter 9: Partnership Formation and Operation

Chapter 9: Partnership Formation and Operation

Chapter 9 Partnership Formation & Operation 2011 Pearson Education, Inc. Publishing as Prentice 9-1 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 9-2 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

9-3 Partnership Definitions Tax definition of a partnership General partnership Limited partnership Limited liability limited partnership Limited liability companies (LLCs) Limited liability partnerships 2011 Pearson Education, Inc. Publishing as 9-4 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 9-5 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 9-6 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 9-7 Limited Liability Limited Partnership Formed under states limited partnership laws General partners have limited liability 2011 Pearson Education, Inc. Publishing as

9-8 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 2011 Pearson Education, Inc. Publishing as 9-9 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 9-10 2011 Pearson Education, Inc. Publishing as 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 9-11 Overview of Partnership Taxation Partnership profits and losses Partners Basis Partnership distributions 2011 Pearson Education, Inc. Publishing as

9-12 Partnership Profits and Losses (1 of 2) Partnership files Form 1065 Information Partners return with no tax due receive a Form K-1

Reports partners share of income or loss and separately reported items 2011 Pearson Education, Inc. Publishing as 9-13 Partnership Profits and Losses (2 of 2) Partners include profit or loss and separate items on their entitys return

Form Loss 1040 for individuals limitation Partners losses limited to entitys basis in the partnership At-risk rules and passive loss rules also apply 9-14 2011 Pearson Education, Inc. Publishing as 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 2011 Pearson Education, Inc. Publishing as 9-15

Partners Basis (2 of 2) Items that decrease basis Partners share of losses Distributions Reduction in partnership debt 2011 Pearson Education, Inc. Publishing as 9-16 Partnership Distributions

Generally nontaxable Return of previously taxed earnings Earnings increased partners basis Distributions reduce partners basis Distributions in excess of basis are generally recognized as 2011 Pearson Education, Inc. Publishing as 9-17 Partnership Formation

Contribution of property Contributions of services Organizational & syndication costs See Topic Review 1 for summary 2011 Pearson Education, Inc. Publishing as 9-18 Contribution of Property General nonrecognition rule Exceptions to nonrecognition rule Effect of liabilities Basis

2011 Pearson Education, Inc. Publishing as 9-19 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

2011 Pearson Education, Inc. Publishing as 9-20 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 partners basis

9-21 2011 Pearson Education, Inc. Publishing as 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 partners basis Gain would be recognized if deemed distribution exceeds 2011 Pearson Education, Inc. Publishing as

9-22 Basis Money contributed + Partners basis in contributed prop + Gain recognized on contribution Partners (outside)basis in partnership Partnerships basis in property 2011 Pearson Education, Inc. Publishing as

9-23 Contributions of Services (1 of 2) Contribution of services in exchange for partnership interest Income is FMV of services contributed Partners basis = FMV of services provided

2011 Pearson Education, Inc. Publishing as 9-24 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 9-25 Organizational and Syndication Costs Organization costs are capital expenditures May immediately expense $5K and amortize the rest over 180 months 709 expense election deemed to be made for org costs incurred after

9/8/2008 $5K immediate expense reduced $ for $ for cumulative organization 2011 Pearson Education, Inc. Publishing as 9-26 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 9-27 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 9-28 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 2011 Pearson Education, Inc. Publishing as 9-29 Partner Reporting of Income Partners 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 9-30 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 2011 Pearson Education, Inc. Publishing as 9-31 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 decrease9-32 2011 Pearson Education, Inc. Publishing as Basis for 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 2011 Pearson Education, Inc. Publishing as 9-33 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 2011 Pearson Education, Inc. Publishing as 9-34 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 9-35 2011 Pearson Education, Inc. Publishing as sold 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 2011 Pearson Education, Inc. Publishing as 9-36

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 9-37 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 2011 Pearson Education, Inc. Publishing as 9-38 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 9-39 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 9-40 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 2011 Pearson Education, Inc. Publishing as 9-41 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 Capital and 1231 gains/losses, interest, dividends, and rental income 9-42 2011 Pearson Education, Inc. Publishing as End Chapter 9

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorados Kenneth W. Monfort College of Business [email protected] 2011 Pearson Education, Inc. Publishing as Prentice Hall 9-43

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