Chapter 9: Partnership Formation and Operation
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Transcript Chapter 9: Partnership Formation and Operation
©2011 Pearson Education, Inc. Publishing as Prentice Hall
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PARTNERSHIP FORMATION &
OPERATION (1 of 2)
Partnership
definitions
Overview of partnership taxation
Partnership formation
Partnership elections
Partnership reporting of income
Partner reporting of income
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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
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Partnership Definitions
Tax
definition of a partnership
General partnership
Limited partnership
Limited liability limited partnership
Limited liability companies (LLCs)
Limited liability partnerships (LLPs)
Electing large partnership (ELP)
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Tax Definition of a Partnership
Syndicate,
group, pool, joint venture
or other unincorporated
organization that carries on a
business
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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
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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
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Limited Liability
Limited Partnership
Formed
under state’s limited
partnership laws
General partners have limited liability
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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
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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
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Electing Large Partnerships
(ELP)
May
elect to have simplified set of
reporting rules apply if
Non-service
partnership, and
100 partners
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Overview of Partnership
Taxation
Partnership
profits and losses
Partner’s Basis
Partnership distributions
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Partnership Profits and Losses
(1 of 2)
Partnership
files Form 1065
Information
Partners
return with no tax due
receive a Form K-1
Reports
partner’s share of income or
loss and separately reported items
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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 also
apply
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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
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Partner’s Basis
(2 of 2)
Items
that decrease basis
Partner’s
share of losses
Distributions
Reduction in partnership debt
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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
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Partnership Formation
Contribution
of property
Contributions of services
Organizational & syndication costs
See Topic Review 1 for summary
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Contribution of Property
General
nonrecognition rule
Exceptions to nonrecognition rule
Effect of liabilities
Basis
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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
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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
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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
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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
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Contributions of Services
(1 of 2)
Contribution
of services in exchange
for partnership interest
Income
Partner’s
provided
is FMV of services contributed
basis = FMV of services
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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
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Organizational and Syndication
Costs
Organization
expenditures
costs are capital
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 costs >$50K
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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
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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
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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
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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
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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
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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 liabilities
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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
See Topic Review 3
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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
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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
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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
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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
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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
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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
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Tax Planning Considerations
Timing
of loss recognition
Accelerate
personal income to absorb
partnership losses
Delay personal income recognition to
use anticipated future partnership losses
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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
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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
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Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
[email protected]
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