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Chapter 10

Partnership TaxationIncome Tax Fundamentals 2007 Gerald E. Whittenburg & Martha Altus-Buller

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What is a Partnership?

A partnership is a syndicate, group, pool, joint venture or other unincorporated organization Through or by means of which any

business, financial operation or venture is carried on

Simply co-owning property does not constitute a partnership

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Partnership Formation

When forming a partnership Individuals contribute assets to partnership in

exchange for a partnership interest Cash or property

No gain/loss is recognized unless Services are performed in exchange for partnership

interest Property is contributed with liabilities in excess of

basis, then

Recognized Gain = Liabilities Allocable to Others – Adjusted Basis of Property Contributed

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Partnership Formation

Partner’s basis in partnership interest

Cash contributed

plus: Basis of property transferred

plus: Gain recognized

less: Liabilities allocable to other partners

equals: Initial basis

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Partner’s Basis in Partnership Interest (Subsequent Activities)

Beginning Basisplus: Additional Contributions

Share of Taxable IncomeShare of Capital Gains/Other Income

less: Distributions of Property or $Share of Net Loss from Operations*Share of Capital Losses/Other Deductions

+/- Increase/Decrease in Liabilities Basis in Partnership Interest (can’t drop below $0)

*Can’t take basis below 0 and must comply with at-risk limitations

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Partnership Income Reporting

Partnerships do not pay tax All information flows through to be reported by the partners Return is due by 15th of 4th month following close of

partnership tax year

Must report all elements of income and expense separately on Form 1065 (Partnership Tax Return) Schedule K-1 takes total partnership income/expenses and

allocates each item to each partner based upon their ownership percentage

Ordinary income/loss Special income/deduction items

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Current Distributions and Guaranteed Payments

Partnerships may make distributions of money or other property to partners ‘Current distribution’ does not

completely terminate partner’s interest No gain recognized by partner, unless

partner’s basis in partnership has reached zero

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At-Risk Limitations Partners cannot deduct losses from activities in

excess of their investment 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

+ Retained profits in activity

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Real Estate & At-Risk Rules

Real estate acquired before 1987 is not subject to at-risk rules

For real estate acquired after 1986, the “qualified nonrecourse financing” is considered to be the amount at risk Defined as debt secured by real estate

and borrowed from person who regularly engages in the lending of money

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Limited Liability Companies (LLCs)

LLCs are a cross between a partnership and a corporation Treated generally as a partnership for tax purposes Each owner has limited liability like a stockholder

Advantages Taxable income/loss passes through to owners There is no general partner requirement Owners in LLCs can participate in management Owners have limited liability LLC ownership interest is not a security Tax attributes pass through to owners LLCs offer greater tax flexibility than S corporations

Disadvantages Because of newness, limited amount of case law dealing with LLCs States are not uniform in treatment of LLCs