Partnership Classification What motivates choice to incorporate/non- incorporate? –Applicable commercial law –Tax treatment –Investment and Business Preferences What are some non-tax considerations of entity choice? Why are these non-tax considerations important?

Relevant classification of entities for tax purposes Individual - How taxed? Corporation - How taxed? Partnership - How taxed? Compare contrast corporation and partnership taxation. Compare contrast individual taxation and partnership taxation.

What is a partnership? IRC Sec. 761 defines partnership –2 or more persons (i.e., partners) who –carry on a business –for profit –as co-owners Failure to meet these requirements may result in ineligibility of partnership status IRS Pub 541: A partnership is an unincorporated organization with 2+ members that carry on a business etc. and divide profits/losses.

When do partnerships not exist/ Rules to Classify Partnerships Not a Partnership ( Reg. Sec ) if –agreement to share expenses only –lack of co-ownership (capital interest) -facts and circumstances test –lack of a business activity / active pursuit Rules used to classify –Check the box regulations (Regs ) / Anti- Abuse Rules / Rules that allow joint ventures to be partnership or tenants in common.

Key Tax Related Issues Self Employment Tax Treatment of Liabilities At Risk Rules Passive Activity Loss Rules Tax Matters Partner: Unified Audit and Litigation Procedures..TMP must be a general partner or Member manager of LLC, not applicable to small ( 100) electing out of Sub K treatment.

Joint Tenancy v. Partnership 3 Key reasons for proper classification –Filing Requirements..Form 1065 needed for partnerships –Tax Elections made at the partnership level…individual elections invalidated. –As TIC, co-owner can more easily use like kind exchange provisions. If a partnership, owners themselves cannot engage in like-kind exchanges. Examples: Investment partnerships/ Expense sharing / Creditor-Debtor

Partnership Tax Years Sec 706(a) - a partner’s distributive share of partnership items is included in gross income for any taxable year of the partnership ending within or with the taxable year of the partner. –For a calendar year taxpayer, in what tax year of the individual is the following partnership information included: Partnerships with a calendar year ending 12/31/04? Partnerships with a fiscal year 2/1/04 to 1/31/05? Partnerships with a fiscal year 12/1/04 to 11/30/05? Partnership tax years generally must have the same taxable year as the common taxable year of the partners that in the aggregate have interests greater than 50% (Majority interest – generally on first day of tax year)

Partnership Tax Years (continued) If there is no partner/group of partners with the same taxable year owning >50%, the partnership must adopt the common taxable year of all of the principal partners. –Principal partner - person owning an interest of 5% or greater in partnership capital or profits. If partnership is unable to determine its tax year by reference to the majority interest or principal partners - calendar year or year with least aggregate deferral is used.

Partnership Tax Year Continued Changes in tax years –Majority interest / Principal Partner Changes –If Y/E changes because of ownership changes, the alteration is deemed an automatic change –No 4 year spread – Use Form 1128 to make changes. When might you see a partnership have a year end other than a calendar year? What is the most common occurrence for this situation? A partnership can avoid the majority interest and principal partner rules if a valid business purpose for an alternate tax year exists.

Tax Years - Business Purpose Use Rev Proc , to determine natural business year Use 25% test - gross receipts from sales and services for the last 2 months of the requested tax year must exceed 25%. This must be the case for 3 years prior to the examination date. However at least 47 months must exist for examination purposes even though only 36 months are used. If a taxpayer fails the 25% test, they may apply for a business purpose year end using a preponderance of the the facts and circumstances - both tax and non-tax considerations are factored into the request.

Sec. 444 Election Allows a year end to be kept (in case of existing partnerships or elected for new partnerships that is not the one authorized by IRS or using rules for business purpose Requires and advance payment of the estimated deferral benefit received from the tax year difference. Deferral cannot exceed 3 months Firm is required to keep a non interest bearing account with the IRS.

Accounting Methods Cash / Accrual / Hybrid…what are they? Treatment of Inventory? Changing accounting methods – automatic versus required. Cannot use cash method if –Tax Shelter –Have corporate partner with avg. gross receipts in excess of $5million.