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

9-2 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 Hall

9-3 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 Hall

9-4 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) ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9-5 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 Hall

9-6 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 Hall

9-7 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 Hall

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

9-9 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 Hall

9-10 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 Hall

9-11 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 Hall

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

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

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

9-15 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 Hall

9-16 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 Hall

9-17 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 Hall

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

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

9-20 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 Hall

9-21 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 Hall

9-22 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 Hall

9-23 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

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

9-25 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 Hall

9-26 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 costs >$50K ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9-27 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 Hall

9-28 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 Hall

9-29 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 ordinary income/loss  All items not separately stated ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9-30 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 Hall

9-31 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 Hall

9-32 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9-33 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

9-34 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 Hall

9-35 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 Hall

9-36 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 Hall

9-37 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 Hall

9-38 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 Hall

9-39 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 Hall

9-40 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 Hall

9-41 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 Hall

9-42 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 ©2011 Pearson Education, Inc. Publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 9-43 ©2011 Pearson Education, Inc. Publishing as Prentice Hall