1. Chapter 10 Partnership Taxation Income Tax Fundamentals 2014 Student Slides Gerald E. Whittenburg Martha Altus-Buller Steven Gill 2014 Cengage Learning 1

2. Nature of Partnership Taxation  Partnerships must file an informational tax return called Form 1065 ◦ Partnership itself does not pay tax; rather, income/expenses ‘flow through’ to partners ◦ Partnership income taxable to partner, even if he/she does not receive cash!!  Partnerships must make various elections (depreciation and inventory methods, for example) 2014 Cengage Learning2

3. What is a Partnership?  A partnership is a syndicate, group, pool, joint venture or other unincorporated organization through which any business, financial operation or venture is carried  Partnerships are legal entities under civil law  In most states they have rights under Uniform Partnership Act 2014 Cengage Learning3

4. Partnership Formation  When forming a partnership, individuals contribute assets to partnership in exchange for a partnership interest  No gain/loss is usually recognized  Exceptions include ◦ When services are performed in exchange for partnership interest ◦ When property is contributed with liabilities in excess of basis, then Recognized Gain = Liabilities Allocable to Others – Adjusted Basis of Property Contributed 2014 Cengage Learning 4

5. Changes in Partner’s Basis 2014 Cengage Learning Changes occur to partner’s basis due to subsequent activities Beginning Basis +Additional Contributions +Share of Net Ordinary Taxable Income +Share of Capital Gains/Other Income -Distributions of Property or Cash -Share of Net Loss from Operations * -Share of Capital Losses/Other Deductions +/- Increase/Decrease in Liabilities Basis in Partnership Interest *Note: Can’t take basis below 0 and must comply with at-risk limitations 5

6. Partnership Income Reporting  Partnerships do not pay tax ◦ All information flows through to be reported by the partners ◦ Tax return is due by the 15th of the 4th month following close of partnership tax year  Must report each element of income and expense separately on Form 1065 (Partnership Tax Return) ◦ Schedule K-1 shows allocable partnership income/expenses for each partner, based upon the individual ownership percentage  Ordinary income/loss  Special income/deduction items such as charitable deductions, interest, capital gains/losses 2014 Cengage Learning 6

7.  Banks and online payments networks (like PayPal) are required to send 1099-Ks to all merchants with more than $20,000 of sales and more than 200 transactions  Form 1099-K is a new and potentially powerful IRS enforcement tool for matching business income to sellers’ tax returns 2014 Cengage Learning 1099-K Reporting Merchant Card & Third-Party Payments 7

8. Limited Liability Companies  Limited Liability Companies (LLCs) have attributes of both partnerships and corporations  Advantages of LLCs are numerous ◦ Taxable income/loss passes through to owners ◦ No general partner requirement ◦ Owners can participate in management ◦ Owners have limited liability ◦ LLC ownership interest is not a security ◦ Tax attributes pass through to owners ◦ Offer greater tax flexibility than S corporations (single member LLCs are very common) 2014 Cengage Learning8

9. Limited Liability Companies  Disadvantages of LLCs ◦ Because of newness, limited amount of case law dealing with limited liability companies ◦ States are not uniform in treatment of LLCs, so potential for confusion if LLC is operating in more than one state LLCs are quickly becoming a major form of business organization in the U.S. 2014 Cengage Learning9