1. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Chapter 14 Partnership Taxation “People who complain about taxes can be divided into two classes: men and women.” -- Anonymous

2. 14-2 LO #1- Partnership Formation Typically, a partner recognizes no gain or loss on the formation of a partnership Outside basis – the basis of the partnership interest in the hands of the partner Inside basis – the partner’s share of the basis of the individual assets in the partnership Inside basis usually equals outside basis

3. 14-3 LO #1- Partnership Formation Basis-in, Basis-out – The beginning basis to the partnership is usually the basis of the contributed assets. Steps into the shoes – the basis of assets in the hands of the partnership is the same as the basis in the hands of the contributing partner.

4. 14-4 LO #1- Partnership Formation Holding periods – general rule is that the holding period of the partnership interest includes the partner’s holding period when Section 1231 or capital assets are contributed Contribution of ordinary assets – the holding period begins on the date of the contribution.

5. 14-5 LO #1- Partnership Formation Contribution of services – a partner providing services in exchange for a partnership interest recognizes ordinary income to the extent of the FMV of the partnership interest Assumed liabilities by the partnership – any release of liability by a contributing partner is treated as a money distribution to the partner (reduces basis)

6. 14-6 LO #2 - Partnership Ordinary Income or Loss Ordinary income or loss –Sales, revenue from services –Ordinary & necessary expenses –No items are included in ordinary income or losses that can be treated differently at the partner level. These are “separately stated items.” Guaranteed payments – payments made to partners that are calculated without regard to partnership income

7. 14-7 LO #2 - Partnership Ordinary Income or Loss Depreciation –Follows the same rules as a sole proprietorship –Section 179 expense must be separately stated Partner health premium –Partners cannot exclude from income the health insurance premiums paid by the partnership –Premiums are treated as guaranteed payments

8. 14-8 LO #3 – Separately Stated Items General rule - All income and expense items of a partnership that may be treated differently at the partner level must be “separately stated.” –Table 14-1 in text Most common separately stated items –Rental income –Interest and dividend income –Capital gains and losses –Section 179 expense

9. 14-9 LO #3 – Separately Stated Items Schedule K-1 – reports the share of ordinary income and separately stated items for each partner. Line numbers of the K-1 correspond to the Schedule K of Form 1065

10. 14-10 LO #3 – Separately Stated Items Self-employment Income – since a partner is not an employee of the partnership, income from the partnership is considered self- employment income Calculation: –1. Ordinary income from Schedule K-1, line 1 –2. Plus any guaranteed payments from Schedule K-1, line 4 –3. Less any §1231 gain included in ordinary income –4. Less any §179 expense from Schedule K-1, line 12

11. 14-11 LO #4 – Basis of the Partnership Interest Outside basis calculation (calculated for each partner) –Basis of property contributed –Plus: FMV of services rendered (or cost, if partnership interest was purchased) –Plus: Basis of cash or property contributions after formation –Plus: Share of partnership ordinary income –Plus: Share of separately stated income or gain items –Plus: Share in partnership liabilities –Less: Basis of cash or property distributed (but not below zero) –Less: Share of partnership ordinary loss (but not below zero) –Less: Share of separately stated loss/expense items –Less: Release of partnership liabilities

12. 14-12 LO #5 – Partnership Distributions General rule - a partner recognizes no gain or loss on a non-liquidating distribution Gain is recognized only: –Only money or marketable securities are distributed in excess of the partner’s basis –Current distribution triggers a pre- contribution gain

13. 14-13 LO #5 – Partnership Distributions Pre-contribution gain - occurs when a partner contributes appreciated property to a partnership and, within seven years, the partnership distributes the same property to another partner. Basis of distributed property – typically the partner steps into the shoes of the partnership.

14. 14-14 LO #6 – Disposal or Liquidation of a Partnership Interest Liquidation –Rules similar to current distributions –A distribution of money in excess of basis causes a capital gain –A loss can be recognized when the amount received in liquidation is less than the partner’s outside basis and only money, receivables and/or inventory are received

15. 14-15 LO #6 – Disposal or Liquidation of a Partnership Interest Sale of a partnership interest –Treated as a sale of a capital asset –If the partnership has substantially appreciated inventory or accounts receivable, some of the capital gain could be ordinary Individual partners report sale on Form 1040, Schedule D.