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Chapter 9: Partnership Formation and Operation. Chapter 9: Partnership Formation & Operation. PARTNERSHIP FORMATION & OPERATION (1 of 2). Partnership definitions Overview of partnership taxation Contributions of Property Partnership elections

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chapter 9 partnership formation and operation

Chapter 9:Partnership Formation and Operation

Chapter 9:

Partnership

Formation

& Operation

partnership formation operation 1 of 2
PARTNERSHIP FORMATION & OPERATION (1 of 2)
  • Partnership definitions
  • Overview of partnership taxation
  • Contributions of Property
  • Partnership elections
  • Ordinary income/loss vs. separately stated items
  • Partners’ distributive share of items
partnership formation operation 2 of 2
PARTNERSHIP FORMATION & OPERATION (2 of 2)
  • Special allocations
  • Partner’s basis in partnership interest
  • Special loss limitations
  • Guaranteed payments
  • Transactions between partner & partnership
  • Family partnerships
partnership definitions 1 of 5
Partnership Definitions(1 of 5)
  • Tax definition of a partnership
    • Syndicate, group, pool, joint venture or other unincorporated organization that carries on a business
partnership definitions 2 of 5
Partnership Definitions(2 of 5)
  • General partnership
    • Two or more partners
    • All partners are general partners
      • May participate in mgmt
      • May make commitments on behalf of partnership
      • Unlimited liability for partnership debts
partnership definitions 3 of 5
Partnership Definitions(3 of 5)
  • 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
partnership definitions 4 of 5
Partnership Definitions(4 of 5)
  • Limited liability companies (LLCs)
    • May be taxed as a partnership or a corp (using check-the-box regs)
    • Allows entity to obtain flow-through and flexibility of partnership allocations while maintaining limited liability of a corp.
partnership definitions 5 of 5
Partnership Definitions(5 of 5)
  • Limited liability partnerships(LLPs)
    • Used by many professional organizations
    • May be taxed as a partnership or a corp (using check-the-box regs)
    • Partners not liable for failures in work of other partners or people supervised by other partners
  • Electing large partnership (ELP)
    • Non-service partnerships w/ 100 ptrs
overview of partnership taxation
Overview of Partnership Taxation
  • Partnership profits and losses
  • Partner’s Basis
  • Partnership distributions
partnership profits and losses 1 of 2
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
partnership profits and losses 2 of 2
Partnership Profits and Losses (2 of 2)
  • Partners include profit or loss and separate items on their individual return (Form 1040 for individuals)
  • Loss limitation
    • Partner’s losses limited to his/her basis in the partnership
    • At-risk rules and passive loss rules also apply
partner s basis
Partner’s Basis
  • Partner’s basis increased by share of partnership earnings, additional contributions, & additional assumption of partnership debt
  • Partner’s basis decreased by losses, distributions, & reduction in partnership debt
partnership distributions
Partnership Distributions
  • Payment of money to partner usually tax-free because earnings previously taxed
  • If distributions exceed the partner’s basis, gain may be recognized
contributions of property
Contributions of Property
  • General rule
  • Exceptions to nonrecogntion rule
  • Contributions of services
  • Basis
  • See Topic Review C9-1 for summary
general rule
General Rule
  • General rule for property contributions in exchange for partnership interest
    • No gain or loss
    • §721 similar to §351
exceptions to nonrecognition rule
Exceptions toNonrecognition Rule
  • Gains recognition at time of property contribution
    • Partnership would be investment company if it were incorporated
    • Contribution followed by a distribution resulting in a deemed sale
    • Liabilities assumed by partnership in excess of partner’s basis
contributions of services 1 of 2
Contributions of Services(1 of 2)
  • Contribution of services in exchange for partnership interest
    • Income is FMV of services contributed
contributions of services 2 of 2
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 – basis in assets allocated to service partner
basis
Basis
  • Partner’s basis in partnership equal to money contributed plus partner’s basis in contributed property plus gain recognized on contribution
  • Partnership’s basis in property is partner’s old basis before contribution
    • Holding period also carries over
partnership elections
Partnership Elections
  • Tax year
    • Must be same as majority partner or partners with a 50% or more interest
    • See Topic Review C9-2
  • Overall accounting method
  • Inventory valuation method
  • Depreciation method
ordinary income loss vs separately stated items 1 of 2
Ordinary Income/Loss vs. Separately Stated Items (1 of 2)
  • Separately stated items
    • Net S-T capital gains and losses
    • Net L-T capital gains and losses
    • §1231 gains and losses
    • Charitable contributions
    • Dividends eligible for DRD
ordinary income loss vs separately stated items 2 of 2
Ordinary Income/Loss vs. Separately Stated Items (2 of 2)
  • Separately stated items (continued)
    • Foreign or possession taxes
    • Tax-exempt interest
    • Any items subject to special allocation
  • Partnership ordinary income/loss
    • All items not separately stated
partners distributive share of items
Partners’ Distributive Share of Items
  • 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
special allocations 1 of 2
Special Allocations(1 of 2)
  • Pre-contribution gains or losses must be allocated to contributing partner for contributions
special allocations 2 of 2
Special Allocations(2 of 2)
  • Allocations not related to contributed property must have substantial economic effect
    • Allocations affect partners’ capital accounts, and
    • Partners must make up deficit in capital account upon liquidation of partnership
partner s basis in partnership interest 1 of 2
Partner’s Basis in 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 transfer of liabilities
partner s basis in partnership interest 2 of 2
Partner’s Basis in Partnership Interest (2 of 2)
  • Affect 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’sliabs assumed by ptrshp

= Partner’s basis in the ptrshp interest

special loss limitations 1 of 2
Special Loss Limitations(1 of 2)
  • Loss recognition limitations
    • Partner’s basis in partnership interest
    • Portion of partner’s basis not “at risk”
      • Amount partner would lose should the partnership suddenly become worthless.
special loss limitations 2 of 2
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
transactions between partner partnership
Transactions Between Partner & Partnership
  • 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
guaranteed payments
Guaranteed Payments
  • Always ordinary income to recipient
  • Deductible by the partnership from ordinary income
  • Losses due to guaranteed payments allocated among partners
family partnerships 1 of 2
Family Partnerships(1 of 2)
  • Interest must be a capital interest
    • Partner has right to receive assets if partnership liquidates immediately
  • Capital must be a material income producing factor
  • Family member must be true owner
family partnerships 2 of 2
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
self employment income
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
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