Chapter 14

1. Chapter 14 Partnership Taxation “People who complain about taxes can be divided into two classes: men and women.” -- Anonymous

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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.