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Chapter 10 Partnership Taxation. Income Tax Fundamentals 2010 Gerald E. Whittenburg Martha Altus- Buller Student’s Copy. What is a Partnership?.

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income tax fundamentals 2010 gerald e whittenburg martha altus buller student s copy

Chapter 10Partnership Taxation

Income Tax Fundamentals 2010

Gerald E. Whittenburg

Martha Altus-Buller

Student’s Copy

2010 Cengage Learning

what is a partnership
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 on
    • Simply co-owning property does not constitute a partnership
      • Note: many co-owners of real estate choose to operate as a limited partnership or limited liability company

2010 Cengage Learning

partnership formation
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

2010 Cengage Learning

partnership formation1
Partnership Formation
  • Partner’s basis in partnership interest

Cash contributed

plus: Basis of property transferred to partnership

plus: Gain recognized (from prior screen)

less: Liabilities allocable to other partners

Equals: Partner’s initial basis in partnership

2010 Cengage Learning

changes in partner s basis
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 $

- 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

Changes in Partner’s Basis

2010 Cengage Learning

partnership income reporting
Partnership Income Reporting
  • Partnerships do not pay tax
    • All information flows through to be reported by the partners
    • Tax return is due by 15th of 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

2010 Cengage Learning

at risk limitations
At-Risk Limitations
  • Partners cannot deduct losses from activities in excess of their investment
    • Losses limited to amounts at risk (AAR) in those activities
  • Definitions
    • A “nonrecourse liability” is a debt for which the borrower is not personally liable
    • “Encumbered property” is the property pledged for a liability
  • Taxpayers are at-risk for an amount equal to

Cash and property contributed to partnership

+ Liabilities on encumbered properties (recourse debt)

+ Liabilities for which taxpayer is personally liable (recourse debt)

+ Retained profits in activity

2010 Cengage Learning

limited liability companies
Limited Liability Companies
  • Limited Liability Companies (LLCs) are a cross between a partnership and a corporation
    • Treated generally as a partnership for tax purposes
    • Each owner has limited liability (similar to a corporation)
  • 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

2010 Cengage Learning

limited liability companies1
Limited Liability Companies
  • Disadvantages
    • 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 operating in more than one state

Note: Limited Liability Companies quickly becoming a major form of business organization in the U.S.

2010 Cengage Learning