Chapter 9: Partnership Formation and Operation

Report
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PARTNERSHIP FORMATION &
OPERATION (1 of 2)
 Partnership
definitions
 Overview of partnership taxation
 Partnership formation
 Partnership elections
 Partnership reporting of income
 Partner reporting of income
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PARTNERSHIP FORMATION &
OPERATION (2 of 2)
 Basis
for partnership interest
 Special loss limitations
 Partnership-partner transactions
 Family partnerships
 Tax planning considerations
 Compliance and procedural
considerations
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Partnership Definitions
 Tax
definition of a partnership
 General partnership
 Limited partnership
 Limited liability limited partnership
 Limited liability companies (LLCs)
 Limited liability partnerships (LLPs)
 Electing large partnership (ELP)
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Tax Definition of a Partnership
 Syndicate,
group, pool, joint venture
or other unincorporated
organization that carries on a
business
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General Partnership
 Two
or more partners
 All partners are general partners
May
participate in management
May make commitments on behalf of
partnership
Unlimited liability for partnership debts
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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
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Limited Liability
Limited Partnership
 Formed
under state’s limited
partnership laws
 General partners have limited liability
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Limited Liability Companies
(LLC)
 May
be taxed as a partnership or a
corp (using check-the-box Regs)
 When taxed as a partnership, entity
obtains pass-through and flexibility
of partnership allocations while
maintaining limited liability of a corp
 59% of all partnerships in 2007
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Limited Liability Partnerships
(LLP)
 Used
by many professional
organizations
 May be taxed as a partnership or a
corporation using check-the-box Regs
 Partners not liable for failures in work
of other partners or people supervised
by other partners
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Electing Large Partnerships
(ELP)
 May
elect to have simplified set of
reporting rules apply if
Non-service
partnership, and
100 partners
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Overview of Partnership
Taxation
 Partnership
profits and losses
 Partner’s Basis
 Partnership distributions
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Partnership Profits and Losses
(1 of 2)
 Partnership
files Form 1065
Information
 Partners
return with no tax due
receive a Form K-1
Reports
partner’s share of income or
loss and separately reported items
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Partnership Profits and Losses
(2 of 2)
 Partners
include profit or loss and
separate items on their entity’s return
Form
 Loss
1040 for individuals
limitation
Partner’s
losses limited to entity’s basis
in the partnership
At-risk rules and passive loss rules also
apply
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Partner’s Basis
(1 of 2)
 Items
that increase basis
Partner’s
share of partnership earnings,
additional contributions, & additional
assumption of partnership debt
Increase
in basis for earnings prevents
double taxation of earnings upon
subsequent distribution
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Partner’s Basis
(2 of 2)
 Items
that decrease basis
Partner’s
share of losses
Distributions
Reduction in partnership debt
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Partnership Distributions
 Generally
nontaxable
 Return of previously taxed earnings
Earnings
increased partner’s basis
Distributions reduce partner’s basis
 Distributions
in excess of basis are
generally recognized as taxable gain
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Partnership Formation
 Contribution
of property
 Contributions of services
 Organizational & syndication costs
 See Topic Review 1 for summary
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Contribution of Property
 General
nonrecognition rule
 Exceptions to nonrecognition rule
 Effect of liabilities
 Basis
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General Nonrecognition Rule
 Property
contributions general rule
No
gain or loss
§721 similar to §351
Partner has substituted basis in
partnership interest
Partnership gets carryover basis
Holding period tacks on for partner and
partnership
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Exceptions to Nonrecognition Rule
 Gain
recognition at time of property
contribution if
Partnership
would be investment
company if it were incorporated,
Contribution followed by a distribution
resulting in a deemed sale, or
Liabilities assumed by partnership in
excess of partner’s basis
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Effect of Liabilities Contributed by
Partner to Partnership
 Basis
of each partner (including
contributing partner) increased by
her share of liabilities, AND
 Contributing partner treated as if
partnership made cash distribution to
partner, decreasing partner’s basis
Gain
would be recognized if deemed
distribution exceeds partner’s basis
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Basis
+
+
Money contributed
Partner’s basis in contributed prop
Gain recognized on contribution
Partner’s (outside)basis in partnership
 Partnership’s
basis in property
Partner’s
old basis before contribution
Depr Recap potential transfers to ptrshp
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Contributions of Services
(1 of 2)
 Contribution
of services in exchange
for partnership interest
Income
 Partner’s
provided
is FMV of services contributed
basis = FMV of services
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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 less basis in assets
allocated to service partner
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Organizational and Syndication
Costs
 Organization
expenditures
costs are capital
May
immediately expense $5K and
amortize the rest over 180 months
§709
expense election deemed to be made
for org costs incurred after 9/8/2008
$5K
immediate expense reduced $ for $
for cumulative organization costs >$50K
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Partnership Elections
 Tax
year
Must
be same as majority partner or
partners with a 50% or more interest
See Topic Review 2
 Overall
accounting method
 Inventory valuation method
 Depreciation method
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Partnership Reporting of
Income (1 of 2)
 Separately
stated items include:
Net
S-T capital gains and losses
Net L-T capital gains and losses
§1231 gains and losses
Charitable contributions
Dividends eligible for DRD
Foreign or possession taxes
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Partnership Reporting of
Income (2 of 2)
 Separately
stated items (continued)
Tax-exempt
interest
Portfolio activities
Passive activities
U.S. production activities deduction
Any items subject to special allocation
 Partnership
All
ordinary income/loss
items not separately stated
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Partner Reporting of Income
Partner’s Distributive Share
 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
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Partner Reporting of Income
Special Allocations
 Pre-contribution
gains or losses must be
allocated to contributing partner
 Allocations unrelated to contrib prop
must have substantial economic effect
Allocations
affect partners’ capital
accounts, AND
Partners must make up deficit in capital
account upon liquidation of partnership
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Basis for 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 decrease in share of liabilities
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Basis for Partnership Interest
(2 of 2)
 Effect
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’s liabs assumed by ptrshp
= Partner’s basis in the ptrshp interest
 See Topic Review 3
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Special Loss Limitations
(1 of 2)
 Loss
recognition limitations
Partner’s
basis in partnership interest
Portion of partner’s basis not “at risk”
At
risk definition: amount partner would
lose should the partnership suddenly
become worthless
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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
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Partnership-Partner Transactions
(Related Party Issues)
 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
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Partnership-Partner Transactions
(Guaranteed Payments)
 Always
ordinary income to recipient
 Partner treats payment as if made to
an outsider
Deduct
or capitalize
If
deductible, GP reduces partnership
ordinary income, which is allocated based
on partnership agreement
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Family Partnerships
(1 of 2)
 Safe-harbor
rule under §704(e) for
family partnerships
Interest
must be a capital interest,
Partner
has right to receive assets if
partnership liquidates immediately
Capital
must be a material income
producing factor, AND
Family member must be true owner
Kiddie
tax may apply
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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
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Tax Planning Considerations
 Timing
of loss recognition
Accelerate
personal income to absorb
partnership losses
Delay personal income recognition to
use anticipated future partnership losses
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Compliance and Procedural
Considerations (1 of 2)
 Forms
Form
1065 for partnership
Form K-1 for each partner
May file for automatic 5 mo. extension
 Schedule
M-3 required instead of M-1
for large partnerships
 Sec. 444 election – use Form 8716
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Compliance and Procedural
Considerations (2 of 2)
 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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Comments or questions about PowerPoint Slides?
Contact Dr. Richard Newmark at
University of Northern Colorado’s
Kenneth W. Monfort College of Business
richard.newmark@PhDuh.com
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