Exam 21: Partnerships

A partnership is an association formed by two or more taxpayers (which may be any type of entity) to carry on a trade or business.

On the formation of a partnership, when might a "disguised sale" occur? How can this treatment be avoided?

Brooke and John formed a partnership. Brooke received a 40% interest in partnership capital and profits in exchange for contributing land (basis of $30,000 and fair market value of $120,000). John received a 60% interest in partnership capital and profits in exchange for contributing $180,000 of cash. Three years after the contribution date, the land contributed by Brooke is sold by the partnership to a third party for $150,000. How much taxable gain will Brooke recognize from the sale?

Samuel is the managing general partner of STU, in which he owns a 25% interest. For the year, STU reported ordinary income of $400,000 (after deducting all guaranteed payments). In addition, the LLC reported interest income of $12,000. Samuel received a guaranteed payment of $120,000 for services he performed for STU. How much income from self-employment did Samuel earn from STU?

The total tax burden on entity income is greater for a partner in a partnership (up to 37% for an individual partner) than on a shareholder in a corporation (21% for an individual shareholder), so partnerships are only used in special situations.

Match each of the following statements with the terms below that provide the best definition. a. Adjusted basis of each partnership asset. b. Operating expenses incurred after entity is formed but before it begins doing business. c. Each partner's basis in the partnership. d. Reconciles book income to "taxable income." e. Tax accounting election made by partnership. f. Tax accounting calculation made by partner. g. Tax accounting election made by partner. h. Does not include liabilities. i. Designed to prevent excessive deferral of taxation of partnership income. j. Amount that may be received by partner for performance of services for the partnership. k. Theory under which a partnership's recourse debt is shared among the partners. l. Will eventually be allocated to partner making tax-free property contribution to partnership. m. Partner's share of partnership items. n. Must generally be satisfied by any allocation to the partners. o. Justification for a tax year other than the required taxable year. p. No correct match is provided. -Schedule K-1

The December 31, balance sheet of DBW, LLP, a service-providing partnership, is as follows. The partners share equally in partnership capital, income, gain, loss, deduction, and credit. Capital is not a material income-producing factor to the partnership. On December 31, partner Dana (who is an active managing partner in the partnership) receives a distribution of $120,000 cash in liquidation of her partnership interest under § 736. Dana's outside basis for the partnership interest immediately before the distribution is $90,000. How much is Dana's gain or loss on the distribution and what is its character?

Which of the following statements is always true regarding accounting methods available to a partnership?

Laura is a real estate developer and owns property that is treated as inventory (not a capital asset) in her business. She contributes a parcel of this land (basis of $15,000) to a partnership, also to be held as inventory. The fair market value of the property is $12,000 at the contribution date. After three years, the partnership sells the land for $10,000. The partnership will recognize a $5,000 ordinary loss on sale of the property.

Janella's basis in her partnership interest was $120,000, including her $150,000 share of partnership debt. At the end of the current year, the partnership pays off its debts and liquidates. Janella receives a proportionate liquidating distribution consisting of $42,000 cash and inventory valued at $24,000 (adjusted basis to the partnership = $20,000). How much gain or loss does Janella recognize, and what is her basis in the distributed property?

Match each of the following statements with the terms below that provide the best definition. a. Organizational choice of many large accounting firms. b. Partner's percentage allocation of current operating income. c. Might affect any two partners' tax liabilities in different ways. d. Partnership in which partners are only liable for torts and malpractice. e. Expense might be reported on either form 1065, page 1 or on Schedule K. f. Transfer of asset to partnership followed by immediate distribution of cash to partner. g. Must have at least one general and one limited partner. h. Long-term capital gain might be recharacterized as ordinary income. i. All partners are jointly and severally liable for entity debts. j. Theory treating the partner and partnership as separate economic units. k. Partner's basis in partnership interest after tax-free contribution of asset to partnership. l. Partnership's basis in asset after tax-free contribution of asset to partnership. m. One way to calculate a partner's economic interest in the partnership. n. Owners are "members." o. Theory treating the partnership as a collection of taxpayers joined in an agency relationship. p. Participates in management. q. Not liable for entity debts. r. No correct match provided. -Disguised sale

BRW Partnership reported gross income from operations of $60,000, interest income of $3,000, rental expense of $20,000, and a charitable contribution of $6,000. On its Schedule K, the partnership reports ordinary business income of $40,000, and separately stated interest income ($3,000) and charitable contributions ($6,000).

On a corporate Form 1120, Schedule M-1 (or M-3) is used to reconcile book and tax income, and Schedule M-2 reconciles retained earnings to the amounts shown on Schedule L. How are these reconciliations accomplished on a partnership return? What additional information must be provided?

Nicholas is a 25% owner in the DDBN LLC (a calendar year entity). At the end of the last tax year, Nicholas's basis in his interest was $50,000, including his $20,000 share of LLC liabilities. On July 1 of the current tax year, Nicholas sells his LLC interest to Anna for $80,000 cash. In addition, Anna assumes Nicholas's share of LLC liabilities, which, at that date, was $15,000. During the current tax year, DDBN's taxable income is $120,000 (earned evenly during the year and allocated using the monthly proration method). Nicholas's share of the LLC's unrealized receivables is valued at $6,000 ($0 basis). At the sale date, what is Nicholas's basis in his LLC interest, how much gain or loss must he recognize, and what is the character of the gain or loss?

Susan is a one-fourth limited partner in the SJ Partnership in which capital is not a material income-producing factor. Partnership assets consist of land (fair market value of $100,000, basis of $80,000), accounts receivable (fair market value of $100,000, basis of $0) and cash of $200,000. SJ distributes $100,000 of the cash to Susan in liquidation of her interest. Susan's basis in the partnership interest was $70,000 immediately before the distribution. How much gain or loss does Susan recognize and what is its character? How much can the partnership deduct?

When Kevin and Marshall formed the equal KM LLC, the fair market values of their interests were each $100,000. Kevin contributed $60,000 cash, equipment with a basis of $0 and a fair market value of $10,000, and a small parcel of land in which he had a basis of $50,000 and which was valued at $30,000. Marshall contributed an account receivable that was valued at $100,000 and which his basis was $0. Kevin has a basis in his partnership interest of $110,000 and Marshall's basis is $0.

Blaine contributes property valued at $50,000 (basis of $40,000) in exchange for a 25% interest in the BIKE Partnership. If the property is later sold for $70,000, gain of $15,000 will be allocated to Blaine.

Cynthia's basis in her LLC interest was $60,000, including her $40,000 share of the LLC's debt. In a proportionate liquidating distribution in which the LLC also liquidates, Cynthia receives cash of $50,000, and inventory with a basis of $3,000 and a fair market value of $5,000. Cynthia recognizes a gain of $30,000 on the distribution and takes a basis of $0 in the inventory.

Which of the following statements is correct regarding the manner in which partnership liabilities are reflected in the partners' bases in their partnership interests?

During the year, LMN LLC reported gross income of $60,000, cost of goods sold of $16,000, utilities and similar cash expenses of $10,000, depreciation expense of $4,000, business interest expense of $20,000, and investment interest expense (for long-term investments) of $1,000. (All amounts are in thousands, and the small business exception does not apply. LMN did not have any additional interest expense or taxes this year.) a. How much interest expense can the LLC deduct on Form 1040, page 1? Why? b. How is any remaining interest expense reported and treated for tax purposes? c. How much is the LLC's ordinary business income (Form 1065, page 1)? d. What separately stated items and other types of information might be reported on the LLC's Schedule K?