Forming a Partnership
John and his daughter each own 50% of a partnership. The partnership has $80,000 profit this year before deducting any guaranteed payments. Capital is a material income-producing factor. John performed services worth $55,000, which is reasonable compensation. The daughter performed no services. How much income will John claim on his individual tax return?
$67,500
John's share of income is $67,500 ($55,000 for reasonable services performed + $12,500 one half remaining profit).
Jasmine, a calendar year taxpayer, is a partner in Jasmine and Prince Partnership that has a fiscal year ending March 31. Starting April 1, 20X1 Jasmine receives a fixed monthly guaranteed payment of $1,000 a month without regard to the income of the partnership. How much of the guaranteed payment will Jasmine report on her 20X1 tax return?
$0
Guaranteed payments are taxable to the partner in the partner's tax year that includes the date of the fiscal year end of the partnership. Payments to the partner did not begin until the Partnership's 20X2 fiscal year. The partner will not receive a K-1 reflecting that income in 20X1. The partner will receive a K-1 reflecting that income in 20X2 for the Partnership's 20X2 fiscal year (April 1, 20X1 to March 31, 20X2).
Jasmine reports the $9,000 of guaranteed payments received in 20X1 (starting April 1, 20X1) along with the $3,000 she receives up through March 31, 20X2 on her 20X2 tax return, not her 20X1 tax return.
A partner's basis in a partnership interest includes the partner's share of a partnership liability in all of the following, EXCEPT:
A partner's share of accrued but unpaid expenses of a cash basis partnership.
A partner's basis in a partnership interest includes the partner's share of a partnership liability if the liability:
Generally, a partner does not recognize loss on a partnership distribution unless all of the following requirements are met EXCEPT:
The adjusted basis of the partner's interest in the partnership exceeds the fair market value of the property distributed.
partner does not recognize loss on a partnership distribution unless all the following requirements are met:
Partner A received inventory items with a basis of $20,000 in complete dissolution of a partnership. Within five years, Partner A sells the entire inventory for $30,000. What amount and type of gain should Partner A report?
$10,000 ordinary gain.
Inventory received in dissolution of the partnership and sold within 5 years of the date of dissolution will result in ordinary income or loss; not a capital gain or loss.
John owns 100% of a residential contracting business. Capital is a material income-producing factor. John's services to the business during the year were worth $30,000. John's son, Alex is interested in eventually working in his father's business. On January 1, Alex receives a gift of 20% of his father's interest in the business. Alex performed no services for the business during the year. If the resulting partnership had a profit of $100,000 for the current tax year, how much of the partnership profit should be allocated to Alex?
$14,000
If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions.
Alex's share of the partnership profits is $14,000. The total partnership profit must first be reduced by the reasonable compensation of John for services rendered of $30,000. Alex's share is then 20% of the reduced profits or $14,000 ($100,000 – $30,000 = $70,000 × 20%).
Jack and Ted formed an equal partnership. Jack contributed $10,000 cash and Ted contributed depreciable equipment that he has owned for 6 months with a fair market value of $10,000 and an adjusted basis of $2,000. Ted had taken $3,000 in depreciation on the equipment before he transferred it to the partnership. What amount should Ted report as a gain as a result of this transaction?
$0
Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. This applies whether a partnership is being formed or is already operating. Thus, Ted would not be required to report a gain as a result of this transaction.
Western Enterprises, a general partnership, distributed $8,000 cash to Peter during the year. His adjusted basis (including his share of liabilities) in his partnership interest at the beginning of the year was $9,500. Peter's share of the partnership's taxable loss for the year was $1,000. What was Peter's ending basis in his partnership interest?
$500
Decreases. The partner's basis is decreased (but never below zero) by the following items:
Charlotte is a 38 percent owner of the Charlotte-Emma Partnership. She has an adjusted basis in this partnership of $31,000. Near the end of the current year, Charlotte is given cash of $35,000 as a distribution from the partnership. She also receives land that has a tax basis to the partnership of $3,000 but a fair value of $5,000. After receiving this distribution, what gain should Charlotte recognize for tax purposes?
$4,000
n partnerships and S corporations, conveyances between an owner and the business are typically reported for tax purposes by retaining the tax basis so that no gain or loss is created. Thus, the answer to this question is usually going to be zero. However, if the cash received exceeds the owner's basis in the business, a gain for the excess is recognized and any additional property is recorded with a zero basis. Here, the cash is $35,000 but the partner's basis in that partnership is only $31,000. The additional $4,000 is a gain for Charlotte and the land has no tax basis to her. This situation is one of the very few times that a gain can result from a transaction between an owner and a partnership or S corporation.
Abby sells her 50% interest in the ABC partnership to Marty for $1,000 cash. Her outside basis at that time is $775. The partnership has inventory and a capital asset with respective basis of $1,200 and $300 and respective fair market values of $1,500 and $450. Abby should properly recognize?
Ordinary income of $150 and a capital gain of $75.
If a partner receives money or property in exchange for any part of a partnership interest, the amount due to his or her share of the partnership's unrealized receivables or inventory items results in ordinary income or loss. This amount is treated as if it were received for the sale or exchange of property that is not a capital asset. The income or loss realized by a partner upon the sale or exchange of its interest in unrealized receivables and inventory items is the amount that would have been allocated to the partner if the partnership had sold all of its property for cash at fair market value. Any gain or loss recognized that is attributable to the unrealized receivables and inventory items will be ordinary gain or loss.
Abby has a total gain on the sale of her partnership interest of $225 ($1,000 sales price – $775 outside basis). Abby must recognize ordinary income of $150 (($1,500 inventory FMV – $1,200 inventory basis) × 50% interest in ABC) and the remaining $75 of gain is a capital gain.
Jane gave each of her two children, Jake & Jeff, a 30% interest in her clothing store. Capital is not a material income-producing factor. Jeff is 21 and has worked in the store since he was 15 and has developed significant sales skills and helps his mom with the management duties. Jake is 25, married and has a job in another state and does not participate in any of the store's management decisions. Who is(are) recognized as a partner(s) for tax purposes?
Jane and Jeff
Members of a family can be partners. However, family members will be recognized as partners only if one of the following requirements is met:
Therefore, Jane and Jeff are recognized as partners for tax purposes.
Guaranteed payments are taxable to the partner in the partner's tax year that includes the date of the fiscal year end of the partnership. Payments to the partner did not begin until the Partnership's 20X2 fiscal year. The partner will not receive a K-1 reflecting that income in 20X1. The partner will receive a K-1 reflecting that income in 20X2 for the Partnership's 20X2 fiscal year (April 1, 20X1 to March 31, 20X2).
Jasmine reports the $9,000 of guaranteed payments received in 20X1 (starting April 1, 20X1) along with the $3,000 she receives up through March 31, 20X2 on her 20X2 tax return, not her 20X1 tax return.
$40,000 distributive share.
If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. Gil's distributive share of the partnership income is $40,000. Since his distributive share is more than the $20,000 minimum payment, the entire $40,000 is characterized as distributive share.
Jane and Bill are equal partners in J & B Partnership. The partnership incurred a $10,000 loss last year. Jane and Bill's adjusted basis in the partnership at the beginning of last year was $2,000 each. Under the partnership agreement, Jane and Bill share all partnership profits and losses equally. The partnership borrowed $20,000 last year to purchase depreciable equipment to be used in the partnership's business. Jane was required under the partnership agreement to pay the creditor if the partnership defaulted. Based upon these facts, what is Jane and Bill's allowable loss on last year's tax return?
Jane / Bill
$ partner may deduct a partnership loss up to their basis in the partnership. If a partner's share of partnership liabilities increases, or a partner's individual liabilities increase because he or she assumes partnership liabilities, this increase is treated as a contribution of money by the partner to the partnership. Since Jane is liable to repay the loan if the partnership defaults, the entire liability is allocated to Jane's partnership basis. The partnership loss is $10,000 or $5,000 each. Jane's basis is $22,000 but her share of loss is only $5,000. Bill's basis remains at $2,000. Jane has an allowable loss of $5,000 and Bill has an allowable loss of $2,000. 5,000 / $2,000
Lori's outside basis in the Briar Patch Partnership on January 1 was $11,000. She is a 50% partner and shares profits and losses in the same ratio. For the current year, the partnership's ordinary business income was $40,000 and tax-exempt interest income was $200. Lori received a cash distribution from the partnership of $700 in the current year. If the partnership were to liquidate on December 31, what would be Lori's basis for determining gain or loss?
$30,400.
Lori's basis for determining gain or loss is $30,400 ($11,000 beginning basis + $20,000 share of current year profits + $100 share of tax-exempt income – $700 distribution).
When payments are made to a retiring partner, or successor in interest of a deceased partner, for an interest in the partnership property, which of the following is correct?
A retiring partner is treated as a partner until his/her interest in the partnership has been completely liquidated.
Payments made by the partnership to a retiring partner or successor in interest of a deceased partner in return for the partner's entire interest in the partnership may have to be allocated between payments in liquidation of the partner's interest in partnership property and other payments. The partnership's payments include an assumption of the partner's share of partnership liabilities treated as a distribution of money. For income tax purposes, a retiring partner or successor in interest of a deceased partner is treated as a partner until his or her interest in the partnership has been completely liquidated.
Regarding family partnerships, if a husband and wife carry on a business together and share in the profits and losses:
They could each carry his or her share of the partnership income or loss from the Form 1065 Schedule K-1 to their joint or separate individual income tax returns.
If the husband and wife do not make the election to treat their joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based.
Because a business jointly owned and operated by a married couple is generally treated as a partnership for Federal tax purposes, the spouses must comply with filing and record keeping requirements imposed on partnerships and their partners.
The election permits certain married co-owners to avoid filing partnership returns, provided that each spouse separately reports a share of all of the business items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes.
Spouses make the election on a jointly filed Form 1040 by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse's respective interest in the joint venture, and each spouse filing with the Form 1040 a separate Schedule C.
On January 1, Ruth had a basis in her partnership interest of $55,000. Thereafter, in liquidation of her entire interest, she received an apartment house and an office building. The apartment house has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. The office building has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. What is Ruth's basis in each property after the distribution?
Apartment house $44,000, Office building $11,000
The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. Ruth assigns a portion of her $55,000 basis to the apartment house ($40,000) and to the office building ($10,000), up to the fair market value (FMV) of each asset. After this assignment, Ruth still has $5,000 of basis to be assigned, which is allocated to each asset based on the proportion of its FMV. $4,000 or 80% ($40,000 ÷ $50,000) is assigned to the apartment house and $1,000 or 20% ($10,000 ÷ $50,000) is assigned to the office building. The result for Ruth is a basis in the apartment house of $44,000 and office building of $11,000.
Ted and Jane form a cash basis general partnership with cash contributions of $20,000 each. They share all partnership profits and losses equally. They borrow $60,000 and purchase depreciable business equipment. Jane, however, is required to pay the creditor if the partnership defaults. Which of the following is correct?
Ted has a basis of $20,000 and Jane has a basis of $80,000 in the partnership.
If a partner's share of partnership liabilities increase, or a partner's individual liabilities increase because he or she assumes partnership liabilities, this increase is treated as a contribution of money by the partner to the partnership. Jane is fully liable for the liability so the entire liability increases only Jane's basis in the partnership.
Greg, a partner in Masters Partnership, receives $1,000 cash and property worth $2,000 in which Masters has a basis of $1,500. Greg's outside basis at the time of the distribution is $20,000. The Partnership has assets of $40,000 and no outstanding liabilities. This distribution is at the end of the year after partnership income (loss) has been recorded. How much gain should Greg recognize on the distribution and what is his basis in the property received?
Greg recognizes no gain on the property received. His basis in the property received is $1,500.
Greg has no gain because the cash received did not exceed his adjusted basis of his interest in the partnership. His basis in the property received is the partnership's adjusted basis in the property immediately before the distribution.
Fred is a partner in DEF Partnership. The adjusted basis of his partnership interest is $38,000, which includes his $30,000 share of partnership liabilities. Fred's share of unrealized receivables in the partnership is $12,000. Fred sold his share of the partnership interest for $45,000 cash. What is the amount and character of Fred's gain?
$12,000 ordinary gain; $25,000 capital gain.
If a partner receives money or property in exchange for any part of a partnership interest, the amount due to his or her share of the partnership's unrealized receivables or inventory items results in ordinary income or loss. This amount is treated as if it were received for the sale or exchange of property that is not a capital asset. This treatment applies to the unrealized receivables part of payments to a retiring partner or successor in interest of a deceased partner only if that part is not treated as paid in exchange for partnership property. If the selling partner is relieved of any partnership liabilities, that partner must include the liability relief as part of the amount realized for his or her interest. Fred was relieved of the partnership liability resulting in a realized amount of $75,000 ($30,000 liability + $45,000 cash). Fred must recognize a gain of $37,000 on the sale ($75,000 realized – $38,000 partnership basis). Fred's share of unrealized receivables is $12,000, so $12,000 of the gain is ordinary gain and the remaining $25,000 is capital gain.
Phil and Don are equal partners in the Hilldale Company. Hilldale has a fiscal year ending on January 31. Phil and Don file their individual tax returns on a calendar year basis. For the tax year ending January 31, 20X1, Hilldale had taxable income from the active conduct of its business of $100,000 of which $60,000 was earned in 20X1. How much of their partnership taxable income should Phil and Don each include in computing their taxable income for their 20X1 tax year?
$50,000
Income from a partnership is allocated to partners on schedule K-1 according to their percentage ownership. A business reports income based on a tax year, which may not always correspond to a calendar year. The entire amount of partnership income for the partnership tax year must be reported on the corresponding tax year return of the individual partners.
Hilldale company has $100,000 in taxable income for the fiscal year ending on January 31, 20X1. As Phil and Don are equal partners, they each have a 50% share of the partnership income. Therefore, Phil and Don should each include $50,000 of the partnership's taxable income (50% interest × $100,000 taxable income for partnership fiscal year ending January 31, 20X1) in their taxable income for their 20X1 tax year.
Columbus is a partner in New World Partnership. He also works in the operations of this business. He receives a guaranteed salary for his work of $2,000 per month. At the end of the year, he also receives a distribution that is equal to 32 percent of the profits for that year. On December 31 of this year, he received a check for $38,000 as his portion of the profits. In determining the ordinary income of the partnership for tax purposes this year, how much of these payments will be viewed as an expense?
$24,000
A guaranteed salary to a partner for work done is considered an expense of the business and should be deducted in determining ordinary income for the year for tax purposes. In a partnership or S corporation, distributions to the owners such as the one paid here for $38,000 are viewed as returns of their capital and is viewed as a reduction of the capital investment rather than as income (to the owner) and expense (to the business). Hence, the expense to be recognized is the guaranteed salary of $24,000 ($2,000 per month for 12 months).
If the partner's distributive share of a partnership item cannot be determined under the partnership agreement, it is determined by his or her interest in the partnership. The partnership interest is determined by taking into account all of the following items EXCEPT:
The amount of the partnership's nonrecourse liabilities.
A partner's interest in a partnership includes the partner's share of recourse liabilities. If a partner's share of partnership liabilities increases, or a partner's individual liabilities increase because said partner assumes partnership liabilities, treat the increase as a contribution of money by the partner to the partnership.
Jayne's basis in her partnership interest is $55,000. In a distribution in liquidation of her entire interest, she receives a rental house and vacant lot, neither of which is inventory or unrealized receivables. The rental house has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. The vacant lot has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. What is Jayne's basis in each property after the distribution?
Rental house $44,000; vacant lot $11,000.
The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. Jayne's partnership basis is first allocated to the assets received based on the assets adjusted bases, $5,000 for the rental house and $10,000 for the vacant lot. Jayne still has $40,000 of basis remaining that must be allocated to the assets she received. The $40,000 is next allocated to the rental house for the difference between the partnership's adjusted basis and FMV of the asset, $35,000. The vacant lot's adjusted basis and FMV are the same so no basis is allocated. Jayne still has $5,000 of basis to allocate which is done based on the ratio of each asset's FMV. $4,000 or 80% ($40,000 ÷ $50,000) is allocated to the rental house and $1,000 or 20% is allocated to the vacant lot. Jayne's basis in the rental house is $44,000 and $11,000 for the vacant lot.
Bill, a partner in Williams-Sonic, is a calendar-year taxpayer. Williams-Sonic's partnership year ends on June 30. For the partnership year ending June 30, 20X1, Bill's distributive share of partnership profits is $4,000. On August 20, 20X1, Bill dies and his estate succeeds to his partnership interest. For the partnership year ending June 30, 20X2, Bill and his estate's distributive share is $6,000. What is Bill's self-employment income for self-employment tax purposes in 20X1?
$5,000
The death of a partner closes the partnership's tax year for that partner. Generally, it does not close the partnership's tax year for the remaining partners. The decedent's distributive share of partnership items must be figured as if the partnership's tax year ended on the date the partner died. To avoid an interim closing of the partnership books, the partners can agree to estimate the decedent's distributive share by prorating the amounts the partner would have included for the entire partnership tax year.
On the decedent's final return, include the decedent's distributive share of partnership items for the following periods.
Bill will include the $4,000 distributive share for 20X1, and $1,000 of the $6,000 payment representing the 2 months he was alive for the partnership year ended 20X2. Include self-employment income actually or constructively received or accrued, depending on the decedent's accounting method. For self-employment tax purposes only, the decedent's self-employment income will include the decedent's distributive share of a partnership's income or loss through the end of the month in which death occurred. For this purpose, the partnership's income or loss is considered to be earned ratably over the partnership's tax year.