Chapter 14
Partnership
Taxation
“People who complain about taxes
can be divided into two classes:
men and women.”
-- Anonymous
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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
14-2
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.
14-3
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.
14-4
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)
14-5
LO #1- Partnership Formation
Concept Check 14-1
1.
Generally, a partner does not recognize a gain on
the formation of a partnership.
True
2.
Typically, the basis of the assets contributed to a
partnership is the same in the hands of the
partnership as it was in the hands of the contributing
partner.
True
3.
If two taxpayers form a partnership and each has a
50% interest in it, each partners outside basis must
be equal.
False
14-6
LO #1- Partnership Formation
Concept Check 14-1
4. A partner does not have to recognize a gain
on the receipt of a partnership interest in
exchange for services.
False
5. A partner who assumes an increased
portion of the partnership debt, is treated as
making a cash contribution and his or her
basis in the partnership increases.
True
14-7
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
14-8
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
14-9
LO #2 - Ordinary Income/Loss
Concept Check 14-2
1. A partnership can deduct which of the following in determining partnership ordinary income or
loss:
a. all ordinary and necessary expenses.
b. guaranteed payments.
c. depreciation.
d. all of the above.
Answer: D
2. What tax form is the partnership required to file each year?
a. Form 1120.
b. Form 1040.
c. Form 1065.
d. Form 1120-S.
Answer: C
3. A payment made to a partner that is must calculated without regard to partnership income is
a:
a. partner salary.
b. partner withdraw.
c. loan to a partner.
d. guaranteed payment.
Answer: D
14-10
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
14-11
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
14-12
LO #3 – Separately Stated Items
• Self-employment Income – since a partner is
not an employee of the partnership, income
from the partnership is considered selfemployment 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
14-13
LO #3 – Separately Stated Items
Concept Check 14-3
1.
Why are items such as rental income/loss, capital gains/losses, and
charitable contributions that flow-through a partnership treated as
separately stated?
All income and expense items of a partnership that may be treated
differently at the partner level must be “separately stated.” Rental
income/loss, capital gains/losses, and charitable contributions all can
be treated differently at the partner level. For example, an individual
partner can take up to $3,000 of capital losses against ordinary
income where a corporate partner in the same partnership can not.
2.
Why is income from a partnership treated as self-employment
income?
A partner is not an employee of the partnership. Thus, income received by
the partner from the partnership has no social security or Medicare
withheld by the partnership.
14-14
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
14-15
LO #4 – Basis of the Partnership Interest Concept Check 14-4
1.
A partner must use basis to determine the gain or loss on a sale
of the partnership interest and whether losses are deductible.
True
A partner’s basis is not increased by his or her share of tax
exempt income items.
False
2.
3.
In the calculation of basis, the order of the basis adjustments is
not important.
False
A partner’s basis is never increased by his or her share of
recourse liabilities.
False
4.
14-16
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 precontribution gain
14-17
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.
14-18
LO #5 – Partnership Distributions
Concept Check 14-5
1. Which of the following is true concerning recognition of gain on a distribution from a
partnership?
a. gain is recognized if the partner receives property with a basis greater than his
or hers partnership interest basis.
b. gain is recognized if the partner receives cash in excess of his or her basis.
c. the partner never recognizes a gain on a partnership distribution.
d. the partner always recognizes a gain on a partnership distribution.
Answer: B
2. Nelson has a partnership basis of $12,000. He receives from the partnership a
distribution of furniture with a basis to the partnership of $16,000 and a FMV of
$10,000. Nelson’s basis in the furniture after the distribution from the partnership:
a. $10,000.
b. $12,000.
c. $16,000.
d. none of the above.
Answer: B
14-19
LO #5 – Partnership Distributions
Concept Check 14-5
3. Assume the same facts as #2. However,
Nelson also receives a cash distribution of
$4,000 with the furniture. The basis in the
furniture after the distributions is:
a. $ 8,000.
b. $10,000.
c. $12,000.
d. $16,000.
Answer: A
14-20
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
14-21
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.
14-22
LO #6 – Disposal or Liquidation of a Partnership
Interest-Concept Check 14-6
1. Shelly has a basis in her partnership interest of $30,000. She receives
the following assets in complete liquidation of the partnership interest:
Cash
$ 9,000
Inventory (basis)
$ 6,000
Equipment (basis)
$ 8,000
Land (basis)
$12,000
a. What is Shelly’s recognized gain?
b. What is Shelly’s basis in each of the assets distributed?
Answer:
a. Shelly’s recognized gain would be $0. She did not receive cash in
excess of her basis.
b. Shelly’s basis in the assets would be as follows:
Cash
$9,000
Inventory
$6,000
Equipment ($15,000 × $8,000/$20,000)
$6,000
Land ($15,000 × $12,000/$20,000)
$9,000
14-23
LO #6 – Disposal or Liquidation of a Partnership
Interest-Concept Check 14-6
2. Callie purchased a 60% partnership interest for $55,000 in March
2013. She had income of $18,000 from the partnership in 2013 and
$26,000 in 2014. She made no additional contributions to or
withdrawals from the partnership. On December 30, 2014, Callie sold
her partnership interest for $107,000.
a. What is her basis before the sale?
b. What is her gain or loss?
c. Is the gain or loss (if any) capital or ordinary?
Answer:
a. $99,000 ($55,000 beginning basis + $18,000 + $26,000)
b. $8,000 ($107,000 sales price - $99,000 basis)
c. Since the partnership interest is a capital asset and there was no
mention of inventory or receivables in the partnership, then the gain
would be a long term capital gain.
14-24