Chapter 10
Partnership Taxation
Income Tax Fundamentals 2013
Student Slides
Gerald E. Whittenburg
Martha Altus-Buller
Steven Gill
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Nature of Partnership Taxation
Partnerships must file an informational
tax return called Form 1065
◦ Partnership itself does not pay tax; rather,
income/expenses ‘flow through’ to partners
◦ Partnership income taxable to partner, even
if he/she does not receive cash!!
Partnerships must make various
elections (depreciation and inventory
methods, for example)
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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
Partnerships are legal entities under
civil law
In most states they have rights under
Uniform Partnership Act
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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
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Changes in Partner’s Basis
Changes occur to partner’s basis due to subsequent activities
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Beginning Basis
Additional Contributions
Share of Net Ordinary Taxable Income
Share of Capital Gains/Other Income
Distributions of Property or Cash
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
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Partnership Income Reporting
Partnerships do not pay tax
◦ All information flows through to be reported by the partners
◦ Tax return is due by the 15th of the 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
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Guaranteed Payments
Amount that a partner receives for services
rendered or use of partner’s capital is called
a guaranteed payment
◦ Guaranteed payments are made regardless of
income/loss situation of partnership
◦ Guaranteed payments are subtracted before
partnership taxable income/loss is allocated to
partners
◦ Guaranteed payments are taxable ordinary
income to partner and deductible by partnership
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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 and doesn’t count towards AAR
◦ “Encumbered property” is the property pledged for a liability and the
adjusted basis is includable in AAR if partner is personally liable for
repayment of debt
 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
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Limited Liability Companies
 Limited Liability Companies (LLCs) have attributes of
both partnerships and corporations
 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 (single
member LLCs are very common)
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Limited Liability Companies
Disadvantages of LLCs
◦ 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 is operating in more than
one state
LLCs are quickly becoming a major form of business organization in the U.S.
2013 Cengage Learning