Partnership Formation and Operation ©2014 Pearson Education, Inc. 9-1 PARTNERSHIP FORMATION & OPERATION (1 of 2)  Partnership definitions  Overview of partnership taxation  Partnership formation  Partnership elections  Partnership reporting of income  Partner reporting of income ©2014 Pearson Education, Inc. 9-2 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 ©2014 Pearson Education, Inc. 9-3 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) ©2014 Pearson Education, Inc. 9-4 Tax Definition of a Partnership  Syndicate, group, pool, joint venture, or other unincorporated organization that carries on a business ©2014 Pearson Education, Inc. 9-5 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 ©2014 Pearson Education, Inc. 9-6 Limited Partnership  One or more general partners AND  One or more limited partners Cannot participate in management Cannot make commitments for partnership Liability generally limited to amount invested in partnership ©2014 Pearson Education, Inc. 9-7 Limited Liability Limited Partnership  Formed under state’s limited partnership laws  General partners have limited liability ©2014 Pearson Education, Inc. 9-8 Limited Liability Companies (LLC)  May be taxed as a partnership or a corp (using check-the-box Regs)  Taxation as a partnership Entity obtains pass-through and flexibility of partnership allocations Maintains  60% limited liability of a corp of all partnerships in 2008 ©2014 Pearson Education, Inc. 9-9 Limited Liability Partnerships (LLP)  Many professional orgs. use LLPs  May be taxed as a partnership or a corp using check-the-box Regs  Partners not liable for failures in work of other partners or people supervised by other partners ©2014 Pearson Education, Inc. 9-10 Electing Large Partnerships (ELP)  May elect to have simplified set of reporting rules apply if Non-service  partnership, and 100 partners ©2014 Pearson Education, Inc. 9-11 Overview of Partnership Taxation  Partnership profits and losses  Partner’s basis  Partnership distributions ©2014 Pearson Education, Inc. 9-12 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 ©2014 Pearson Education, Inc. 9-13 Partnership Profits and Losses (2 of 2)  Partners include profit or loss and separate items from entity’s return Form  Loss 1040 for individuals limitation Partner’s losses limited to entity’s basis in the partnership At-risk and passive loss rules apply ©2014 Pearson Education, Inc. 9-14 Partner’s Basis 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 ©2014 Pearson Education, Inc. 9-15 Partner’s Basis Items that Decrease Basis  Partner’s share of losses  Distributions  Reduction in partnership debt ©2014 Pearson Education, Inc. 9-16 Partnership Distributions  Generally nontaxable  Return of previously taxed earnings Earnings increased partner’s basis Distributions  Distributions Generally reduce partner’s basis in excess of basis recognize as taxable gain ©2014 Pearson Education, Inc. 9-17 Partnership Formation  Contribution of property  Contributions of services  Organizational & syndication costs  See Topic Review 1 for summary ©2014 Pearson Education, Inc. 9-18 Contribution of Property  General nonrecognition rule  Exceptions to nonrecognition rule  Effect of liabilities  Basis ©2014 Pearson Education, Inc. 9-19 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 ©2014 Pearson Education, Inc. 9-20 Exceptions to Nonrecognition Rule  Gain recognition at time of property contribution when Partnership would be investment company if it were incorporated Contribution followed by distribution resulting in a deemed sale, or Liabilities assumed by partnership in excess of partner’s basis ©2014 Pearson Education, Inc. 9-21 Effect of Liabilities Contributed by Partner to Partnership  Basis increase for ALL partners Their  Basis share of liabilities decrease for contributing ptr Deemed cash distribution by partnership to partner Gain would be recognized if deemed distribution exceeds partner’s basis ©2014 Pearson Education, Inc. 9-22 Basis Basic Concepts  Partnership’s basis in property Partner’s old basis before contribution Depr Recap potential transfers to ptrshp Special rules for Unrealized receivables Inventory Capital loss property ©2014 Pearson Education, Inc. 9-23 Basis Computation Money contributed + Partner’s basis in contributed prop + Gain recognized on contribution Partner’s (outside) basis in ptrshp ©2014 Pearson Education, Inc. 9-24 Contributions of Services (1 of 2)  Contribution of services in exchange for partnership interest Income  Partner’s is FMV of services contributed basis = FMV of services provided ©2014 Pearson Education, Inc. 9-25 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 ©2014 Pearson Education, Inc. 9-26 Organizational and Syndication Costs  Organization costs are capital expenditures May immediately expense $5K and amortize the rest over 180 months §709 expense election deemed to be made $5K limit reduced by cumulative organization costs in excess of $50K ©2014 Pearson Education, Inc. 9-27 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 ©2014 Pearson Education, Inc. 9-28 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 Unrecaptured §1250 gains §179 expense Charitable contributions ©2014 Pearson Education, Inc. 9-29 Partnership Reporting of Income (2 of 2)  Separately stated items (cont’d) Dividends and interest income Foreign or possession taxes Tax-exempt interest Investment income and expenses Items subject to special allocation  Partnership All ordinary income/loss items not separately stated ©2014 Pearson Education, Inc. 9-30 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 ©2014 Pearson Education, Inc. 9-31 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 ©2014 Pearson Education, Inc. 9-32 Basis for Partnership Interest Basic Concepts  Beginning basis Amount paid for interest OR Basis of property/services contributed  Additions to basis Contribs.,  Reductions earnings, assumption of liabs in basis Withdrawals, losses, decrease in share of liabilities ©2014 Pearson Education, Inc. 9-33 Basis for Partnership Interest 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 ptr’s liabs assumed by ptrshp Partner’s basis in the ptrshp interest  See Topic Review 3 ©2014 Pearson Education, Inc. 9-34 Special Loss Recognition Limitations (1 of 2)  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 ©2014 Pearson Education, Inc. 9-35 Special Loss Recognition Limitations (2 of 2)  Designation of partnership interest as a “passive activity” “Passive” losses can only be used to offset “passive” income Disallowed losses are suspended Can be used to offset future passive income, or when the passive activity is sold ©2014 Pearson Education, Inc. 9-36 Partnership-Partner Transactions Related Party Issues  Loss on sales of property Loss involving >50% owner No loss deducted Ownership includes  Gain direct and indirect on sales of property Gains on involving >50% owner Ordinary income unless property will be capital asset in hands of new owner Ownership includes direct and indirect ©2014 Pearson Education, Inc. 9-37 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 ©2014 Pearson Education, Inc. 9-38 Family Partnerships Safe Harbor Rule - §704(e)  All three requirements must be met Interest must be a capital interest Partner has right to receive assets if partnership liquidates immediately Capital must be a material incomeproducing factor Family member must be true owner Kiddie tax may apply ©2014 Pearson Education, Inc. 9-39 Family Partnerships Donor-donee Income Allocations  Donor must be allocated reasonable compensation for services rendered to partnership  Remaining partnership income must be allocated based on relative capital interest ©2014 Pearson Education, Inc. 9-40 Tax Planning Considerations  Timing of loss recognition Accelerate personal income to absorb partnership losses Delay personal income recognition to use anticipated future partnership losses ©2014 Pearson Education, Inc. 9-41 Compliance & Procedural Considerations Forms/Schedules  Form 1065 for partnership  Form K-1 for each partner  May file for automatic 5 mo. extn.  Schedule M-3 required instead of M-1 for large partnerships  Form 8716 – use for §444 election ©2014 Pearson Education, Inc. 9-42 Compliance & Procedural Considerations SE Income  Individuals who are partners must pay SE tax on following ptrshp inc. Guaranteed payments Partnership ordinary income or loss All separately stated items, except Capital and §1231 gains/losses, interest, dividends, and rental income ©2014 Pearson Education, Inc. 9-43 END Chapter 9 ©2014 Pearson Education, Inc. 9-44 The Estate Tax Chapter 13 ©2014 Pearson Education, Inc. 13-1 THE ESTATE TAX (1 of 2)  Estate tax formula  The gross estate: valuation  The gross estate: inclusions  Deductions  Computation of tax liability ©2014 Pearson Education, Inc. 13-2 THE ESTATE TAX (2 of 2)  Liquidity concerns  Generation-skipping transfer tax  Tax planning considerations  Compliance and procedural considerations ©2014 Pearson Education, Inc. 13-3 Estate Tax Formula Estate Tax Base Computation Gross Estate - Deductions (exp, debts, & losses; marital, charitable, and state death tax deductions) Taxable estate + Adjusted taxable gifts (post ’76) Estate tax base ©2014 Pearson Education, Inc. 13-4 Estate Tax Formula Taxable Estate  Taxable estate is gross estate minus deductions  All taxable gifts made after 1976, other than gifts included in gross estate, are added to taxable estate Gifts Sum valued at date-of-gift values of two amounts is tax base ©2014 Pearson Education, Inc. 13-5 Estate Tax Formula Estate Tax Due Computation Tentative tax - Recomputed gift tax - Available unified credit - Other credits Estate tax due ©2014 Pearson Education, Inc. 13-6 The Gross Estate: Valuation  Gross estate valued at FMV at Date of death or alternate OR Alternate valuation date 6 mo. after death unless dispositions occur  Both gross estate & tax liability must be reduced for alternate date to be effective ©2014 Pearson Education, Inc. 13-7 The Gross Estate: Inclusions (1 of 3)  §2033 - Property in which decedent had an interest  §2035 - Gift taxes paid on gifts w/in three years of date of death  §2036 - Property transferred to others but which decedent still controlled or obtained benefits ©2014 Pearson Education, Inc. 13-8 The Gross Estate: Inclusions (2 of 3)  §2038 - Property not owned, but decedent had general powers of appointment  §2039 - Annuities and other retirement benefits  §2040 - Jointly owned property  §2042 - Life insurance If decedent had incidents of ownership ©2014 Pearson Education, Inc. 13-9 The Gross Estate: Inclusions (3 of 3)  §2044 - QTIP trust for which marital ded. claimed by decedent’s spouse  Probate estate State law concept Property that passes subject to the will and is subject to court administration  See Table 1 ©2014 Pearson Education, Inc. 13-10 Deductions (1 of 2)  §2053 authorizes deductions for Mortgages Other debt owed by decedent Funeral expenses Administration expenses ©2014 Pearson Education, Inc. 13-11 Deductions (2 of 2)  §2054 - Casualty and theft losses  §2055 - Charitable contributions Unlimited  §2056 - Marital deduction Unlimited  §2058 - State death taxes  See Table 2 ©2014 Pearson Education, Inc. 13-12 Computation of Tax Liability  Progressive Tax Rates  Reduction for post-1976 gift taxes  Credits Portability between spouses of exemption amount Unified Other ©2014 Pearson Education, Inc. 13-13 Progressive Tax Rates  Applied to estate tax base to determine tentative tax  Rate varies from 18% to 40% ©2014 Pearson Education, Inc. 13-14 Reduction for Post-1976 Gift Taxes  If taxable gifts have been added to base, recompute gift tax using rates in effect at date of death  Subtract unified credit ACTUALLY claimed in gift year  Reduce tentative estate tax by net gift tax ©2014 Pearson Education, Inc. 13-15 Unified Credit  Unified credit not previously used Maximum Shelters credit of $2,045,800 estate/gift tax of up to $5.25M Unified credit never generates a refund ©2014 Pearson Education, Inc. 13-16 Portability between Spouses of Exemption Amount  Unused exemption may be used by other spouse  Example H dies in 2013 and only uses $1M of $5.25M exemption H’s spouse, W, may add the remaining $4.25M unused exemption to W’s exemption amount in year W dies ©2014 Pearson Education, Inc. 13-17 Other Credits  Pre-2005 state death tax credit  Gift tax credit on pre-1977 gifts  Credit for estate taxes paid on prior transfers  Credit for foreign death taxes ©2014 Pearson Education, Inc. 13-18 Liquidity Concerns Deferring Estate Tax Payment (1 of 2)  Sec. of Treasury may extend payment for up to 12 months  Sec. can extend payment for up to 10 yrs. if reasonable cause can be shown ©2014 Pearson Education, Inc. 13-19 Liquidity Concerns Deferring Estate Tax Payment (2 of 2)  Due date for remainder or reversionary interests owned by estate can be extended up to 6 mo. after other interests terminate  Payment of taxes related to closely held businesses can be spread over 10 years ©2014 Pearson Education, Inc. 13-20 Liquidity Concerns Other Issues  Stock redemptions to pay death taxes Estate may treat redemption as an exchange even if it does not meet provisions of §302  Special use valuation of farm real property ©2014 Pearson Education, Inc. 13-21 Generation-Skipping Transfer Tax (GSTT) (1 of 4)  Purpose of GSTT Ensure some form of transfer tax imposed at least once per generation  GSTT levied at a flat 40% Highest gift or estate tax rate  Applies to taxable terminations of and taxable distributions from generation-skipping transfers ©2014 Pearson Education, Inc. 13-22 Generation-Skipping Transfer Tax (GSTT) (2 of 4)  Generation-skipping transfer dispositions Provide interests for >1 generation of beneficiaries in a younger generation than the transferor OR Provide an interest solely for person ≥ 2 generations younger than transferor ©2014 Pearson Education, Inc. 13-23 Generation-Skipping Transfer Tax (GSTT) (3 of 4)  Termination of an interest in a G-S arrangement is a taxable termination Termination triggers imposition of GSTT GSTT levied on pre-tax amount transferred Trustee pays tax ©2014 Pearson Education, Inc. 13-24 Generation-Skipping Transfer Tax (GSTT) (4 of 4)  Grantor gets $5.25M exemption in 2012 Same amount as applicable exclusion amount for estate tax purposes ©2014 Pearson Education, Inc. 13-25 Tax Planning Considerations  Use (1 of 2) of inter vivos gifts Up to per-donee annual exclusion amount  Use of exemption-equivalent ($5.25M) for transfers to people other than spouse  Use life insurance to provide liquidity ©2014 Pearson Education, Inc. 13-26 Tax Planning Considerations  Qualifying (2 of 2) estate for installment payments Favorable interest rate Where to deduct administration expenses Estate tax return OR Estate’s income tax return ©2014 Pearson Education, Inc. 13-27 Compliance & Procedural Considerations  Filing requirements Form 706 Due date 9 mo after decedent’s death 6-mo extension available  Alternate valuation date election Made on estate tax return Irrevocable ©2014 Pearson Education, Inc. 13-28 END Chapter 13 ©2014 Pearson Education, Inc. 13-29
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