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Chapter 10
Partnership Taxation
Income Tax Fundamentals 2007
Gerald E. Whittenburg & Martha Altus-Buller
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
What is a Partnership?
A
partnership is a syndicate, group,
pool, joint venture or other
unincorporated organization
Through or by means of which any
business, financial operation or
venture is carried on
 Simply co-owning property does not
constitute a partnership

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Partnership Formation

When forming a partnership

Individuals contribute assets to partnership in
exchange for a partnership interest


Cash or property
No gain/loss is recognized unless
Services are performed in exchange for partnership
interest
 Property is contributed with liabilities in excess of
basis, then
Recognized Gain = Liabilities Allocable to Others –
Adjusted Basis of Property Contributed

©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Partnership Formation

Partner’s basis in partnership interest
plus:
plus:
less:
equals:
Cash contributed
Basis of property transferred
Gain recognized
Liabilities allocable to other partners
Initial basis
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Partner’s Basis in Partnership Interest
(Subsequent Activities)
Beginning Basis
plus: Additional Contributions
Share of Taxable Income
Share of Capital Gains/Other Income
less: Distributions of Property or $
Share of Net Loss from Operations*
Share of Capital Losses/Other Deductions
+/Increase/Decrease in Liabilities
Basis in Partnership Interest (can’t drop below $0)
*Can’t take basis below 0 and must comply with at-risk limitations
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Partnership Income Reporting

Partnerships do not pay tax



All information flows through to be reported by the partners
Return is due by 15th of 4th month following close of
partnership tax year
Must report all elements of income and expense
separately on Form 1065 (Partnership Tax Return)

Schedule K-1 takes total partnership income/expenses and
allocates each item to each partner based upon their
ownership percentage


Ordinary income/loss
Special income/deduction items
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Current Distributions and
Guaranteed Payments

Partnerships may make distributions
of money or other property to
partners


‘Current distribution’ does not
completely terminate partner’s interest
No gain recognized by partner, unless
partner’s basis in partnership has
reached zero
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
At-Risk Limitations


Partners cannot deduct losses from activities in
excess of their investment in those activities
Definitions



A “nonrecourse liability” is a debt for which the
borrower is not personally liable
“Encumbered property” is the property pledged for a
liability
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
+ Retained profits in activity
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Real Estate & At-Risk Rules


Real estate acquired before 1987 is
not subject to at-risk rules
For real estate acquired after 1986,
the “qualified nonrecourse
financing” is considered to be the
amount at risk

Defined as debt secured by real estate
and borrowed from person who
regularly engages in the lending of
money
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.
Limited Liability Companies (LLCs)

LLCs are a cross between a partnership and a corporation



Advantages








Treated generally as a partnership for tax purposes
Each owner has limited liability like a stockholder
Taxable income/loss passes through to owners
There is no general partner requirement
Owners in LLCs can participate in management
Owners have limited liability
LLC ownership interest is not a security
Tax attributes pass through to owners
LLCs offer greater tax flexibility than S corporations
Disadvantages


Because of newness, limited amount of case law dealing with LLCs
States are not uniform in treatment of LLCs
©2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star
logo, and South-Western are trademarks used herein under license.