Partnership Taxation
Professor Monroe – Fall 2014
On Exam: Cite to each step to save time, paraphrase
Ch. 1
How do we treat entities for tax purposes?
Aggregate model of taxation: tax individuals as if they are the entity, classic model is sole
proprietorship where no difference btw business and owner, owner is taxed on earnings
and takes ded., avoids double taxation, taxes earnings once, simpler
Entity model of tax: entity is separate and distinct taxpayer from owners, earnings taxed twice –
entity then owners
Laura’s lemonade stand: She and sister form partnership, aggregate model would treat both as if
they own 50% of the assets, one level of tax on earnings, partnership can be quite
informal, don’t have to have an agreement, if it was treated as corp. it would be double
taxed but much easier to file return
Congress chose a hybrid of aggregate and entity: get flexibility and single tax of aggregate with
simplicity of entity
§761: Partnership must be a separate entity from the owners & can NOT be a corp.
§§301.7701-1(a) Separate entity is a joint undertaking involving T/B or financial operation
where profits are divided; does NOT include undertaking to just share
expenses or hold property
§7701(a) Partnership includes syndicate, group, pool, joint venture and is NOT trust, estate, corp.
§7704: Publicly traded partnership is treated as a corp.
Wheeler: two parties agreed to a flip partnership where they buy develop and sell real estate, was 75/25 ownership, Perot brought cash and he took the losses, Wheeler was the brains, Perot would get all his cash back plus interest where Wheeler would get cut when investment returned, Gov’t found it was not a partnership and it was business and wheeler was an employee, Look to the intent of the parties, Characterization of I for Wheeler would be paycheck and ordinary if business; But would be LTCG if partnership where Wheeler owns property, footnote stated the agreement BTW parties said it wasn’t a partnership, Ct. Found it to be a standard business arrangement as a partnership, Ruling other way would have serious ripple effects for other standing businesses, Perot treated it as partnership which were against his financial interests (better for wages paid ded.), But Perot reported it as partnership
Problem 1: HOA buys snowblower for its members, allow non-members to use it for fee, HOA hires kids to perform snow removal with it, It was statutorily a partnership, §§301.7701-1(a)(2): just co-owning property is not enough, RR 75-374 co-ownership with additional services or an agent’s services can amount to a partnership, kids were agents providing services for snow blowing and is partnership; §7701(a) excludes associations taxed as corp.
Challenges: Aggregate-Entity tension, Pass through challenge of planning, Diversity of entities
are endless and must work for the owners
Sub-Ch. K’s goal is to provide rules which allow partners the flexibility to organize their
business in whatever way makes the best business sense
Ch. 2: Passthrough System
Schneer: Atty agreed to turn his fees from clients to his new firm / partnership in exchange for partnership profits, who is the taxpayer? Issue whether this agreement was assignment of I or partnership agreement, TP argues the fees are partnership I but IRS says it’s his own I, Lucas v. Earl assignment principal where TP there had an agreement to split all his I with his wife which would take him to a lower bracket – Ct. doesn’t allow anticipatory assignment of I since the one who earns it is taxed on it, Ct. basically says if one can’t assign I to a partnership then partnership provisions are useless, Partners each earn different amounts of I and contribute it to the partnership where they share in the I disproportionately and are each taxed on their distributive share (allows partners shift income), Principal violates Earl but Ct. sided with Subchapter K, Assignment of I is not technically violated since a partnership is treated as an Entity since it is the body that earns the I, Law Firm earned the fees and divided it to the partners so the I was never assigned, Treating Schneer as never earning the I in the first place
– There are different rules for partnerships that allow different actions which an individual never could (I shifting in this case)
– I must be earned during the partnership period, already earned I doesn’t come in
– One can’t set up a partnership to simply avoid Earl assignment, must have business if you want to plan for gains
§701: Partnership is not subject to I tax, but Partners carrying on the business are liable for it
Distributive Share: the share of I allocated to a particular partner from the overall I earned by the
partnership, whether or not it’s actually distributed
§702(a) Each partner takes into account their distributive share of partnership’s: gains and
losses, charitable contributions, dividends, taxes paid, other items in regs (separately
stated items for the partner to report)
(b) Character of any item of I, gain, loss, ded. or credit included in partner’s distributive
share is determined as if incurred by the partnership
§703(a) TI of a partnership is computed as an individual, except it may not claim deductions
for personal exemptions, foreign taxes, charitable contributions, net operating losses and
other itemized
§§1.702-1(a)(8) Each partner must take into account separately stated items for their distr. share
Partnership Taxable Yr.
§706(b) Partnership picks its own taxable year
§706(a) Reconciliation rule – Partner includes their share of partnership I for the partnership’s
taxable year ending within the taxable year of the partner
Problem 2-1: Firm’s taxable year ends January 31, Joe is calendar year and becomes partner on Feb. 1, 2001, Earns $20k a month
– Joe’s taxable year extends from Jan. 1 to Dec. 31, So he must look to the partnership taxable year to include his partnership share, Since the Partnership taxable year starts Feb. 1 and ends on Jan. 31, 2001, Joe received
e outside basis to take the excess loss
Problem 2-5
Liz contributes $5 to partnership to be partner, her distr. share of the loss for Y1 is $8, Y2 her dist. share is $8 of profit, sells her partnership interest at end of Y2 for $5; No gain or loss from the initial contribution (§721), Her outside basis is $5 in the partnership (§722), She takes her outside basis down to $0 (§705(a)(2)) and has $5 loss with $3 of loss for next years (§704(d)), Y2 her $8 of income increases her outside basis to $8 and her $3 of suspended loss brings her outside basis to $5 (§705(a)(1))
– If there was no 704(d), Laura would get to take that loss twice in bringing her basis into the negative in Y1 and having extra loss for Y2
RR 66-94: In determining outside basis, income increases come first for adjustment (705(a)), Distributions come out of and reduce outside basis BEFORE losses (if there is basis left)
– Distributions must be accounted for immediately whereas losses and income are accounted at the end of the taxable yr.
– I, Dist., Loss (ordering)
Problem 2-7(a)
Partner has outside basis of $6k, with ordinary I in Y1 of $1k and share of LTCL of $5k and cash dist. of $7k = 6k basis – 7k dist. §733; $1k gain recognized above basis 731; $5k of LTCL are carried fwd since there was not enough outside basis §704(d)
– If Partner’s $1k of I is LTCG instead, Gains are netted together for $4k LTCL, Cash dist. of $7k is in excess of $6k outside basis where $1k gain is recognized
– §702(a) CG and CL must be separately stated for a partner’s I tax
Ch. 3
Capital Accounts (assets = liabilities + capital)
Represents the equity amount the partners can take out of the partnership, has to match the
partner’s outside basis (income and contributions must increase capital and dist. to the
partner and partnership losses decrease capital)
Liabilities are never reflected in the capital accounts since debts do not amount to equity;
§§1.704-1(b)(2)(iv)(c)(1) (increases and decreases in liabilities are not reflected lang.)
Book Value represents the value of each item when it was acquired by the partnership
Previously taxed capital is generally equal to the partner’s share of inside basis less the partner’s
share of partnership liabilities (maintains §704(c) obligations of the partners, built in
gains then increase the partner’s tax capital)
