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Federal Taxation of Partnerships & S-Corps
University of Connecticut School of Law
Utz, Stephen

Federal Taxation of Partnerships Utz Spring 2017

Inside Basis v. Outside Basis- The inside basis is the partnership’s tax basis in the individual assets. The outside basis is the tax basis of each individual partner’s interest in the partnership. When a partner contributes property to the partnership, the partnership’s basis in the contributed property is equal to its fair market value (FMV)

Pages 1-10: Discuss what is an LLC, why someone would choose and LLC over a corporation, difference between “C-Corp” and “S-Corp”

Code 761 Definition of Partnership: “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 and which is not within the meaning of this Title, a corporation or trust or estate”

-The definition is very broad to encompass many common economic relationships.

Main two areas for partnership are “business activity and sharing of profits”

Advantage of LLC: They are taxed as partnerships, not corporations.

Pages 11-25:The Basics of Partnership Formation

Basic Statutory Scheme of formation of partnership

Section 721 (Nonrecognition)- Except in the case of certain investment partnerships, Section 721 protects both the partnership and its partners from recognizing any gain or loss on the transfer of property to a partnership in exchange for an interest in the partnership.

Section 722 (Partners’ “Outside Basis”)- Under Section 722, each contributing partner takes as her basis in the partnership interest received an amount equal to the sum of the adjusted basis she had in any contributed property, plus any cash contributed. The partner’s basis in her interest is commonly referred to as her “outside basis”. This is in contrast to the partnership’s basis in the contributed property, which is referred to as the “inside basis” On the theory that the partner has merely changed the form of her investment in the contributed property, she is permitted to “tack” the holding period of her partnership interest.

Section 723 (Partnership’s “Inside Basis”)- Under Section 723, the partnership takes a transferred basis in contributed property equal to that of the contributing partner. The partnership is also entitled to tack the partners’ holding periods to its own.

Built-in Gains

-When a partner contributes something that already has gain attached to it.

Example: A contributes stock with a value of $100 and a basis of $60 to the ABC partnership. Three years later, ABC sells the stock for $130, resulting in a $70 tax gain. Under the traditional method, ABC must first allocate $40 of this gain to A. The balance of the gain will be allocated among all the partners in accordance with their agreement.

Built-in Losses

-Treated differently than gains. The partnership is required to separately account for built-in losses and preserve them solely for allocation to the partners who contributed the loss property.

Contribution of Depreciable Property

-In order to calculate the value of the depreciated property, the partnership must step into the shoes of the contributing partner and continue to use their method of depreciation.

Characterization of Gains and Losses from the Disposition of Contributed Property

-Section 724 established three special characterization rules for gain or loss recognized on contributed property

Unrealized Receivables-If the contributed property is an “unrealized receivable” (As defined in Section 751 ©) in the hands of the contributing partner, any gain or loss that is recognized by the partnership on the disposition of that property is characterized as ordinary, no matter how long it is held by the partnership

Inventory Items- If the contributed property is an “inventory item” (as defined in section 751 (d)) in the contributing partner’s hands, then any gain or loss that is recognized on that property by the partnership within 5 years of the contribution is characterized as ordinary.

Capital Loss Property- If a partner contributed property that is a capital asset in her hands and that has a built-in loss, any loss recognized on that property by the partnership within 5 years of the contribution is characterized as capital.

Pages 16-17: Examples of the partner’s contributions and their outside basis

Liabilities—In General

A partnership’s basis in its assets (“inside basis”) includes partnership liabilities encumbering its assets.

Partnership Liabilities must also be reflected in the partners’ outside basis, this is reflected in

s receivable as property for purposes of section 721
Assigning the partnership a transferred (typically zero) basis in the receivables under section 723
Characterizing the income realized by the partnership upon collection of the receivables as ordinary under section 724
Allocating the income to the contributing partner under section 704 ©

Accounts Payable

Cash method taxpayers will not deduct the accounts payable until they are paid.

Under Section 704©(3), when the partnership pays the payables, it must allocate the deductions for the amounts to the partner who assigned them to the partnership

Organization and Syndication Expenses

Syndication Expenses: The expenses connected with issuing and marketing of the partnership interests, including legal, accounting, and brokerage fees.

Under section 709(a), neither organization nor syndication expenses are deductible. Since both types of expenses are incurred in connection with creation of the partnership entity, they are properly chargeable to capital.

Under section 709(b) a partnership may elect to currently deduct the lesser of: (i) the amount of organization expenses (not syndication expenses) or

(ii) $5,000 reduced by the amount by which its organization expenses exceed $50,000. Those organizational expenses that are not deducted currently may be amortized over 180 months (15 years). Syndication expenses continue to be nondeductible, nonamortizable capital expenditures

Pages 25-Partnership Operations: The Basics

Partnerships Taxable Years-The key date is the last day of the partnership’s taxable year

-It is on that date that each partner is treated as receiving and paying (in the case of cash method partners) her distributive share of the partnership’s income and deductions for the partnership’s taxable year that has just ended.