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Partnership Tax
University of Nebraska School of Law
Lyons, William H.

Bill Lyons Spring 2011 Partnership Tax—Fundamentals of Partnership Tax: 8th ed. Lind

Choice of Entity

A. No Liability

Sole Proprietorship

no entity to limit liability

i. K liability, vicarious liability

good start-up choice

files Schedule C but income goes onto 1040

withholding is complicated

B. Limitation of Liability

General Partnership

general partner is wholly exposed to the liabilities of the p/s

i. “jointly and severally” under state law

don’t want business dragging in house/car

ways to protect against liability:

i. (1) indemnifying agreements

1. might depend on solvency of partners

ii. (2) insurance

1. only for insurable risks

accounting profession created LLP

Limited Partnership

limited partners are simply investors

i. cannot participate or they become general partners

ii. general partners run the business

limited liability limited partnership

i. no utility other than estate planning (not a business entity)

Limited Liability Partnership

file a statement with Sec of State stating the p/s is a LLP

i. notice on a going forward basis—not accepting GP rules

most cover both torts and contracts (NE)

could go public but not practical

Limited Liability Company

came out of WY and CO—does not require creation of a corp. entity

taxed as a p/s UNLESS elected to be taxed as corp.

C. Client Considerations

Start-up Costs

filing fees

drafting of p/s agmt, bylaws, articles, etc.

i. GP agmt is essential

1. essence of the p/s (tax considerations, elections, etc.)

ii. voting

1. p/s usually one vote one partner regardless of ownership

2. corp. usually share ownership

Maintenance Costs

corp. files annual report in every state

i. franchise fees

ii. directors with meetings and minutes

iii. SHs with meetings and minutes

GP generally does not have annual reports

i. but LLP usually does

ii. not as formalistic as corp. but need some records

Termination Costs

terminating a p/s is much easier than a corp.

i. corp. entity realizes gains and losses

ii. no p/s level tax

Ownership and Control

most states don’t allow SH controlled corps. (DE)

can have different types of stock

i. BUT can do the same thing in p/s agreement

LLP or LLC might have an edge

i. more flexibility in terms of who votes, weight of voting, mgmt

1. BUT no problem of defining different voting rights/arrangements

a. AND S corp. can only have one class of stock

Federal Law Controls

state law recognition of what is a partnership is irrelevant according to the SC

D. Comparisons

Formation

non-recognition

i. § 721(a)

1. allow transfer of property from partner to entity w/out recognition

ii. § 351(a)

1. same

basis

i. §§ 722 & 723

1. temporary doubling of gain/loss

a. partner takes basis in p/s = basis in proper contributed

b. p/s takes transferred basis

ii. same happens in C corp. arena

1. basis in stock equal to basis in property and corp. takes transferred

iii. BUT

1. duplication of gain for a C corp. is real whereas p/s is temporary

a. no double gain or double loss

i. duplications are passed through to partners

1. schedule K / 1065

a. regardless of actual distributions

i. like an S corp. (basis adjusts)

pass-through determined in agmt

i. “share” is determined therein

1. in S corp. and C corp., number of shares is what matters

a. i.e. S corp. is pro rate based on shares

ii. in p/s can have gain to some, loss to some, deductions to some, etc.

Operation

if p/s makes an actual non-liquidating distribution

i. never causes the p/s to realize and recognize gain or loss

1. take basis in property distributed and recognize upon sale

in C & S corp. context, non-liquidating distribution causes recognition

i. entity and SH may have gain

Liquidation

generally a taxable event for the partner when selling interest, but not p/s

i. all tax at partner level may be deferred if property

in corp. world liquidation = gains recognized and most losses (w/limits)

i. SH and corp. level

Summary

if eventually taking an entity public, p/s may not be the best option

i. have to consider TVM

subchapter K is schizophrenic

i. pass-though nature of p/s is an aggregate concept

ii. character is determined at the p/s level

iii. sometimes an entity level sometimes not

NE § 67-409

i. a p/s is an entity it can be sued, etc.

1. state law has resolved the duality idea

Overview of Taxation

A. Tax Classification Issues

Anti-Abuse

IRS has reserved the ability to disregard a partnership (under § 701, etc.)

i. say p/s is a sham and eliminate any tax benefits

Tower / Culbertson

the question of whether two or more persons have the intent to carry on a business for joint profit is a question of fact, requiring consideration of all the relevant indicia of partnership status, including:

i. joint contribution of capital or services

ii. a purpose of carrying on a trade or business

iii. joint ownership of the capital contributed

iv. sharing of profits and losses

v. exercise of control of the business

vi. the nature of the agreement and the parties’ conduct thereunder

vii. the existence of separate books of account for the business

viii. holding title to the business property and conducting the business in the partnership name

ix. representations to others that the business is or is not a partnership AND

x. filing of a partnership tax return

no longer relevant in family p/s due to § 704(e)

NE § 67-410 (1)

i. “whether or not the persons intended to form a partnership”

Podell v. Commissioner

one “partner” contributed services/knowledge, the other capital

parties showed they entered into the real estate venture for joint profits

i. not profit expectation, but coming together with the intent to share jointly

Podell reserved the right to say “no” even though he did not exercise it

i. court acknowledges that he had the power, thus not a passive investor

wanted no p/s for capital v. ordinary income purposes, otherwise selling inventory

Elements of a JV (which is considered a p/s):

i. K: express or implied that a JV be formed

ii. Contribution of money, property, and/or services

ii

he p/s

no control group issues like in corp. tax

Exceptions

(1) if partner contributed encumbered property

i. may be recognition of gain despite § 721(a)

(2) if partner contributes services rather than property

i. by its terms, § 721(a) cannot apply for tax purposes

1. ask whether state law permits you to give a LLC or p/s interest to someone who has not given property

a. p/s statutes have pretty much said a partner can be admitted by contributing money, property, or services (like corps.)

i. BUT LLCs are all over the place

(3) investment company exception

i. IRC § 721(b)

1. p/s that would have been an investment company if 351 applied

a. basically, incorporation of an investment portfolio

i. worry about in family LPs where securities go in

(4) disguised sale

i. IRC § 707(a)

1. what hat is the purported p/s wearing?

(5) partner gets “boot”

i. i.e. a p/s interest plus cash or other property

Other Tax Law Doctrines Affecting General Rule

(1) substance v. form

i. IRS/Treasury have the right to disregard a partnership is it is abused

1. Rev. Rul. 72-350

a. TP had no r/s w/p/s other than making a loan to a LP

i. p/s had no liability to pay loan

ii. partners had no liability to pay loan

iii. taxpayer had the right to turn the loan into a partnership interest at his pleasure

b. despite “form”, the purported lender was a partner always

(2) recapture provisions

i. § 1245

1. depreciation recapture for personalty

2. (b)(3) if the basis is determined by reference to § 721

a. rule operates to carry this over into the hands of the p/s

i. partner is not responsible for recapture at this point

3. if disguised sale

a. § 1245 will apply

ii. § 1250

1. depreciation recapture for realty, but does not really apply anymore

a. use of straight line and this recaptures stuff above straight line

(3) tax benefit rule (§ 111)

i. requires GI this year for recovery of amt previously deducted

1. Hillsboro National Bank / Bliss Dairy

a. judicially imposed rule that is broader than § 111

i. “fundamentally inconsistent event”

1. e.g. deduction for grain b/f incorporation

2. need to have a checklist of deductions taken

ii. depreciation recovery does not seem fundamentally inconsistent

1. § 167 will govern

(4) assignment of income

i. Lucas v. Earl

1. tried to assign income to W but H controlled and earned it

ii. § 704(c)(1)(A)

income, gain, loss, and deduction with respect to property contributed to the partnership by a partner shall be shared among the partners so as to take account