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Exam 21: Partnerships

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Question 1

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Your client has operated a sole proprietorship for several years and is now interested in raising capital for expansion. client is considering forming either a C corporation or an LLC. a. Describe the treatment of an LLC and discuss any advantages the LLC offers over the C corporation. b. Assume instead the client has previously operated as a C corporation. Describe the tax consequences of converting to an LLC.

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a. The limited liability company (LLC) generally provides for Federal taxation under Subchapter K (partnership taxation) and limited liability for all owners. Therefore, LLC provides for the same protection from personal liability as a C corporation wh providing for (pass-through) taxation of LLC operations at the owner level. The C corporation double taxation does not apply to an LLC. Partnership provisions such optional adjustments to basis; special allocations of income, gain, loss, deduction, an credit; and inclusion of all LLC liabilities in outside basis are additional advantages LLC over a C corporation. b. An existing C corporation should carefully weigh the consequences before convert an LLC. The IRS has ruled that a C corporation must liquidate and re-form as an When a C corporation liquidates, any appreciation in corporate assets triggers a corporate level gain. This results in immediate double taxation of the gain (at the corporate level and then as a shareholder gain or loss on liquidation of the entity). partnership, on the other hand, does not liquidate when it converts to an LLC, and appreciation in partnership assets remains untaxed.

Question 2

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In a liquidating distribution that liquidates the partnership, each partner recognizes gain or loss equal to the difference between the value of assets received less the partner's basis in the partnership interest.

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B) False

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Question 3

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Ashley purchased her partnership interest from Lindsey on the first day of the current year for $40,000 cash. Ashley received a $10,000 cash distribution from the partnership during the year, and her share of partnership income is $15,000. Her share of partnership liabilities on the last day of the partnership year is $20,000. Ashley's outside basis for her partnership interest at the end of the year is $45,000.

Which of the following is not a requirement of the substantial economic effect test?

At the beginning of the tax year, Zach's basis for his partnership interest and his amount at risk in the partnership was $30,000. His share of partnership items for the year consisted of tax-exempt interest income of $2,000 and an ordinary loss of $44,000. He also received a distribution of $20,000 cash from the partnership during the year. He is an active general partner and has no passive income or business losses from other sources. For the tax year, Zach will report:

On August 31 of the current tax year, the balance sheet of the RBD General Partnership reads as follows $\begin{array}{lrr}&\text { Adjusted }\\&\text { Basis } & \text { FMV } \\\text { Cash } & \$ 150,000 & \$ 150,000 \\\text { Receivables } & -0- & 90,000 \\\text { Capital assets } & \underline{600,000} & \underline{660,000} \\\text { Total } & \$ 750,000 & \$ 900,000\\\\\text { Nonrecourse debt } & \$ 150,000 & \$ 150,000 \\\text { Rachel, capital } & 200,000 & 250,000 \\\text { Barry, capital } & 200,000 & 250,000 \\\text { Dale, capital } & \underline{200,000} & \underline{250,000} \\\text { Total } & \$ 750,000 & \$ 900,000\end{array}$ On that date, Rachel sells her one-third partnership interest to Lisa for $300,000, consisting of cash and relief of Rachel's share of the nonrecourse debt. The nonrecourse debt is shared equally among the partners. Rachel's outside basis for her partnership interest is $250,000 (including her share of partnership debt). How much capital gain and/or ordinary income will Rachel recognize on the sale?

Ken and Lars formed the equal KL Partnership during the current year; Ken contributes $100,000 in cash and Lars contributes land (basis of $60,000, fair market value of $40,000) and equipment (basis of $0, fair market value of $60,000). Lars recognizes a $40,000 gain on the contribution and his basis in his partnership interest is $100,000.

The RGBY LLC operating agreement provides that 50% of depreciation expense is allocated to Red, and all remaining income (including the remaining 50% of depreciation) is allocated equally among the four partners. Before guaranteed payments and depreciation, RGBY's net income is $120,000 for the year. RGBY's depreciation expense is $20,000, and it paid a guaranteed payment to Yellow of $8,000. Assume that all allocations and payments meet the substantial economic effect rules. After all deductions and special allocations are taken into account, Red is allocated a net deduction of $15,500 from the partnership.

When Kevin and Marshall formed the equal KM LLC, the fair market values of their interests were each $100,000. Kevin contributed $60,000 cash, equipment with a basis of $0 and a fair market value of $10,000, and a small parcel of land in which he had a basis of $50,000 and that was valued at $30,000. Marshall contributed receivable that was valued at $100,000 and in which his basis was $0. Kevin has a basis in his partnership interest of $110,000 and Marshall's basis is $0.

The total tax burden on entity income is greater for a partner in a partnership (up to 37% for an individual partner) than on a shareholder in a corporation (21% for an individual shareholder), so partnerships are used only in special situations.

Which of the following statements is correct regarding the manner in which partnership liabilities are reflected in the partners' bases in their partnership interests?

Marcie is a 40% member of the M&A LLC. Her basis is $10,000 immediately before the LLC distributes to her $30,000 of cash and land (basis to the LLC of $20,000 and fair market value of $25,000). As a result of the proportionate, current (nonliquidating) distribution, Marcie recognizes a gain of $20,000 and her basis in the land is $0.

Morgan is a 50% managing member in the calendar year, cash basis MKK LLC. The LLC received $150,000 income from services and paid the following other amounts. $\begin{array}{lr}\text { Rent expense } & \$ 10,000 \\\text { Salary expense to employees } & 40,000 \\\text { Payment to Morgan for services per the operating agreement } & 40,000 \\\text { Distributions to partners, Kristin and Katie } & 12,000 \\\text { Payment to } 30 \% \text { cash basis partner Katie for tax and accounting } & 10,000\end{array}$ 10,000 How much will Morgan's adjusted gross income increase as a result of these items? What other deductions must be considered? What amount will be included in Morgan's self-employment tax calculation?

Tim, Al, and Pat contributed assets to form the equal TAP Partnership. Tim contributed cash of $40,000 and land with a basis of $80,000 (fair market value of $60,000) . Al contributed cash of $60,000 and land with a basis of $50,000 (fair market value of $40,000) . Pat contributed cash of $60,000 and a fully depreciated property ($0 basis) Valued at $40,000. Which of the following tax treatments is not correct?

Anthony's basis in the WAM Partnership interest was $200,000 just before he received a proportionate liquidating distribution consisting of investment land (basis of $90,000, fair market value of $100,000) , and inventory (basis of $30,000, fair market value of $70,000) . After the distribution, Anthony's recognized gain or loss and his basis in the land and inventory are:

Patricia is a 25% owner and an active member in the PBK LLC, which operates a qualified trade or business for purposes of the deduction under § 199A. Patricia's distributive share of qualified income from the LLC is $250,000 for the year (the LLC's income is $1,000,000) . Her share of the LLC's W-2 wages is $40,000, and she received a guaranteed payment for services of $30,000. Her share of the LLC's unadjusted basis immediately after acquisition of qualified property is $1,200,000. How much is her qualified business income for this separate trade or business?

Tom and William are equal partners in the TW Partnership. Just before TW liquidated, Tom's capital account balance was $50,000 and William's capital account balance was $30,000. To meet the substantial economic effect requirements, any liquidating cash distribution must be allocated in proportion to those ending capital account balances.

In the current year, the CAR Partnership received revenues of $400,000 and paid the following amounts: $160,000 in rent, utilities, and salaries; a $40,000 guaranteed payment to partner Ryan; $20,000 to partner Amy for consulting services; and a $40,000 distribution to 25% partner Cameron. In addition, the partnership realized a $12,000 net long- term capital gain. Cameron's basis in his partnership interest was $60,000 at the beginning of the year and included his $25,000 share of partnership liabilities. At the end of the year, his share of partnership liabilities was $15,000. a. How much income must Cameron report for the tax year? b. What is Cameron's basis in the partnership interest at the end of the year?

Which of the following statements is true regarding the sale of a partnership interest?

Julie and Kate form an equal partnership during the current year. Julie contributes cash of $200,000, and Kate contributes property (adjusted basis of $90,000, fair market value of $260,000) subject to a nonrecourse liability of $60,000. As a result of these transactions, Kate has a basis in her partnership interest of $120,000.