Partnership Tax Outline

Partnership Tax
Fall 2015

Unit 1: Choice of Entity

• What is a partnership?

  • §761 (**232): joint venture by means of which any business or financial operating is carried on, other than a corporation, trust or estate.

  • Culbertson: Must have joined together for the purpose of carrying on business and sharing profits/losses. Question of fact.

    • Must be a bona fide business purpose other than saving taxes.

    • BUT SEE Moline Properties: For corp, “intended to conduct or actually conducted business” Either/or.

    • YALE: Regulations may have replaced Culbertson standard with Moline.

  • Partnership interest may come through capital, service, or gift (§704(e)(1)).

  • Interests

    • Capital interest: partner gets something at liquidation

      • Anyone with a capital interest is a partner regardless of whether they supplied the capital (so long is the partnership is sufficiently capital intensive to require that capital)

    • Profits/losses interest: only a share in future profit or loss

• Partnerships vs. Other Entities/Forms of Taxation

  • Check the Box (**71)

    • (1) Separate entity from the partners for fed tax purposes? IF YES

    • (2) Is it a trust, or a business entity? IF BIZ

    • (3) Is it a per se corp (publicly traded partnership, joint stock, insurance, bank, anything with “inc”, state-owned business orgs)? IF NO

    • (4) Is there more than one member?

      • If 1: disregarded entity or corporation by election

      • If >1: Partnership (or C Corporation by election)

        • BUT: Still must meet Culbertson to be a partnership. If you only meet Moline and don’t elect C, confusion.

  • Corporations

    • §7704: Publicly traded partnership (stakes traded on securities market) is per se a corporation

    • C Corporations (default): no pass-through, double tax, separate entity

    • S Corporations (elected once you’ve established a C corp)

      • Benefits: simple, lower overhead, pass-thru, fewer payroll taxes

      • Cons: Less profit-sharing flexibility, doesn’t allow for as much depreciation because you can’t bump up basis with debt.

  • §761(a): Election out of Subchapter K (must meet all 3 requirements)

    • Unanimous Election

    • Adequate determination of income

    • Qualifying activity (**233)

      • (1) Investment Club, no actual business

      • (2)Joint production/extraction, no resale

      • (3) Syndication of securities (must be brief holding period)

  • §761(f): Spouses: generally can’t form partnership because marital unit is 1 person

    • Qualified joint venture: (1) only H+W; (2) both materially participate; (3) both elect into partnership.

  • Partnership Agreements & Logistics

    • 1.704-1(h): includes all oral understandings, side agreements, etc.

    • SECA: Parrtnership payroll tax that follows FICA. Also either a 3.8% hospital tax, or an equal investment income tax from Obamacare.

    • Partners may change agreement.

    • §706(a): partnership year ends on default 12/31, but can be changed. Use this hierarcy.

      • (1) Valid business purpose

      • (2) Majority interest’s (50%+) tax year

      • (3) Principal partners’ tax years

      • (4) Least Aggregate Default Rule: 1.706-1(b)(3) (**375): partnership uses tax year that results in least aggregate tax deferral for all partners.

UNIT 2: Formation

• §721 (**217): Transfer to a partnership is a nonrecognition event. Neither gain nor loss.

  • See Cottage Savings, not a recognition event.

  • Exception: §721(b), §351: If it’s an investment company (>80% of noncash assets are securities), then contribution is recognition.

• Basis, Tax Capital Account, and Book Capital Account

  • Outside Basis, §722 (**218): The basis of the partner’s share in the partnership

    • Original partners: Their basis in the property they contributed (not FMV if the asset has built-in gain or loss. Always FMV for cash.)

    • Partners who buy shares: Price they paid for share.

    • §704(d): (**209). Losses, depreciation, other deductions limited to the outside basis. All further deductions suspended when OB hits 0.

    • §752: Increase or decrease in partner’s share of liabilities is considered a contribution or distribution of money.

      • When partners contribute debts to the partnership:

        • First divide the debt among all partners and increase each of their OB’s according to their share (assuming debt=contribution)

        • Then subtract the debt each partner contributed from their OB (partnership taking on debt=distribution)

        • See 9/10 slides; Unit 2 Question 3.

  • Inside Basis, §723 (**218): Partnership’s basis in its assets. Equal to the basis the contributing partner had in the asset.

    • Tacking of Holding Period: Partnership assumes partner’s holding period.

  • Tax Capital Account: For original partners, equal to their outside basis(?)

    • Tax capital account + 704(c) gain = Book capital account (after book-up)

  • Book Capital Account: The value the partner would receive at liquidation if all assets were sold for book value.

    • The total assets of the partnership times that partner’s % share

    • Booking up: bring assets up to FMV, subtract liabilities, divide by shares to find new book capital account.

      • Not required to do so at arrival of new partner, but only way to balance the sheet.

• §709 (**216): Must capitalize organization and syndication expenses that are greater than de minimis.

• Character of Gains

  • §702(b) (**206): Quality of sale fixed at partnership level. Partner generally takes gains/losses as the partnership would. This is the entity theory.

    • §724 (**218): Sticky character rule.

      • Unrealized receiveable: perpetual taint. Always use partner’s character.

      • Inventory, pre-contribution capital losses: 5 year taint.

• Service Partnerships

  • If service partner receives a capital stake in exchange for their services: treat like capital partners. They have income in the amount of their capital account, per §83 (property rec’d for services).

    • Use FMV of their share in partnership to find income.

  • If service partner only gets profits/losses stake: No income until profits/losses.

  • Notice 2005, **110: Safe harbor for service partner does not exist if he transfers his interest within 2 years (rebuttable presumption).

  • Circle...

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