Cengage Taxation Chapter 10 Homework Assignment
Q1. How does a partnership report its income for tax purposes? Who makes most elections related to partnership income and deductions?
In keeping with the entity concept, a partnership must file an informational return, Form 1065. On this return, the partnership makes most elections regarding the treatment of partnership items and no tax is calculated.
Q2. Compare the treatment of the business interest expense limitation versus the qualified business income deduction. What theories underly this treatment?
For business interest expense, the partnership determines whether the 30% deduction limitation under § 163(j) applies. Treatment of the carryover at the partner level is consistent with the aggregate theory. The partner calculates the § 199A qualified business income deduction. The partnership calculates and reports the information the partners need to calculate any limitation on the deduction. This treatment is consistent with the aggregate theory.
Q3. Indicate whether each of the following partnerships can use the cash method of accounting. Select “Yes” or “No”, whether is applicable.
- A partnership engaging in the business of farming. Yes
- A partnership with partners that are C corporations (other than personal service corporations) and the partnership does not meet the $25 million gross receipts test. No
- A partnership that is a tax shelter. No
- A partnership with a C corporation partner which meets the $25 million gross receipts test. Yes
Q4. Select for each of the following either “Yes”, it is a guaranteed payment or “No”, it is not.
- An amount paid to a partner for the performance of services. Yes
- An amount paid each year to the partners as a return of their investment in the partnership. No
- An amount paid that is comparable to a salary or interest payment. Yes
- Payments that are generally not deductible. No
- Payments that can result in a loss to the entity. Yes
Q5. Complete the statements below regarding the reporting of guaranteed payments on Form 1065 and its various schedules.
Guaranteed payments are deducted on Form 1065. These amounts are also shown on Schedule K as an item that must be allocated to the partners for them to report as ordinary income. Therefore, in the partnership’s “book-tax reconciliation” on Schedules M-1 or M-3 , the guaranteed payments are added to book income so the two measures of the partnership’s income can be equal.
Q6. Complete the statement below regarding the reporting of guaranteed payments to and by the partner.
The amount received by a partner as a guaranteed payment is shown on that partner’s Schedule K-1 and is reported by the partner as ordinary income.
Q7. Complete the statement below regarding the ways in which a guaranteed payment for services differs from guaranteed payments for use of the partner’s capital.
A guaranteed payment the partner receives for contributing capital to the partnership is eligible for the § 199A deduction, and is potentially subject to the net investment income tax, but generally it is not subject to self-employment tax.
Q8. Regarding the limitations that apply to the deductibility of a loss from a partnership, label each of the following as being either “True” or “False”.
- A partner must have sufficient basis to deduct a loss. True
- A partner must be sufficiently at-risk to deduct a loss. True
- A passive loss is deductible if the partner has sufficient basis, is at-risk, and has sufficient passive income from other activities. True
- Losses that cannot be deducted are suspended and carried back. False
- The at-risk limitations limit the losses to the amounts the partner could actually lose if the partnership were to liquidate in bankruptcy. True
- If a loss passes the basis, at-risk, and passive activity loss limitations, a noncorporate taxpayer must consider whether the excess business loss limitation might apply. True
Q9. When is partnership income subject to self-employment tax or the net investment income tax by an individual partner?
A general partner must pay self-employment tax on his or her distributive share of partnership income. Any partner (general or limited) must pay self-employment tax on any guaranteed payments for services. The net investment income tax applies to “income on investment of working capital,” which includes guaranteed payments for use of a partner’s capital.
Q10. Complete the e-mail below by classifying each of the situations as an “Advantage of partnership” or a “Disadvantage of partnership” over operating as a C or S corporation.
To: Liang Industries
From: Shelly Nunez
Date: February 1, 2019
Subject: Advantages and disadvantages of a partnership compared to a C corporation
You have asked when a partnership might be more or less advantageous than a C corporation. Below are several situations to be considered.
- If the entity plans to distribute its excess cash flow to the owners on a regular basis. Advantage of partnership
- If the entity owners are individuals and the income will be eligible for the qualified business income deduction. Advantage of partnership
- If the entity currently operates as a C corporation and has substantial built-in gains on its assets. Disadvantage of partnership
- If special allocations of income, expenses, and cash flows can be made by the entity owners. Advantage of partnership
- The entity has taxable losses that the owners can utilize on their individual tax returns. Advantage of partnership
- If the entity will exist for only a short period of time. Advantage of partnership
- The entity is in a high-risk business, and the owners require protection from personal liability. Disadvantage of partnership
- If the entity plans to lease property from the owners or the owners plan on loaning funds to the entity. Disadvantage of partnership
Q11. Enercio contributes $294,800 in exchange for a 40% interest in the calendar year ABC LLC, which is taxed as a partnership. This year, the LLC generates $235,840 of ordinary taxable income. Enercio withdrew $29,480 from the partnership during the year.
- How much of the $29,480 withdraw will Enercio be taxed?
- Enercio is taxed on what amount of ABC’s income? 0
Q12. Henrietta transfers cash of $295,600 and equipment with a fair market value of $88,680 (basis to her as a sole proprietor, $35,472) in exchange for a 40% profit and loss interest worth $384,280.
- Henrietta has a realized gain of $53,208 and recognizes a gain of $0
- Henrietta’s basis in the partnership interest is $331,072
- The partnership’s basis in the equipment is $35,472
Q13. Wozniacki and others form Jewel LLC, with each receiving a one-fourth interest in the capital and profits of the LLC. Wozniacki receives his one-fourth interest as compensation for tax planning services he rendered prior to the formation of the LLC. The other partners each contribute $199,200 cash. The value of a one-fourth capital interest in the LLC (for each of the parties) is $199,200.
- How much income does Wozniacki recognize as a result of this transaction, and what is its character? Wozniacki recognizes $199,200 as compensation income
- How much is Wozniacki’s basis in the LLC interest? How will Jewel LLC treat this amount? His basis is $199,200 and the partnership has a business deduction
Q14. This year, the Tastee Partnership reported income before guaranteed payments of $263,000. Stella owns a 30% profits interest and works 1,900 hours per year in the business. Euclid owns a 70% profits interest (with a basis of $30,000 at the beginning of the tax year) and performs no services for the partnership during the year. For services performed during the year, Stella receives a “salary” of $13,150 per month. Euclid withdrew $26,300 from the partnership during the year as a normal distribution of cash from Tastee (i.e., not for services).
- What is the amount of guaranteed payments made by the partnership this year?
- How much is the partnership’s ordinary income after any permitted deduction for guaranteed payments?
- How much income will Stella report?
- How much income will Euclid report?
Q15. When Padgett Properties LLC was formed, Nova contributed land (value of $241,500 and basis of $60,375) and $120,750 cash, and Oscar contributed cash of $362,250. Both partners received a 50% interest in partnership profits and capital.
- How is the land recorded for § 704(b) book capital account purposes? For § 704(b) book capital account purposes, Padgett records the land at $241,500
- What is Padgett’s tax basis in the land? $60,375
- If Padgett sells the land several years later for $362,250, Nova reports a $241,500 gain and Oscar’s gain is $60,375
Q16. At the beginning of the tax year, Barnaby’s basis in the BBB Partnership was $154,000, including his $15,400 share of partnership debt. At the end of the tax year, his share of debt was $23,100. His share of the partnership’s income for the year was $61,600, and he received cash distributions totaling $38,500. In addition, his share of the partnership’s nontaxable income was $3,080. How much is Barnaby’s basis at the end of the tax year?
Q17. On June 1 of the current tax year, Elisha and Ezra (who are equal partners) contribute property to form the Double E Partnership. Elisha contributes cash of $361,440. Ezra contributes a building and land with an adjusted basis and fair market value of $602,400, subject to a liability of $240,960. The partnership borrows $37,650 to finance construction of a parking lot in front of the building. At the end of the first year (December 31), the accrual basis partnership owes $15,060 in trade accounts payable to various creditors. The partnership reported net income of $56,475 for the year that they share equally. Assume that Elisha and Ezra share equally in partnership liabilities. How much is Elisha’s basis in the partnership interest on December 31? Ezra’s? Round interim and final answers to whole dollars.
- Elisha’s basis:
- Ezra’s basis:
Q18. Jokan contributes a nondepreciable asset to the Mahali LLC in exchange for a one-fourth (25%) interest in the capital, profits, and losses of the LLC. The asset has an adjusted tax basis to Jokan and the LLC of $135,000 and a fair market value and § 704(b) “book” basis on the contribution date of $243,000. The asset is encumbered by a nonrecourse note of $81,000 that has not been guaranteed by any of the LLC members.
- How much of the nonrecourse debt is allocated to Jokan?
- What is the amount of Jokan’s basis in the LLC interest following the contribution?
Q19. Heather sells land (adjusted basis, $298,400; fair market value, $387,920) to a partnership in which she controls an 80% capital interest. The partnership pays her only $208,880 for the land.
- Heather’s $89,520 realized loss cannot be recognized.
- The partnership later sells the land to a third party for $328,240. The partnership has a realized gain of $119,360 and a recognized gain of $29,840 on its sale of the land.
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