Startup Partnership Agreement by yts16970


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									Partnership Operations
    Module learning objectives

• Describe how a partnership's income,
  deductions, gains and losses are taxed and
• Determine a partnership's taxable income
• Determine the amount of a partner's
  distributive share of partnership income,
  deductions, gains and losses
    Module learning objectives

• Identify and distinguish between
  organizational syndication and startup costs
• Determine the required year-end of a
    The partnership agreement
• Includes all agreements among the partners or
  between partners and the partnership
• Can be written or oral
• Governs the economic arrangement among the
• May be modified up to the original due date of the
  partnership's tax return
• See §761(c) and Reg. §1.704 – 1(b)(2)(ii)(h)
      Partnership’s tax reporting
• Partnerships are tax-reporting entities, not tax-paying
• Form 1065, U.S. Return of Partnership Income
• Form K-1, Partner's Share of Income, Credits,
  Deductions, etc.
    Partnership’s tax reporting
• For example:
   – RST, an equal partnership of R, S and T, has
     operating income of $345,000 and a long-
     term capital gain of $30,000.
   – Because RST is a tax-reporting and not a
     taxpaying entity, it will pay no income tax on
     the ordinary income or the capital gain.
   – Instead, each partner will report one-third of
     his or her share of the partnership income and
     pay the related income tax.
         Separately stated items
• Section 702(a) provides the following items
  must be separately stated:

  –   Net short-term capital gains/losses
  –   Net long-term capital gains/losses
  –   Section 1231 gains/losses
  –   Charitable contributions
  –   Dividends eligible for dividends-received deduction
  –   Taxes paid to foreign country or US possession
  –   Any other items provided by regulations that, if not
      separately stated, would result in different tax liability
      for a partner

Computing taxable income
• XYZ, a calendar-year partnership, has
  operating income for the year of $50,000,
  operating expenses of $37,000, and a
  charitable contribution of $10,000.
• What is the taxable income of the
     Partner’s distributive share
• Each partner's distributive share of gain, loss, income or
  deduction generally is determined according to the
  partnership agreement.
• For example:
  – John and Ted form a partnership, with each partner
    contributing $5,000.
  – An oral agreement to split the profits and losses of the
    company (60% to John and 40% to Ted) will be binding
    on the partnership and its partners.
  – However, the burden of proof that this agreement exists
    will be borne by John and Ted.
    Partner’s distributive share
• If partner profit- and loss-sharing ratios are
  – The partnership's taxable income or loss for the
    year is first computed to determine whether net
    profit or net loss has been earned.
  – The appropriate percentage (profit-sharing if
    the partnership realized taxable income, or
    loss-sharing if the partnership incurred taxable
    loss) is applied to each class of income.

• The XYZ Partnership reports a net short-
  term capital loss for the year of $30,000 and
  ordinary income from operations of $20,000.
  Jane, a partner, shares in 20% of the profits
  and 30% of the losses.
• How much of the ordinary income will be
  allocated to Jane?
  Organizational costs - Section
• A partnership may deduct organizational costs, in the
  taxable year in which the partnership begins, in an
  amount of equal to the lesser of:
  – The amount of organizational expenses with respect to
     the partnership or
  – $5,000, reduced (but not below zero) by the amount by
     which such organizational expenses exceed $50,000
• The partnership may deduct the remainder of such
  organizational expenses ratably over the 180-month
  period, beginning with the month in which the partnership
  begins business.
  Organizational costs - Section
• Organization costs include
    •   Costs incident to the formation of the partnership
    •   Costs that ordinarily would be subject to capitalization
    •   Costs that normally would be amortized over the life of the partnership

• Examples of organization costs are: Legal
  fees for drafting the partnership agreement,
  accounting fees for setting up the accounting
  records and state franchise fees
                 Syndication fees

• Costs incurred to promote the sale of (or to
  sell) an interest in a partnership
• No deduction allowed by the partnership or
  its partners
  – Examples:
    •   Expenses of issuing and marketing partnership interests, including
        registration of brokerage fees
    •   Accounting fees and legal fees relating to opinions, including in
        offering materials
    •   Printing costs of offering materials
  Startup expenditures – Section
• A partnership may deduct start up expenses, in the
  taxable year in which the partnership begins, in an
  amount of equal to the lesser of:
  – The amount of start up expenses with respect to the
     partnership or
  – $5,000, reduced (but not below zero) by the amount by
     which such organizational expenses exceed $50,000
• The partnership may deduct the remainder of such start
  up expenses ratably over the 180-month period,
  beginning with the month in which the partnership begins
 Startup expenditures – Section
• Start up expenses are amounts paid or
  incurred in connection with:
   •   Investigating the creation or acquisition of an active trade or business
   •   Creating an active trade or business
   •   Any activity engaged in for profit before the day on which the active
       trade or business begins or in anticipation of such activity becoming an
       active trade or business

 – Only amortizable if the expense would
   otherwise be deductible if paid or incurred in
   connection with the operation of an existing
   active trade or business (in the same field as
   the trade or business)
           Partnership tax years
• Generally, a partnership must have the same taxable year
  as that of its majority interest partners.

• When there are no majority interest partners with the
  same tax year, the partnership must adopt the same tax
  year as that of its principal partners.

• If the principal partners have different tax years, the
  partnership must adopt a year that results in the least
  aggregate deferral of income to partners.

• If none of these periods applies, the partnership defaults
  to the calendar year.
    Partnership tax years (cont.)
• A natural business year may also be allowed.
• A partnership must:
  – Demonstrate sufficient business purpose
     •   Tax and nontax factors considered
     •   If nonconforming year results in deferral or distortion of income, the nontax factors must be

  – 25% Gross Receipts Test
     •   Last two months' gross receipts greater than 25% of annual gross receipts
     •   Test met for current 12 months and three preceding 12-month periods

• Section 444 election
• Allows a partnership to retain or adopt any taxable year,
  provided both that:
  – The deferral is not longer than three months.
  – The partnership is not part of a tiered structure.
• Form 8716, Election to Have a Year Other Than a
  Required Tax Year

• A new partnership is formed by 30 calendar-
  year individuals, each of whom owns a 2%
  interest, and by a fiscal-year domestic
  corporation that owns the remaining 40%.

• What tax year must the partnership use?

• Individual X, Corporation Y and Z Corporation formed the
  XYZ Partnership on 1 October. The partners made equal
  contributions of cash in exchange for their partnership
  interests, and the partnership profits and losses are to be
  divided equally among the partners. X is on a calendar
  taxable year. Corporation Y and Z Corporation have fiscal
  years ending 30 June and 30 September, respectively.
  The partnership earns approximately the same net
  income each month so that its income is spread evenly
  throughout the year.
• What tax year must the partnership use?
         Loss limitations (cont.)

          §704(d)      §465     §469

Losses                                          Deduction

           Suspended    Suspended   Suspended

• Mrs. Allen receives an $85,000 distributive share of
  ordinary loss as a limited partner in the ABC
  Partnership. Mrs. Allen's outside basis in her
  partnership interest is $70,000, which includes her
  share of a nonrecourse note of $25,000. Mrs. Allen
  has $10,000 of passive activity income from
  another business venture.

• What is Mrs. Allen's deductible loss from the ABC
 Carryover of suspended losses

• Any loss previously disallowed is carried
  forward to future years and allowable to the
  extent that the partner's adjusted basis in the
  partnership interest exceeds zero (before
  reduction by such loss carryforward) at the
  end of any such year.

• Suspended losses deducted in subsequent
  tax years maintain the same character as the
  original loss.

• In Year 1, Partner C (outside basis of $1,000)
  receives the following share of distributive items:
  – Long-term capital loss of $6,000
  – Short-term capital loss of $2,000
  – Partnership ordinary income of $4,000

• What is the amount of Partner C's deductible
  capital losses? What are Partner C's loss
  carryforwards, if any?
 Carryover of suspended losses
• Disposition of a partnership interest
  – Section 704(d) – Gain is not available to offset any
    previously suspended losses under §704(d), and
    suspended losses at the time of sale are not includible
    in the basis of the partnership interest.
  – Section 465 – Gain on the sale of a partnership
    interest that is considered income from the same
    activity under §465(c) may be used to offset any
    suspended losses (capital or ordinary) from that same
Carryover of suspended losses
 – Section 469 – Gain on a sale of a partnership
   interest that produced §469 passive income is
   also considered passive gain that may be
   used to offset any previously suspended
   passive activity losses. If the entire interest in
   the "passive activity" is disposed of in a fully
   taxable transaction, any excess loss is treated
   as a nonpassive loss.

• In January 1,2009, Mrs. Allen sold her interest in
  the ABC partnership for $12,000. On this date Mrs.
  Allen’s outside basis and her at-risk amount in ABC
  were both zero.

• What are the tax consequences of this sale to Mrs.
   Varying interests rule – §706(d)(1)

• If there is a change in any partner's interest
  in the partnership during the partnership's
  tax year, then each partner's distributive
  share of partnership's tax items must
  account for the varying interests of the
  partners in the partnership during the
  partnership's tax year.
  – Prohibits retroactive allocations to newly
    admitted partners
  – Also applies to changes in the P/S interests of
    existing partners
   Varying interests rule – §706(d)(1)
• Permissible methods for determining
  partners' distributive shares:
 – Interim closing of books
 – Pro rata, such as daily or monthly
 – Any reasonable method
• Combinations of methods must be
• Transferor and transferee must use same

• Kate sold her one-fourth interest in JKLM
  this year on July 31st. The partnership had
  earned $240,000 as of that date, however, it
  expects to loose $60,000 over the next five
  months. Kate’s adjusted basis at the
  beginning of the year was $40,000.
• How much income should she be
  allocated this year?

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