Sample Answers to Question 3
Partnership Tax
Spring 2013
Exam No. 4464
Initial Balance Sheet: see Exhibit A.
Recourse
Debt
By joining a general partnership with recourse debt, Chris is taking on the economic burden of $10k, or 1/3 of the $30k line of credit. Therefore, Chris gets an initial basis of $10k (§752(a)), and Amanda's and Brett's bases decrease by $5k to $55k since they were relieved of that debt burden. §752(b).
Contribution of Services
§721 non-recognition only applies to the transfer of property to a partnership, not services. The FMV of what a partner receives in exchange for services, therefore, is taxable under §83(a). However, the FMV would have to be ascertainable. Rev. Proc. 93-27 outlines what would be ascertainable: (1) a profit interest relating to substantially certain & predictable stream of income from partnership assets, (2) sale of the partner's interest within 2 years, or (3) an interest in a publicly traded partnership. None of these apply here, so Chris' income will be taxed as profits come in under §§702, 704.
By Chris agreeing to pay the $21k in A/R from Olson, he is essentially contributing an asset with a built-in gain of $21k, which will be passed through to Chris as ordinary income upon collection. Unlike Schneer, this is work Chris completed before being admitted to the partnership. However, like Schneer, Chris is not getting a capital account equal to the $21k, so he could argue that it is not his gain. Given that this was work completed before entering the partnership, it seems that the Schneer court would require the income be attributed to Chris, and that he be given a capital account for that income. The IRS frowns upon one trying to accomplish through partnership tax that which he could not accomplish outside of partnership tax.
Brett's work as a weekend model also likely runs afoul of Schneer given that it is unrelated to the partnership's accounting business. Therefore, the ordinary income will pass through to Brett.
Year 1
Aside from the specifically attributable income above, the partnership made $240k of ordinary income (passed through to partners) and distributed $240k of cash throughout year 1, netting out to a zero impact on basis and capital accounts. The fact that the partners drew on their distributive share does not matter - the calculations are all done at the end of the year, so the partners do not have to worry about having taken out cash in excess of their bases during the year.
Aside from the modeling income and prior A/R, all three partners appear to be acting in their partner capacities (providing accounting services), so the income passes through under §702, with tax-free distributions under §731. The partnership would not get any deductions, and the basis and capital accounts shift up and down with income and expenses of the partnership, as illustrated above. There do not appear to be any guaranteed payments, which would fall under §707(c) and would be deductible by the partnership.
The factors hinting at a §707 transaction are (1) whether the payment is subject to risk as to amount (yes, no fixed amounts here), (2) partner status as recipient is transitory (not here), (3) allocation & distribution close in time to services (yes, but continuing services here), (4) tax motive (not here), and (5) value of interest in continuing partnership profits in relation to allocation in question - all continuing here.
See Exhibit B for the year-end balance sheet.
Year 2
The stock was sold at a tax gain of $30k, increasing each partner's basis by $10k (1/3 shares), and a book loss of $30k, decreasing each partner's capital account by $10k (1/3 shares). See Exhibit C for the tentative Year 2 balance sheet.
Exam No.
4201
Chris gets profits interest
Under § 61 and 83 getting a partnership interest for performing services is taxable income. However, when it is a profits interest, instead of a capital interest there is a valuation problem. This profits interest does not relate to a "substantially certain and predictable stream of income," (even though the stock is increasing it's not predictable) and its not an interest in a publicly traded partnership. thus, I don't think the interest could be valued properly to allow Chris to recognize income. If he disposed of it within 2 years, then he would have to recognize income in the year he got the interest in the amount he disposed of it for. However, that doesn't mean there is no tax consequence to Chris. Because he is joining a partnership with recourse debt, he is now liable for some of that debt. This means he gets a basis in his interest of $10,000, his new share of the debt. A and B are thus discharged of some of their indebtedness. This is treated like a cash distribution and lowers their basis by $5,000 each.
Chris contributes Acct.
This is treated like a normal contribution to a partnership of property. Accounts receivable are considered property under the definitions in § 721. There is no gain or loss to Chris, under § 721. He now has $21,000 in his capital account and his basis is adjusted by his basis in the receivables, or $0. Nothing happens to the other partners. It's worth noting that there is $21,000 built-in gain in this property and that it will always have ordinary character.
Year One
1) When the partnership collects on the receivable all of that is taxed to Chris under § 704(c). This income to Chris is ordinary since it was ordinary when held by him. His basis increases by the amount of taxable gain he had, so $21,000. Nothing happens to the other partners.
2) The $9,000 earned by Brett and given to the partnership is not income earned by a partner in her capacity. It's not even related, like the income in the Schneer case. Thus, the tax cannot be shifted to the other partners. Brett must pay all the tax on it, under § 61. It's then treated as a contribution to the partnership and so Brett get's basis and capital account for the money. Nothing happens to the other partners.
3) The partnership has $240,000 overall profits this year. This is taxed equally to all the partners, because they are equal partners. Thus each pays tax on $80,000 and receives a corresponding boost to their capital accounts and outside basis. This is capital gains income. This income passes through at the end of the year.
4) The 80,000 distributions are no problem because they all have enough basis, there are no longer any hot assets in the partnership, and they're just money. Distributions are not taxable events so it doesn't matter if they received them monthly or at the end of the year.
Please see Exhibit A for the balance sheet at the end of year one.
Exam No. 4638
Initial balance sheet before
restatement is Q3, Exh A.
Since the PS does not elect
association, it is a partnership for tax purposes under check the box.
The Partnership is permitted to
restate its book values to FMV when it admits a new P. Because C gets just a profits interest, 721
does not apply to the transaction. RP
93-27. None of the exceptions under the
Rev Proc apply. It is stock, not a debt
security or a lease, we are not told it is a publicly traded PS, and we are not
told C disposes of his profits interest w/in 2 yrs. Therefore, there is no taxable transaction
under 721. This is good, because if it
was a 721 transaction, 721(b) would make it a recognition event since stock and
$ are 100% of the LLC. There is no G/L on
the transaction, and C comes in with a 0
CA and 0
However, because this is a recourse
loan, C is now on the hook for $10k of the RL under 752 and 1.752-3(a)(3)
(based on interest in profits). As such,
his
Under Schneer,
the modeling work will not be assigned to the PS. Since modeling is nothing like accounting,
the case will not interfere with normal assignment of income principles. Therefore, the $9k will all be taxed to
Brett. Since he added this money, it
will be treated as a contribution (no G/L under 721), which will increase his
CA, his
The 21k was for fees for past
services already performed, However,
because he is a C/M TP, he did not already earn the fees like the lawyer
in Schneer. Therefore, the 21k will be
assigned to the PS and added to the general income. The $321k of income passes through under
702. The $60k losses pass through under
702 and 704. These expenses are ordinary
losses (trade or bus exps) and the income is ordinary
income (service income). Therefore, each
P will pay ordinary income on $107k and will have ordinary loses of $20k. The income will increase their
The $240k in total draws pass
through on the last day of the year. There
will be no G/L on the distirbutions because they will
not exceed any Ps'
In Year 2, when the PS sells the Furco stock, this is at a tax gain of $30k but a book loss
of $30k. If no 754 election was made,
then each P (including C) must pay tax on their $10k share of the gain,
capital.
This creates a negative CA for C.
Because the prompt says there is SEE, we do not know whether this is because
there is a QIO or because each P is obligated to restore deficit Cas. If the former,
then C's CA can't go negative. If it has SEE because each P is oblig'd to restore deficit CA, then C can go below zero CA
and will have a negative CA. See Q3, Exh
G (assuming oblig'd to restore).
The disparity also adds another $20k
to the disparity between his CA & OB. C can fix this disparity if Ps elects
754. Unfortunately, the mini-754
election under 732(d) won't apply since the company just sold assets. Therefore, the PS must elect the option (at
PS level, 703(b)). Here, a 754 election
would work against him though, because it would actually decrease his OB.
743(b).
Unfortunately for C, his admittance
does not create a constructive liquidation under 708 (since not at least 50%
and not profits and capital and no sale/exchange). If it did, then there would be 704(c)
property from when he was admitted to when the sale took place, and thus could
use the remedial method to fix this wacky allocation. But since no 704(c) property is involved, it
looks like C is stuck with this big disparity.
Created by: bojack@lclark.edu
Update: 13 Jun 13
Expires: 31 Aug 15