Partnership Taxation
Spring 2013
Bogdanski
FINAL EXAMINATION
(Three hours)
INSTRUCTIONS
This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination.
At the end of the three hours, you must turn in this set of essay questions in the original envelope in which this set came. If you wish to submit handwritten partnership balance sheets with your answers, you must (1) enclose them in the envelope, clearly labeled with your exam number and the question to which they relate, and (2) refer to them in your answers.
If you are using a computer, unless you have been otherwise expressly authorized by the law school, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.
No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s), and any enclosed balance sheets, will be graded.
Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.
Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.
The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.
Unless otherwise instructed, you should assume that:
○ all partners described in the
questions are individuals and
○ all partners and partnerships described in the questions use the calendar year as their taxable year for federal income tax purposes; and
○ all partners and partnerships report their income on the cash method for such purposes.
References to “the Code” are to the Internal Revenue Code of 1986, as amended.
QUESTION ONE
(One hour)
Judy and Karen are one-fourth members in a limited liability company named LLCo. Judy, Karen, and their two fellow members formed LLCo several years ago by making cash contributions in exchange for their membership interests. Since then, none of the members has contributed any additional money or property to LLCo; the company has been profitable, and the members have been taking cash contributions (in equal amounts) annually.
LLCo makes no election to be taxed as an association. At all times, the allocations of income, deduction, loss, and credit set out in LLCo’s operating agreement – that is, equal allocations among the four members – have substantial economic effect.
On January 1, 2013, the LLCo balance sheet reveals the following assets and liabilities:
|
|
Assets |
|
|
Liabilities |
|
|
|
Adjusted
basis |
Fair
market value |
|
Adjusted
basis |
Fair
market value |
|
Cash |
$
30,000 |
$
30,000 |
Bank debt |
|
$180,000 |
|
Inventory |
40,000 |
60,000 |
|
Members’
equity |
|
|
Land held for
investment |
230,000 |
170,000 |
Judy |
$
75,000 |
40,000 |
|
Accounts receivable |
-0- |
80,000 |
Karen |
75,000 |
40,000 |
|
|
|
|
Xavier |
75,000 |
40,000 |
|
|
|
|
Yolanda |
75,000 |
40,000 |
|
Total
assets |
$300,000 |
$340,000 |
Total
liabilities |
$300,000 |
$340,000 |
On January 1, 2013, Judy sells her membership interest to a buyer, Bob. Bob pays Judy $40,000 cash for her interest. The other members welcome Bob to the company. Later in 2013, LLCo collects $80,000 on the accounts receivable and sells the land to Karen for cash of $170,000, the land’s fair market value at the time of the sale. Those are LLCo’s only two transactions during 2013. (The inventory remains in the LLCo warehouse at the end of 2013.)
What are the federal income tax consequences — to Judy, Karen, Bob, and LLCo — of the transactions just described, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.
Discuss.
(End of Question 1)
QUESTION TWO
(One hour)
On the first day of year 1, Gary and Louise form a limited partnership, named G-Lu, which does not elect to be taxed as an association. Gary, the general partner, contributes $10,000 cash, and Louise contributes $30,000 cash. Immediately after its formation, G-Lu borrows $60,000 from a bank and purchases a piece of equipment for $100,000. The loan is a nonrecourse loan; the bank’s only remedy in the event of default is to repossess and sell the equipment. The loan agreement requires G-Lu to pay interest only for the first five years. G-Lu puts the equipment into service immediately.
Assume that G-Lu properly depreciates the equipment using the straight-line method over a five-year recovery period, and that it is entitled to a full year’s depreciation deduction ($20,000) in each of the first five taxable years in which it owns the equipment. Assume that G-Lu does not deduct bonus depreciation on the equipment or elect to deduct immediately any of the basis of the equipment under section 179 of the Code.
The G-Lu
partnership agreement allocates all income, gain, loss, and deductions 10
percent to
The
partnership agreement provides that all nonliquidating distributions will be
made 25 percent to
In each of years 1 through 3, G-Lu’s operating income and operating expenses (including interest on the bank loan but not depreciation) are equal. Therefore, G-Lu has a net operating loss each year equal to the amount of its depreciation deduction attributable to the equipment.
What are the federal income tax consequences for years 1, 2, and 3 – to Gary, Louise, and G-Lu – of the transactions just discussed, with and without any available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.
Explain.
(End of Question 2)
QUESTION THREE
(One hour)
Amanda and Brett are equal partners in a partnership, AB, which practices accounting. AB, which is a general partnership under state law, makes no election to be taxed as an association. At all times, the allocations of income, deduction, loss, and credit set forth in the AB partnership agreement have substantial economic effect.
On the first day of year 1, AB has two assets: cash of $20,000, and stock in Furco, a client. The Furco stock, which AB purchased several years back, has an adjusted basis and book value of $100,000, and a fair market value of $160,000. AB owes $30,000 to a bank on a line of credit that supports AB’s operations; it is a recourse debt. Amanda and Brett’s partnership interests each have an adjusted basis of $60,000.
On the first day of year 1, AB admits Chris as a new partner. Chris receives a one-third profits interest, but no initial capital account. The firm is renamed ABC. In preparation for Chris’s arrival, AB performs a restatement of its assets to current value for book accounting purposes.
ABC’s partnership agreement contains a rule that any income earned by partners from any personal services, professional or otherwise, must be turned in to the firm, to be treated as part of ABC’s book accounting income for the year. Amanda, Brett, and Chris also agree that Chris will pay over to ABC, if and when he collects it, $21,000 that Chris is owed by one of his personal accounting clients, Olson, for past work. At the time he is admitted to the partnership, Chris transfers no cash or other assets to ABC.
During year 1, ABC collects $21,000 from Olson for the work previously performed by Chris, and $300,000 from ABC clients for services rendered during the year. In addition, during year 1, Brett collects $9,000 for his current weekend work as a model; under the firm’s rules, he endorses the modeling checks over to ABC. The firm incurs and pays deductible expenses for the year of $60,000, none of which are attributable to the Olson account or to Brett’s modeling work. In addition, ABC pays $80,000 cash to each partner during year 1 – some as monthly “draws,” and the rest on the last day of the year.
Early in year 2, ABC sells the Furco stock in an arm’s-length transaction to an unrelated third party for $130,000 cash, the stock’s fair market value at the time of the sale. ABC repays no principal on the bank line of credit in year 1 or year 2.
What are the federal income tax consequences of the transaction just described – to Amanda, Brett, Chris, and ABC – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party's basis in the property or partnership interest which that party holds (actually or constructively), at each stage of the transactions.
Discuss.
(End of examination)
Created by: bojack@lclark.edu
Update: 21 May 13
Expires: 31 Aug 14