Partnership Taxation

Spring 2014

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 U.S. residents;

 

○          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.

 

Any references to “the Code” are to the Internal Revenue Code of 1986, as amended.

QUESTION ONE

(One hour)

 

            Tara, Upton, and Vivienne form a general partnership, TUV.  TUV makes no election under the “check the box” regulations under Section 7701 of the Code.  Each partner contributes cash to set up the partnership.  The partners’ contributions are as follows:

 

Partner

Contribution

Tara

$   50,000

Upton

100,000

Vivienne

150,000

Total

$ 300,000

 

All three partners pay federal income tax at the highest marginal tax bracket.

 

            The partnership agreement of TUV requires that: (1) all allocations of income and deduction are to be reflected in appropriate adjustments to the partners’ capital accounts; (2) proceeds of liquidation of the partnership are to be distributed in accordance with positive capital account balances; and (3) upon liquidation, any partner with a negative capital account balance is required to restore that balance by immediate cash payment to TUV.  The agree­ment also provides that the profits and losses of TUV are allocated 40 per­cent to Tara; 40 percent to Upton; and 20 percent to Vivienne.

 

            TUV borrows $200,000 to finance its initial operations.  In the first year of its operations, TUV has gross income of $100,000 and deductions of $500,00­0, for a net operating loss of $400,000, for federal income tax purposes.

 

            What are the federal income tax consequences — to Tara, Upton, Vivienne, and TUV — 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 partnership interest which that party holds (actually or constructively), ­­at each stage of the transactions. Do not discuss an election under the “check the box” regulations under Section 7701 of the Code. 

 

            Discuss.

 

(End of Question 1)

 

 

QUESTION TWO

(One hour)

 

            Ken, Lori, and Melissa form a limited liability company, KLM, to operate a recrea­tional equipment rental business near a state park.  KLM makes no election under the “check the box” regulations under Section 7701 of the Code.  The LLC operating agree­ment, which satisfies the primary test for economic effect contained in the regulations under section 704(b) of the Code, provides that all profits and losses are to be shared as follows: 40 percent to Ken, 40 percent to Lori, and 20 percent to Melissa.

 

            In the formation of KLM, Ken transfers $40,000 cash to KLM in exchange for his member­ship interest.  Lori contributes some of her inventory, with an adjusted basis in Lori’s hands of $25,000 and a fair market value of $90,000; KLM takes the inventory subject to a nonrecourse liability with an outstanding principal balance of $50,000.  Melissa contributes no capital to KLM and receives no interest in the company’s initial capital; instead, she receives her partnership interest in ex­change for her agreement to perform services for KLM in the first year of its operations.

 

            During its first taxable year, KLM sells off the inventory it received from Lori for an aggregate cash sale price of $65,000.  KLM pays off the nonrecourse loan, and KLM operates debt-free thereafter.

 

            Answer each of the following questions:

 

            A.  (80% of question score)  What are the federal income tax consequences to Ken, Lori, Melissa, and KLM 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 member­ship interest which that party holds (actually or con­structive­ly), at each stage of the transactions. Do not discuss an election under the “check the box” regulations under Section 7701 of the Code.

 

            B.  (20% of question score)  If KLM wishes to adopt a taxable year ending September 30, will it be permitted to do so?

 

            Explain.

 

(End of Question 2)

 

 

QUESTION THREE

(One hour)

 

            Oscar and Paige are the partners in a limited partnership, Lilco.  Oscar is the general partner of Lilco; Paige, a passive investor, is the limited partner.  Lilco makes no election under the “check the box” regulations under Section 7701 of the Code.  Lilco’s partnership agree­ment provides that capital accounts will be maintained in accordance with the regulations under Section 704(b) of the Code; and that on liquidation, distributions to partners will be made according to their respective positive capital accounts. Under the agreement, income, loss, and deduction are to be shared between then partners equally.

 

            Lilco is a successful venture with steady annual profits.  Before the transactions dis­cussed in this question, Osc­ar has an adjusted basis in his partnership interest of $­120,000, and Paige has an adjusted basis in her partnership interest of $300,000.

 

            In an operating distribution to its members, Lilco distributes some of its unwanted inventory to Oscar and Paige.  Each member receives two inventory items.  The items that Oscar receives are identical to the items that Paige receives. Each partner receives items with a combined fair market value of $90,000; the total fair market value distributed by Lilco to the two partners is $180,000.

 

            The first inventory item that each mem­ber receives (Item A) has a fair market value of $30,000 and a basis to the partnership immediately before the distribution of $120,000.  The other inventory item that each member re­ceives (Item B) has a fair market value of $60,000 and a basis to the partnership immediately before the distribution of $30,000.  The next year, Paige sells the second inven­tory item she receives (Item B) to a third party for $­65,000 cash.

 

            A few years later, in recognition of Oscar’s extraordinary efforts on behalf of Lilco, the partners amend the partnership agreement.  The amendment specifies that Oscar will receive a $40,000 special allocation of Lilco’s net profit over the next year; beyond this $40,000, the profit of Lilco, and any loss, are to be shared equally, as usual.  In the unlikely event that Lilco does not have $40,000 of profit that year, Oscar’s preference is to be satisfied the following year.  Lilco also pays special bonuses to all of its employees.

 

            In the year in which the special allocation is in effect, Lilco has a profit of $200,000.  Under the amended partnership agreement, the profit is allocated on the Lilco books as follows: $120,000 to Oscar and $80,000 to Paige.

 

            What are the federal income tax consequences of the transaction just described – to Oscar, Paige, and Lilco – 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.  Do not discuss an election under the “check the box” regulations under Section 7701 of the Code.

 

            Discuss.

 

(End of examination)

 

 

Created by: bojack@lclark.edu
Update:  19 May 14
Expires:  31 Aug 15