Question 1

When Kevin and Marshall formed the equal KM LLC, the fair market values of their interests were each $100,000.
Kevin contributed $60,000 cash, equipment with a basis of $0 and a fair market value of $10,000, and a small parcel of land in which he had a basis of $50,000 and which was valued at $30,000. Marshall contributed an account receivable that was valued at $100,000 and which his basis was $0. Kevin has a basis in his partnership interest of $110,000 and Marshall's basis is $0.

Accepted Answer

The fair market value of Kevin's contribution is $100,000 ($60,000 cash + $10,000 equipment + $30,000 land). The fair market value of Marshall's contribution is also $100,000 (the account receivable). Therefore, their interests are equal. Kevin's basis in his partnership interest is the total value of his contributions ($100,000) plus any previously taxed income or loss allocated to him, minus any distributions received. Therefore, his basis of $110,000 is correct. Marshall's basis is $0 because he did not contribute any capital, and his basis in the account receivable is also $0 because it was not taxed yet.

Question 2

Laura is a real estate developer and owns property that is treated as inventory (not a capital asset) in her business.
She contributes a parcel of this land (basis of $15,000) to a partnership, also to be held as inventory. The fair market value of the property is $12,000 at the contribution date. After three years, the partnership sells the land for $10,000. The partnership will recognize a $5,000 ordinary loss on sale of the property.

Accepted Answer

Since Laura contributed the land with a basis of $15,000 but a fair market value of only $12,000, she will recognize a $3,000 loss on the contribution. When the partnership sells the land for $10,000, it will recognize a $5,000 ordinary loss on the sale. However, this loss will be allocated to Laura based on her share of the partnership's profits and losses, which will reduce her basis in the partnership.

Question 3

Section 721 provides that no gain or loss is recognized on a contribution of property to a partnership in exchange for an interest in the partnership. An exception might apply if the taxpayer receives a cash distribution from the partnership soon after the property contribution is made.

Accepted Answer

This is the basic rule of Section 721, which provides nonrecognition treatment for property contributed to a partnership in exchange for a partnership interest. However, if the taxpayer receives a cash distribution from the partnership soon after the contribution, there may be tax consequences.

Question 4

The "inside basis" is defined as a partner's basis in the partnership interest.

Accepted Answer

The answer of The "inside basis" is defined as a...

Question 5

George received a fully-vested 10% interest in partnership capital and a 20% interest in future partnership profits in exchange for services rendered to the GHP, LLC (not a publicly-traded partnership interest). The future profits of the partnership are subject to normal operating risks. George will report ordinary income equal to the fair market value of the profits interest, but the capital interest will not be currently taxed to him.

Accepted Answer

George will not report ordinary income for the profits interest if it is related to future partnership profits and subject to significant entrepreneurial risk. However, the vested capital interest he received is taxable as ordinary income at its fair market value at the time of receipt, contrary to the statement.

Question 6

An example of the aggregate concept of partnership taxation is that the partnership makes elections related to depreciation, tax credit calculations (except the foreign tax credit), and whether or not to claim a § 179 deduction.

Accepted Answer

The answer of An example of the aggregate concept of...

Question 7

An example of the "aggregate concept" underlying partnership taxation is the fact that the partners (rather than the partnership) pay tax on partnership income.

Accepted Answer

This is because partnership taxation operates under the "aggregate concept" where the partnership is viewed as a collection of individual partners rather than a separate entity for tax purposes. Therefore, the partnership itself does not pay taxes on its income, but rather the partners are responsible for reporting and paying taxes on their share of the partnership income on their individual tax returns.

Question 8

The partnership reports each partner's share of income to the partner on a Form 1099-MISC.

Accepted Answer

Partnerships report each partner's share of income on a Schedule K-1 (Form 1065), not a Form 1099-MISC.

Question 9

The partnership agreement might provide, for example, that the first $40,000 of ordinary income is allocated to Partner A.
Allocating income in this manner is an example of a separately stated item.

Accepted Answer

Allocating income in this manner is not an example of a separately stated item; it is an example of a special allocation of partnership income, which is different from separately stated items that must be reported individually by partners on their tax returns due to their tax treatment.

Question 10

A partnership is an association formed by two or more taxpayers (which may be any type of entity) to carry on a trade or business.

Accepted Answer

A partnership is indeed an association formed by two or more taxpayers to carry on a trade or business.

Question 11

A limited partnership (LP) offers all partners protection from claims by the LP's creditors.

Accepted Answer

Limited partners have limited liability and are only responsible for the amount of their investment in the partnership. However, general partners do not have limited liability and can be held personally responsible for the debts and obligations of the partnership. Therefore, all partners in a limited partnership do not have protection from claims by the LP's creditors.

Question 12

In a limited liability partnership all members may participate in management and have personal liability for entity debts, except for malpractice committed by the other partners.

Accepted Answer

The answer of In a limited liability partnership all members...

Question 13

Section 721 provides that, in general, no gain or loss is recognized by the partnership or the partner on contribution of appreciated or depreciated property to a partnership in exchange for an interest in the partnership.

Accepted Answer

This is a correct statement according to Section 721 of the Internal Revenue Code. When a partner contributes appreciated or depreciated property to a partnership in exchange for an interest, no gain or loss is recognized by the partnership or the partner.

Question 14

Ken and Lars formed the equal KL Partnership during the current year, with Ken contributing $100,000 in cash and Lars contributing land (basis of $60,000, fair market value of $40,000) and equipment (basis of $0, fair market value of $60,000). Lars recognizes a $40,000 gain on the contribution and his basis in his partnership interest is $100,000.

Accepted Answer

Lars has a $20,000 loss on the contribution ($60,000 basis - $40,000 fair market value), not a gain. Therefore, his basis in his partnership interest would be $80,000 ($60,000 basis in land - $20,000 loss + $0 basis in equipment + $40,000 gain recognized = $80,000).

Question 15

A partner will have the same profit-sharing, loss-sharing, and capital-sharing ownership percentages.

Accepted Answer

The percentages for profit-sharing, loss-sharing, and capital-sharing can differ based on the partnership agreement.

Question 16

In a limited liability company, all members are protected from all debts of the partnership unless they personally guaranteed the debt.

Accepted Answer

In a limited liability company, all members have limited liability and are protected from the debts of the partnership. However, if they personally guaranteed the debt, then they would not have limited liability for that specific debt.

Question 17

Morgan and Kristen formed an equal partnership on August 1 of the current year. Morgan contributed $60,000 cash and land with a basis of $18,000 and a fair market value of $40,000. Kristen contributed equipment with a basis of $42,000 and a value of $100,000. Kristen and Morgan each have a basis of $100,000 in their partnership interests.

Accepted Answer

Morgan's basis in the partnership should be $78,000 (cash $60,000 + land basis $18,000), while Kristen's basis should be $42,000 (equipment basis $42,000). The fair market value does not affect the initial basis calculation for contributed property.

Question 18

The primary purpose of the partnership agreement is to document the various tax elections made by the partners regarding depreciation methods, treatment of research and experimental costs, calculation of the § 199 deduction, and the § 754 election.

Accepted Answer

The primary purpose of the partnership agreement is to establish the terms and conditions of the partnership, including the financial and managerial responsibilities of each partner, the distribution of profits and losses, and the procedures for admitting or withdrawing partners. While the partnership agreement may document tax elections made by the partners, this is not its primary purpose.

Question 19

In a limited liability company, all members may participate in management (the operating agreement cannot limit participation) and all entity debts are treated as nonrecourse liabilities for purposes of allocating the LLC's liabilities to basis.

Accepted Answer

In a limited liability company (LLC), the operating agreement can indeed limit members' participation in management, and not all entity debts are treated as nonrecourse liabilities for purposes of allocating the LLC's liabilities to basis; recourse and nonrecourse liabilities are allocated according to the LLC's operating agreement and tax regulations.

Question 20

The taxable income of a partnership flows through to the partners, who report the income on their tax returns.

Accepted Answer

Partnership income is not taxed at the partnership level, but rather flows through to the individual partners, who report their share of the income on their personal tax returns.

Quiz 21: Partnerships