ch20
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ch20

Course Number: ACCOUNTING 401, Spring 2012

College/University: Regis

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ch20 Student: ___________________________________________________________________________ 1. Income earned by flow-through entities is usually taxed once at the entity level. True False 2. Partnerships tax rules incorporate both the entity and aggregate approaches. True False 3. The term "outside basis" refers to the partnership's basis in its assets; whereas, the term "inside basis"...

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___________________________________________________________________________ 1. Income ch20 Student: earned by flow-through entities is usually taxed once at the entity level. True False 2. Partnerships tax rules incorporate both the entity and aggregate approaches. True False 3. The term "outside basis" refers to the partnership's basis in its assets; whereas, the term "inside basis" refers an individual partner's basis in her partnership interest. True False 4. A partnership can elect to amortize organization and startup costs; however, syndication costs are not deductible. True False 5. Nonrecourse debt is generally allocated according to the profit-sharing ratios of the partnership. True False 6. Partners must generally treat the value of profits interests they receive in exchange for services as ordinary income. True False 7. A purchased partnership interest has a holding period beginning on the date of purchase regardless of the type of property held by the partnership. True False 8. Tax elections are rarely made at the partnership level. True False 9. The least aggregate deferral test uses the profit percentage of each partner to determine the minimum amount of tax deferral for the partner group as a whole. True False 10. A partnership with a C corporation partner must always use the accrual method as its accounting method. True False 11. The character of each separately-stated item is determined at the partner level. True False 12. Guaranteed payments are included in the calculation of a partnership's ordinary business income (loss) and are also treated as separately-stated items. True False 13. A general partner's share of ordinary business income is similar to investment income; thus, a general partner only includes their guaranteed payments as self-employment income. True False 14. Partnerships can use special allocations to shift built-in gains and built-in losses on contributed property from a partner who contributed the property to other partners. True False 15. A partnership can request a five month extension by filing Form 7004 prior to the original due date of the partnership return. True False 16. A partner's outside basis must first be decreased by any negative basis adjustments and then increased by any positive basis adjustments. True False 17. Actual or deemed cash distributions in excess of a partner's outside basis are generally taxable as capital gains. True False 18. Adjustments to a partner's outside basis are made annually to prevent double taxation on the sale of a partnership interest or at the time of a partnership distribution. True False 19. Partners adjust their outside basis by adding non-deductible expenses and subtracting any tax-exempt income to avoid being double taxed. True False 20. An additional allocation of partnership debt or relief of partnership debt is considered to be a deemed cash contribution or cash distribution respectively. True False 21. Any losses that exceed the tax basis of a partner are suspended and carried forward for 20 years. True False 22. The main difference between a partner's tax basis and at risk amount is that qualified nonrecourse financing is not included in the at risk amount. True False 23. A partner can apply any passive activity losses against any passive activity income for the year. True False 24. If a partner participates in partnership activities on a regular, continuous, and substantial basis, then the partnership's activities with respect to this individual partner are not considered passive. True False 25. A partner's tax basis or at risk amount can be increased by making capital contributions, by paying off partnership debt, or by increasing the profitability of the partnership. True False 26. Which of the following entities is not considered a flow-through entity? A. C corporation B. S corporation C. Limited Liability Company (LLC) D. Partnership 27. Which of the following statements exemplifies the entity theory of partnership taxation? A. Partnerships are taxable entities. B. Partnerships determine the character of separately stated items at the partnership level. C. Partnerships make the majority of the tax elections. D. Both A and C are correct E. Both B and C are correct 28. Gerald received a 33% capital and profit (loss) interest in XYZ Limited Partnership (LP). In exchange for this interest, Gerald contributed a building with a FMV of $30,000. His adjusted basis in the building was $15,000. In addition, the building was encumbered with a $9,000 nonrecourse mortgage that XYZ, LP assumed at the time the property was contributed. What is Gerald's outside basis immediately after his contribution? A. $6,000 B. $9,000 C. $21,000 D. $24,000 29. Sue and Andrew form SA general partnership. Each person receives an equal interest in the newly created partnership. Sue contributes $10,000 of cash and land with a FMV of $55,000. Her basis in the land is $20,000. Andrew contributes equipment with a FMV of $12,000 and a building with a FMV of $33,000. His basis in the equipment is $8,000, and his basis in the building is $20,000. How much gain must the SA general partnership recognize on the transfer of these assets from Sue and Andrew? A. $0 B. $4,000 C. $48,000 D. $52,000 30. Erica and Brett decide to form their new motorcycle business as a LLC. Each will receive an equal profits (loss) interest by contributing cash, property, or both. In addition to the members' contributions, their LLC will obtain a $50,000 nonrecourse loan from First Bank at the time it is formed. Brett contributes cash of $5,000 and a building he bought as a storefront for the motorcycles. The building has a FMV of $45,000, an adjusted basis of $30,000, and is secured by a $35,000 nonrecourse mortgage that the LLC will assume. What is Brett's outside tax basis in his LLC interest? A. $37,500 B. $40,000 C. $42,500 D. $45,000 31. Under general circumstances, debt is allocated from the partnership to each partner in the following manner: A. Recourse - profit sharing ratios; nonrecourse - profit sharing ratios B. Recourse - capital ratios; nonrecourse - capital ratios C. Recourse - to partners with the ultimate responsibility for paying the debt; nonrecourse - profit sharing ratios D. Recourse - profit sharing ratios; nonrecourse - to partners with the ultimate responsibility for paying the debt 32. Which of the following statements is true when property is contributed in exchange for a partnership interest? A Any contributed property in a partnership has a carryover basis, and the character of the property is . determined by the way the contributing partner used the property. B. The partnership's inside basis is typically increased by any gain the partner recognizes from the property contribution. C. The holding period for a partner's partnership interest depends upon the type of assets a partner contributes. D. Services are not allowed to be contributed to a partnership in return for a partnership interest. E. All of the above are true. 33. In X1, Adam and Jason formed ABC, LLC, a car dealership in Kansas City. In X2, Adam and Jason realized they needed an advertising expert to assist in their business. Thus, the two members offered Cory, a marketing expert, a 1/3 capital interest in their partnership for contributing his expert services. Cory agreed to this arrangement and received his capital interest in X2. If the value of the LLC's capital equals $180,000 when Cory receives his 1/3 capital interest, which of the following tax consequences does not occur in X2? A. Cory reports $60,000 of ordinary income in X2 B. Adam, Jason and Cory receive an ordinary deduction of $20,000 in X2 C. Adam and Jason receive an ordinary deduction of $30,000 in X2 D. A and C 34. Tom is talking to his friend Bob, who has an interest in Freedom, LLC, about purchasing his LLC interest. Bob's outside basis in Freedom, LLC is $10,000. This includes his $2,500 one-fourth share of the LLC's debt. Bob's 704(b) capital account is $17,000. If Tom bought Bob's LLC interest for $17,000, what would Tom's outside basis be in Freedom, LLC? A. $10,000 B. $14,500 C. $17,000 D. $19,500 35. Which of the following statements regarding capital and profit interests received for services contributed to a partnership is false? A. The holding period of a capital or profits interest begins on the date the interest is received B. Partners receiving capital interests must recognize the liquidation value of their capital interests as capital gain C. Partners receiving only profits interests generally don't recognize income when the profits interest is received D. Partners receiving only profits interests include their share of partnership debt in the tax basis of their partnership interest 36. Partnerships must maintain their capital accounts according to which of the following rules? A. GAAP B. 704(b) C. Tax D. All of the above E. Only A and B. 37. Zinc, LP was formed on August 1, 20X9. When the partnership was formed, Al contributed $10,000 in cash and inventory with a FMV and tax basis of $40,000. In addition, Bill contributed equipment with a FMV of $30,000 and adjusted basis of $25,000 along with accounts receivable with a FMV and tax basis of $20,000. Also, Chad contributed land with a FMV of $50,000 and tax basis of $35,000. Finally, Dave contributed a machine, secured by $35,000 of debt, with a FMV of $15,000 and a tax basis of $10,000. What is the total inside basis of all the assets contributed to Zinc, LP? A. $140,000 B. $165,000 C. $175,000 D. $200,000 38. Which of the following does not represent a tax election available to either partners or partnerships? A. Electing to change an accounting method B. Electing to amortize organization costs C. Electing to expense a portion of syndication costs D. Electing to immediately expense depreciable property under Section 179 39. In what order should the tests to determine a partnership's year end be applied? A. majority interest taxable year - least aggregate deferral - principal partners test. B. principal partners test - majority interest taxable year - least aggregate deferral. C. principal partners test - least aggregate deferral - majority interest taxable year. D. majority interest taxable year - principal partners test - least aggregate deferral. E. None of the above. 40. Sarah, Sue, and AS Inc. formed a partnership on May 1, 20X9 called SSAS, LP. Now that the partnership is formed, they must determine its appropriate year-end. Sarah has a 30% profits and capital interest while Sue has a 35% profits and capital interest. Both Sarah and Sue have calendar year-ends. AS Inc. holds the remaining profits and capital interest in the LP, and it has a September 30 year-end. What tax year-end must SSAS, LP use for 20X9 and which test or rule requires this year-end? A. 9/30, majority interest taxable year B. 12/31, majority interest taxable year C. 12/31, principal partners test D. 12/31, least aggregate deferral test 41. XYZ, LLC has several individual and corporate members. Abe and Joe, individuals with 4/30 year-ends, each have a 23% profits and capital interest. RST, Inc., a corporation with a 6/30 year end, owns a 4% profits and capital interest while DEF, Inc., a corporation with an 8/30 year end, owns a 4.9% profits and capital interest. Finally, thirty other calendar year-end individual partners (each with less than a 2% profits and capital interest) own the remaining 45% of the profits and capital interests in XYZ. What tax year-end should XYZ use and which test or rule requires this year-end? A. 4/30, principal partners test B. 4/30, least aggregate deferral test C. 12/31, principal partners test D. 12/31, least aggregate deferral test 42. During 2009, HPLC, LLC was formed by H Inc., P Inc., L Inc., and C Inc. Each member had an equal share in the LLC's capital. H Inc., P Inc., and L Inc. each had a 30% profits interest in the LLC with C Inc. having a 10% profits interest. The members had the following tax year-ends: H Inc. [1/31], P Inc. [5/ 31], L Inc. [7/31], and C Inc. [10/31]. What tax year-end must the LLC use? A. 1/31 B. 5/31 C. 7/31 D. 10/31 43. Which of the following statements regarding the process for determining a partnership's tax year-end is true? A. Only the partners' profits interests are relevant when determining if a partnership has a majority interest taxable year. B Under the principal partners test, a principal partner is defined as a partner having an interest of 3% or . more in the profits or capital of the partnership. C. The least aggregate deferral test utilizes the partners' capital interests to measure the amount of aggregate deferral. D. A partnership is required to use a calendar year-end if it has a corporate partner. E. None of the above is true. 44. A partnership may use the cash method despite having a corporate partner when the partnership's average gross receipts for the prior three taxable years don't exceed _________. A. $500,000 B. $1,000,000 C. $5,000,000 D. Partnerships may never use the cash method if they have corporate partners 45. TQK, LLC provides consulting services and was formed on 1/31/X5. Aaron and ABC, Inc. each hold a 50% capital and profits interest in TQK. If TQK averaged $7,000,000 in annual gross receipts over the last three years, what accounting method can TQK use for X9? A. Accrual method B. Cash method C. Hybrid method D. Either A or B 46. How does a partnership make a tax election for the current year? A. Partnerships make certain elections automatically by simply filing their returns. B. Partnerships make certain tax elections by filing a separate form with the IRS. C. Partnerships do not need to file anything to make a tax election. D. Partnerships do not make tax elections. Partners must make tax elections separately. E. A and B 47. What is the rationale for the specific rules partnerships must follow in determining a partnership's taxable year-end? A. To increase the amount of aggregate tax deferral partners receive B. To minimize the amount of aggregate tax deferral partners receive C. To align the year-end of the partnership with the year-end of a majority of the partners D. To spread the workload of CPAs more evenly over the year E. B and C 48. On 12/31/X4, Zoom, LLC reported a $60,000 loss on its books. The items included in the loss computation were $30,000 in sales revenue, $15,000 in qualifying dividends, $22,000 in cost of goods sold, $50,000 of Section 179 expense, $20,000 in employee wages, and $13,000 of rent expense. How much ordinary business income (loss) will Zoom report on its X4 return? A. ($8,000) B. ($25,000) C. ($60,000) D. ($95,000) 49. Which of the following would not be classified as a separately-stated item? A. Short-term capital gains B. Charitable contributions C. MACRS depreciation expense D. Guaranteed payments 50. Tim, a real estate investor, Ken, a dealer in securities, and Hardware, Inc., a retail lumber store form a partnership called HKT, LP. HKT is in the home building business. Tim recently purchased his interest in HKT while the other partners purchased their interest several years ago. During X3, HKT reports a $12,000 gain from the sale of a stock in a wholesale lumber company it purchased in X1 for investment purposes. Which of the following statements best represents how their portion of the gain should be reported to the partner? A. Tim - Short-term capital gain B. Ken - Ordinary Income C. Hardware, Inc. - Long-term capital gain D. All of the above accurately report the gain to the partner E. None of the above accurately report the gain to the partner 51. Kim received a 1/3 profits and capital interest in Bright Line, LLC in exchange for legal services she provided. In addition to her share of partnership profits or losses, she receives a $30,000 guaranteed payment each year for ongoing services she provides to the LLC. For X4, Bright Line reported the following revenues and expenses: Sales - $150,000, Cost of Goods Sold - $90,000, Depreciation Expense - $45,000, Long-Term Capital Gains - $15,000, Qualifying Dividends - $6,000, and Municipal Bond Interest - $3,000. How much ordinary business income (loss) will Bright Line allocate to Kim on her Schedule K-1 for X4? A. ($15,000) B. $6,000 C. $9,000 D. $15,000 E. None of the above will be reported as ordinary business income (loss) on Schedule K-1. 52. A partner's self-employment earnings (loss) may be affected by her share of ordinary business income (loss) and any guaranteed payments she receives. The impact of these amounts typically depends on the status of the partner. Which of the following statements correctly describes the affect of these items on the partner's self-employment earnings (loss)? A. General partner -only guaranteed payments affect self-employment earnings (loss) B. General partner -ordinary business income (loss) and guaranteed payments affect self-employment earnings (loss) C. Limited partner - only guaranteed payments affect self-employment earnings (loss) D. Limited partner - only ordinary business income (loss) affects self-employment income (loss) E. Both B and C are correct 53. Under proposed rules issued by the IRS, in which of the following situations should an LLC member be treated as a general partner for self-employment tax purposes? A. The member is not personally liable for any of the LLC debt. B. The member has authority to contract on behalf of the LLC. C. The member spends 450 hours participating in the management of the LLC's trade or business during the taxable year. D. The member is listed on the LLC's letterhead. 54. Which requirement must be satisfied in order to specially allocate partnership income or losses to partners? A. Special allocations must have economic effect B. At least one partner must agree to the special allocations C. Special allocations must be insignificant D. Special allocations must reduce the combined tax liability of all the partners 55. Frank and Bob are equal members in Soxy Socks, LLC. When forming the LLC, Frank contributed $50,000 in cash and $50,000 worth of equipment. Frank's adjusted basis in the equipment was $35,000. Bob contributed $50,000 in cash and $50,000 worth of land. Bob's adjusted basis in the land was $30,000. On 3/15/X4, Soxy Socks sells the land Bob contributed for $60,000. How much gain (loss) related to this transaction will Bob report on his X4 return? A. $10,000 B. $15,000 C. $25,000 D. $35,000 56. When must a partnership file its return? A. By the 15th day of the 4th month after the partnerships tax year end B. By the sixth month after the original due date if an extension is filed C. By the 15th day of the 3rd month after the partnerships tax year end D. A and B E. B and C 57. What form does a partnership use when filing an annual informational return? A. Form 1040 B. Form 1041 C. Form 1065 D. Form 1120 58. Which of the following does not adjust a partner's basis? A. Ordinary business income (loss) B. Change in amount of partnership debt C. Tax-exempt income D. All of the above adjust a partner's basis 59. What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1) Increase for share of ordinary business income, (2) Decrease for share of separately stated loss items, and (3) Decrease for distributions? A. 1, 3, 2 B. 1, 2, 3 C. 3, 1, 2 D. 2, 3, 1 60. Which of the following statements regarding a partner's basis adjustments is true? A. A partner's basis may never be reduced below zero. B. A partner must adjust his basis for ordinary income (loss) but not for separately-stated items. C. A partnership fine or penalty does affect a partner's basis. D. Relief of partnership debt increases a partner's tax basis. 61. Which of the following statements regarding the rationale for adjusting a partner's basis is false? A. To prevent partners from being double taxed when they sell their partnership interests B. To ensure that partnership tax-exempt income is not ultimately taxed C. To prevent partners from being double taxed then they receive cash distributions D. To ensure that partnership non-deductible expenses are never deductible E. None of the above rationales are false 62. If partnership debt is reduced and a partner is deemed to receive a cash distribution, what impact does the deemed distribution have on the partner if it is in excess of her tax basis? A. The partner will treat the distribution in excess of her basis as ordinary income B. The partner will treat the distribution in excess of her basis as capital gain C. The partner will not ever be taxed on the distribution in excess of her basis D. The partner will not be taxed on the distribution in excess of her basis until she sells her partnership interest 63. Jerry, a partner with 30% capital and profit interest, received his Schedule K-1 from Plush Pillows, LP. At the beginning of the year, Jerry's tax basis in his partnership interest was $50,000. His current year Schedule K-1 reported an ordinary loss of $15,000, long-term capital gain of $3,000, qualifying dividends of $2,000, $500 of non-deductible expenses, a $10,000 cash contribution, and a reduction of $4,000 in his share of partnership debt. What is Jerry's adjusted basis in his partnership interest at the end of the year? A. B. C. D. $35,000 $40,000 $45,500 $49,500 64. Styling Shoes, LLC filed its 20X8 Form 1065 on March 15, 20X9. Styling had three members with the following ownership interests and tax basis at the beginning of the 20X8: (1) Jane, a member with a 25% profits and capital interest and a $5,000 outside basis, (2) Joe, a member with a 45% profits and capital interest and a $10,000 outside basis, and (3) Jack, a member with a 30% profits and capital interest and a $2,000 outside basis. The following items were reported on Styling's Schedule K for the year: ordinary income of $100,000, Section 1231 gain of $15,000, charitable contributions of $25,000, and tax-exempt income of $3,000. In addition, Styling received an additional bank loan of $12,000 during 20X8. What is Jane's tax basis after adjustment for her share of these items? A. $28,250 B. $31,250 C. $33,500 D. $57,250 65. Hilary had an outside basis in LTL, General Partnership of $10,000 at the beginning of the year. LTL reported the following items on Hilary's K-1 for the year: ordinary business income of $5,000, a $10,000 reduction in Hilary's share of partnership debt, a cash distribution of $20,000, and tax-exempt income of $3,000. What is Hilary's adjusted basis at the end of the year? A. ($12,000) B. ($9,000) C. $0 D. $15,000 E. $18,000 66. How does additional debt or relief of debt affect a partner's basis? A. Debt has no effect on a partner's basis B. Relief of debt increases a partner's basis C. Both additional debt and relief of debt increase a partner's basis D. Additional debt increases a partner's basis 67. Does adjusting a partner's basis for tax-exempt income prevent double taxation? A Yes, if this basis adjustment is not made the partner will be taxed once when the income is allocated to . him and a second time when he sells his partnership interest BYes, if this basis adjustment is not made the partner will be taxed on the tax-exempt income twice when . he sells his partnership interest because he was not taxed on this income when it was earned C. No, making this adjustment to the partner's basis prevents the tax-exempt income from being converted to taxable income D. No, the partner should not adjust his tax basis by his share of tax-exempt income 68. In what order are the loss limitations for partnerships applied? A. Tax Basis - At Risk Amount - Passive Activity Loss B. Passive Activity Loss - Tax Basis - At Risk Amount C. At Risk Amount - Passive Activity Loss - Tax Basis D. At Risk Amount - Tax Basis - Passive Activity Loss 69. Which of the following items will affect a partner's tax basis? A. Share of ordinary business income (loss) B. Share of nonrecourse debt C. Share of recourse debt D. Share of qualified nonrecourse debt E. All of the above will affect a partner's tax basis 70. On January 1, X9, Gerald received his 50% profits and capital interest in High Air, LLC in exchange for $2,000 in cash and real property with a $3,000 tax basis secured by a $2,000 nonrecourse mortgage. High Air reported a $15,000 loss for its X9 calendar year. How much loss can Gerald deduct, and how much loss must he suspend if he only applies the tax basis loss limitation? A. $0, $4,000 B. $0, $7,500 C. $0, $15,000 D. $4,000, $0 E. None of the above 71. What type of debt is not included in calculating a partner's at-risk amount? A. Recourse debt B. Qualified nonrecourse debt C. Nonrecourse debt D. All of the above types of debt are included in the at-risk amount 72. Jay has a tax basis of $14,000 in his partnership interest at the beginning of the partnership tax year. The following amounts of partnership debt were allocated to Jay and are included in his beginning of the year tax basis: (1) recourse debt - $3,000, (2) qualified nonrecourse debt - $1,000, and (3) nonrecourse debt $500. If Jay is allocated a $15,000 loss for the current year, how much of the loss will be suspended under the tax basis and at-risk limitations? A. $500, $1,000 B. $1,000, $500 C. $0, $0 D. $14,000, $1,000 73. Which person would generally be treated as a material participant in an activity? A. A participant in a rental activity B. A limited partner C. A LLC member not involved with management of the LLC D. A general partner 74. If a taxpayer sells a passive activity with suspended passive activity losses from prior years, what type of income can be offset by the suspended passive losses in the year of sale? A. Passive activity income B. Portfolio income C. Active business income D. Any of the above types of income can be offset. E. None of the above. The suspended losses disappear when the passive activity is sold. 75. John, a limited partner of Candy Apple, LP, is allocated $30,000 of ordinary business loss from the partnership. Before the loss allocation, his tax basis is $20,000 and at-risk amount is $10,000. John also has ordinary business income of $20,000 from Sweet Pea, LP as a general partner and ordinary business income of $5,000 from Red Tomato, as a limited partner. How much of the $30,000 loss from Candy Apple can John deduct currently? A. $5,000 B. $10,000 C. $25,000 D. $30,000 76. Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true? A. Partnership losses must be used only in the year the losses are created B. Partnership losses may be carried back 2 years and carried forward 5 years C. Partnership losses may be carried forward indefinitely D. Partnership losses may be carried back 2 years and carried forward 20 years 77. Which of the following would not be classified as a material participant in an activity? A An individual who participates more than 100 hours a year and the person's participation is not less . than any other individual's participation B. An individual who participated in the activity for at least one of the preceding five taxable years C. An individual who participates in an activity regularly, continuously, and substantially D. An individual who participates in an activity for more than 500 hours a year 78. What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory. 79. On March 15, 20X9, Troy, Peter, and Sarah formed Picture Perfect general partnership. This partnership was created to sell a variety of cameras, picture frames, and other photography accessories. When it was formed, the partners received equal profits and capital interests and the following items were contributed by each partner: Troy - cash of $3,000, inventory with a FMV and tax basis of $5,000, and a building with a FMV of $22,000 and adjusted basis of $10,000. Additionally, the building was secured by a $10,000 nonrecourse mortgage. Peter - cash of $5,000, accounts payable of $12,000 (recourse debt for which each partner becomes equally responsible), and land with a FMV of $27,000 and tax basis of $20,000. Sarah - cash of $2,000, accounts receivable with a FMV and tax basis of $1,000, and equipment with a FMV of $40,000 and adjusted basis of $3,500. Sarah also contributed a $23,000 nonrecourse note payable secured by the equipment. What is each partner's outside basis and how much gain (loss) must the partners recognize in 20X9 when Picture Perfect was formed? 80. J&J, LLC was in its third year of operations when J&J decided to expand the number of members from two, A & B, with equal profits and capital interests to three members, A, B, and C. The third member, C, will contribute her financial expertise to the LLC in exchange for a 1/3 capital interest in J&J. Given the balance below sheet reflecting the financial position of J&J on the date member C is admitted, what are the tax consequences to members A, B, and C, and to J&J when C receives her capital interest? If, instead, member C receives a 1/3 profit interest, what would be the tax consequences to members A, B, and C, and to J&J? 81. On April 18, 20X8, Robert sold his 35 percent partnership interest in Fruit Wonder, LLC to Richard for $120,000. Prior to selling his interest, Robert had a basis in Fruit Wonder of $80,000. Robert's basis included $5,000 of recourse debt and $15,000 of nonrecourse debt that had been allocated to him. Immediately after the purchase, what is Richard's tax basis in Fruit Wonder? 82. On March 15, 20X9, Troy, Peter, and Sarah formed Picture Perfect General Partnership. This partnership was created to sell a variety of cameras, picture frames, and other photography accessories. The following items were contributed by each partner in exchange for a 1/3 capital and profits interest: Troy - cash of $3,000, inventory with a FMV and tax basis $5,000, and a building with a FMV of $8,000 and adjusted basis of $10,000. Additionally, the building is secured by a $10,000 mortgage. Peter - cash of $5,000, accounts payable with a FMV and tax basis of $19,000, and land with a FMV and tax basis of $20,000. Sarah - cash of $2,000, accounts receivable with a FMV and tax basis of $1,000, and equipment with a FMV of $26,000 and adjusted basis of 4,000. Also, the equipment is secured by a $23,000 note payable. What is the partnership's inside basis in each asset? How much gain or loss must Picture Perfect recognize? Prepare Picture Perfect's balance sheet reflecting the partners' capital accounts on both a tax basis and 704(b)/FMV basis. 83. In each of the independent scenarios below, how does the partner or partnership determine its holding period in the property received? a. A partner contributes property in exchange for a partnership interest b. The partnership receives contributed property c. A partner contributes services in exchange for a partnership interest d. A partner purchases a partnership interest from an existing partner 84. On June 12, 20X9, Kevin, Chris, and Candy Corp. came together to form Scrumptious Sweets General Partnership. Now, Scrumptious Sweets must decide which tax year-end to use. Kevin and Chris have calendar year-ends and each holds a 35% profits and capital interest. However, Candy Corp has a September 30th year-end and holds the remaining 30% profits and capital interest. What tax year-end must Scrumptious Sweets adopt and what rule mandates this year-end? 85. KBL, Inc., AGW, Inc., Blaster, Inc., Shiny Shoes, Inc., and a group of 24 individuals form Shoes Galore General Partnership on October 11, 20X9. Now, Shoes Galore must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Shoes Galore use and what rule requires this year-end? 86. Lincoln, Inc., Washington, Inc., and Adams, Inc. form Presidential Suites Partnership on February 15, 20X9. Now, Presidential Suites must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Presidential Suites use and what rule requires this year-end? 87. Jordan, Inc., Bird, Inc., Ewing, Inc., and Barkley, Inc. formed Nothing-But-Net Partnership on June 1st, 20X9. Now, Nothing-But-Net must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Nothing-But-Net use and what rule requires this year-end? 88. What general accounting methods may be used by a partnership and how and by whom are they selected? 89. Illuminating Light Partnership had the following revenues, expenses, gains, losses, and distributions: Given these items, what is Illuminating Light's ordinary business income (loss) for the year? 90. Lloyd and Harry, equal partners, form the Ant World Partnership. During the year, Ant World had the following revenue, expenses, gains, losses, and distributions: Given these items, what amount of ordinary business income (loss) and what separately-stated items should be allocated to each partner for the year? 91. Why are guaranteed payments deducted in calculating the ordinary business income (loss) of partnerships and treated as a separately-stated item for the partners that receive the payment? 92. ER General Partnership, a medical supplies business, states in its partnership agreement that Erin and Ryan agree to split profits and losses according to a 40/60 ratio. Additionally, the partnership will provide Erin with a $15,000 guaranteed payment for services she provides to the partnership. ER Partnership reports the following revenues, expenses, gains, losses, and distributions for its current taxable year: Given these items, answer the following questions: A. Compute Erin's share of ordinary income (loss) and separately-stated items. Include her selfemployment income as a separately-stated item. B. Compute Erin's self-employment income, except assume ER Partnership is a limited partnership and Erin is a limited partner. C. Compute Erin's self-employment income, except assume ER Partnership is an LLC and Erin is personally liable for half of the debt of the LLC. Apply the IRS's proposed regulations in formulating your answer. 93. Greg, a 40% partner in GSS Partnership, contributed land to the partnership in exchange for his partnership interest when the partnership was formed. At the time, his basis in the land was $30,000 and its FMV was $133,000. Three years after the partnership was formed, GSS Partnership decided to sell the land to an unrelated party for $150,000. When the land is sold, how much of the gain should be allocated to each partner of GSS Partnership if Sam and Steve are each 30% partners? 94. Ruby's tax basis in her partnership interest at the beginning of the partnership's tax year was $13,000. The following items were included in her Schedule K-1 from the partnership for the year: Determine what amounts related to these items Ruby will report on her tax return assuming her tax basis and at risk amount are equal and that she is a material participant in the partnership's activities. 95. At the end of year 1, Tony had a tax basis of $40,000 in Tall Ladders, Limited Partnership. Tony has a 20 percent profits interest in Tall Ladders. For year 2, Tall Ladders will pay Tony a $10,000 guaranteed payment for extra services he provides to the partnership. Given the following Income Statement and Balance Sheet from Tall Ladders, what is Tony's adjusted tax basis at the end of year 2? 96. Alfred, a 33% profits and capital partner in Pizzeria Partnership, needs help in adjusting his tax basis to reflect the information contained in his most recent Schedule K-1 from the partnership. Unfortunately, the Schedule K-1 he recently received was for year 3 of the partnership, but Alfred only knows that his tax basis at the beginning of year 2 of the partnership was $23,000. Thankfully, Alfred still has his Schedule K-1 from the partnership for years 1 and 2. Using the following information from Alfred's year 1, year 2, and year 3 Schedule K-1, calculate his tax basis the end of year 2 and year 3. 97. Explain why partners must increase their tax basis for their share of partnership taxable and nontaxable income or gain and reduce their basis by their share of partnership deductible and nondeductible expenses or losses? 98. On January 1, 20X9, Mr. Blue and Mr. Grey each contributed $100,000 to form the B&G general partnership. Their partnership agreement states that they will each receive a 50% profits and loss interest. The partnership agreement also provides that Mr. Blue will receive an annual $36,000 guaranteed payment. B&G began business on January 1, 20X9. For its first taxable year, its accounting records contained the following information. The $3,000 of interest was paid on a $60,000 loan made to B&G by Key Bank on June 30, 20X9. B&G repaid $10,000 of the loan on December 15, 20X9. Neither of the partners received a cash distribution from B&G in 20X9. Complete the following table related to Mr. Blue's interest in B&G partnership: 99. Peter, Matt, Priscilla, and Mary began the year in the PMPM General Partnership sharing profits, losses, and capital equally. They each had a tax basis at the beginning of the year of $3,000, $10,000, $8,000, and $11,000 respectively. Early in the year, Mary provided general consulting services to the partnership and received an additional 15 percent profits, losses, and capital interest in the partnership. The liquidation value of her additional interest was $45,000. Later the same year, the partnership received cash contributions of $25,000 from Peter and Matt that it used to repay the partnership's $35,000 recourse debt. According to state law, the partners shared responsibility for this debt in accordance with their loss sharing ratios. What is each partner's tax basis after adjustment for these transactions? 100.Bob is a partner in Fresh Foods Partnership and is trying to determine if the income reported on his K-1 should be classified as passive or active trade or business income. List three different criteria that, if met, would allow Bob to treat the income from Fresh Foods as active trade or business income. 101.Clint noticed that the Schedule K-1 he just received from ABC Partnership included a $20,000 ordinary business loss allocation. His tax basis in ABC at the beginning of ABC's most recent tax year was $10,000. Comparing the Schedule K-1 he recently received from ABC with the Schedule K-1 he received from ABC last year, Clint noted that his share of ABC partnership debt changed as follows: recourse debt increased from $0 to $2,000, qualified nonrecourse debt increased from $0 to $3,000, and nonrecourse debt increased from $0 to $3,000. Finally, the Schedule K-1 Clint recently received from ABC reflected a $1,000 cash contribution he made to ABC during the year. Clint is not a material participant in ABC partnership, and he received $10,000 of passive income from another investment during the same year he received the loss allocation from ABC. How much of the $20,000 loss from ABC can Clint deduct currently, and how much of the loss is suspended because of the tax basis, the at-risk, and the passive activity loss limitations? 102.Fred has a 45% profits interest and 30% capital interest in the SAP Partnership and his tax basis before considering his share of SAP's current year loss is $11,000. Included in his tax basis is a $2,600 share of recourse debt and $5,300 share of nonrecourse debt. Fred is a limited partner in SAP. He is not involved in any other activities. If SAP has a $15,000 ordinary loss for the year, how much of the loss can be deducted currently, and how much of the loss is suspended because of the tax basis, the at-risk, and the passive activity loss limitations? 103.What is the difference between a partner's tax basis and at-risk amount? ch20 Key 1. FALSE 2. TRUE 3. FALSE 4. TRUE 5. TRUE 6. FALSE 7. TRUE 8. FALSE 9. TRUE 10. FALSE 11. FALSE 12. TRUE 13. FALSE 14. FALSE 15. TRUE 16. FALSE 17. TRUE 18. TRUE 19. FALSE 20. TRUE 21. FALSE 22. FALSE 23. TRUE 24. TRUE 25. FALSE 26. A 27. E 28. B 29. A 30. D 31. C 32. C 33. B 34. D 35. B 36. D 37. A 38. C 39. D 40. B 41. A 42. B 43. E 44. C 45. A 46. E 47. E 48. B 49. C 50. C 51. E 52. E 53. B 54. A 55. C 56. A 57. C 58. D 59. A 60. A 61. E 62. B 63. C 64. B 65. C 66. D 67. C 68. A 69. E 70. E 71. C 72. B 73. D 74. D 75. A 76. C 77. B 78. The aggregate theory treats a partnership as an aggregation of the partners' undivided interests in the partnership's assets and liabilities. On the other hand, the entity theory views partnerships as distinct entities separate from their owners. In reality, partnership tax rules are a hybrid of these two approaches. Partnership tax rules uses the aggregate theory in the way they (1) treat partnerships as flow-through entities, (2) specially allocate built-in gains and built-in losses to the partners contributing these assets, and (3) treat distributions to partners as generally nontaxable. Partnership tax rules use the entity theory in the way they (1) require partnerships rather than partners to make the majority of tax elections, (2) characterize gains and losses at the partnership level, and (3) require the partnership to file a return. 79. Troy would have an outside basis of $16,500 with $0 gain (loss). Peter would have an outside basis of $21,500 with $0 gain (loss). Sarah would have an outside basis of $11,500 with $0 gain (loss). The required calculations are presented in the table below: J&J LLC - No gain or loss recognized and no adjustments to assets and liabilities. C - Member C would not recognize any income because the liquidation value of her partnership interest is zero with a profits interest. Additionally, member C would have $0 in both her FMV and tax basis capital accounts. Her tax basis would include a 1/3 share of the LLC debt or $9,000. From this point forward, C's capital accounts will be adjusted to reflect her share of future LLC profits and losses. B - No deduction would be available to member B because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a 1/3 share of the LLC debt or $9,000. A - No deduction would be available to member A because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a 1/3 share of the LLC debt or $9,000. If member C received a 1/3 profits interest for her services, the following tax consequences would result: J&J, LLC- No gain or loss recognized and no adjustments to assets and liabilities. Member's capital accounts are adjusted as indicated. C reports ordinary income of $20,000 as a guaranteed payment for services provided. C's FMV and tax basis capital account will equal $20,000. Her tax basis would include a 1/3 share of the LLC debt or $9,000. B is allocated a $10,000 expense reducing B's FMV capital account to $20,000 and his tax basis capital account to $6,000. His tax basis would include a 1/3 share of the LLC debt or $9,000. A is allocated a $10,000 expense reducing A's FMV capital account to $20,000 and his tax basis capital account to $12,000. His tax basis would include a 1/3 share of the LLC debt or $9,000. 80. If member C received a 1/3 capital interest for her services, the following tax consequences would result: 81. Richard's tax basis would be equal the amount he paid for his interest plus any debt allocated to Robert from the LLC. Thus, he would have a tax basis in his interest of $140,000 computed as follows: $120,000 purchase price + $5,000 recourse debt + $15,000 nonrecourse debt. 82. The inside basis of the assets to the partnership is simply carryover basis as reflected in the tax basis balance sheet below. Further, no gain or loss is ever recognized by the partnership when property is contributed. Picture Perfect's balance sheets prepared using the tax basis and 704(b)/ FMV approaches are shown below: d. When a partner purchases a partnership interest, the holding period of the acquired partnership interest will begin on the date the interest was purchased. c. When a partner contributes service to a partnership, the holding period of the acquired partnership interest will begin on the date the partnership interest is received. b. The partnership will include the holding period of the contributing partner in its holding period. 83. a. When a partner contributes property to a partnership, the holding period of the acquired partnership interest depends on the type of property contributed to the partnership. If the contributed property is either a capital asset or Section 1231 asset, the holding period of the asset tacks on to the partnership interest. Otherwise, the holding period for acquired partnership interest begins on the date the interest is received. 84. Scrumptious Sweets must use a calendar year-end because that is the majority interest taxable year. Partnerships have a majority interest taxable year if one or more partners with the same taxable year own more than 50 percent of the profits and capital interests in the partnership. Since Kevin and Chris together own 70 percent of the profits and capital interests in Scrumptious Sweets and both have a calendar year-end, Scrumptious Sweets must also adopt a calendar year-end. Shoes Galore does not have a majority interest taxable year because KBL, Inc. and AGW, Inc. together do not own more than 50 percent of the profits and capital interests. Moreover, Shoes Galore does not have a majority interest taxable year because the twenty-four individual investors together do not own more than 50 percent of the profits and capital interests in Shoes Galore. 85. Shoes Galore must adopt a 1/31 year end because all of its principal partners use this year-end. A principal partner is a partner having an interest of 5 percent or more in the capital or profits of the partnership. KBL, Inc. and AGW, Inc. are both principal partners because they each own more than a 5% profits and capital interest in Shoes Galore. Blaster, Inc., Shiny Shoes, Inc., and the individual partners are not principal partners because none of them individually owns 5% or more of the profits or capital interests in Shoes Galore. 86. Because the partners all have different tax year-ends, neither the majority interest taxable year nor the taxable year of the principal partners applies in this situation. Therefore, the least aggregate deferral test must be applied to determine the appropriate tax year-end for Presidential Suites. Under the least aggregate deferral test (see calculations below) Presidential Suites must use a November 30th year end. Note that the least aggregate deferral test requires the use of the profits interest percentages only. Note that the least aggregate deferral test requires the use of the profits interest percentages only. Further, note that the October 31st year-end must be tested as a potential year-end for the partnership even though the partner with this year-end doesn't have a profits interest. 87. Because the partners all have different tax year-ends, neither the majority interest taxable year nor the taxable year of the principal partners applies in this situation. Therefore, the least aggregate deferral test must be applied to determine the appropriate tax year-end for Nothing-But-Net. Under the least aggregate deferral test (see calculations below) Nothing-But-Net must use an April 30th year end. 88. A partnership generally has the option of choosing either the accrual or the cash method. However, partnerships with C corporation partners must use the accrual method unless the partnership's average annual gross receipts for the last three years are less than $5 million. The partnership rather than the individual partners chooses an overall accounting method by using the desired method in calculating ordinary business income on its first return. 89. ($28,000), computed as follows: 90. The amount of ordinary business income (loss) and the separately-stated items allocated to Lloyd and Harry are shown in the table below: 91. Guaranteed payments are conceptually similar to salary payments made to specific partners for services provided to partnerships. For this reason, partnerships treat guaranteed payments similar to salary or wage payments made to unrelated partiesthey are typically deducted in calculating the ordinary business income (loss) of partnerships. Including guaranteed payments as separately-stated items on the Schedule K-1s of partners receiving guaranteed payments serves the same function as providing W-2 forms to employees. It puts these partners on notice that they must report ordinary income related to the guaranteed payments they have received. However, unlike an employee's W-2 form, the Schedule K-1 also reports partners' guaranteed payments as separately-stated self-employment income from the partnership. C. Erin's self-employment income would be ($3,800) + $15,000 = $11,200. This is similar to treating Erin as a general partner. Under proposed regulations, an LLC member that is (a) personally liable for LLC debt, (b) has authority to contract on behalf of the LLC, or (c) participates for more than 500 hours in the active trade or business of the LLC should treat her share of LLC ordinary business income as self-employment income. Any guaranteed payments received by LLC members are treated as self-employment income regardless. B. Erin's self-employment income would only be $15,000. Since Erin is considered a limited partner, her share of the partnership's ordinary business income (loss) is not self-employment income. Erin's self-employment income is ($3,800) + $15,000 = $11,200. Because Erin is a general partner, she must include not only her guaranteed payment but also her share of the partnership's ordinary business income (loss). 92. A. Erin's share of ordinary income (loss) and separately-stated items are shown in the table below: 93. The $103,000 built-in gain on the land at the time it was contributed must be specially allocated to Greg, the contributing partner. Any remaining gain should be allocated to the partners according to their profit sharing ratios. The table below reflects the required allocations: 94. As shown in the table below, Ruby must first increase her tax basis by any income items, then reduce her basis by any actual or cash distributions, and then reduce her basis by any loss items to determine what should be reported on her tax return for the year. 95. Tony's adjusted basis at the end of year 2 is $65,600. The required computations are reflected in the tables below: $14,500 - $15,000 = ($500) + $500 Capital Gain = $0 Tax basis at the beginning of year 3 - Relief of debt + Capital gain recognized = New adjusted basis At the end of Year 3, Alfred's basis is zero. As shown below, Alfred's deemed distribution from debt relief exceeds his tax basis prior to the distribution by $500; thus, he will recognize a $500 capital gain leaving his tax basis at zero. His share of ordinary business loss and nondeductible expenses are carried forward and will reduce his basis in the future when his basis has increased. $23,000 + $10,000 + $1,500 - $12,000 - $3,000 - $5,000 = $14,500 Tax basis at the beginning of year 2 + Cash contributions + Tax-exempt income - Relief of debt - Nondeductible expenses - Ordinary business loss = New adjusted basis 96. At the end of year 2, Alfred's basis is $14,500 as shown in the calculations below: 97. A partner's tax basis must be adjusted to take into account the income and deductions the partner is allocated for the year. These basis adjustments prevent partners from being double taxed on taxable income/gains and from receiving a double benefit for deductible expenses/losses. The double tax or double benefit scenario would occur at the time the partner sells her partnership interest if she has not made the appropriate basis adjustments. Similarly, a partner must adjust her tax basis by her share of tax-exempt income and nondeductible expenses to prevent these items from being taxed or deducted when she sells her partnership interest. 98. See table below: Tax basis at the beginning of the year + Basis in 15% interest received for services + Increase in share of partnership debt when she received her 15% interest for services - Debt relief when debt was repaid. $11,000 + $45,000 + $5,250 ($35,000 .15) - $14,000 ($35,000 .40) = $47,250 Mary Tax basis at the beginning of the year - Debt relief when Priscilla gave Mary a 5% interest - Debt relief when debt was repaid - Deduction allocated to Priscilla when she gave Mary a 5% interest. $8,000 - $1,750 ($35,000 .05) - $7,000 ($35,000 x.20) = ($750) + $750 (Capital gain recognized by Priscilla) = $0. Priscilla's $15,000 deduction from the transfer of her 5% interest to Mary will reduce her basis in the future after it has been increased by other partnership items. Priscilla Tax basis at the beginning of the year + Cash contribution - Debt relief when Matt gave Mary a 5% interest - Debt relief when debt was repaid - Deduction allocated to Matt when he gave Mary a 5% interest. $10,000 + $25,000 - $1,750 ($35,000 .05) - $7,000 ($35,000 x. 20) - $15,000 ($45,000/3) = $11,250 Matt Tax basis at the beginning of the year + Cash contribution - Debt relief when Peter gave Mary a 5% interest - Debt relief when debt was repaid - Deduction allocated to Peter when he gave Mary a 5% interest. $3,000 + $25,000 - $1,750 ($35,000 .05) - $7,000 ($35,000 .20) - $15,000 ($45,000/3) = $4,250 Peter 99. Each partner's tax basis calculations are included below: 100. Income from a trade or business is treated as active income if a partner is a material participant in the activity. Regulations provide seven different criteria that, if any one of the seven is met, would qualify a partner as a material participant. If Bob satisfies any one of the seven tests in the table below, he will treat his income from Fresh Foods as active trade or business income. 101. The amount of loss Clint can deduct currently depends on his tax basis and at-risk amount before considering the loss. Clint's tax basis at the beginning of the year was $10,000, which should be increased by his $1,000 actual cash contribution and his deemed cash contribution from the increase in his share of partnership debt. Thus, his tax basis before considering the loss is $19,000 ($10,000 + $1,000 + $2,000 + $3,000 + $3,000). Clint's at-risk amount is calculated by reducing his tax basis by the nonrecourse debt included in his tax basis. Therefore, he has an atrisk amount of $16,000 ($19,000 - $3,000). Because Clint's $20,000 loss exceeds his tax basis by $1,000, $1,000 of loss is suspended by the tax basis limitation. Since his remaining $19,000 loss exceeds his at-risk amount by $3,000, $3,000 of additional loss is suspended because of the atrisk limitation. Only $10,000 of the remaining $16,000 of loss may be deducted currently against the $10,000 of passive income Clint has from the other investment. This leaves $6,000 remaining as a passive activity loss carryforward. 102. Fred is allocated 45 percent of the loss or $6,750 ($15,000 .45). Because his $11,000 tax basis is greater than his $6,750 share of loss, none of the loss is limited by his tax basis. However, Fred's $6,750 loss exceeds his at-risk amount of $5,700 ($11,000 - $5,300) by $1,050. Therefore, $1,050 of his loss is limited by his at-risk amount, and his remaining $5,700 of loss will be limited by the passive activity loss limitation since Frank is not a material participant in SAP (due to his limited partner status) and he has no passive income from another activity. 103. A partner's tax basis is adjusted to include the impact of a variety of items. A partner's tax basis is affected by partner contributions, partner distributions, changes in the amount of partnership debt allocated to partners, a partner's share of tax-exempt income, a partner's share of nondeductible expenses, a partner's share of ordinary business income (loss), etc. A partner's at-risk amount is calculated in much the same way except that a partner's share of nonrecourse debt is generally not included in the at-risk amount. ch20 Summary Category # of Questions AACSB: Analytic 38 AACSB: Reflective thinking 65 AICPA: BB Critical thinking 103 Blooms: Analyze 45 Blooms: Comprehension 31 Blooms: Knowledge 27 Learning Objective: 20-01 Determine whether a flow5 through entity is taxed as a partnership or S corporation and distinguish the entity approach from the aggregate approach for taxing partnerships. Learning Objective: 2021 02 Resolve tax issues applicable to partnership formations and other acquisitions of partnership interests; including gain recognitio n to partners and tax basis for partners and partnerships. Learning Objective: 20-03 Determine the appropriate accounting periods and methods for partnerships. 18 Learning Objective: 2020 04 Calculate and characterize a partnerships ordinary business income or loss and its separately stated items and demonstrate how t o report these items to partners. Learning Objective: 20-05 Explain the importance of a partners tax basis and the adjustments that affect it. 21 Learning Objective: 20-06 Apply the basis; at-risk; and passive activity loss limits to losses from partnerships. 19 Level of Difficulty: Easy 29 Level of Difficulty: Hard 17 Level of Difficulty: Medium 57 Spilker - Chapter 20 103
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