How do you calculate the Taxable Income of a Partnership?
Under § 701, partnerships do not pay income tax, partners pay income tax. In determining their income
tax, partners must take into account separately their distributive share of the partnership’s items of gain or loss
to the partnership under § 702(a). Additionally, § 703 requires that items in § 702(a) are stated separately for
each partner and certain deductions shall not be allowed to the partnership. Character is determined at the
partnership level in accordance with § 702(b). However, the character of certain items, such as receivables,
inventory and capital loss property, is determined under § 724.
How is the basis of a Partner’s Interest in the Partnership determined?
Generally, § 705(a) requires that the adjusted basis of a partner’s interest in the partnership shall, except
as provided in § 705(b), be the basis
of the such interest as determined under § 722 or § 742, increased by: (1)
taxable income of the partnership as determined under § 703(a); (2) income of the partnership exempt from tax;
(3) excess of deductions for depletion over the basis of property subject to depletion, and decreased, but not
below zero, by distributions by the partnership as provided in § 733 the sum of the partner’s distributive share
for the taxable year and prior taxable years of: (1) losses of the partnership and (2) expenditures of the
partnership not deductible in computing the partnership’s taxable income and not properly chargeable to the
partner’s capital accounts.
Treas. Reg. § 1.705-1(a)(1) requires adjustment to basis only when necessary for
Under Rev. Rul 66-94, an ordering rule was established for adjustments to the basis of a partner’s
interest in the partnership. The basis shall be:
(1) Decreased for distributions in chronological order, unless the distribution is an advance or draw;
(2) Increased by items of income (non separately stated);
(3) Decreased by distributions treated as occurring on the last day of the year, such as advances, draws or debt
(4) Decreased by loss items that are non separately stated.
The taking of losses is proportional to the each type
of loss, such as short term capital loss or long term capital loss.
1.704-1(d)(2) and ex. 3, where:
Loss Taken By Type =
Loss Amount Tested
What if a partner contributes property to a partnership?
Under § 721, no gain or loss is recognized by the partnership or partners on a contribution of property to a
partnership in exchange for a partnership interest. Non recognition under § 721 is accorded only to
contributions of property in exchange for a partnership interest.
If a partnership interest is received in exchange
for services rendered to the partnership or to a partner, § 721 does not apply,
Reg. § 1.721-1(b)(2)).