PARTNERSHIP INTERESTS, AND
SOLUTIONS TO RESEARCH PROBLEMS
Family partnerships are attractive for both tax and nontax reasons. The income-shifting potential of a
family partnership depends on the spread between the lowest and highest marginal tax rates of the
partners. The income-shifting potential is limited by the kiddie tax under which the unearned income of
certain dependents is taxed at the higher of their marginal tax rate or their parents’ marginal tax rate. The
kiddie tax applies to children who are 18 and under and children between 19 and 23 who are full-time
students. However, children between 18 and 23 are only included if their earned income does not exceed
50% of their total support for the year.
The income from a partnership could constitute unearned income, particularly if the daughter is a
limited partner. The kiddie tax will continue to apply until she is at least 18, and perhaps longer depending
on her college plans. Family partnerships also provide an incentive for a family member to enter the
Because family partnerships may transfer income from a member active in the business to an inactive
member, and thereby reduce the tax liability of the family unit, they are closely scrutinized to ensure that
the effect is not merely an assignment of income but rather a transfer of a capital interest.
In order to achieve the tax advantages inherent in family partnerships, the validity of the partnership
must be established. In assessing its validity, the IRS and the courts determine whether the parties actually
intend to join together to carry on a business and to share the profits and losses of this business [Comm. v.
Culbertson 49-1 USTC
9112, 10 AFTR2d 6068, 310 F2d 412 (CA-7, 1962)]. This decision is based on a
number of factors. Some of the more important ones are the capital contributions, rendition of vital
services, participation in management, and control of the assets necessary to the partnership business.
Difficulties often arise with family partnerships where one or more of the partners is a minor who
contributes no services and whose interest was acquired by gift. Such is the case with B and his daughter.
They, therefore, must prove that the daughter owns a capital interest in a partnership in which capital is a
material income-producing factor [§ 704(e)].
Capital (including goodwill) is a material income-producing factor if a substantial part of the gross
income of the business was earned by its use. [Bateman v. U.S. 74-1 USTC
9176, 33 AFTR2d 74-483,
490 F2d 549 (CA-9 1973)]. Because the business manufactures and sells utility tables, it requires a
substantial investment in plant, equipment, and inventory and should have amassed at least some
unrecorded goodwill. Furthermore, net ordinary income for the proprietorship is relatively small in
relation to net assets (27%) when you consider the fact that no proprietor’s salary is deductible in arriving
at net income. Thus, capital undoubtedly is a material income-producing factor.