National Tax Week 3 Problem Solutions

National Tax Week 3 Problem Solutions - I/C CH 19 Q 1 thru...

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I/C: CH 19: Q 1 thru 5, -7 thru -9. P36, P38, & P52. Practice: CH 19: P-26 -27-43. I/C: CH20: Q 3, -4, -12, -15. P 26, & 32. Practice: CH20: P 23, -32, -34, -39. Reporting Partnership Income: Entity and Aggregate Theories 1. The “entity theory” of partnership taxation is the application of the income tax laws to the partnership as if it were a “person” separate and distinct from its owners, the partners. The “bottom line” on page 1 of Form 1065 reveals the partnership’s “ordinary income” in much the same way as the income of a corporation would be shown. The “aggregate theory” of partnership taxation is the application of the income tax laws to the partnership as if the partnership did not exist but was merely an aggregation, a group of individuals acting together. Those items which are required to be reported separately by the partners illustrate this theory. Characteristics of a Partnership 2. Under the federal income tax regulations, an unincorporated domestic business may elect to be taxed as a partnership, whether it is a partnership under state law or not. Adjustments to Outside Basis 3. A partner’s basis in the partnership interest is increased by (1) the contribution of money or property to the partnership, (2) the partnership’s income, taxable or nontaxable, and (3) the partnership’s debts increasing. The partner’s basis in the partnership interest will decrease if (1) there is a withdrawal by the partner of assets from the partnership, (2) the partnership incurs losses, and (3) the liabilities of the partnership decrease. Basis of Partnership Interest: Tax-Exempt Items 4. The partnership reports to the partners all items of income, both taxable and nontaxable. However, the income item retains its character when passed through to the partners. Therefore, tax-exempt income items, such as the interest income from municipal bonds, would not be taxed to the partners. The receipt by the partnership of such items, however, increases the basis of the partner by the partner’s proportionate share of these items. Allocation of Partnership Items: Contributed Property 5. When the cash-basis taxpayer contributes accounts receivable to an accrual partnership, the collection of those items, whenever, generates ordinary income. When the contribution is of inventory items, their sale within fi ve years of their contribution generates ordinary income or loss no matter to what use the partnership has put them, and capital assets contributed with “built-in” losses will generate capital losses, to the extent of the built-in loss, if disposed of at a loss within fi ve years of their contribution to the partnership, even if they are not capital assets to the partnership. Gain Recognition on Receipt of a Partnership Interest 6. First, if property is contributed to a partnership which is treated as an investment company, and there is realized gain, it is recognized by the contributing partner. If there is realized loss, it is not recognized under the usual nonrecognition rules which cover property transfers to a partnership for an interest in the partnership. (Code Sec. 721(b).)
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