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FTax SM_ch22_p001-016

2011 Federal Taxation (with H&R BLOCK At Home(TM) Tax Preparation Software CD-ROM)

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* C HAPTER T WENTY - TWO * TAXATION OF PARTNERSHIPS AND PARTNERS SOLUTIONS TO PROBLEM MATERIALS DISCUSSION QUESTIONS 22-1 The primary tax advantage of operating a business in partnership form is that business income is taxed only once to the partners. Business income earned by a corporation is subject to double taxation at both the corporate level and again at the shareholder level when the corporation pays a dividend or a shareholder sells stock at a gain. Under the rates currently in effect, the highest marginal rate for individual partners is only 35%, equal to the highest corporate rate of 35%. The disadvantages of operating in partnership form include general partners’ unlimited liability for partnership debts (as contrasted to the limited liability of corporate shareholders) and the limited transferability of partnership interests (as contrasted to the free transferability of shares of corporate stock). (See pp. 22-2 through 22-4.) 22-2 A general partner has the right to participate in the management of the partnership and make business decisions binding the partnership, while a limited partner may not participate in the operation and control of the partnership business. A general partner has unlimited personal liability for partnership debts, while a limited partner can only lose the amount of his capital investment in the partnership. (See p. 22-4.) 22-3 Under the aggregate theory, a partnership is merely a collection of specific partners who each own an indirect interest in the assets of the partnership. Under the entity theory, the partnership is an entity with an identity separate and distinct from that of its partners. The fact that partnership income is taxed to the partners rather than the partnership reflects the aggregate theory. However, the fact that the character of that income is determined by reference to the partnership’s activities reflects the entity theory. [See p. 22-4 and §§ 701 and 702(b).] 22-4 The statement is generally true. Section 721(a) provides that neither the partner nor partnership recognizes gain or loss upon the contribution of property by a
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partner in exchange for an interest in a partnership. The only exception to the nonrecognition rule applies to transfers of appreciated stocks or securities to investment partnerships. (See pp. 22-5 and 22-6.) 22-5 Recourse partnership debt represents a liability that the general partners may have to repay out of their personal assets if the partnership itself is unable to make repayment. Because such debt is economically equivalent to an additional investment of capital by the general partners, it is included in the outside basis of their partnership interests. No partner is legally obligated to use personal assets to repay partnership nonrecourse debt. However, such debt will be repaid with income earned by the partnership and taxed to the partners. Therefore, both general and limited partners may include their apportionable share of such debt in their outside bases.
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