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C
HAPTER
T
WENTY
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TWO
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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.
(See pp. 22-8 through 22-11 and § 752.)
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