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The basis of each partner’s interest in the partnership includes the partner’s share of the partnership liabilities (recourse and nonrecourse).The partner’s basis in the partnership is increased for income items (taxable and nontaxable) and decreased by losses (deductible and nondeductible) and distributions.The partnership’s required tax year is determined in a manner that minimizes deferral of income to the partners. Alternatively, the partnership may establish a natural business year or select a year with no more than three months’ deferral and prepay tax on the deferred income.Most elections are made at the partnership level.The partnership does not pay tax on its income but instead files an information return that allocates its income to the partners.The income from the partnership retains its character when it passes through to the partners.The partnership may specially allocate income and deductions in accordance with the partnership agreement as long as the special allocations have substantial economic effect.Some items of income and deductions are required to be specially allocated to the contributing partner.No loss is allowed on a sale of property between a partner and a controlled partnership.Guaranteed payments are deductible by the partnership and includible in income by the recipient partner. A partner’s share of losses from a partnership may be limited by the partnership basis rules, the at-risk rules, and the passive activity loss rules.A partnership terminates if no part of its business is continued to be carried on by any of its partners in a partnership or if there is a sale of 50 percent or more of the total interest in partnership capital and profits within a 12-month period.A partnership year ends with respect to a partner (but not necessarily the partnership) if the partner disposes of the entire interest in the partnership by death, sale, exchange, or otherwise.Family partnerships may be used to split income among family members, however, special care should be used to ensure that minors’ income will not be reallocated to other partners.QUESTIONS1. Give illustrations of the application of the “entity” and the “aggregate” theories as applied to the treatment of partnerships.2. Will a partnership under state law be taxed as a partnership under the Internal Revenue Code?3. List at least three items which will increase a partner’s basis in a partnership and at least three items which will decrease a partner’s basis.4. What income tax effect does a partnership’s receipt of tax-exempt interest and the proceeds of key-person life insurance payable on account of the death of the insured have upon the partnership taxable income? Upon the basis of the surviving partners’ interests in the partnership?
5. Discuss the partnership’s treatment of contributed (1) accounts receivable of a cash-basis taxpayer, (2) inventory and (3) capital assets with a “built-in loss” at the time of the contribution.