Partnership Taxation Paper 2

(b) The requirement is to determine the amount to be reported as ordinary income on the partnership’s return given partnership book income of $100,000. The $60,000 of guaranteed payments to partners were deducted in computing partnership book income and are also deductible in computing partnership ordinary income. However, the $1,000 charitable contribution deducted in arriving at partnership book income must be separately passed through to partners on Schedule K-1 and cannot be deducted in computing partnership ordinary income. Thus, the partnership’s ordinary income is $100,000 + $1,000 = $101,000.

(a) The requirement is to determine the amount and type of partnership loss to be deducted on Clark’s individual return. Since a partnership functions as a pass-through entity, the nature of a loss as an ordinary loss is maintained when passed through to partners. However, the amount of partnership loss that can be deducted by a partner is limited to a partner’s tax basis in the partnership at the end of the partnership taxable year. Thus, Clark’s distributive share of the ordinary loss ($42,000) is only deductible to the extent of $36,000. The remaining $6,000 of loss would be carried forward by Clark and could be deducted after his partnership basis has been increased.

(a) The requirement is to determine the ordinary income of the partnership. Income from operations is considered ordinary income. The net rental income and the dividends from foreign corporations are separately allocated to partners and must be excluded from the computation of the partnership’s ordinary income. Tax-exempt income remains tax-exempt and must also be excluded from the computation of ordinary income. Thus, ordinary income only consists of the income from operations of $156,000.

(a) The requirement is to determine the ordinary income of the partnership. Income from operations is considered ordinary income. The net rental income and the dividends from foreign corporations are separately allocated to partners and must be excluded from the computation of the partnership’s ordinary income. Tax-exempt income remains tax-exempt and must also be excluded from the computation of ordinary income. Thus, ordinary income only consists of the income from operations of $156,000.

(a) The requirement is to determine the correct statement( s) concerning agreements for guaranteed payments. Guaranteed payments are payments made to a partner for services or for the use of capital if the payments are determined without regard to the amount of partnership income. Guaranteed payments are deductible by a partnership in computing its ordinary income or loss from trade or business activities, and must be reported as self-employment income by the partner receiving payment. A payment that represents a 25% interest in partnership profits could not be classified as a guaranteed payment because the payment is conditioned on the partnership having profits.

(a) The requirement is to determine the amount of income that Chris should report as a result of her 25% partnership interest. A partnership is a pass-through entity and its items of income and deduction pass through to be reported on partners’ returns even though not distributed. The amount to be reported by Chris consists of her guaranteed payment, plus her 25% share of the partnership’s business income and capital gains. Since Chris’s $20,000 guaranteed payment is for deductible services rendered to the partnership, it must be subtracted from the partnership’s net business income before guaranteed payments of $80,000 to determine the amount of net business income to be allocated among partners. Chris’s reportable income from the partnership includes
Guaranteed payment $20,000
Business income [($80,000 – $20,000) × 25%] 15,000
Net long-term capital gain ($10,000 × 25%) 2,500
$37,500

(d) The requirement is to determine Arch’s share of the JK Partnership’s ordinary income for 2012. A partnership functions as a pass-through entity and its items of income and deduction are passed through to partners according to their profit and loss sharing ratios, which may differ from the ratios used to divide capital. Here, Arch’s distributive share of the partnership’s ordinary income is $40,000 × 75% = $30,000. Note that Arch will be taxed on his $30,000 distributive share of ordinary income even though only $5,000 was distributed to him.

(c) The requirement is to determine whether the statements regarding partners’ guaranteed payments are correct. Guaranteed payments made by a partnership to partners for services rendered are an ordinary deduction in computing a partnership’s ordinary income or loss from trade or business activities on page 1 of Form 1065. Partners must report the receipt of guaranteed payments as ordinary income (self-employment income) and that is why the payments also must be separately listed on Schedule K and Schedule K-1.

(b) The requirement is to determine the correct statement regarding a partnership’s election of a depreciation method. The method used to depreciate partnership property is an election made by the partnership and may be any method approved by the IRS. The partnership is not restricted to using the same method as used by its “principal partner.” Since the election is made at the partnership level, and not by each individual partner, partners are bound by whatever depreciation method that the partnership elects to use.

(c) The requirement is to determine the correct statement regarding guaranteed payments to partners. Guaranteed payments are payments made to partners for their services or for the use of capital without regard to the amount of the partnership’s income. Guaranteed payments are deductible by the partnership in computing its ordinary income or loss from trade of business activities, and must be reported as self-employment income by the partners receiving payment.