17-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall.

17-1©2009 Pearson Education, Inc. Publishing as Prentice Hall

17-2

PARTNERSHIPS ANDPARTNERSHIPS ANDS CORPORATIONSS CORPORATIONS

Types of pass-through entitiesTaxation of partnershipsPartnership electionsTaxation of S corporationsTax planning considerationsCompliance and procedural

considerations©2009 Pearson Education, Inc. Publishing as

Prentice Hall

17-3

Types of Pass-Through Types of Pass-Through EntitiesEntities

(1 of 4)(1 of 4)

PartnershipsUnincorporated associationPartners have unlimited liability for

partnership debt and claimsLimited partnership

Limited partners only liable for investmentCannot participate in mgmt activitiesMust have at least 1 general partner

©2009 Pearson Education, Inc. Publishing as Prentice Hall

17-4


(2 of 4)(2 of 4)

S corporationsFollow C corp rules except when

Subchapter S pass-through rules apply

Limited liability companies (LLCs)Limited liability of a corporationMay be taxed as partnership or corp


17-5


(3 of 4)(3 of 4)

Limited liability partnerships (LLPs)Used by professional service partnerships

Not liable for negligence or misconduct of other partners

Limited liability limited partnershipAllowed by some statesFormed under state’s limited ptrshp lawsGeneral partners have limited liability


17-6


(4 of 4)(4 of 4)

Taxation only at ownership levelSingle level of taxation achieved by

Exempting the entity from taxation Passing income, deductions, losses, and

credit through to the owners, and Adjusting the basis of the owners’

interest in the entity


17-7

Taxation of PartnershipsTaxation of Partnerships(1 of 3)(1 of 3)

Formation of a partnershipPartnership operationsSpecial allocationsAllocation of partnership

income, deductions, losses, and credits to partners


17-8


Basis adjustments for operating items

Limitations on losses and restoration of basis

Transactions between a partner and the partnership

Partnership distributions©2009 Pearson Education, Inc. Publishing as

Prentice Hall

17-9


Sale of a partnership interestOptional and mandatory basis

adjustmentsElecting large partnerships


17-10

Formation of a Partnership(1 of 2)

Partners receive a partnership interest in exchange for property and/or services (§721)Nonrecognition rules similar to §351 for

contributions to a corporation exceptBasis decreases for contribution of liabilitiesPartner increases basis for her share of

partnership liabilities


17-11

Formation of a Partnership(2 of 2)

Cannot have negative basisMust recognize gain to avoid negative

basisGenerally partnership assumes

carryover basis of assets contributedGenerally, holding period also carries

over to partnership


17-12

Partnership Operations Certain items passed through to partners

without losing their identityThese should be separately stated due to

each partner’s different tax situation Items with no special tax effect netted at

partnership levelResults are ordinary income or loss, then

allocated to partners based on agreement


17-13

Special Allocations§704 permits partners to allocate

income, deductions, losses, and credits in virtually any manner as long as allocations have substantial economic effect

Capital accounts affected and deficit in capital account must be restored upon liquidation


17-14

Basis Adjustments for Operating Items (1 of 2)

See summary in table I17-1Items that increase basis

Partner’s share of partnership earnings, additional contributions, & additional assumption of partnership debtIncrease in basis for earnings prevents

double taxation of earnings upon subsequent distribution


17-15

Basis Adjustments for Operating Items (2 of 2)

Items that decrease basisPartner’s share of lossesDistributionsReduction in partnership debt

Allocating liabilitiesRecourse debt allocated based on

economic risk of lossNonrecourse debt allocated based on

profit sharing percentages


17-16

Limitations on Losses and Restoration of Basis (1 of 2)

Loss recognition limitationsPartner’s basis in partnership

interestPortion of partner’s basis not “at

risk”At risk definition: amount partner

would lose should the partnership suddenly become worthless


17-17

Limitations on Losses and Restoration of Basis (2 of 2)

Loss recognition limitations (continued)Designation of partnership interest as a

“passive activity”“Passive” losses can only be used to offset

“passive” income.Disallowed losses are suspended and can be

used to offset future passive income, or when the passive activity is sold


17-18

Transactions Between a Partner

and the PartnershipLoss sales

No loss deducted on sale of property between a partnership and a > 50% owner (direct or indirect)

Gain salesGains on sale of property involving a >

50% owner produce ordinary income unless property will be a capital asset in hands of new owner


17-19

Partnership DistributionsGenerally neither partnership nor

partners recognize gain or loss on distributions of money or property

Partner’s basis reduced by basis of property distributedPartner recognizes gain to extent

distribution exceeds partner’s basis in partnership interest


17-20

Sale of a Partnership Interest

Partnership interest is a capital asset

Generally results in capital gain or loss

Exception for when partnership owns §751 hot assetsPortion of gain will be ordinary income


17-21

Optional and Mandatory Basis Adjustments (1 of 3)

New partner’s outside basisPurchase price plus new partner’s

share of partnership liabilitiesNew partner’s inside basis likely

different than outside basis


17-22


§754 adjustment allows partnership to adjust basis of partnership assets for new partner’s share of partnership assetsBasis adjustment belongs only to

new partner


17-23


Mandatory basis adjustment for substantial built-in lossSubstantial if Built-in loss > $250K,Exchange of partnership interest,

ANDNo §754 optional basis adjustment

election in effect


17-24

Electing Large PartnershipsQualifications

Non-service partnershipNot engaged in commodity

tradingHave at least 100 partnersFile an election to be taxed as a

large partnership


17-25

Electing Large PartnershipsTaxable Income

Misc. itemized deductions combined & subject to a 70% deduction at partner levelRemaining misc. deductions combined

w/ other partnership income Charitable contributions combined and

not separately stated by partners §179 deductions combined


17-26

Partnership ElectionsPartnership ElectionsTax year restrictions

Must be same as majority partner or partners with a 50% or more interest

Cash method of accounting restrictionsPartnerships cannot use cash method

of accounting if gross receipts exceed $5M during the prior three years


17-27

Taxation of S Taxation of S CorporationsCorporations

Qualification requirementsElection requirementsTermination conditionsS corporation operationsBasis adjustments to S corporation stockS corporation losses and limitationsOther S corporation considerations


17-28

Qualification Requirements(1 of 3)

Shareholder requirementsNo more than 100 shareholders

Family members count as one shareholderInclude common ancestor, spouses of

common ancestor or lineal descendents, and estates of family members

Individuals, estates, and certain types of trusts (including QSSTs)QSSTs may be complex trusts


17-29


Shareholder requirements (continued)U.S. citizens or resident aliensTax-exempt public charity or private

foundation may be a shareholderCorporation-related requirements

Domestic corporationOr unincorporated entity electing to be

treated as a corp under check-the-box Regs


17-30


Corporation-related requirements (continued)Must not be an “ineligible” corporationOnly one class of stockMay be a Qualified Subchapter S

Subsidiary (QSSS)QSSS is 100% owned by an S corpAssets, liabilities, income deductions, etc.

considered owned by S corp parent


17-31

Election RequirementsForm 2553 must be filed no later

than 15th day of third month for year election is to be effectiveA new corporation’s tax year begins

on first day it acquires assets, has shareholders or begins business

All shareholders must consent to election


17-32

Termination Conditions(1 of 3)

Voluntary S election terminationOwners of more than 50% of the

corporation’s stock must agreeRevocation made w/in 1st 2-1/2

months can be retroactive to beginning of yearOtherwise, election effective for 1st

day of next taxable year


17-33


Involuntary S election terminationOccurs when corporation ceases to

meet S corporation requirementsIf termination occurs during tax year

Portion of year prior to termination is a short S corp year and

Portion of year after termination is a short C corp year


17-34


Inadvertent termination can be undone

New S corp election cannot be made for 5 tax years after terminationUnless inadvertent termination


17-35

S Corporation OperationsS corp pass-through rules similar to

partnership rulesTax treatment of some items similar

as C corp treatmentE.g., salaries paid to shareholders

deductibleItems allocated on per-share per-day

basis©2009 Pearson Education, Inc. Publishing as

Prentice Hall

17-36

Basis Adjustments to S Corporation Stock (1 of 2)

Initial investment+ Additional contributions+ Share of income/separate items- Distrib’s excluded from s/h gross inc.- Non-deductible expenses not

chargeable to capital- Share of losses/distributions

Ending basis (but not below zero)


17-37

Basis Adjustments to S Corporation Stock (2 of 2)

Basis adjustments to shareholder debtAfter stock basis reduced to zero,

basis reduction applies to indebtedness based on relative adjusted basis for each loan

Loss/deduction not currently deductible is suspended until shareholder has basis in debt or stock


17-38

S Corporation Losses and Limitations (1 of 2)

Ordinary & separately stated loss amounts “passed” through to shareholders

Shareholder’s deduction limited to adjusted basis in stock plus adjusted basis of debt owed directly by corp to shareholder


17-39

S Corporation Losses and Limitations (2 of 2)

Sequence for stock basis limitation 1. Beginning basis2.+ Capital contributions3.+ Share of ordinary income and

separately stated items4.- Distributions not included in s/h inc.5.- Nondeductible, noncapital

expenditures Basis available to absorb S corp loss


17-40

Other S Corporation Considerations

Distributions of Cash and Property

Money distributions tax-free and reduce shareholder basis, but not < $0

When shareholder has a zero basis, distributions received treated as gain from sale of stock

Corporation recognizes gain on distribution of appreciated property

No loss reported when corp distributes property that has declined in value


17-41


Other Restrictions (1 of 2)

S corps generally must use calendar year

>2% s/hs not eligible for most tax-free treatment of qualified fringe benefits

Built-in gains tax applies to C corps that make S election Applies to assets that appreciated in value

while operating as a C corp


17-42


Other Restrictions (2 of 2)

Built-in gains tax (continued)Tax is 35% (top corp rate) on net built-in

gains recognized during tax yearTax on excess net passive income

Passive income in excess of 25% of S corp gross receipts and has C corp E&P

Excess net passive income taxed at highest corporate tax rate (35%)


17-43

Tax Planning Tax Planning ConsiderationsConsiderations

(1 of 2)(1 of 2)

Use of net operating losses from pass-through entities to offset other income

Income shifting among family membersGift non-voting S corp stock or

partnership interest to low tax-rate kidsMay be taxed at parents’ highest tax

rate if kids subject to kiddie taxFamily members may be employees


17-44

Tax Planning Tax Planning ConsiderationsConsiderations

(2 of 2)(2 of 2)

Optional basis adjusting under §754Increases incoming partner’s basis

in partnership assets


17-45

Compliance and Compliance and Procedural Procedural

ConsiderationsConsiderations (1 of 2) (1 of 2)

Partnership filing requirements and elections

Reporting partnership items on Form 1065 on or before the 15th day of the 4th month

S Corporation filing requirements and accounting method elections


17-46

Compliance and Compliance and Procedural Procedural

ConsiderationsConsiderations (2 of 2) (2 of 2)

Reporting S Corporation items on Form 1120S

Comparison of alternative forms of business organizations (See Table I17-2)


Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark at University of Northern Colorado’s

Kenneth W. Monfort College of [email protected]

17-47©2009 Pearson Education, Inc. Publishing as Prentice Hall

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