TAX524 Taxation of Partnerships Lesson Assignment 4 Taxing

TAX524 – Taxation of Partnerships

         Lesson Assignment # 4 Taxing Partnership Operations

Text: Study Lessons 9 through 11 of the text.

Facts:

Ralph and Potsie are general partners of Happy Lemonade, a general partnership that operates a lemonade stand. Ralph contributed $12,000 for a 60% capital interest and Potsie contributed $8,000 for a 40% capital interest in the partnership. The partnership earns $100,000 in its first year.

NOTE: Each question should be reproduced in bold italic type, followed by your answer in normal type. There is no minimum or maximum length for your answers. They should simply be sufficient to answer the questions.

Questions:

Assume that in the first year the partnership borrows $20,000, further assume that Ralph and Potsie agree to share profits and losses 60% to Ralph and 40% to Potsie; what is the effect of such borrowing on Ralph and Potsie’s outside tax basis?

Same as question number 4, however assume that Happy Lemonade is a limited liability company taxed as a partnership instead of a general partnership?

Assume that Happy Lemonade is a limited liability company taxed as a partnership in its first year of operations is suffers a loss of $40,000. This represents the invested cash contributions from Ralph ($12,000) and Potsie ($8,000) and the borrowed funds of $20,000. Ralph and Potsie share profits and losses 60% and 40% respectively. How should the $40,000 loss be allocated under IRC Section 704?

Solution

4. When the partnership borrows $20,000, it will create a liability and this liability will be assumed by both the partners in their profit sharing ratio, thus increase their outside tax basis.

Ralph outside basis will increase by $12000 ($20000*60%)

and Potsie\'s outside basis will increase by $8000 ($20000*40%)

5. For the tax purpose, general partnership and LLC partnership are treated in the same way. Thus the liability assumed by the partners will remain same as above.

6. Loss of $40000 will be allocated between both the partners in their profit sharing ratio.

Ralph ($40000 x 60%) $24000

Potsie ($40000 x 40%) $16000

This allocation of loss will reduce the outside basis of both the partners

Ralph Potsie

Capital investment $12000 $8000

Liability assumed $12000 $8000

Loss allocated -$24000 -$16000

Outside basis $0 $0