Study Unit 9: Contributions to a Partnership

For federal tax purposes, the term “partnership” includes all of the following EXCEPT a

• Syndicate.

  
  

• Pool.

  
  

• Joint venture.

  
  

• Trust.

  
  

Answer explanation

Subchapter K is the part of the Code containing most of the tax rules that apply to partnerships. A partnership is defined under Sec. 761(a) as including a syndicate, group, pool, joint venture, or other unincorporated organization that carries on a business and is not a corporation, a trust, or an estate.

Jane gave each of her two children, Jake and Jeff, a 30% interest in her clothing store. Capital is a material income-producing factor. Jeff is 21 and has worked in the store since he was 15, has developed significant sales skills, and helps his mom with the management duties. Jake is 25, is married, has a job in another state, and does not participate in any of the store’s management decisions. Who is(are) recognized as a partner(s)?

• Jane

• Jane and Jake.

• Jane, Jake, and Jeff.

• Jane and Jeff.

Answer explanation

Section 704 defines a family partnership as one consisting of a taxpayer and his or her spouse, ancestors, lineal descendants, or trusts for the primary benefit of any of them. A family member is treated as a partner in a partnership in which capital is a material income-producing factor, whether the interest is acquired by gift or purchase. However, the partnership agreement is disregarded to the extent a partner receives less than reasonable compensation for services.

In determining the ownership rules of partnerships, which one of the following combinations would total more than 50% ownership of The Peach Company for Jake?

• Jake

  30%

  Jake’s wife

  10%

  Jake’s aunt

  60%

• Jake

  45%

  His uncle’s trust

  55%

• Jake

  10%

  Jake’s wife’s corporation

  90%

• Jake

  30%

  Jake’s father

  10%

  Jake’s nephew

  60%

Answer explanation

An individual is treated as owning the stock owned by his or her spouse, siblings, children, grandchildren, and parents. If 50% or more in value of the interest in a partnership is owned, directly or indirectly, by or for any person, that person is considered to own the interest, directly or indirectly, by or for his or her partnership in the proportion that the value of the stock (s)he owns bears to the value of all the stock in the partnership. Stock owned, directly or indirectly, by or for a trust is considered to be owned by its beneficiaries in proportion to their actuarial interest in the trust. Stock owned, directly or indirectly, by or for an estate is considered to be owned proportionately by the beneficiaries. Jake is considered to own more than 50% of the partnership only in the answer choice stating that Jake has 10% direct ownership plus 90% indirect ownership from his wife’s corporation.

John sold his daughter 50% of his business partnership. The partnership had an $80,000 profit this year before deducting any compensation to the partner as a guaranteed payment. Capital is a material income-producing factor. John performed services worth $55,000, which is reasonable compensation. The daughter performed no services. How much income will John claim on his individual tax return?

• $40,000

  
  

• $55,000

  
  

• $67,500

  
  

• $80,000

  
  

Answer explanation

In a partnership in which a partner performs services for compensation and capital is a material-producing factor, the compensation is first allocated from profits to the respective partner. Any remaining profits are then distributed to each partner in their respective share. Each partner will receive 50% of $25,000 ($80,000 profit – $55,000 services), or $12,500. Therefore, John must claim $67,500 ($55,000 + $12,500) on his return.

Andrew is a 40% partner in the ABC Partnership, in which capital is a material income-producing factor. He gives one-half of his interest to his brother, John. During the current year, Andrew performs services for the partnership for which reasonable compensation is $65,000 but for which he accepts no pay. Andrew and John are each credited with a $100,000 distributive share of the partnership’s ordinary income. How much should Andrew report?

• $132,500

  
  

• $100,000

  
  

• $67,500

  
  

• $105,000

  
  

Answer explanation

The partnership agreement is disregarded to the extent a partner receives less than reasonable compensation for services. Of ABC’s $200,000 gross income credited to Andrew and John, $65,000 must be allocated to Andrew for his services. The remaining $135,000 is split between the two. Thus, Andrew should report $132,500 [($65,000 + ($135,000 × 1/2)].

A domestic limited liability company with at least two members that does not file Form 8832, Entity Classification Election, is classified as

• An entity disregarded as an entity separate from its owner by applying the rules in Reg. 301.7701-3.

  
  

• A partnership.

  
  

• A corporation.

  
  

• A non-entity, which requires members to report the income and related expenses on Form 1040.

  
  

Answer explanation

An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members. However, certain entities with two or more members are not partnerships if they are classified as something else, such as any other organization that elects to be classified as a corporation by filing Form 8832. A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes.

Dianne owns 10% interest in DJJ Partnership and 20% of the outstanding stock of PAD Corporation. Her son, Nick, owns 60% of the outstanding shares of PAD Corporation. The PAD Corporation owns 50% interest in the DJJ Partnership. Dianne’s sister, Dolores, owns 40% interest in the DJJ Partnership. Using the constructive ownership rules for partnerships, Dianne is considered to own how much of DJJ Partnership?

• 80%

  
  

• 50%

  
  

• 90%

  
  

• 20%

  
  

Answer explanation

An individual is treated as owning the stock owned by his or her spouse, brothers and sisters, children, grandchildren, and parents. If 50% or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, that person is considered to own the stock, directly or indirectly, by or for his or her corporation in the proportion that the value of the stock (s)he owns bears to the value of all the stock in the corporation. Dianne is considered to own 90% of the partnership: 10% direct ownership, plus 80% indirect ownership (made up of her 20% ownership of PAD corporation plus her son’s 60% ownership of the corporation times the 50% corporate ownership of the partnership), plus her sister’s 40% ownership of the partnership.

Which of the following organizations formed after 1996 cannot be classified as a partnership?

• An insurance company.

  
  

• A tax-exempt organization.

  
  

• A real estate investment trust.

  
  

• All of the answers are correct.

  
  

Answer explanation

A partnership is defined under Sec. 761(a) as including a syndicate, group, pool, joint venture, or other unincorporated organization that carries on a business and is not a corporation, a trust, or an estate. Partnerships include organizations that carry on a business, financial operation, or venture with a profit motive. Also, under Reg. 301.7701-2(b), an insurance company is a corporation.

A partnership is defined under Sec. 761(a) as including a syndicate, group, pool, joint venture, or other unincorporated organization that carries on a business and is not a corporation, a trust, or an estate. Partnerships include organizations that carry on a business, financial operation, or venture with a profit motive. Also, under Reg. 301.7701-2(b), an insurance company is a corporation.

• They must have a formal partnership agreement to be considered a partnership.

  
  

• They can report the income or loss on a Schedule C (Form 1040) if they are filing a joint return.

  
  

• Each spouse should carry his or her share of the partnership income or loss from the Form 1065, Schedule K-1, to his or her joint or separate individual income tax returns.

  
  

• They should combine the self-employment income on a single Schedule SE (Form 1040).

  
  

Answer explanation

If spouses carry on a business together and share in the profits and losses, they may in fact be partners, whether or not they have a formal partnership agreement. In this case, income or loss should be reported on Form 1065, rather than on Schedule C of 1040. By reporting in this manner, each spouse will be credited with his or her pro rata share of self-employment tax.

Two brothers each inherited from their mother a 50% ownership interest in a building. The building is subject to a lease whereby the brothers provide no services to the tenant. The brothers agree to split the rental income and expenses and share equally in any profits or losses. Which of the following statements is true?

• Because the brothers received the property in a distribution from their mother’s estate, they must report the income and expenses associated with the property on Form 1041.

  
  

• Because the brothers jointly inherited the property, they have a partnership and must report the property’s income and expenses on Form 1065.

  
  

• Because the brothers have an agreement to share in the profits and losses, they have a partnership and must report the property’s income and expenses on Form 1065.

  
  

• Because the brothers’ co-ownership of the property is not a trade or business, they do not have a partnership. Each brother must report his respective share of income and expenses on Schedule E, Form 1040.

  
  

Answer explanation

Under Reg. 301.7701-1(a), mere co-ownership, maintenance, repair, and rental of property do not constitute a partnership. The co-owners are partners only if, in addition to renting the property, they provide additional services to the occupants and share the profits. Because the brothers are not partners, they must report their income and expenses on Schedule E, Form 1040.