Partnership Taxation

US
Agenda/Topics to Be Covered
• Recap
• Guaranteed payments
• Partnership Taxable Income
• Separately stated Items
• Adjustment of basis
Guaranteed payments
• A guaranteed payment (GP) is a payment to a partner for services rendered
or capital used that is determined without regard to the income of the
partnership. It is used to distinguish payments that are a function of
partnership income and payments connected with partners

• a, The services must be a customary function of a partner. They are normal

activities of a partner in conducting partnership business.

• b. Use of capital. The payment may be stated to be interest on the partner's

capital account or to be rent on contributed property.
Guaranteed payments
• c. Fixed amount stated. If the partnership agreement provides for a Gp
in a fixed amount, e. g., annual salary amount, the Gp amount is the
stated amount.

• d. Stated minimum amount. The partnership agreement may allocate

a share of Partnership income to the partner but guarantee payment
of not less than a stated amount to the partner even if the allocable
share is less.
– If so, the GP amount is any excess of the guaranteed minimum amount over
the distributive share allocable to the partner.
Guaranteed payments
• Alex is a member of an LLC. The LLC operating agreement states
that he has a 40 percent share of the LLC profits each year and
that he has a minimum guaranteed payment amount of
$25,000. This year, the LLC net income is $50,000
Guaranteed payments
• Alex's share is $20,000 (40 percent of $50,000). Since he has a
guaranteed minimum of $25,000, $5,000 is considered as his
guaranteed minimum and the other $20,000 is his distributive share.

• Remember, Alex must pay tax on his share of the profits even if he
doesn't receive all—or any—of that money.

• The LLC could take a tax deduction for the $5,000 considered as
guaranteed payment.
Guaranteed payments
• Alex is a member of an LLC. The LLC operating agreement states
that he has a 40 percent share of the LLC profits each year and
that he has a minimum guaranteed payment amount of
$25,000. This year, If the net income of the partnership was
$70,000.
Guaranteed payments
• Alex's share would be $28,000 and no guaranteed payments
would be made. There is no guaranteed minimum for that year,
so the partnership can't take a tax deduction for this payment.
Guaranteed payments
• A partnership or LLC doesn't pay taxes on business income. Instead, these
businesses are considered pass-through entities, meaning that the income
passes through to the owners.

• The IRS considers guaranteed payments as ordinary income to the owners.

• This guaranteed payment is considered a deductible expense to the business.

• If the owner's share of net income is greater than the guaranteed amount,
there is no guaranteed amount for that year.
Guaranteed payments
• From the standpoint of payroll taxes, guaranteed payments are
not salary.

• But from the standpoint of tax-deductible expenses to the

company, LLC guaranteed payments are treated in the same
way as salary.

• Partners and LLC members are not paid a salary in their positions
as owners.
Guaranteed payments
• A partner or LLC member may be paid a salary as an employee,
but this payment has nothing to do with payments to the owner
as an owner through the ownership agreements.

• If an LLC owner is paid a salary as an employee, the IRS requires

that federal income taxes and FICA taxes (Social Security and
Medicare) be withheld from the employee's pay.
Partnership Taxable Income
• Partnership taxable income is determined in the same way as for
individuals except that certain deductions are not allowed for a
partnership, and other items are required to be separately
stated.
Separately stated Items
• Each partnership item of income, gain, deduction, loss, or credit that
may vary the tax separately stated Items that must be separately
stated include the following
– a. Section 1231 gains and losses
– b. Net STCG and net LTCG or loss from the sale or exchange of capital assets
– c. Dividends that are eligible for a corporate dividends- received deductions
– d. Tax-exempt income and related expenses
– e. Investment income and related expenses
– f. Rental activities, portfolio income, and related expenses
Separately stated Items
– g. Recovery items (e. g., prior taxes, bad debts)
– h. Charitable contributions
– i. Foreign income taxes paid or accrued
– j. Depletion on oil and gas wells
– k. Section 179 deductions
Separately stated Items-Numerical
– ABC Partnership’s financial records show the following in terms of $
– Gross receipts from sales 600,000
– Cost of goods sold 400,000
– Operating expenses 90,000
– Business entertainment expenses disallowed 6000
– Section 1231 loss 10000
– Charitable contribution 5000
– Guaranteed payments 15000
– Distribution to partners 17000

– What is the partnerships ordinary income and separately stated items.

Adjustments to Basis
• The basis of a partner's, interest in a partnership is adjusted each year for subsequent
variations in the partner's share of partnership liabilities, and distributions from the

• Initial basis
– + Subsequent contributions of capital
– +/-Distributive share of partnership taxable income (loss)
– + Separately stated taxable and on taxable income
– - Separately stated deductible and non deductible expenditures
– + Increase in allocable share of partnership liabilities
– - Decrease in allocable share of partnership liabilities
– - Distributions from partnership

• Adjusted basis in partnership interest

Adjustments to Basis
• The taxpayer’s ownership and basis in the partnership are 50% and $15,000,

respectively, at the beginning of the year. The partnership has ordinary income of $

8,000, made charitable contributions of $ 3,000 and made a $ 5,000 distribution to the

taxpayer. Calculate the taxpayer’s basis at the end of the year.

Adjustments to Basis
• Tony and Mary form a partnership as equal partners. Tony contributes cash of

$100,000, and Mary contributes an asset with a basis of $80, 000 and a FMV of

$100,000. Two years later, the partnership sells the asset for $110, 000. Calculate the

Basis of Each partner post sale of the asset.

Adjustments to Basis
• The $30,000 gain ($110, 000 selling price-$80, 000 basis) is allocated,

• $25, 000 to Mary [$20, 000 precontribution gain + (50% partnership interest × $10, 000

postcontribution gain) ] and

• $5, 000 to Tony (50% partnership interest × $1o, ooo postcontribution gain).
Adjustments to Basis
• In 2016, Albert acquired a 20% interest in a partnership by contributing a parcel of land

and $10, 000 in cash. At the time of Albert's contribution, the land had a fair market

value of $50, 000, had an adjusted basis to Albert of $20, 000, and was subject to a

mortgage of $70, 000. Compute Albert’s Basis.

Adjustments to Basis
• Albert's relinquished liability is a gain. When Albert became a 20% partner, he was

relieved of 80% of the mortgage debt. Thus, 80% of his $70, 000 mortgage, or $56, 000,

is a benefit to Albert because the other partners are assuming part of the mortgage

obligation.

• Therefore, Albert has a recognized gain of $26, 000

• ($56, 000 benefit-$10,000 cash-$20, 000 AB of property).