Partnership Taxation

Formation (Section 721)

• No gain or loss; no control test.
• Outside basis = cash + property basis + share of partnership debt − own debt assumed by partnership.
• Net debt relief > basis → gain. Services for a capital interest → income.
• Inside basis = carryover. Section 704(c): built-in gain to the contributor.

Operations

• Form 1065 due March 15; Schedule K-1 to partners.
• Guaranteed payments: deductible by the partnership; ordinary income to the partner; self-employment tax.
• General partner's share → self-employment tax; limited partner's generally not.
• Special allocations need substantial economic effect.

Basis

+ contributions, income (incl. tax-exempt), ↑ debt share. − distributions, losses, ↓ debt share, nondeductible expenses. Never below zero.

Distributions

• Current: gain only if cash > basis; property takes partnership basis (limited to outside basis).
• Liquidating: remaining basis goes to property. Loss only if solely cash, receivables, inventory.

Sale of interest

Capital gain, except Section 751 hot assets (receivables, inventory, recapture) → ordinary.

Exam traps

• Partners are taxed on their share of income whether or not it is distributed.
• Guaranteed payments are ordinary income to the partner even if the partnership has a loss.
• A partnership's tax year generally follows the majority-interest partners' year.
• Contributed property with a built-in loss: only the contributing partner can use that loss; for other partners its basis is fair value.