Essentials of taxation 2016 cengage chapter 14

Chapter 14 Partnerships and Limited Liability Entities Essentials of Taxation © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Big Picture (slide of 3) • For 15 years, Maria has owned and operated a seaside bakery and cafe called The Beachsider – Maria would like to expand and has talked to her landlord, Kyle about it • The Beachsider is one of several older buildings on acres of a 10-acre parcel that Kyle inherited 30 years ago – The remaining acres are undeveloped • Kyle and Maria talked to Josh, a real estate developer, and he proposed an expansion to The Beachsider and upgrades to the other buildings The Big Picture (slide of 3) • The parties agreed to form a partnership to own and operate The Beachsider and to improve and lease the other buildings • Under the plan, Kyle and Maria will each contribute ½ of the capital needed – Kyle’s real estate is valued at about $2 million – Maria’s bakery equipment and the cafe furnishings are valued at about $500,000 – The improvements will cost about $1.5 million, which Maria has agreed to contribute to the partnership The Big Picture (slide of 3) • Josh will not contribute any capital to the partnership – Instead, he will manage the construction and the operation of the partnership in exchange for 5% of the capital and 20% of the ongoing profits – His capital interest is valued at $200,000 • What are the tax consequences if the trio forms Beachside Properties as a partnership to own and operate the shopping center? – What issues might arise later in the life of the entity? • Read the chapter and formulate your response Partnership Definition • An association of two or more persons to carry on a trade or business – Contribute money, property, labor – Expect to share in profit and losses • For tax purposes, includes: – – – – Syndicate Group Pool Joint venture, etc Entities Taxed as Partnerships (slide of 4) • General partnership – Consists of at least general partners – Partners are jointly and severally liable • Creditors can collect from both partnership and partners’ personal assets • General partner’s assets are at risk for malpractice of other partners even though not personally involved Entities Taxed as Partnerships (slide of 4) • Limited liability company (LLC) – Combines the corporate benefit of limited liability with benefits of partnership taxation • Unlike corporations, income is subject to tax only once • Special allocations of income, losses, and cash flow are available – Owners are “members,” not partners, but if properly structured will receive partnership tax treatment Entities Taxed as Partnerships (slide of 4) • Limited partnership – Has at least one general partner • One or more limited partners – Only general partner(s) are personally liable to creditors • Limited partners’ loss is limited to equity investment Entities Taxed as Partnerships (slide of 4) • Limited liability partnership (LLP) – An LLP partner is not personally liable for malpractice committed by other partners – Popular organizational form for large accounting firms • Limited liability limited partnership (LLLP) – An extension of the limited partnership form – All partners, whether general or limited, are accorded limited liability Partnership Taxation (slide of 2) • Generally, the calculation of partnership income is a 2-step approach – Step 1: Net ordinary income and expenses related to the trade or business of the partnership – Step 2: Segregate and report separately some partnership items – If an item of income, expense, gain or loss might affect any partners’ tax liabilities differently, it is separately stated – e.g., Charitable contributions Loss Limitation Example 35 (slide of 2) Provisions Deductible loss 704(d) $ 50,000 465 35,000 469 25,000* Suspended loss $ 10,000 15,000 10,000 *Amount deducted on tax return: $25,000 -passes all three loss limitations Guaranteed Payments • Payment to partner for use of capital or for services provided to partnership – May not be determined by reference to partnership income – Usually expressed as a fixed dollar amount or as a % of capital Treatment of Guaranteed Payments (slide of 2) • May be deducted or capitalized by partnership depending on the nature of the payment – Deductible by partnership if meets “ordinary and necessary business expense” test – May create partnership loss Treatment of Guaranteed Payments (slide of 2) • Includable in income of partner at time partnership deducts – Treated as if received on last day of partnership tax year – Character is ordinary income to recipient partner Other Transactions Between Partner and Partnership (slide of 2) • May be treated as if partner were an outsider, for example: – Loan transactions – Rental payments – Sales of property Other Transactions Between Partner and Partnership (slide of 2) • Timing of deduction for payment by an accrual basis partnership to a cash basis partner depends on whether payment is: – Guaranteed payment • Included in partner’s income on last day of partnership year when accrued (even if not paid until the next year) – Payment to partner treated as an outsider • Deduction cannot be claimed until partner includes the amount in income Sales of Property • No loss is recognized on the sale of property between a partnership and a partner who owns > 50% of partnership capital or profits – If property is subsequently sold at a gain, the disallowed loss reduces gain recognized Partners as Employees • A partner usually does not qualify as an employee for tax purposes resulting in the following tax consequences: – A partner receiving guaranteed payments from the partnership is not subject to tax withholding – The partnership cannot deduct payments for a partner’s fringe benefits – A general partner’s distributive share of ordinary partnership income and guaranteed payments for services are generally subject to the Federal self-employment tax Limited Liability Companies • A LLC with or more owners is taxed as a partnership – LLC members are not personally liable for debts of the entity • Effectively treated as a limited partnership with no general partners – LLCs are relatively new so there is no established body of case law available • Makes planning difficult Limited Liability Companies • A LLC with or more owners is taxed as a partnership – LLC members are not personally liable for debts of the entity • Effectively treated as a limited partnership with no general partners – LLCs are relatively new so there is no established body of case law available • Makes planning difficult Limited Liability Companies • A LLC with or more owners is taxed as a partnership – LLC members are not personally liable for debts of the entity • Effectively treated as a limited partnership with no general partners – LLCs are relatively new so there is no established body of case law available • Makes planning difficult Refocus On The Big Picture (slide of 3) •After considering the various types of partnerships, Kyle, Maria, and Josh decide to form Beachside Properties as an LLC •On formation of the entity, there was no gross income to the LLC or to any of its members (see Example 15) •Beachside Properties computes its income as shown in Example 17 and allocates the income as illustrated in Example 19 Refocus On The Big Picture (slide of 3) • The LLC’s income affects the members’ bases and capital accounts •An important consideration for the LLC members is whether their distributive shares and guaranteed payments will be treated as selfemployment income Refocus On The Big Picture (slide of 3) What If? •What happens in the future when the LLC members decide to expand or renovate Beachside’s facilities? – At that time, the existing members can contribute additional funds, the LLC can obtain capital from new members, or the entity can solicit third-party financing – An LLC is not subject to the 80% control requirement applicable to corporations • Therefore, new investors can contribute cash or other property in exchange for interests in the LLC—and the transaction will qualify for tax-deferred treatment If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr Donald R Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 87 ... (slide of 3) • Josh will not contribute any capital to the partnership – Instead, he will manage the construction and the operation of the partnership in exchange for 5% of the capital and 20% of. .. extension of the limited partnership form – All partners, whether general or limited, are accorded limited liability Partnership Taxation (slide of 2) • Generally, the calculation of partnership... Deductibility of partnership losses – Tax treatment of partnership distributions – Calculating gain or loss on the partner’s disposition of the partnership interest Basis Issues (slide of 3) • Partner’s