Chapter 20 Forming and Operating Partnerships

Chapter 20

Forming and Operating Partnerships

True / False Questions

1. Income earned by flow-through entities is usually taxed once at the entity level.

True False

2. Partnerships tax rules incorporate both the entity and aggregate approaches.

True False

3. The term "outside basis" refers to the partnership's basis in its assets; whereas, the term "inside basis" refers an individual partner's basis in her partnership interest.

True False

4. A partnership can elect to amortize organization and startup costs; however, syndication costs are not deductible.

True False

5. Nonrecourse debt is generally allocated according to the profit-sharing ratios of the partnership.

True False

6. Partners must generally treat the value of profits interests they receive in exchange for services as ordinary income.

True False

7. A purchased partnership interest has a holding period beginning on the date of purchase regardless of the type of property held by the partnership.

True False

8. Tax elections are rarely made at the partnership level.

True False

9. The least aggregate deferral test uses the profit percentage of each partner to determine the minimum amount of tax deferral for the partner group as a whole.

True False

10. A partnership with a C corporation partner must always use the accrual method as its accounting method.

True False

11. The character of each separately-stated item is determined at the partner level.

True False

12. Guaranteed payments are included in the calculation of a partnership's ordinary business income (loss) and are also treated as separately-stated items.

True False

13. A general partner's share of ordinary business income is similar to investment income; thus, a general partner only includes their guaranteed payments as self-employment income.

True False

14. Partnerships can use special allocations to shift built-in gains and built-in losses on contributed property from a partner who contributed the property to other partners.

True False

15. A partnership can request a five month extension by filing Form 7004 prior to the original due date of the partnership return.

True False

16. A partner's outside basis must first be decreased by any negative basis adjustments and then increased by any positive basis adjustments.

True False

17. Actual or deemed cash distributions in excess of a partner's outside basis are generally taxable as capital gains.

True False

18. Adjustments to a partner's outside basis are made annually to prevent double taxation on the sale of a partnership interest or at the time of a partnership distribution.

True False

19. Partners adjust their outside basis by adding non-deductible expenses and subtracting any tax-exempt income to avoid being double taxed.

True False

20. An additional allocation of partnership debt or relief of partnership debt is considered to be a deemed cash contribution or cash distribution respectively.

True False

21. Any losses that exceed the tax basis of a partner are suspended and carried forward for 20 years.

True False

22. The main difference between a partner's tax basis and at-risk amount is that qualified nonrecourse financing is not included in the at-risk amount.

True False

23. A partner can apply any passive activity losses against any passive activity income for the year.

True False

24. If a partner participates in partnership activities on a regular, continuous, and substantial basis, then the partnership's activities with respect to this individual partner are not considered passive.

True False

25. A partner's tax basis or at-risk amount can be increased by making capital contributions, by paying off partnership debt, or by increasing the profitability of the partnership.

True False

Multiple Choice Questions

26. Which of the following entities is not considered a flow-through entity?

A. C corporation

B. S corporation

C. Limited Liability Company (LLC)

D. Partnership

27. Which of the following statements exemplifies the entity theory of partnership taxation?

A. Partnerships are taxable entities.

B. Partnerships determine the character of separately stated items at the partnership level.

C. Partnerships make the majority of the tax elections.

D. Both partnerships are taxable entities and partnerships make the majority of the tax elections are correct

E. Both partnerships determine the character of separately stated items at the partnership level and partnerships make the majority of the tax elections are correct

28. Gerald received a 33% capital and profit (loss) interest in XYZ Limited Partnership (LP). In exchange for this interest, Gerald contributed a building with a FMV of $30,000. His adjusted basis in the building was $15,000. In addition, the building was encumbered with a $9,000 nonrecourse mortgage that XYZ, LP assumed at the time the property was contributed. What is Gerald's outside basis immediately after his contribution?

A. $6,000

B. $9,000

C. $21,000

D. $24,000

29. Sue and Andrew form SA general partnership. Each person receives an equal interest in the newly created partnership. Sue contributes $10,000 of cash and land with a FMV of $55,000. Her basis in the land is $20,000. Andrew contributes equipment with a FMV of $12,000 and a building with a FMV of $33,000. His basis in the equipment is $8,000, and his basis in the building is $20,000. How much gain must the SA general partnership recognize on the transfer of these assets from Sue and Andrew?

A. $0

B. $4,000

C. $48,000

D. $52,000

30. Erica and Brett decide to form their new motorcycle business as a LLC. Each will receive an equal profits (loss) interest by contributing cash, property, or both. In addition to the members' contributions, their LLC will obtain a $50,000 nonrecourse loan from First Bank at the time it is formed. Brett contributes cash of $5,000 and a building he bought as a storefront for the motorcycles. The building has a FMV of $45,000, an adjusted basis of $30,000, and is secured by a $35,000 nonrecourse mortgage that the LLC will assume. What is Brett's outside tax basis in his LLC interest?

A. $37,500

B. $40,000

C. $42,500

D. $45,000

31. Under general circumstances, debt is allocated from the partnership to each partner in the following manner:

A. Recourse - profit sharing ratios; nonrecourse - profit sharing ratios

B. Recourse - capital ratios; nonrecourse - capital ratios

C. Recourse - to partners with the ultimate responsibility for paying the debt; nonrecourse - profit sharing ratios

D. Recourse - profit sharing ratios; nonrecourse - to partners with the ultimate responsibility for paying the debt

32. Which of the following statements is true when property is contributed in exchange for a partnership interest?

A. Any contributed property in a partnership has a carryover basis, and the character of the property is determined by the way the contributing partner used the property.

B. The partnership's inside basis is typically increased by any gain the partner recognizes from the property contribution.

C. The holding period for a partner's partnership interest depends upon the type of assets a partner contributes.

D. Services are not allowed to be contributed to a partnership in return for a partnership interest.

E. All of these are true.

33. In X1, Adam and Jason formed ABC, LLC, a car dealership in Kansas City. In X2, Adam and Jason realized they needed an advertising expert to assist in their business. Thus, the two members offered Cory, a marketing expert, a 1/3 capital interest in their partnership for contributing his expert services. Cory agreed to this arrangement and received his capital interest in X2. If the value of the LLC's capital equals $180,000 when Cory receives his 1/3 capital interest, which of the following tax consequences does not occur in X2?

A. Cory reports $60,000 of ordinary income in X2

B. Adam, Jason and Cory receive an ordinary deduction of $20,000 in X2

C. Adam and Jason receive an ordinary deduction of $30,000 in X2

D. Cory reports $60,000 of ordinary income in X2, and Adam and Jason receive an ordinary deduction of $30,000 in X2

34. Tom is talking to his friend Bob, who has an interest in Freedom, LLC, about purchasing his LLC interest. Bob's outside basis in Freedom, LLC is $10,000. This includes his $2,500 one-fourth share of the LLC's debt. Bob's 704(b) capital account is $17,000. If Tom bought Bob's LLC interest for $17,000, what would Tom's outside basis be in Freedom, LLC?

A. $10,000

B. $14,500

C. $17,000

D. $19,500

35. Which of the following statements regarding capital and profit interests received for services contributed to a partnership is false?

A. The holding period of a capital or profits interest begins on the date the interest is received

B. Partners receiving capital interests must recognize the liquidation value of their capital interests as capital gain

C. Partners receiving only profits interests generally don't recognize income when the profits interest is received

D. Partners receiving only profits interests include their share of partnership debt in the tax basis of their partnership interest

36. Partnerships must maintain their capital accounts according to which of the following rules?

A. GAAP

B. 704(b)

C. Tax

D. All of these

E. Only GAAP and 704(b)

37. Zinc, LP was formed on August 1, 20X9. When the partnership was formed, Al contributed $10,000 in cash and inventory with a FMV and tax basis of $40,000. In addition, Bill contributed equipment with a FMV of $30,000 and adjusted basis of $25,000 along with accounts receivable with a FMV and tax basis of $20,000. Also, Chad contributed land with a FMV of $50,000 and tax basis of $35,000. Finally, Dave contributed a machine, secured by $35,000 of debt, with a FMV of $15,000 and a tax basis of $10,000. What is the total inside basis of all the assets contributed to Zinc, LP?

A. $140,000

B. $165,000

C. $175,000

D. $200,000

38. Which of the following does not represent a tax election available to either partners or partnerships?

A. Electing to change an accounting method

B. Electing to amortize organization costs

C. Electing to expense a portion of syndication costs

D. Electing to immediately expense depreciable property under Section 179

39. In what order should the tests to determine a partnership's year end be applied?

A. majority interest taxable year - least aggregate deferral - principal partners test.

B. principal partners test - majority interest taxable year - least aggregate deferral.

C. principal partners test - least aggregate deferral - majority interest taxable year.

D. majority interest taxable year - principal partners test - least aggregate deferral.

E. None of these.

40. Sarah, Sue, and AS Inc. formed a partnership on May 1, 20X9 called SSAS, LP. Now that the partnership is formed, they must determine its appropriate year-end. Sarah has a 30% profits and capital interest while Sue has a 35% profits and capital interest. Both Sarah and Sue have calendar year-ends. AS Inc. holds the remaining profits and capital interest in the LP, and it has a September 30 year-end. What tax year-end must SSAS, LP use for 20X9 and which test or rule requires this year-end?

A. 9/30, majority interest taxable year

B. 12/31, majority interest taxable year

C. 12/31, principal partners test

D. 12/31, least aggregate deferral test

41. XYZ, LLC has several individual and corporate members. Abe and Joe, individuals with 4/30 year-ends, each have a 23% profits and capital interest. RST, Inc., a corporation with a 6/30 year end, owns a 4% profits and capital interest while DEF, Inc., a corporation with an 8/30 year end, owns a 4.9% profits and capital interest. Finally, thirty other calendar year-end individual partners (each with less than a 2% profits and capital interest) own the remaining 45% of the profits and capital interests in XYZ. What tax year-end should XYZ use and which test or rule requires this year-end?

A. 4/30, principal partners test

B. 4/30, least aggregate deferral test

C. 12/31, principal partners test

D. 12/31, least aggregate deferral test

42. This year, HPLC, LLC was formed by H Inc., P Inc., L Inc., and C Inc. Each member had an equal share in the LLC's capital. H Inc., P Inc., and L Inc. each had a 30% profits interest in the LLC with C Inc. having a 10% profits interest. The members had the following tax year-ends: H Inc. [1/31], P Inc. [5/31], L Inc. [7/31], and C Inc. [10/31]. What tax year-end must the LLC use?

A. 1/31

B. 5/31

C. 7/31

D. 10/31

43. Which of the following statements regarding the process for determining a partnership's tax year-end is true?

A. Only the partners' profits interests are relevant when determining if a partnership has a majority interest taxable year.

B. Under the principal partners test, a principal partner is defined as a partner having an interest of 3% or more in the profits or capital of the partnership.

C. The least aggregate deferral test utilizes the partners' capital interests to measure the amount of aggregate deferral.

D. A partnership is required to use a calendar year-end if it has a corporate partner.

E. None of these is true.

44. A partnership may use the cash method despite having a corporate partner when the partnership's average gross receipts for the prior three taxable years don't exceed _________.

A. $500,000

B. $1,000,000

C. $5,000,000

D. Partnerships may never use the cash method if they have corporate partners

45. TQK, LLC provides consulting services and was formed on 1/31/X5. Aaron and ABC, Inc. each hold a 50% capital and profits interest in TQK. If TQK averaged $7,000,000 in annual gross receipts over the last three years, what accounting method can TQK use for X9?

A. Accrual method

B. Cash method

C. Hybrid method

D. Either accrual method or cash method

46. How does a partnership make a tax election for the current year?

A. Partnerships make certain elections automatically by simply filing their returns.

B. Partnerships make certain tax elections by filing a separate form with the IRS.

C. Partnerships do not need to file anything to make a tax election.

D. Partnerships do not make tax elections. Partners must make tax elections separately.

E. Partnerships make certain elections automatically by simply filing their returns, and partnerships make certain tax elections by filing a separate form with the IRS.

47. What is the rationale for the specific rules partnerships must follow in determining a partnership's taxable year-end?

A. To increase the amount of aggregate tax deferral partners receive

B. To minimize the amount of aggregate tax deferral partners receive

C. To align the year-end of the partnership with the year-end of a majority of the partners

D. To spread the workload of CPAs more evenly over the year

E. To minimize the amount of aggregate tax deferral partners receive and to align the year-end of the partnership with the year-end of a majority of the partners

48. On 12/31/X4, Zoom, LLC reported a $60,000 loss on its books. The items included in the loss computation were $30,000 in sales revenue, $15,000 in qualifying dividends, $22,000 in cost of goods sold, $50,000 charitable contribution, $20,000 in employee wages, and $13,000 of rent expense. How much ordinary business income (loss) will Zoom report on its X4 return?

A. ($8,000)

B. ($25,000)

C. ($60,000)

D. ($95,000)

49. Which of the following would not be classified as a separately-stated item?

A. Short-term capital gains

B. Charitable contributions

C. MACRS depreciation expense

D. Guaranteed payments

50. Tim, a real estate investor, Ken, a dealer in securities, and Hardware, Inc., a retail lumber store form a partnership called HKT, LP. HKT is in the home building business. Tim recently purchased his interest in HKT while the other partners purchased their interest several years ago. During X3, HKT reports a $12,000 gain from the sale of a stock in a wholesale lumber company it purchased in X1 for investment purposes. Which of the following statements best represents how their portion of the gain should be reported to the partner?

A. Tim - Short-term capital gain

B. Ken - Ordinary Income

C. Hardware, Inc. - Long-term capital gain

D. All of these accurately report the gain to the partner

E. None of these accurately report the gain to the partner

51. Kim received a 1/3 profits and capital interest in Bright Line, LLC in exchange for legal services she provided. In addition to her share of partnership profits or losses, she receives a $30,000 guaranteed payment each year for ongoing services she provides to the LLC. For X4, Bright Line reported the following revenues and expenses: Sales - $150,000, Cost of Goods Sold - $90,000, Depreciation Expense - $45,000, Long-Term Capital Gains - $15,000, Qualifying Dividends - $6,000, and Municipal Bond Interest - $3,000. How much ordinary business income (loss) will Bright Line allocate to Kim on her Schedule K-1 for X4?

A. ($15,000)

B. $6,000

C. $9,000

D. $15,000

E. None of these will be reported as ordinary business income (loss) on Schedule K-1.

52. A partner's self-employment earnings (loss) may be affected by her share of ordinary business income (loss) and any guaranteed payments she receives. The impact of these amounts typically depends on the status of the partner. Which of the following statements correctly describes the effect these items have on the partner's self-employment earnings (loss)?

A. General partner - only guaranteed payments affect self-employment earnings (loss)

B. General partner - ordinary business income (loss) and guaranteed payments affect self-employment earnings (loss)

C. Limited partner - only guaranteed payments affect self-employment earnings (loss)

D. Limited partner - only ordinary business income (loss) affects self-employment income (loss)

E. Both general partner - ordinary business income (loss) and guaranteed payments affect self-employment earnings (loss) and limited partner - only guaranteed payments affect self-employment earnings (loss) are correct

53. Under proposed rules issued by the IRS, in which of the following situations should an LLC member be treated as a general partner for self-employment tax purposes?

A. The member is not personally liable for any of the LLC debt.

B. The member has authority to contract on behalf of the LLC.

C. The member spends 450 hours participating in the management of the LLC's trade or business during the taxable year.

D. The member is listed on the LLC's letterhead.

54. Which of the following items are subject to the Medicare contribution tax when an individual partner is a material participant in the partnership?

A. Partner's distributive share of dividends

B. Partner's distributive share of interest

C. Partner's distributive share of ordinary business income

D. Both partner's distributive share of dividends and of interest are correct

55. Which of the following items are subject to the Medicare contribution tax when a partner is a not a material participant in the partnership?

A. Partner's distributive share of dividends

B. Partner's distributive share of interest

C. Partner's distributive share of ordinary business income

D. All of these are correct.

56. Which requirement must be satisfied in order to specially allocate partnership income or losses to partners?

A. Special allocations must have economic effect

B. At least one partner must agree to the special allocations

C. Special allocations must be insignificant

D. Special allocations must reduce the combined tax liability of all the partners

57. Frank and Bob are equal members in Soxy Socks, LLC. When forming the LLC, Frank contributed $50,000 in cash and $50,000 worth of equipment. Frank's adjusted basis in the equipment was $35,000. Bob contributed $50,000 in cash and $50,000 worth of land. Bob's adjusted basis in the land was $30,000. On 3/15/X4, Soxy Socks sells the land Bob contributed for $60,000. How much gain (loss) related to this transaction will Bob report on his X4 return?

A. $10,000

B. $15,000

C. $25,000

D. $35,000

58. When must a partnership file its return?

A. By the 15th day of the 4th month after the partnership's tax year end

B. By the sixth month after the original due date if an extension is filed

C. By the 15th day of the 3rd month after the partnership's tax year end

D. By the 15th day of the 4th month after the partnership's tax year end and by the sixth month after the original due date if an extension is filed

E. By the sixth month after the original due date if an extension is filed and by the 15th day of the 3rd month after the partnership's tax year end

59. What form does a partnership use when filing an annual informational return?

A. Form 1040

B. Form 1041

C. Form 1065

D. Form 1120

60. Which of the following does not adjust a partner's basis?

A. Ordinary business income (loss)

B. Change in amount of partnership debt

C. Tax-exempt income

D. All of these adjust a partner's basis

61. What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1) Increase for share of ordinary business income, (2) Decrease for share of separately stated loss items, and (3) Decrease for distributions?

A. 1, 3, 2

B. 1, 2, 3

C. 3, 1, 2

D. 2, 3, 1

62. Which of the following statements regarding a partner's basis adjustments is true?

A. A partner's basis may never be reduced below zero.

B. A partner must adjust his basis for ordinary income (loss) but not for separately-stated items.

C. A partnership fine or penalty does not affect a partner's basis.

D. Relief of partnership debt increases a partner's tax basis.

63. Which of the following statements regarding the rationale for adjusting a partner's basis is false?

A. To prevent partners from being double taxed when they sell their partnership interests

B. To ensure that partnership tax-exempt income is not ultimately taxed

C. To prevent partners from being double taxed when they receive cash distributions

D. To ensure that partnership non-deductible expenses are never deductible

E. None of these rationales are false

64. If partnership debt is reduced and a partner is deemed to receive a cash distribution, what impact does the deemed distribution have on the partner if it is in excess of her tax basis?

A. The partner will treat the distribution in excess of her basis as ordinary income

B. The partner will treat the distribution in excess of her basis as capital gain

C. The partner will not ever be taxed on the distribution in excess of her basis

D. The partner will not be taxed on the distribution in excess of her basis until she sells her partnership interest

65. Jerry, a partner with 30% capital and profit interest, received his Schedule K-1 from Plush Pillows, LP. At the beginning of the year, Jerry's tax basis in his partnership interest was $50,000. His current year Schedule K-1 reported an ordinary loss of $15,000, long-term capital gain of $3,000, qualifying dividends of $2,000, $500 of non-deductible expenses, a $10,000 cash contribution, and a reduction of $4,000 in his share of partnership debt. What is Jerry's adjusted basis in his partnership interest at the end of the year?

A. $35,000

B. $40,000

C. $45,500

D. $49,500

66. Styling Shoes, LLC filed its 20X8 Form 1065 on March 15, 20X9. Styling had three members with the following ownership interests and tax basis at the beginning of the 20X8: (1) Jane, a member with a 25% profits and capital interest and a $5,000 outside basis, (2) Joe, a member with a 45% profits and capital interest and a $10,000 outside basis, and (3) Jack, a member with a 30% profits and capital interest and a $2,000 outside basis. The following items were reported on Styling's Schedule K for the year: ordinary income of $100,000, Section 1231 gain of $15,000, charitable contributions of $25,000, and tax-exempt income of $3,000. In addition, Styling received an additional bank loan of $12,000 during 20X8. What is Jane's tax basis after adjustment for her share of these items?

A. $28,250

B. $31,250

C. $33,500

D. $57,250

67. Hilary had an outside basis in LTL, General Partnership of $10,000 at the beginning of the year. LTL reported the following items on Hilary's K-1 for the year: ordinary business income of $5,000, a $10,000 reduction in Hilary's share of partnership debt, a cash distribution of $20,000, and tax-exempt income of $3,000. What is Hilary's adjusted basis at the end of the year?

A. ($12,000)

B. ($9,000)

C. $0

D. $15,000

E. $18,000

68. How does additional debt or relief of debt affect a partner's basis?

A. Debt has no effect on a partner's basis

B. Relief of debt increases a partner's basis

C. Both additional debt and relief of debt increase a partner's basis

D. Additional debt increases a partner's basis

69. Does adjusting a partner's basis for tax-exempt income prevent double taxation?

A. Yes, if this basis adjustment is not made the partner will be taxed once when the income is allocated to him and a second time when he sells his partnership interest

B. Yes, if this basis adjustment is not made the partner will be taxed on the tax-exempt income twice when he sells his partnership interest because he was not taxed on this income when it was earned

C. No, making this adjustment to the partner's basis prevents the tax-exempt income from being converted to taxable income

D. No, the partner should not adjust his tax basis by his share of tax-exempt income

70. In what order are the loss limitations for partnerships applied?

A. Tax Basis - At-Risk Amount - Passive Activity Loss

B. Passive Activity Loss - Tax Basis - At-Risk Amount

C. At-Risk Amount - Passive Activity Loss - Tax Basis

D. At-Risk Amount - Tax Basis - Passive Activity Loss

71. Which of the following items will affect a partner's tax basis?

A. Share of ordinary business income (loss)

B. Share of nonrecourse debt

C. Share of recourse debt

D. Share of qualified nonrecourse debt

E. All of these will affect a partner's tax basis

72. On January 1, X9, Gerald received his 50% profits and capital interest in High Air, LLC in exchange for $2,000 in cash and real property with a $3,000 tax basis secured by a $2,000 nonrecourse mortgage. High Air reported a $15,000 loss for its X9 calendar year. How much loss can Gerald deduct, and how much loss must he suspend if he only applies the tax basis loss limitation?

A. $0, $4,000

B. $0, $7,500

C. $0, $15,000

D. $4,000, $0

E. None of these

73. What type of debt is not included in calculating a partner's at-risk amount?

A. Recourse debt

B. Qualified nonrecourse debt

C. Nonrecourse debt

D. All of these types of debt are included in the at-risk amount

74. Jay has a tax basis of $14,000 in his partnership interest at the beginning of the partnership tax year. The following amounts of partnership debt were allocated to Jay and are included in his beginning of the year tax basis: (1) recourse debt - $3,000, (2) qualified nonrecourse debt - $1,000, and (3) nonrecourse debt - $500. If Jay is allocated a $15,000 loss for the current year, how much of the loss will be suspended under the tax basis and at-risk limitations?

A. $500, $1,000

B. $1,000, $500

C. $0, $0

D. $14,000, $1,000

75. Which person would generally be treated as a material participant in an activity?

A. A participant in a rental activity

B. A limited partner

C. A LLC member not involved with management of the LLC

D. A general partner

76. If a taxpayer sells a passive activity with suspended passive activity losses from prior years, what type of income can be offset by the suspended passive losses in the year of sale?

A. Passive activity income

B. Portfolio income

C. Active business income

D. Any of these types of income can be offset.

E. None of these. The suspended losses disappear when the passive activity is sold.

77. John, a limited partner of Candy Apple, LP, is allocated $30,000 of ordinary business loss from the partnership. Before the loss allocation, his tax basis is $20,000 and at-risk amount is $10,000. John also has ordinary business income of $20,000 from Sweet Pea, LP as a general partner and ordinary business income of $5,000 from Red Tomato, as a limited partner. How much of the $30,000 loss from Candy Apple can John deduct currently?

A. $5,000

B. $10,000

C. $25,000

D. $30,000

78. Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true?

A. Partnership losses must be used only in the year the losses are created

B. Partnership losses may be carried back 2 years and carried forward 5 years

C. Partnership losses may be carried forward indefinitely

D. Partnership losses may be carried back 2 years and carried forward 20 years

79. Which of the following would not be classified as a material participant in an activity?

A. An individual who participates more than 100 hours a year and the person's participation is not less than any other individual's participation

B. An individual who participated in the activity for at least one of the preceding five taxable years

C. An individual who participates in an activity regularly, continuously, and substantially

D. An individual who participates in an activity for more than 500 hours a year

Essay Questions

80. What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory.

81. On March 15, 20X9, Troy, Peter, and Sarah formed Picture Perfect general partnership. This partnership was created to sell a variety of cameras, picture frames, and other photography accessories. When it was formed, the partners received equal profits and capital interests and the following items were contributed by each partner:

• Troy - cash of $3,000, inventory with a FMV and tax basis of $5,000, and a building with a FMV of $22,000 and adjusted basis of $10,000. Additionally, the building was secured by a $10,000 nonrecourse mortgage.

• Peter - cash of $5,000, accounts payable of $12,000 (recourse debt for which each partner becomes equally responsible), and land with a FMV of $27,000 and tax basis of $20,000.

• Sarah - cash of $2,000, accounts receivable with a FMV and tax basis of $1,000, and equipment with a FMV of $40,000 and adjusted basis of $3,500. Sarah also contributed a $23,000 nonrecourse note payable secured by the equipment.

What is each partner's outside basis and how much gain (loss) must the partners recognize in 20X9 when Picture Perfect was formed?

82. J&J, LLC was in its third year of operations when J&J decided to expand the number of members from two, A & B, with equal profits and capital interests to three members, A, B, and C. The third member, C, will contribute her financial expertise to the LLC in exchange for a 1/3 capital interest in J&J. Given the balance sheet below reflecting the financial position of J&J on the date member C is admitted, what are the tax consequences to members A, B, and C, and to J&J when C receives her capital interest? If, instead, member C receives a 1/3 profit interest, what would be the tax consequences to members A, B, and C, and to J&J?

83. On April 18, 20X8, Robert sold his 35 percent partnership interest in Fruit Wonder, LLC to Richard for $120,000. Prior to selling his interest, Robert had a basis in Fruit Wonder of $80,000. Robert's basis included $5,000 of recourse debt and $15,000 of nonrecourse debt that had been allocated to him. Immediately after the purchase, what is Richard's tax basis in Fruit Wonder?

84. On March 15, 20X9, Troy, Peter, and Sarah formed Picture Perfect General Partnership. This partnership was created to sell a variety of cameras, picture frames, and other photography accessories. The following items were contributed by each partner in exchange for a 1/3 capital and profits interest:

• Troy - cash of $3,000, inventory with a FMV and tax basis $5,000, and a building with a FMV of $8,000 and adjusted basis of $10,000. Additionally, the building is secured by a $10,000 mortgage.

• Peter - cash of $5,000, accounts payable with a FMV and tax basis of $19,000, and land with a FMV and tax basis of $20,000.

• Sarah - cash of $2,000, accounts receivable with a FMV and tax basis of $1,000, and equipment with a FMV of $26,000 and adjusted basis of 4,000. Also, the equipment is secured by a $23,000 note payable.

What is the partnership's inside basis in each asset? How much gain or loss must Picture Perfect recognize? Prepare Picture Perfect's balance sheet reflecting the partners' capital accounts on both a tax basis and 704(b)/FMV basis.

85. In each of the independent scenarios below, how does the partner or partnership determine its holding period in the property received?

a. A partner contributes property in exchange for a partnership interest

b. The partnership receives contributed property

c. A partner contributes services in exchange for a partnership interest

d. A partner purchases a partnership interest from an existing partner

86. On June 12, 20X9, Kevin, Chris, and Candy Corp. came together to form Scrumptious Sweets General Partnership. Now, Scrumptious Sweets must decide which tax year-end to use. Kevin and Chris have calendar year-ends and each holds a 35% profits and capital interest. However, Candy Corp. has a September 30th year-end and holds the remaining 30% profits and capital interest. What tax year-end must Scrumptious Sweets adopt and what rule mandates this year-end?

87. KBL, Inc., AGW, Inc., Blaster, Inc., Shiny Shoes, Inc., and a group of 24 individuals form Shoes Galore General Partnership on October 11, 20X9. Now, Shoes Galore must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Shoes Galore use and what rule requires this year-end?

88. Lincoln, Inc., Washington, Inc., and Adams, Inc. form Presidential Suites Partnership on February 15, 20X9. Now, Presidential Suites must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Presidential Suites use and what rule requires this year-end?

89. Jordan, Inc., Bird, Inc., Ewing, Inc., and Barkley, Inc. formed Nothing-But-Net Partnership on June 1st, 20X9. Now, Nothing-But-Net must adopt its required tax year-end. The partners' year-ends, profits interests, and capital interests are reflected in the table below. Given this information, what tax year-end must Nothing-But-Net use and what rule requires this year-end?

90. What general accounting methods may be used by a partnership and how and by whom are they selected?

91. Illuminating Light Partnership had the following revenues, expenses, gains, losses, and distributions:

Given these items, what is Illuminating Light's ordinary business income (loss) for the year?

92. Lloyd and Harry, equal partners, form the Ant World Partnership. During the year, Ant World had the following revenue, expenses, gains, losses, and distributions:

Given these items, what amount of ordinary business income (loss) and what separately-stated items should be allocated to each partner for the year?

93. Why are guaranteed payments deducted in calculating the ordinary business income (loss) of partnerships and treated as a separately-stated item for the partners that receive the payment?

94. ER General Partnership, a medical supplies business, states in its partnership agreement that Erin and Ryan agree to split profits and losses according to a 40/60 ratio. Additionally, the partnership will provide Erin with a $15,000 guaranteed payment for services she provides to the partnership. ER Partnership reports the following revenues, expenses, gains, losses, and distributions for its current taxable year:

Given these items, answer the following questions:

A. Compute Erin's share of ordinary income (loss) and separately-stated items. Include her self-employment income as a separately-stated item.

B. Compute Erin's self-employment income, except assume ER Partnership is a limited partnership and Erin is a limited partner.

C. Compute Erin's self-employment income, except assume ER Partnership is an LLC and Erin is personally liable for half of the debt of the LLC. Apply the IRS's proposed regulations in formulating your answer.

95. This year, Reggie's distributive share from Almonte Partnership includes $8,000 of interest income, $4,000 of dividend income, and $60,000 ordinary business income.

A. Assume that Reggie materially participates in the partnership. How much of his distributive share from Almonte Partnership is potentially subject to the Medicare contribution tax?

B. Assume that Reggie does not materially participate in the partnership. How much of his distributive share from Almonte Partnership is potentially subject to the Medicare contribution tax?

96. Greg, a 40% partner in GSS Partnership, contributed land to the partnership in exchange for his partnership interest when the partnership was formed. At the time, his basis in the land was $30,000 and its FMV was $133,000. Three years after the partnership was formed, GSS Partnership decided to sell the land to an unrelated party for $150,000. When the land is sold, how much of the gain should be allocated to each partner of GSS Partnership if Sam and Steve are each 30% partners?

97. Ruby's tax basis in her partnership interest at the beginning of the partnership's tax year was $13,000. The following items were included in her Schedule K-1 from the partnership for the year:

Determine what amounts related to these items Ruby will report on her tax return assuming her tax basis and at risk amount are equal and that she is a material participant in the partnership's activities.

98. At the end of year 1, Tony had a tax basis of $40,000 in Tall Ladders, Limited Partnership. Tony has a 20 percent profits interest in Tall Ladders. For year 2, Tall Ladders will pay Tony a $10,000 guaranteed payment for extra services he provides to the partnership. Given the following Income Statement and Balance Sheet from Tall Ladders, what is Tony's adjusted tax basis at the end of year 2?

99. Alfred, a 33% profits and capital partner in Pizzeria Partnership, needs help in adjusting his tax basis to reflect the information contained in his most recent Schedule K-1 from the partnership. Unfortunately, the Schedule K-1 he recently received was for year 3 of the partnership, but Alfred only knows that his tax basis at the beginning of year 2 of the partnership was $23,000. Thankfully, Alfred still has his Schedule K-1 from the partnership for years 1 and 2.

Using the following information from Alfred's year 1, year 2, and year 3 Schedule K-1, calculate his tax basis the end of year 2 and year 3.

100. Explain why partners must increase their tax basis for their share of partnership taxable and nontaxable income or gain and reduce their basis by their share of partnership deductible and nondeductible expenses or losses?

101. On January 1, 20X9, Mr. Blue and Mr. Grey each contributed $100,000 to form the B&G general partnership. Their partnership agreement states that they will each receive a 50% profits and loss interest. The partnership agreement also provides that Mr. Blue will receive an annual $36,000 guaranteed payment.

B&G began business on January 1, 20X9. For its first taxable year, its accounting records contained the following information.

The $3,000 of interest was paid on a $60,000 loan made to B&G by Key Bank on June 30, 20X9. B&G repaid $10,000 of the loan on December 15, 20X9. Neither of the partners received a cash distribution from B&G in 20X9.

Complete the following table related to Mr. Blue's interest in B&G partnership:

102. Peter, Matt, Priscilla, and Mary began the year in the PMPM General Partnership sharing profits, losses, and capital equally. They each had a tax basis at the beginning of the year of $3,000, $10,000, $8,000, and $11,000 respectively. Early in the year, Mary provided general consulting services to the partnership and received an additional 15 percent profits, losses, and capital interest in the partnership. The liquidation value of her additional interest was $45,000. Later the same year, the partnership received cash contributions of $25,000 from Peter and Matt that it used to repay the partnership's $35,000 recourse debt. According to state law, the partners shared responsibility for this debt in accordance with their loss sharing ratios. What is each partner's tax basis after adjustment for these transactions?

103. Bob is a general partner in Fresh Foods Partnership and is trying to determine if the income reported on his K-1 should be classified as passive or active trade or business income. List three different criteria that, if met, would allow Bob to treat the income from Fresh Foods as active trade or business income.

104. Clint noticed that the Schedule K-1 he just received from ABC Partnership included a $20,000 ordinary business loss allocation. His tax basis in ABC at the beginning of ABC's most recent tax year was $10,000. Comparing the Schedule K-1 he recently received from ABC with the Schedule K-1 he received from ABC last year, Clint noted that his share of ABC partnership debt changed as follows: recourse debt increased from $0 to $2,000, qualified nonrecourse debt increased from $0 to $3,000, and nonrecourse debt increased from $0 to $3,000. Finally, the Schedule K-1 Clint recently received from ABC reflected a $1,000 cash contribution he made to ABC during the year.

Clint is not a material participant in ABC partnership, and he received $10,000 of passive income from another investment during the same year he received the loss allocation from ABC. How much of the $20,000 loss from ABC can Clint deduct currently, and how much of the loss is suspended because of the tax basis, the at-risk, and the passive activity loss limitations?

105. Fred has a 45% profits interest and 30% capital interest in the SAP Partnership and his tax basis before considering his share of SAP's current year loss is $11,000. Included in his tax basis is a $2,600 share of recourse debt and $5,300 share of nonrecourse debt. Fred is a limited partner in SAP. He is not involved in any other activities. If SAP has a $15,000 ordinary loss for the year, how much of the loss can be deducted currently, and how much of the loss is suspended because of the tax basis, the at-risk, and the passive activity loss limitations?

106. What is the difference between a partner's tax basis and at-risk amount?