Chapter 20 Forming and Operating Partnerships

66. [LO 4] This year, Alex’s distributive share from Eden Lakes Partnership includes $8,000 of interest income, $4,000 of net long-term capital gains, $2,000 net section 1231 gain from the sale of property used in the partnership’s trade or business, and $83,000 of ordinary business income.

a. Assume that Alex materially participates in the partnership. How much of his distributive share from Eden Lakes Partnership is potentially subject to the net investment income tax?

b. Assume that Alex does not materially participate in the partnership. How much of his distributive share from the Eden Lakes partnership is potentially subject to the net investment income tax?

67. [LO 4] {Research} Lane and Cal each own 50 percent of the profits and capital of HighYield LLC. HighYield owns a portfolio of taxable bonds and municipal bonds, and each year the portfolio generates approximately $10,000 of taxable interest and $10,000 of tax- exempt interest. Lane’s marginal tax rate is 35 percent while Cal’s marginal tax rate is 15 percent. To take advantage of the difference in their marginal tax rates, Lane and Cal want to modify their operating agreement to specially allocate all of the taxable interest to Cal and all of the tax-exempt interest to Lane. Until now, Lane and Cal had been allocated 50 percent of each type of interest income.

a. Is HighYield’s proposed special allocation acceptable under current tax rules? Why or why not? {Hint:See Reg. §1.704-1(b)(2)(iii)(b) and §1.704-1(b)(5) Example (5).}

b. If the IRS ultimately disagrees with HighYield’s special allocation, how will it likely reallocate the taxable and tax-exempt interest among the members? {Hint: See Reg. §1.704-1(b)(5) Example (5)(ii).}

68. [LO 5] Larry’s tax basis in his partnership interest at the beginning of the year was $10,000. If his share of the partnership debt increased by $10,000 during the year and his share of partnership income for the year is $3,000, what is his tax basis in his partnership interest at the end of the year?

69. [LO 5] Carmine was allocated the following items from the Piccolo LLC for last year:

Ordinary business loss

Nondeductible penalties

Tax-exempt interest income

Short-term capital gain

Cash distributions

Rank these items in terms of the order they should be applied to adjust Carmine’s tax basis in Piccolo for the year (some items may be of equal rank).

70. [LO 5] Oscar, Felix, and Marv are all one-third partners in the capital and profits of Eastside general partnership. In addition to their normal share of the partnership’s annual income, Oscar and Felix receive annual guaranteed payments of $7,000 to compensate them for additional services they provide. Eastside’s income statement for the current year reflects the following revenues and expenses:

Sales revenue $ 420,000

Dividend income 5,700

Short-term capital gains 2,800

Cost of goods sold (210,000)

Employee wages (115,000)

Depreciation expense (28,000)

Guaranteed payments (14,000)

Miscellaneous expenses (9,500)

Overall net income $ 52,000

In addition, Eastside owed creditors $120,000 at the beginning of the year but managed to pay down its debts to $90,000 by the end of the year. All partnership debt is allocated equally among the partners. Finally, Oscar, Felix and Marv had a tax basis of $80,000 in their interests at the beginning of the year.

a. What tax basis do the partners have in their partnership interests at the end of the year?

b. Assume the partners began the year with a tax basis of $10,000 and all the debt was paid off on the last day of the year. How much gain will the partners recognize when the debt is paid off? What tax basis do the partners have in their partnership interests at the end of the year?