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Introduction to Partnership Taxation

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Partnership Taxation © Joe Walsh, 2012:

Partnership Taxation © Joe Walsh, 2012 Introduction to The Balance Sheets Approach Methodology and Terminology

Partnership’s Balance Sheets Fundamental Accounting Equation © Joe Walsh, 2012:

Partnership’s Balance Sheets Fundamental Accounting Equation © Joe Walsh, 2012 Assets = Liabilities + Owners’ Equity Partnerships have TWO Balance Sheets BOOK balance sheet TAX balance sheet

Fundamental Academic Methodology Partnership BOOK Balance Sheet © Joe Walsh, 2012 :

Fundamental Academic Methodology Partnership BOOK Balance Sheet © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value CAPTIAL ACCOUNTS Cash 100 100 A 50 100 Accounts Receivable 0 150 B 50 100 Equipment 50 75 C 50 100 Intellectual Property 50 75 D 50 100 Total 200 400 200 400

Fundamental Accounting Equation Book Balance Sheet © Joe Walsh, 2012 :

Fundamental Accounting Equation Book Balance Sheet © Joe Walsh, 2012 Assets = Liabilities + Owners’ Equity Assets = Liabilities + Partners’ Capital Accounts Capital Accounts determined per Sec. 1.704-1(b)(2)(iv) Amount of wealth partner entitled to receive from partnership Asset Book Values – no direct authority – infer from capital account maintenance rules of Sec. 704(b)

Fundamental Academic Methodology Partnership TAX Balance Sheet © Joe Walsh, 2012 :

Fundamental Academic Methodology Partnership TAX Balance Sheet © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 100 A 50 100 Accounts Receivable 0 150 B 50 100 Equipment 50 75 C 50 100 Intellectual Property 50 75 D 50 100 Total 200 400 200 400

Fundamental Accounting Equation TAX Balance Sheet © Joe Walsh, 2012 :

Fundamental Accounting Equation TAX Balance Sheet © Joe Walsh, 2012 Inside Basis = basis of assets Contribution – Sec. 723 Cost – Sec. 1012 Depreciation, etc. – Secs . 168, etc. Outside Basis = partners’ basis in partnership interest Single most important concept of course Contribution – Sec. 722 Purchase – Sec. 742 Thereafter – Sec. 705

Fundamental Accounting Equation TAX Balance Sheet © Joe Walsh, 2012 :

Fundamental Accounting Equation TAX Balance Sheet © Joe Walsh, 2012 Total Inside Basis = Total Outside Basis Three transactions that cause inequality Sec. 754 election can restore equality Adjust Inside Basis

Inside Basis NOT Equal Outside Basis E Buys D’s Partnership Interest © Joe Walsh, 2012 :

Inside Basis NOT Equal Outside Basis E Buys D’s Partnership Interest © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 100 A 50 100 Accounts Receivable 0 150 B 50 100 Equipment 50 75 C 50 100 Intellectual Property 50 75 E 100 100 Total 200 400 250 400

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012:

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 100 A 50 100 Accounts Receivable 0 150 B 50 100 Equipment 50 75 C 50 100 Intellectual Property 50 75 D 50 100 Total 200 400 200 400

Partnership Taxation Book-Tax Differences © Joe Walsh, 2012 :

Partnership Taxation Book-Tax Differences © Joe Walsh, 2012 Difference between Book Value and Inside Basis of Assets Required by Sec. 704( c ) to account for difference On sale must allocate tax gain to contributing partner Will usually eliminate book-tax difference [Capital Account/ Outside Basis] of contributing partner

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012:

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 100 A 50 100 Property 25 100 B 25 100 Equipment 25 100 C 75 100 Intellectual Property 50 100 D 50 100 Total 200 400 200 400

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012:

Partnership Balance Sheets Book-Tax Difference © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100+100=200 100+100=200 A 50 100 Property --- --- B 25+75=100 100 Equipment 25 100 C 75 100 Intellectual Property 50 100 D 50 100 Total 275 400 275 400

Partnership Taxation Balance Sheets Approach:

Partnership Taxation Balance Sheets Approach Requires us to look at same transaction from 4 different perspectives Book Value – economics to partnership Capital Accounts – economics to partners Inside Basis – tax consequences to partnership Outside Basis – tax consequences to partners

Partnership Balance Sheets Partnership Debt:

Assets = Liabilities + Owners Equity Increase in Partner’s share of partnership debt treated as Contribution of Money that increases Outside Basis Decrease in Partner’s share of Partnership debt treated as a Distribution of Money that decreases Outside Basis Maintains equality between Inside and Outside Basis Partnership Balance Sheets Partnership Debt

Partnership Balance Sheets Effect of Debt © Joe Walsh, 2012:

Partnership Balance Sheets Effect of Debt © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 +100 =200 100+ 100 =200 Debt 100 100 Accounts Receivable 0 150 A 50 100 Equipment 50 75 B 50 100 Intellectual Property 50 75 C 50 100 D 50 100 Total 200 +100 =300 400 +100 =500 200+ 100 =300 400+100=500

Partnership Balance Sheets Effect of Debt © Joe Walsh, 2012:

Partnership Balance Sheets Effect of Debt © Joe Walsh, 2012 Assets Inside Basis Book Value Partners Outside Basis Book Value Cash 100 +100 =200 100+ 100 =200 Debt 100 Accounts Receivable 0 150 A 50 +25 =75 100 Equipment 50 75 B 50 +25 =75 100 Intellectual Property 50 75 C 50 +25 =75 100 D 50 +25 =75 100 Total 200 +100 =300 400 +100 =500 200+ 100 =300 400 +100 =500

Partnership Taxation Summary © Joe Walsh, 2012 :

Partnership Taxation Summary © Joe Walsh, 2012 Inside Basis Outside Basis Capital Account Inside Basis = Outside Basis Sec. 754 election Book-Tax Difference Required to Account for Under Sec. 704( c )

Partnership Taxation Summary © Joe Walsh, 2012 :

Partnership Taxation Summary © Joe Walsh, 2012 Hope you enjoyed this See you next week for Contributions

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