CPA Regulation (REG) : Taxation of Flow-Through Entities
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Example Questions
Example Question #1 : Realized & Recognized Gains In Formation/Liquidation
Anne and Bart formed AB, LLC, a limited liability company, and elected to treat it as a partnership for tax purposes. Anne contributed $10,000 cash, and Bart contributed $5,000 cash, but Bart had a special skill that the partnership needed to be successful. The partnership agreement stated that Anne and Bart would both have a 50% interest in the LLC and that all profits and losses would be divided evenly between them. The LLC paid Bart $5,000 in year 1 for Bart's services to the partnership. The $5,000 would generally be reported to Bart as which of the following?
Dividends.
Wages.
A guaranteed payment.
Salary.
A guaranteed payment.
When a capital interest is acquired for services provided to a partnership, the interest is treated as ordinary income to the partner. Ordinary income to a partner is classified as guaranteed payments.
Example Question #2 : Taxation Of Flow Through Entities
A partner sold a 25% interest in a partnership for $400,000 cash plus assumption of the partner's share of the partnership liabilities. The following additional information relates to the partnership activities:
- Partner's initial cash contribution: $ 100,000
- Partnership income during the partner's ownership time period: 1,000,000
- Partnership liabilities at date of sale: 60,000
- Partner's cash withdrawals: 50,000
How much gain is recognized by the partner upon the sale of the partnership interest?
$50,000
$35,000
$100,000
$650,000
$100,000
To determine the gain on the sale of the interest, the partner’s basis in the interest must first be determined:
- Initial Contribution: $100,000
- 25% Partnership Income over Period of Ownership: $250,000
- 25% Share of Partnership Liabilities: $15,000
- Partner’s Cash Withdrawals: $(50,000)
- Total Partnership Basis: $315,000
Example Question #3 : Taxation Of Flow Through Entities
Taryn, Rose, and Summer are equal partners in TRS partnership. Taryn contributed land with an adjusted basis of $20,000 and a fair market value (FMV) of $50,000. Rose contributed equipment with an adjusted basis of $40,000 and an FMV of $50,000. Summer provided services worth $50,000. What amount of income is recognized as a result of the transfers?
$50,000
$90,000
$60,000
$150,000
$50,000
In formation of a partnership, the only two instances in which a gain (income) is recognized is when a partner contributes services in exchange for capital interest, or when property contributed is subject to a liability in excess of the property’s adjusted basis. Here, Summer provided services and so would recognize $50,000 of income. The other two partners would recognize no gain on their contribution of property.
Example Question #3 : Taxation Of Flow Through Entities
In the absence of an election to adopt an annual accounting period, the required tax year for a partnership is:
A tax year of one or more partners with a more than 50% interest in profits and capital
A calendar year
A tax year of a principal partner having a 10% or greater interest
A tax year that results in the greatest aggregate deferral of income
A tax year of one or more partners with a more than 50% interest in profits and capital
In the absence of election to adopt an annual accounting period, the required tax year for a partnership is the tax year of one or more partners who have more than 50% interest in aggregate of profits and capital, per the majority interest rule
Example Question #4 : Taxation Of Flow Through Entities
Andrew contributed the following assets to a partnership in exchange for a 50% interest in the partnership’s capital and profits: Cash of $50,000, Equipment with a FMV of $35,000 and Carrying amount of $25,000. Andrew’s basis in the partnership is:
$75,000
$37,500
$42,500
$85,000
$85,000
The basis of the partner’s interest in the partnership is calculated as $50,000 + $25,000 = $75,000.
Example Question #5 : Taxation Of Flow Through Entities
A partner’s basis in a partnership will increase by his or her share of liabilities assumed by the partnership.
False
False if the partnership was formed before 2017
True if the partnership was formed before 2017
True
True
This statement is true and has no correlation with the TCJA or any other tax reform.
Example Question #1 : Shareholder & Partnership Basis
Strom acquired a 25% interest in Ace Partnership by contributing land having an adjusted basis of $16,000 and a fair market value of $50,000. The land was subject to a $24,000 mortgage, which was assumed by Ace. No other liabilities existed at the time of the contribution. What was Strom's basis in Ace?
$32,000
$26,000
$16,000
$0
$0
Since Strom contributed property subject to a liability, where the value of the liability exceeded the property, Strom begins with a negative basis of $(8,000). Strom’s partnership basis is increased by the assumption of the 25% share of the liability (=$6,000), bringing Strom’s basis up to $(2,000). Since a negative basis is not possible, Strom would have to recognize a gain to bring the partnership basis up to zero.
Example Question #1 : Shareholder & Partnership Basis
Lemon owned 2,000 shares of Spectrol Corp. common stock that were purchased in year 1 at $10.50 per share. In year 4, Lemon received a 5% non-taxable dividend of Spectrol common stock. In year 5, the stock split 2-for-1. In the current year Lemon sold 800 shares. What is Lemon's basis in the 800 shares of stock sold?
$4,000
$8,000
$8,400
$16,800
$4,000
The original basis in the stock was $21,000 (2,000 shares at $10.50/share). The stock dividend of 5% increased the number of shares by 100 (2,000 * 5%), bringing the total shares to 2,100, while the basis remained the same ($21,000) and consequently the per share value decreased to $10/share. The stock split doubled the number of shares from 2,100 to 4,200, but the basis remained the same and the per share value was halved (from $10/share to $5/share). As a result, the 800 shares sold had a basis of $4,000 (800 shares * $5/share).
Example Question #1 : Taxation Of Flow Through Entities
Mark and Mary formed MM, Inc. as an S corporation. Each contributed $50,000 in exchange for five shares of corporate stock. In addition, MM obtained a $60,000 loan from a local bank that was still outstanding at the end of the year. In MM's first year of operation, it reported a loss of $20,000 and did not make any distributions to the shareholders. What is Mark's basis in his MM shares at the beginning of the second year?
$70,000
$40,000
$100,000
$50,000
$40,000
Mark began with a basis of $50,000, which was decreased by his 50% share of the operating loss of $20,000. As a result, his basis was $40,000 at the beginning of the second year. For S corporations, unlike partnerships, liabilities assumed by the corporation do not increase shareholders’ basis in the organization.
Example Question #2 : Taxation Of Flow Through Entities
Steve received a one third interest in a partnership by contributing $3,000 in cash, stock with FMV of $5,000 and a basis of $2,000, and a new computer that cost Steve $2,500. Of the following, which amount represents Steve’s basis in the partnership?
$5,500
$10,500
$3,000
$7,500
$5,500
Steve’s basis in the partnership is calculated as $3,000 cash + $2,000 stock basis + $2,500 computer basis.
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