Publication 541 |
2000 Tax Year |
Partner's Income or Loss
A partner's income or loss from a partnership is the partner's
distributive share of partnership items for the partnership's tax year
that ends with or within the partner's tax year. These items are
reported to the partner on Schedule K-1 (Form 1065).
Gross income.
When it is necessary to determine the gross income of a partner,
the partner's gross income includes his or her distributive share of
the partnership's gross income. For example, the partner's share of
the partnership gross income is used in determining whether an income
tax return must be filed by that partner.
Estimated tax.
Partners may have to make payments of estimated tax during the year
as a result of partnership income.
Generally, estimated tax for individuals is the smaller of the
following amounts, reduced by any expected withholding and credits.
- 90% of the tax expected to be shown on the current year's
tax return.
- 100% of the total tax shown on the prior year's tax
return.
Different rules apply to certain higher income individuals and
individuals who receive at least two-thirds of their gross income from
farming or fishing.
See Publication 505
for more information.
Self-employment income.
A partner is not an employee of the partnership. The partner's
distributive share of ordinary income from a partnership is generally
included in figuring net earnings from self-employment. However, a
limited partner generally does not include his or her distributive
share of income or loss in computing net earnings from
self-employment. This exclusion does not apply to guaranteed payments
made to a limited partner for services actually rendered to or on
behalf of a partnership engaged in a trade or business.
Self-employment tax.
If an individual partner has net earnings from self-employment of
$400 or more for the year, the partner must figure self-employment tax
on Schedule SE (Form 1040). For more information on self-employment
tax, see Publication 533.
Alternative minimum tax.
To figure alternative minimum tax, a partner must separately take
into account any distributive share of items of income and deductions
that enter into the computation of alternative minimum taxable income.
For information on which items of income and deductions are affected,
see the Form 6251 instructions.
Partners of electing large partnerships should see the
Partner's Instructions for Schedule K-1 (Form 1065-B),
for information on alternative minimum tax.
Figuring Distributive Share
Generally, the partnership agreement determines a partner's
distributive share of any item or class of items of income, gain,
loss, deduction, or credit. However, the allocations provided for in
the partnership agreement or any modification will be disregarded if
they do not have substantial economic effect. If the partnership
agreement does not provide for an allocation, or an allocation does
not have substantial economic effect, the partner's distributive share
of the partnership items is generally determined by the partner's
interest in the partnership. For special allocation rules for items
attributable to built-in gain or loss on property contributed by a
partner, see Contribution of Property under
Transactions Between Partnership and Partners, later.
Substantial economic effect.
An allocation has substantial economic effect if both of the
following tests are met.
- There is a reasonable possibility that the allocation will
substantially affect the dollar amount of the partners' shares of
partnership income or loss independently of tax consequences.
- The partner to whom the allocation is made actually receives
the economic benefit or bears the economic burden corresponding to
that allocation.
Allocation attributable to a nonrecourse liability.
An allocation of a loss, deduction, or expense attributable to a
partnership nonrecourse liability does not have any
economic effect because the partner does not bear the economic burden
corresponding to that allocation. (See Effect of Partnership
Liabilities under Basis of Partner's Interest,
later.) Therefore, the partner's distributive share of the item must
be determined by his or her interest in the partnership. For more
information, see section 1.704-2 of the regulations.
Partner's interest in partnership.
If a partner's distributive share of a partnership item cannot be
determined under the partnership agreement, it is determined by his or
her interest in the partnership. The partner's interest is determined
by taking into account all of the following items.
- The partners' relative contributions to the
partnership.
- The interests of all partners in economic profits and losses
(if different from interests in taxable income or loss) and in cash
flow and other nonliquidating distributions.
- The rights of the partners to distributions of capital upon
liquidation.
Varying interests.
A change in a partner's interest during the partnership's tax year
requires the partner's distributive share of partnership items to be
determined by taking into account his or her varying interests in the
partnership during the tax year. Partnership items are allocated to
the partner only for the portion of the year in which he or she is a
member of the partnership.
This rule applies to a partner who sells or exchanges part of an
interest in a partnership, or whose interest is reduced or increased
(whether by entry of a new partner, partial liquidation of a partner's
interest, gift, additional contributions, or otherwise).
Example.
ABC is a calendar year partnership with three partners, Alan, Bob,
and Cathy. Under the partnership agreement, profits and losses are
shared in proportion to each partner's contributions. On January 1 the
ratio was 90% for Alan, 5% for Bob, and 5% for Cathy. On December 1
Bob and Cathy each contributed additional amounts. The new profit and
loss sharing ratios were 30% for Alan, 35% for Bob, and 35% for Cathy.
For its tax year ended December 31, the partnership had a loss of
$1,200. This loss occurred equally over the partnership's tax year.
The loss is divided among the partners as follows:
Partner |
Profit
of Loss
% x |
Part
of Year
Held x |
Total
Loss = |
Share
of Loss |
Alan |
90 x |
11/12 x |
$1,200 = |
$990 |
30 x |
1/12 x |
1,200 = |
30 |
Bob |
5 x |
11/12 x |
1,200 = |
55 |
35 x |
1/12 x |
1,200 = |
35 |
Cathy |
5 x |
11/12 x |
1,200 = |
55 |
35 x |
1/12 x |
1,200 = |
35 |
Certain cash basis items prorated daily.
If any partner's interest in a partnership changes during the tax
year, each partner's share of certain cash basis items of the
partnership must be determined by prorating the items on a daily
basis. That daily portion is then allocated to the partners in
proportion to their interests in the partnership at the close of each
day. This rule applies to the following items for which the
partnership uses the cash method of accounting.
- Interest.
- Taxes.
- Payments for services or for the use of property.
Distributive share in year of disposition.
If a partner's entire interest in a partnership is disposed of,
whether by sale, exchange, liquidation, the partner's death, or
otherwise, his or her distributive share of partnership items must be
included in the partner's income for the tax year in which membership
in the partnership ends. To compute the distributive share of these
items, the partnership's tax year is considered ended on the date the
partner disposed of the interest. To avoid an interim closing of the
partnership books, the partners can agree to estimate the distributive
share by taking the prorated amount the partner would have included in
income if he or she had remained a partner for the entire partnership
tax year.
Self-employment income of deceased partner.
A different rule applies in computing a deceased partner's
self-employment income for the year of death. The partner's
self-employment income includes the partner's distributive share of
income earned by the partnership through the end of the month in which
the partner's death occurs. This is true even though the deceased
partner's estate or heirs may succeed to the decedent's rights in the
partnership. For this purpose, partnership income for the
partnership's tax year in which a partner dies is considered to be
earned equally in each month.
Example.
Larry, a partner in WoodsPar, is a calendar year taxpayer.
WoodsPar's fiscal year ends June 30. For the partnership year ending
June 30, 2000, Larry's distributive share of partnership profits is
$2,000. On August 18, 2000, Larry dies and his estate succeeds to his
partnership interest. For the partnership year ending June 30, 2001,
Larry and his estate's distributive share is $3,000.
Larry's self-employment income to be reported on Schedule SE (Form
1040) for 2000 is $2,500. This consists of his $2,000 distributive
share for the partnership tax year ending June 30, 2000, plus $500 ( 2/12 x $3,000) of the distributive share for the tax
year ending June 30, 2001.
Reporting Distributive Share
A partner must report his or her distributive share of partnership
items on his or her tax return, whether or not it is actually
distributed. (However, a partner's deduction for his or her
distributive share of a loss may be limited. See Limits on
Losses, later.) These items are reported to the partner on
Schedule K-1 (Form 1065).
The following discussions explain how partnership items are treated
on a partner's return.
See the Partner's Instructions for Schedule K-1 (Form
1065) for more information.
Character of items.
The character of each item of income, gain, loss, deduction, or
credit included in a partner's distributive share is determined as if
the partner realized the item directly from the same source as the
partnership or incurred the item in the same manner as the
partnership.
For example, a partner's distributive share of gain from the sale
of partnership depreciable property used in the trade or business of
the partnership is treated as gain from the sale of depreciable
property the partner used in a trade or business.
Inconsistent treatment of items.
Partners must generally treat partnership items the same way on
their individual tax returns as they are treated on the partnership
return. If a partner treats an item differently on his or her
individual return, the IRS can immediately assess and collect any tax
and penalties that result from adjusting the item to make it
consistent with the partnership return. However, this rule will not
apply if a partner identifies the different treatment by filing
Form 8082, Notice of Inconsistent Treatment or
Administrative Adjustment Request (AAR), with his or her return.
Consolidated audit procedures.
In a consolidated audit proceeding, the tax treatment of any
partnership item is generally determined at the partnership level
rather than at the individual partner's level. After the proper
treatment is determined at the partnership level, the IRS can
automatically make related adjustments to the tax returns of the
partners, based on their share of the adjusted items.
The consolidated audit procedures do not apply to certain small
partnerships (with 10 or fewer partners) if all partners are one of
the following.
- An individual (other than a nonresident alien).
- A C corporation.
- An estate of a deceased partner.
However, small partnerships can make an election to have these
procedures apply.
Limits on Losses
Partner's adjusted basis.
A partner's distributive share of partnership loss is allowed only
to the extent of the adjusted basis of the partner's partnership
interest. The adjusted basis is figured at the end of the
partnership's tax year in which the loss occurred, before taking the
loss into account. Any loss more than the partner's adjusted basis is
not deductible for that year. However, any loss not allowed for this
reason will be allowed as a deduction (up to the partner's basis) at
the end of any succeeding year in which the partner increases his or
her basis to more than zero. See Basis of Partner's Interest,
later.
Example.
Mike and Joe are equal partners in a partnership. Mike files his
individual return on a calendar year basis. The partnership return is
also filed on a calendar year basis. The partnership incurred a
$10,000 loss last year and Mike's distributive share of the loss is
$5,000. The adjusted basis of his partnership interest before
considering his share of last year's loss was $2,000. He could claim
only $2,000 of the loss on last year's individual return. The adjusted
basis of his interest at the end of last year was then reduced to
zero.
The partnership showed an $8,000 profit for this year. Mike's
$4,000 share of the profit increases the adjusted basis of his
interest by $4,000 (not taking into account the $3,000 excess loss he
could not deduct last year). His return for this year will show his
$4,000 distributive share of this year's profits and the $3,000 loss
not allowable last year. The adjusted basis of his partnership
interest at the end of this year is $1,000.
Not-for-profit activity.
Deductions relating to an activity not engaged in for profit are
limited. For a discussion of the limits, see chapter 1 in Publication 535.
At-risk limits.
At-risk rules apply to most trade or business activities, including
activities conducted through a partnership. The at-risk rules limit a
partner's deductible loss to the amounts for which that partner is
considered at risk in the activity.
A partner is considered at risk for all of the following amounts.
- The money and adjusted basis of any property he or she
contributed to the activity.
- The partner's share of net income retained by the
partnership.
- Certain amounts borrowed by the partnership for use in the
activity if the partner is personally liable for repayment or the
amounts borrowed are secured by the partner's property (other than
property used in the activity).
A partner is not considered at risk for amounts protected against
loss through guarantees, stop-loss agreements, or similar
arrangements. Nor is the partner at risk for amounts borrowed if the
lender has an interest in the activity (other than as a creditor) or
is related to a person (other than the partner) having such an
interest.
For more information on determining the amount at risk, see
Publication 925,
the instructions for Form 6198,
At-Risk Limitations, and the Partner's Instructions for
Schedule K-1 (Form 1065).
Passive activities.
Generally, section 469 of the Internal Revenue Code limits the
amount a partner can deduct for passive activity losses and credits.
The passive activity limits do not apply to the partnership. Instead,
they apply to each partner's share of income, loss, or credit from
passive activities. Because the treatment of each partner's share of
partnership income, loss, or credit depends on the nature of the
activity that generated it, the partnership must report income, loss,
and credits separately for each activity.
Generally, passive activities include a trade or business activity
in which the partner does not materially participate. The level of
each partner's participation must be determined by the partner.
Rental activities.
Passive activities also include rental activities, regardless of
the partner's participation. However, a rental real estate activity in
which the partner materially participates is not considered a passive
activity. The partner must also meet both of the following conditions
for the tax year.
- More than half of the personal services the partner performs
in any trade or business are in a real property trade or business in
which the partner materially participates.
- The partner performs more than 750 hours of services in real
property trades or businesses in which the partner materially
participates.
Limited partners.
Limited partners are generally not considered to materially
participate in trade or business activities conducted through
partnerships.
More information.
For more information on passive activities, see Publication 925,
the instructions for Form 8582 and the Partner's
Instructions for Schedule K-1 (Form 1065).
Partner's Exclusions and Deductions
To determine the allowable amount of any exclusion or deduction
subject to a limit, a partner must combine any separate exclusions or
deductions on his or her income tax return with the distributive share
of partnership exclusions or deductions before applying the limit.
Cancellation of qualified real property business debt.
A partner other than a C corporation can elect to exclude from
gross income the partner's distributive share of income from
cancellation of the partnership's qualified real property business
debt. This is a debt (other than a qualified farm debt) incurred or
assumed by the partnership in connection with real property used in
its trade or business and secured by that property. A debt incurred or
assumed after 1992 qualifies only if it was incurred or assumed to
acquire, construct, reconstruct, or substantially improve such
property. A debt incurred to refinance a qualified real property
business debt qualifies, but only up to the refinanced debt.
A partner who elects the exclusion must reduce the basis of his or
her depreciable real property by the amount excluded. For this
purpose, a partnership interest is treated as depreciable real
property to the extent of the partner's share of the partnership's
depreciable real property. However, a partnership interest cannot be
treated as depreciable real property unless the partnership makes a
corresponding reduction in the basis of its depreciable real property
with respect to that partner.
To elect the exclusion, the partner must
file Form 982, Reduction of Tax Attributes Due To
Discharge of Indebtedness, with his or her original income tax
return. However, if the partner timely filed the return without making
the election, he or she can still make the election by filing an
amended return within six months of the due date of the original
return (excluding extensions). The election must be attached to the
amended return with "Filed pursuant to section 301.9100-2"
written on the election statement. The amended return should be filed
at the same address as the original return.
Exclusion limit.
The partner's exclusion cannot be more than the smaller of the
following two amounts.
- The partner's share of the excess (if any) of:
- The outstanding principal of the debt immediately before the
cancellation, over
- The fair market value (as of that time) of the property
securing the debt, reduced by the outstanding principal of other
qualified real property business debt secured by that property (as of
that time).
- The total adjusted bases of depreciable real property held
by the partner immediately before the cancellation (other than
property acquired in contemplation of the cancellation).
Effect on partner's basis.
Because of offsetting adjustments, the cancellation of a
partnership debt does not usually cause a net change in the basis of a
partnership interest. Each partner's basis is:
- Increased by his or her share of the partnership income from
the cancellation of debt (whether or not the partner excludes the
income), and
- Reduced by the deemed distribution resulting from the
reduction in his or her share of partnership liabilities.
(See Adjusted Basis under Basis of Partner's
Interest, later.) The basis of a partner's interest will change
only if the partner's share of income is different from the partner's
share of debt.
As explained earlier, however, a partner's election to exclude
income from the cancellation of qualified real property business debt
may reduce the basis of the partner's interest to the extent the
interest is treated as depreciable real property.
Basis of depreciable real property reduced.
If the basis of depreciable real property is reduced and the
property is disposed of, then the following rules apply for purposes
of determining the ordinary income from recapture of depreciation
under section 1250 of the Internal Revenue Code.
- Any such basis reduction is treated as a deduction allowed
for depreciation.
- The determination of what would have been the depreciation
adjustment under the straight line method is made as if there had been
no such reduction.
Therefore, the basis reduction recaptured as ordinary income is
reduced over the time the partnership continues to hold the property,
as the partnership forgoes depreciation deductions due to the basis
reduction.
Section 179 deduction.
A partnership can elect to deduct all or part of the cost of
certain assets under section 179 of the Internal Revenue Code. The
deduction is passed through to the partners as a separately stated
item.
Limits.
The section 179 deduction is subject to certain limits that apply
to the partnership and to each partner. The partnership determines its
section 179 deduction subject to the limits. It then allocates the
deduction among its partners.
Each partner adds the amount allocated from the partnership (shown
on Schedule K-1) to his or her other nonpartnership section 179
costs and then applies the maximum dollar limit to this total. To
determine if a partner has exceeded the $200,000 investment limit, the
partner does not include any of the cost of section 179 property
placed in service by the partnership. After the maximum dollar limit
and investment limit are applied, the remaining cost of the
partnership and nonpartnership section 179 property is subject to the
taxable income limit.
Figuring partnership's taxable income.
For purposes of the taxable income limit, taxable income of a
partnership is figured by adding together the net income (or loss)
from all trades or businesses actively conducted by the partnership
during the tax year.
Figuring partner's taxable income.
For purposes of the taxable income limit, the taxable income of a
partner who is engaged in the active conduct of one or more of a
partnership's trades or businesses includes his or her allocable share
of taxable income derived from the partnership's active conduct of any
trade or business.
Basis adjustment.
A partner who is allocated section 179 expenses from the
partnership must reduce the basis of his or her partnership interest
by the total section 179 expenses allocated, regardless of whether the
full amount allocated can be currently deducted. See Adjusted
Basis under Basis of Partner's Interest, later. If a
partner disposes of his or her interest in a partnership, the
partner's basis for determining gain or loss is increased by any
outstanding carryover of disallowed deductions of section 179 expenses
allocated from the partnership.
The basis of a partnership's section 179 property must be reduced
by the section 179 deduction elected by the partnership. This
reduction of basis must be made even if any partner cannot deduct his
or her entire allocable share of the section 179 deduction because of
the limits.
More information.
See Publication 946
for more information on the section 179
deduction.
Amortization deduction for reforestation costs.
A partnership can elect to amortize certain reforestation costs for
qualified timber property over an 84-month period. The
amortizable costs are passed through to the partners as a separately
stated item.
Annual limit.
The election can be made for no more than $10,000 of qualified
costs each tax year. Both the partnership and partner are subject to
this limit. The partnership applies the $10,000 limit in determining
the amount of its amortizable costs and allocates that amount among
its partners. The partner adds the amount allocated from the
partnership to his or her qualified costs from other sources and then
applies the $10,000 limit ($5,000 limit, if married filing a separate
return).
More information.
See chapter 9 of Publication 535
for more information.
Partnership expenses paid by partner.
In general, a partner cannot deduct partnership expenses paid out
of personal funds unless the partnership agreement requires the
partner to pay the expenses. These expenses are usually considered
incurred and deductible by the partnership.
If an employee of the partnership performs part of a partner's
duties and the partnership agreement requires the partner to pay the
employee out of personal funds, the partner can deduct the payment as
a business expense.
Interest expense for distributed loan.
If the partnership distributes borrowed funds to a partner, the
partnership should list the partner's share of interest expense for
these funds as "Interest expense allocated to debt-financed
distributions" under "Other deductions" on the partner's
Schedule K-1. The partner deducts this interest on his or her
tax return depending on how the partner uses the funds. See chapter 5
in Publication 535
for more information on the allocation of interest
expense related to debt-financed distributions.
Debt-financed acquisitions.
The interest expense on loan proceeds used to purchase an interest
in, or make a contribution to, a partnership must be allocated as
explained in chapter 5 of Publication 535.
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