Publication 541 |
2000 Tax Year |
Transactions Between Partnership & Partners
For certain transactions between a partner and his or her
partnership, the partner is treated as not being a member of the
partnership. These transactions include the following.
- Performing services for or transferring property to a
partnership if--
- There is a related allocation and distribution to a partner,
and
- The entire transaction, when viewed together, is properly
characterized as occurring between the partnership and a partner not
acting in the capacity of a partner.
- Transferring money or other property to a partnership
if--
- There is a related transfer of money or other property by
the partnership to the contributing partner or another partner,
and
- The transfers together are properly characterized as a sale
or exchange of property.
Payments by accrual basis partnership to cash basis partner.
A partnership that uses an accrual method of accounting cannot
deduct any business expense owed to a cash basis partner until the
amount is paid. However, this rule does not apply to guaranteed
payments made to a partner, which are generally deductible when
accrued.
Guaranteed Payments
Guaranteed payments are those made by a partnership to a partner
that are determined without regard to the partnership's income. A
partnership treats guaranteed payments for services, or for the use of
capital, as if they were made to a person who is not a partner. This
treatment is for purposes of determining gross income and deductible
business expenses only. For other tax purposes, guaranteed payments
are treated as a partner's distributive share of ordinary income.
Guaranteed payments are not subject to income tax withholding.
The partnership generally deducts guaranteed payments on line 10 of
Form 1065 as a business expense. They are also listed on Schedules K
and K-1 of the partnership return. The individual partner
reports guaranteed payments on Schedule E (Form 1040) as ordinary
income, along with his or her distributive share of the partnership's
other ordinary income.
Guaranteed payments made to partners for organizing the partnership
or syndicating interests in the partnership are capital expenses and
are not deductible by the partnership. (See Organization expenses
and syndication fees under Partnership Income or Loss,
earlier). However, these payments must be included in the
partners' individual income tax returns.
Minimum payment.
If a partner is to receive a minimum payment from the partnership,
the guaranteed payment is the amount by which the minimum payment is
more than the partner's distributive share of the partnership income
before taking into account the guaranteed payment.
Example.
Under a partnership agreement, Sandy is to receive 30% of the
partnership income, but not less than $8,000. The partnership has net
income of $20,000. Sandy's share, without regard to the minimum
guarantee, is $6,000 (30% x $20,000). The guaranteed payment
that can be deducted by the partnership is $2,000 ($8,000 -
$6,000). Sandy's income from the partnership is $8,000, and the
remaining $12,000 of partnership income will be reported by the other
partners in proportion to their shares under the partnership
agreement.
If the partnership net income had been $30,000, there would have
been no guaranteed payment since her share, without regard to the
guarantee, would have been greater than the guarantee.
Self-employed health insurance premiums.
Premiums for health insurance paid by a partnership on behalf of a
partner for services as a partner are treated as guaranteed payments.
The partnership can deduct the payments as a business expense and the
partner must include them in gross income. However, if the partnership
accounts for insurance paid for a partner as a reduction in
distributions to the partner, the partnership cannot deduct the
premiums.
For 2000, a partner who qualifies can deduct 60% of the health
insurance premiums paid by the partnership on his or her behalf as an
adjustment to income. The partner cannot deduct the premiums for any
calendar month or part of a month in which the partner is eligible to
participate in any subsidized health plan maintained by any employer
of the partner or the partner's spouse. For more information on the
self-employed health insurance deduction, see chapter 7 in Publication 535.
Including payments in partner's income.
Guaranteed payments are included in income in the partner's tax
year in which the partnership's tax year ends.
Example 1.
Under the terms of a partnership agreement, Erica is entitled to a
fixed annual payment of $10,000 without regard to the income of the
partnership. Her distributive share of the partnership income is 10%.
The partnership has $50,000 of ordinary income after deducting the
guaranteed payment. She must include ordinary income of $15,000
($10,000 guaranteed payment + $5,000 ($50,000 x 10%)
distributive share) on her individual income tax return for her tax
year in which the partnership's tax year ends.
Example 2.
Mike is a calendar year taxpayer who is a partner in a partnership.
The partnership uses a fiscal year that ended January 31, 2000. Mike
received guaranteed payments from the partnership from February 1,
1999, until December 31, 1999. He must include these guaranteed
payments in income for 2000 and report them on his 2000 income tax
return.
Payments resulting in loss.
If guaranteed payments to a partner result in a partnership loss in
which the partner shares, the partner must report the full amount of
the guaranteed payments as ordinary income. The partner separately
takes into account his or her distributive share of the partnership
loss, to the extent of the adjusted basis of the partner's partnership
interest.
Sale or Exchange
of Property
Special rules apply to a sale or exchange of property between a
partnership and certain persons.
Losses.
Losses will not be allowed from a sale or exchange of property
(other than an interest in the partnership) directly or indirectly
between a partnership and a person whose direct or indirect interest
in the capital or profits of the partnership is more than 50%.
If the sale or exchange is between two partnerships in which the
same persons directly or indirectly own more than 50% of the capital
or profits interests in each partnership, no deduction of a loss is
allowed.
The basis of each partner's interest in the partnership is
decreased (but not below zero) by the partner's share of the
disallowed loss.
If the purchaser later sells the property, only the gain realized
that is greater than the loss not allowed will be taxable. If any gain
from the sale of the property is not recognized because of this rule,
the basis of each partner's interest in the partnership is increased
by the partner's share of that gain.
Gains.
Gains are treated as ordinary income in a sale or exchange of
property directly or indirectly between a person and a partnership, or
between two partnerships, if both of the following tests are met.
- More than 50% of the capital or profits interest in the
partnership(s) is directly or indirectly owned by the same
person(s).
- The property in the hands of the transferee immediately
after the transfer is not a capital asset. Property that is not a
capital asset includes accounts receivable, inventory, stock-in-trade,
and depreciable or real property used in a trade or business.
More than 50% ownership.
To determine if there is more than 50% ownership in partnership
capital or profits, the following rules apply.
- An interest directly or indirectly owned by or for a
corporation, partnership, estate, or trust is considered to be owned
proportionately by or for its shareholders, partners, or
beneficiaries.
- An individual is considered to own the interest directly or
indirectly owned by or for the individual's family. For this rule,
"family" includes only brothers, sisters, half-brothers,
half-sisters, spouses, ancestors, and lineal descendants.
- If a person is considered to own an interest using rule (1),
that person (the "constructive owner") is treated as if actually
owning that interest when rules (1) and (2) are applied. However, if a
person is considered to own an interest using rule (2), that person is
not treated as actually owning that interest in reapplying rule (2) to
make another person the constructive owner.
Example.
Individuals A and B and Trust T are equal partners in Partnership
ABT. A's husband, AH, is the sole beneficiary of Trust T. Trust T's
partnership interest will be attributed to AH only for the purpose of
further attributing the interest to A. As a result, A is a
more-than-50% partner. This means that any deduction for losses on
transactions between her and ABT will not be allowed, and gain from
property that in the hands of the transferee is not a capital asset is
treated as ordinary, rather than capital, gain.
More information.
For more information on these special rules, see Sales and
Exchanges Between Related Persons in chapter 2 of Publication 544.
Contribution of Property
Usually, neither the partner nor the partnership recognizes a gain
or loss when property is contributed to the partnership in exchange
for a partnership interest. This applies whether a partnership is
being formed or is already operating. The partnership's holding period
for the property includes the partner's holding period.
The contribution of limited partnership interests in one
partnership for limited partnership interests in another partnership
qualifies as a tax-free contribution of property to the second
partnership if the transaction is made for business purposes. The
exchange is not subject to the rules explained later under
Disposition of Partner's Interest.
Disguised sales.
A contribution of money or other property to the partnership
followed by a distribution of different property from the partnership
to the partner is treated not as a contribution and distribution, but
as a sale of property, if both of the following tests are met.
- The distribution would not have been made but for the
contribution.
- The partner's right to the distribution does not depend on
the success of partnership operations.
All facts and circumstances are considered in determining if the
contribution and distribution are more properly characterized as a
sale. However, if the contribution and distribution occur within 2
years of each other, the transfers are presumed to be a sale unless
the facts clearly indicate that the transfers are not a sale. If the
contribution and distribution occur more than 2 years apart, the
transfers are presumed not to be a sale unless the facts clearly
indicate that the transfers are a sale.
Form 8275 required.
A partner must attach Form 8275, Disclosure Statement,
(or other statement) to his or her return if the partner
contributes property to a partnership and, within 2 years (before or
after the contribution), the partnership transfers money or other
consideration to the partner. For exceptions to this requirement, see
section 1.707-3(c)(2) of the regulations.
A partnership must attach Form 8275 (or other statement) to its
return if it distributes property to a partner, and, within 2 years
(before or after the distribution), the partner transfers money or
other consideration to the partnership.
Form 8275 must include the following information.
- A caption identifying the statement as a disclosure under
section 707 of the Internal Revenue Code.
- A description of the transferred property or money,
including its value.
- A description of any relevant facts in determining if the
transfers are properly viewed as a disguised sale. (See section
1.707-3(b)(2) of the regulations for a description of the facts
and circumstances considered in determining if the transfers are a
disguised sale.)
Contribution to investment company.
Gain is recognized when property is contributed (in exchange for an
interest in the partnership) to a partnership that would be treated as
an investment company if it were incorporated.
A partnership is generally treated as an investment company if over
80% of the value of its assets is held for investment and consists of
certain readily marketable items. These items include money, stocks
and other equity interests in a corporation, and interests in
regulated investment companies and real estate investment trusts. For
more information, see section 351(e)(1) of the Internal Revenue Code
and the related regulations. Whether a partnership is an investment
company under this test is ordinarily determined immediately after the
transfer of property.
This rule applies to limited partnerships and general partnerships,
regardless of whether they are privately formed or publicly
syndicated.
Contribution to foreign partnership.
A domestic partnership that contributed property after August 5,
1997, to a foreign partnership in exchange for a partnership interest
may have to file Form 8865 if either of the following
apply.
- Immediately after the contribution, the partnership owned,
directly or indirectly, at least a 10% interest in the foreign
partnership.
- The fair market value of the property contributed to the
foreign partnership, when added to other contributions of property
made to the partnership during the preceding 12-month period, is
greater than $100,000.
The partnership may also have to file Form 8865, even if no
contributions are made during the tax year, if it owns a 10% or more
interest in a foreign partnership at any time during the year. See the
form instructions for more information.
Basis of contributed property.
If a partner contributes property to a partnership, the
partnership's basis for determining depreciation, depletion, and gain
or loss for the property is the same as the partner's adjusted basis
for the property when it was contributed, increased by any gain
recognized by the partner at the time of contribution.
Allocations to account for built-in gain or loss.
The fair market value of property at the time it is contributed may
be different from the partner's adjusted basis. The partnership must
allocate among the partners any income, deduction, gain, or loss on
the property in a manner that will account for the difference. This
rule also applies to contributions of accounts payable and other
accrued but unpaid items of a cash basis partner.
The partnership can use different allocation methods for different
items of contributed property. A single reasonable method must be
consistently applied to each item, and the overall method or
combination of methods must be reasonable. See section 1.704-3
of the regulations for allocation methods generally considered
reasonable.
If the partnership sells contributed property and recognizes gain
or loss, built-in gain or loss is allocated to the contributing
partner. If contributed property is subject to depreciation or other
cost recovery, the allocation of deductions for these items takes into
account built-in gain or loss on the property. However, the total
depreciation, depletion, gain, or loss allocated to partners cannot be
more than the depreciation or depletion allowable to the partnership
or the gain or loss realized by the partnership.
Example.
Sara and Gail formed an equal partnership. Sara contributed $10,000
in cash to the partnership and Gail contributed depreciable property
with a fair market value of $10,000 and an adjusted basis of $4,000.
The partnership's basis for depreciation is limited to the adjusted
basis of the property in Gail's hands, $4,000.
In effect, Sara purchased an undivided one-half interest in the
depreciable property with her contribution of $10,000. Assuming that
the depreciation rate is 10% a year under the General Depreciation
System (GDS), she would have been entitled to a depreciation deduction
of $500 per year, based on her interest in the partnership, if the
adjusted basis of the property equaled its fair market value when
contributed.
However, since the partnership is allowed only $400 per year of
depreciation (10% of $4,000), no more than $400 can be allocated
between the partners. The entire $400 must be allocated to Sara.
Distribution of contributed property to another partner.
If a partner contributes property to a partnership and the
partnership distributes the property to another partner within 7 years
of the contribution, the contributing partner must recognize gain or
loss on the distribution.
A 5-year period applies to property contributed before June 9,
1997, or under a written binding contract:
- That was in effect on June 8, 1997, and at all times
thereafter before the contribution, and
- That provides for the contribution of a fixed amount of
property.
The recognized gain or loss is the amount the contributing partner
would have recognized if the property had been sold for its fair
market value when it was distributed. This amount is the difference
between the property's basis and its fair market value at the time of
contribution. The character of the gain or loss will be the same as
the character of the gain or loss that would have resulted if the
partnership had sold the property to the distributee partner.
Appropriate adjustments must be made to the adjusted basis of the
contributing partner's partnership interest and to the adjusted basis
of the property distributed to reflect the recognized gain or loss.
Disposition of certain contributed property.
The following rules determine the character of the partnership's
gain or loss on a disposition of certain types of contributed
property.
- Unrealized receivables. If the property was an
unrealized receivable in the hands of the contributing partner, any
gain or loss on its disposition by the partnership is ordinary income
or loss. Unrealized receivables are defined later under Payments
for Unrealized Receivables and Inventory Items. When reading the
definition, substitute "partner" for "partnership."
- Inventory items. If the property was an inventory
item in the hands of the contributing partner, any gain or loss on its
disposition by the partnership within 5 years after the contribution
is ordinary income or loss. Inventory items are defined later in
Payments for Unrealized Receivables and Inventory Items.
- Capital loss property. If the property was a
capital asset in the contributing partner's hands, any loss on its
disposition by the partnership within 5 years after the contribution
is a capital loss. The capital loss is limited to the amount by which
the partner's adjusted basis for the property exceeded the property's
fair market value immediately before the contribution.
- Substituted basis property. If the disposition of
any of the property listed in (1), (2), or (3) above is a
nonrecognition transaction, these rules apply when the recipient of
the property disposes of any substituted basis property resulting from
the transaction.
Contribution of Services
A partner can acquire an interest in partnership capital or profits
as compensation for services performed or to be performed.
Capital interest.
A capital interest is an interest that would give the holder a
share of the proceeds if the partnership's assets were sold at fair
market value and the proceeds were distributed in a complete
liquidation of the partnership. This determination generally is made
at the time of receipt of the partnership interest. The fair market
value of such an interest received by a partner as compensation for
services must generally be included in the partner's gross income in
the first tax year in which the partner can transfer the interest or
the interest is not subject to a substantial risk of forfeiture. The
partnership interest transferred as compensation for services is
subject to the rules for restricted property discussed in Publication 525
under Employee Compensation.
The fair market value of an interest in partnership capital
transferred to a partner as payment for services to the partnership is
a guaranteed payment, discussed earlier.
Profits interest.
A profits interest is a partnership interest other than a capital
interest. If a person receives a profits interest for providing
services to or for the benefit of a partnership in a partner capacity
or in anticipation of being a partner, the receipt of such an interest
is not a taxable event for the partner or the partnership. However,
this does not apply in the following situations.
- The profits interest relates to a substantially certain and
predictable stream of income from partnership assets, such as income
from high-quality debt securities or a high-quality net lease.
- Within 2 years of receipt, the partner disposes of the
profits interest.
- The profits interest is a limited partnership interest in a
publicly traded partnership.
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