Individual O owned a sole proprietorship with a net value of $400,000.At the beginning of the current year, O created a partnership by giving a 20% interest in the business to his best friend M, and a 30% interest in the business to his daughter D.During the current year, O performed services for the partnership worth $20,000, although he chose not to bill the partnership for his work.The partnership's operating income for the year is $160,000.Based on these facts, the maximum amount of this income allocable to M and D is:

Question

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The first step is to determine the new value of the business after the creation of the partnership:

$400,000 (net value of the sole proprietorship) + $400,000 x 20% (M's interest) + $400,000 x 30% (D's interest) = $560,000 (new value of the business)

Next, we need to determine the share of operating income that each partner is entitled to receive. Since O performed services for the partnership without billing for them, this is considered a contribution of capital and must be taken into account when determining the partners' shares of the income.

M's share: 20% x $160,000 (operating income) = $32,000
D's share: 30% x ($160,000 - $20,000) (operating income less O's contribution of services) = $42,000

Therefore, the maximum allocations to M and D respectively are $28,000 and $42,000, which is answer choice B.

Individual O Owned a Sole Proprietorship with a Net Value