In X1, Adam and Jason formed ABC, LLC, a car dealership in Kansas City. In X2, Adam and Jason realized they needed an advertising expert to assist in their business. Thus, the two members offered Cory, a marketing expert, a one-third capital interest in their partnership for contributing his expert services. Cory agreed to this arrangement and received his capital interest in X2. If the value of the LLC's capital equals $180,000 when Cory receives his one-third capital interest, which of the following tax consequences does not occur in X2?
A)Cory reports $60,000 of ordinary income in X2.
B)Adam, Jason, and Cory receive an ordinary deduction of $20,000 in X2.
C)Adam and Jason receive an ordinary deduction of $30,000 in X2.
D)Cory reports $60,000 of ordinary income in X2, and Adam and Jason receive an ordinary deduction of $30,000 in X2.

Question

Quizplus · Accepted Answer

When a partnership grants a capital interest in exchange for services performed, the individual receiving the interest must recognize ordinary income equal to the fair market value of the interest received. In this case, since Cory received a one-third capital interest and the total capital of the LLC equaled $180,000, the fair market value of his interest is $60,000. Therefore, option A is true. However, the partnership can generally deduct the amount of any guaranteed payments made to partners for services performed. Because Cory is now a partner and not merely an independent contractor, the guaranteed payment no longer constitutes an expense, and Adam and Jason cannot claim a deduction for the payment. Thus, option C is false, and option D is also false since it combines the true statement from option A with the false statement from option C. Option B is true because the partnership can generally deduct the amount of any guaranteed payments made to partners for services performed, and since it is likely that Cory will be paid a guaranteed payment in addition to his share of profits and losses, Adam, Jason, and Cory would receive an ordinary deduction of $20,000 in X2.

In X1, Adam and Jason Formed ABC, LLC, a Car