Question 1

Styling Shoes, LLC filed its 20X8 Form 1065 on March 15, 20X9. Styling had three members with the following ownership interests and tax basis at the beginning of the 20X8: (1) Jane, a member with a 25% profits and capital interest and a $5,000 outside basis, (2) Joe, a member with a 45% profits and capital interest and a $10,000 outside basis, and (3) Jack, a member with a 30% profits and capital interest and a $2,000 outside basis. The following items were reported on Styling's Schedule K for the year: ordinary income of $100,000, Section 1231 gain of $15,000, charitable contributions of $25,000, and tax-exempt income of $3,000. In addition, Styling received an additional bank loan of $12,000 during 20X8. What is Jane's tax basis after adjustment for her share of these items?
A) $28,250
B) $31,250
C) $33,500
D) $57,250

Accepted Answer

First, we need to calculate the total income and deductions to determine Styling's net income. 
Total Income: 
Ordinary Income: $100,000 
Section 1231 Gain: $15,000 
Tax-exempt Income: $3,000 
Total: $118,000

Total Deductions: 
Charitable Contributions: $25,000 
Total: $25,000

Net Income: $118,000 - $25,000 = $93,000

Next, we need to allocate the net income and deductions to each member based on their ownership interests.

Jane: 
Profit and Capital Interest: 25% 
Net Income Allocation: 25% x $93,000 = $23,250 
Beginning Outside Basis: $5,000 
Allocable Share of Income: $23,250 
Allocable Share of Charitable Contributions: ($25,000 x 25%) = ($6,250) 
Allocable Share of Additional Bank Loan: ($12,000 x 25%) = ($3,000) 
Ending Outside Basis: $5,000 + $23,250 - $6,250 - $3,000 = $19,000

Joe: 
Profit and Capital Interest: 45% 
Net Income Allocation: 45% x $93,000 = $41,850 
Beginning Outside Basis: $10,000 
Allocable Share of Income: $41,850 
Allocable Share of Charitable Contributions: ($25,000 x 45%) = ($11,250) 
Allocable Share of Additional Bank Loan: ($12,000 x 45%) = ($5,400) 
Ending Outside Basis: $10,000 + $41,850 - $11,250 - $5,400 = $35,200

Jack: 
Profit and Capital Interest: 30% 
Net Income Allocation: 30% x $93,000 = $27,900 
Beginning Outside Basis: $2,000 
Allocable Share of Income: $27,900 
Allocable Share of Charitable Contributions: ($25,000 x 30%) = ($7,500) 
Allocable Share of Additional Bank Loan: ($12,000 x 30%) = ($3,600) 
Ending Outside Basis: $2,000 + $27,900 - $7,500 - $3,600 = $19,800

Therefore, Jane's ending tax basis is $19,000.

Question 2

Jay has a tax basis of $14,000 in his partnership interest at the beginning of the partnership tax year. The following amounts of partnership debt were allocated to Jay and are included in his beginning of the year tax basis: (1) recourse debt - $3,000, (2) qualified nonrecourse debt - $1,000, and (3) nonrecourse debt - $500. If Jay is allocated a $15,000 loss for the current year, how much of the loss will be suspended under the tax basis and at-risk limitations?
A) $500, $1,000
B) $1,000, $500
C) $0, $0
D) $14,000, $1,000

Accepted Answer

Under the tax basis limitation, Jay's beginning tax basis of $14,000 is increased by his share of recourse debt ($3,000) and qualified nonrecourse debt ($1,000). Therefore, his adjusted tax basis is $18,000 ($14,000 + $3,000 + $1,000). Since the allocated loss of $15,000 exceeds Jay's adjusted tax basis of $18,000, $1,000 of the loss will be suspended under the tax basis limitation.

Under the at-risk limitation, Jay's beginning at-risk amount is increased by his share of recourse debt ($3,000) and qualified nonrecourse debt ($1,000), but not by his share of nonrecourse debt ($500). Therefore, his adjusted at-risk amount is $18,000 ($14,000 + $3,000 + $1,000). Since the allocated loss of $15,000 does not exceed Jay's adjusted at-risk amount of $18,000, none of the loss will be suspended under the at-risk limitation.

Question 3

Which of the following would not be classified as a material participant in an activity?
A) An individual who participates more than 100 hours a year and the person's participation is not less than any other individual's participation
B) An individual who participated in the activity for at least one of the preceding five taxable years
C) An individual who participates in an activity regularly, continuously, and substantially
D) An individual who participates in an activity for more than 500 hours a year

Accepted Answer

A material participant is defined as an individual who participated in the activity for any three of the preceding five taxable years, in which the participation was regular, continuous, and substantial. Option B only mentions participation for one out of the preceding five taxable years, which would not classify the individual as a material participant.

Question 4

Which of the following items will affect a partner's tax basis?
A) Share of ordinary business income (loss)
B) Share of nonrecourse debt
C) Share of recourse debt
D) Share of qualified nonrecourse debt
E) All of these will affect a partner's tax basis

Accepted Answer

All of these items will affect a partner's tax basis. The partner's share of ordinary business income (loss), share of nonrecourse debt, share of recourse debt, and share of qualified nonrecourse debt will all increase or decrease the partner's tax basis in the partnership.

Question 5

What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1) Increase for share of ordinary business income, (2) Decrease for share of separately stated loss items, and (3) Decrease for distributions?
A) 1, 3, 2
B) 1, 2, 3
C) 3, 1, 2
D) 2, 3, 1

Accepted Answer

The answer of What is the correct order for applying...

Question 6

Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true?
A) Partnership losses must be used only in the year the losses are created
B) Partnership losses may be carried back 2 years and carried forward 5 years
C) Partnership losses may be carried forward indefinitely
D) Partnership losses may be carried back 2 years and carried forward 20 years

Accepted Answer

Partnership losses that are suspended by the tax basis limitation may be carried forward indefinitely. This means that they may be used in future years when the partnership generates taxable income, subject to further limitations. The other options are incorrect: partnership losses may not be carried back, and the carryforward period is not limited to 5 or 20 years.

Question 7

Does adjusting a partner's basis for tax-exempt income prevent double taxation?
A) Yes, if this basis adjustment is not made the partner will be taxed once when the income is allocated to him and a second time when he sells his partnership interest
B) Yes, if this basis adjustment is not made the partner will be taxed on the tax-exempt income twice when he sells his partnership interest because he was not taxed on this income when it was earned
C) No, making this adjustment to the partner's basis prevents the tax-exempt income from being converted to taxable income
D) No, the partner should not adjust his tax basis by his share of tax-exempt income

Accepted Answer

The answer of Does adjusting a partner's basis for tax-exempt...

Question 8

In what order are the loss limitations for partnerships applied?
A) Tax Basis - At-Risk Amount - Passive Activity Loss
B) Passive Activity Loss - Tax Basis - At-Risk Amount
C) At-Risk Amount - Passive Activity Loss - Tax Basis
D) At-Risk Amount - Tax Basis - Passive Activity Loss

Accepted Answer

The correct order for applying loss limitations for partnerships is Tax Basis, At-Risk Amount, and then Passive Activity Loss. This sequence ensures that losses are first limited to the partner's investment in the partnership, then to the amount they are at risk, and finally by passive activity loss rules.

Question 9

Which of the following statements regarding a partner's basis adjustments is true?
A) A partner's basis may never be reduced below zero.
B) A partner must adjust his basis for ordinary income (loss) but not for separately-stated items.
C) A partnership fine or penalty does not affect a partner's basis.
D) Relief of partnership debt increases a partner's tax basis.

Accepted Answer

The answer of Which of the following statements regarding a...

Question 10

Jerry, a partner with 30% capital and profit interest, received his Schedule K-1 from Plush Pillows, LP. At the beginning of the year, Jerry's tax basis in his partnership interest was $50,000. His current year Schedule K-1 reported an ordinary loss of $15,000, long-term capital gain of $3,000, qualifying dividends of $2,000, $500 of non-deductible expenses, a $10,000 cash contribution, and a reduction of $4,000 in his share of partnership debt. What is Jerry's adjusted basis in his partnership interest at the end of the year?
A) $35,000
B) $40,000
C) $45,500
D) $49,500

Accepted Answer

To calculate Jerry's adjusted basis in his partnership interest at the end of the year, we need to take into account the following:

Beginning tax basis in partnership interest: $50,000
+ Share of ordinary loss: -$15,000
+ Share of long-term capital gain: +$3,000
+ Share of qualifying dividends: +$2,000
+ Non-deductible expenses: -$500
+ Cash contribution: +$10,000
- Reduction in share of partnership debt: -$4,000

Adjusted basis in partnership interest at the end of the year:
= $50,000 - $15,000 + $3,000 + $2,000 - $500 + $10,000 - $4,000
= $45,500

Therefore, the correct answer is C) $45,500.

Question 11

On January 1, X9, Gerald received his 50% profits and capital interest in High Air, LLC in exchange for $2,000 in cash and real property with a $3,000 tax basis secured by a $2,000 nonrecourse mortgage. High Air reported a $15,000 loss for its X9 calendar year. How much loss can Gerald deduct, and how much loss must he suspend if he only applies the tax basis loss limitation?
A) $0, $4,000
B) $0, $7,500
C) $0, $15,000
D) $4,000, $0
E) None of these

Accepted Answer

The answer of On January 1, X9, Gerald received his...

Question 12

What type of debt is not included in calculating a partner's at-risk amount?
A) Recourse debt
B) Qualified nonrecourse debt
C) Nonrecourse debt
D) All of these types of debt are included in the at-risk amount

Accepted Answer

Nonrecourse debt is not included in calculating a partner's at-risk amount because the partner is not personally liable for the debt.

Question 13

Hilary had an outside basis in LTL, General Partnership of $10,000 at the beginning of the year. LTL reported the following items on Hilary's K-1 for the year: ordinary business income of $5,000, a $10,000 reduction in Hilary's share of partnership debt, a cash distribution of $20,000, and tax-exempt income of $3,000. What is Hilary's adjusted basis at the end of the year?
A) ($12,000)
B) ($9,000)
C) $0
D) $15,000
E) $18,000

Accepted Answer

Hilary's adjusted basis calculation: Starting basis of $10,000 + $5,000 ordinary business income + $3,000 tax-exempt income - $10,000 reduction in share of partnership debt - $20,000 cash distribution = $0. The basis cannot go below zero, so the correct answer is $0.

Question 14

Which of the following statements regarding the rationale for adjusting a partner's basis is false?
A) To prevent partners from being double taxed when they sell their partnership interests
B) To ensure that partnership tax-exempt income is not ultimately taxed
C) To prevent partners from being double taxed when they receive cash distributions
D) To ensure that partnership non-deductible expenses are never deductible
E) None of these rationales are false

Accepted Answer

Adjusting a partner's basis in a partnership is crucial for tax purposes, including preventing double taxation on the sale of partnership interests (A), ensuring tax-exempt income remains untaxed (B), avoiding double taxation on cash distributions (C), and properly handling nondeductible expenses (D). Therefore, none of the provided rationales are false.

Question 15

Which person would generally be treated as a material participant in an activity?
A) A participant in a rental activity
B) A limited partner
C) A LLC member not involved with management of the LLC
D) A general partner

Accepted Answer

Limited partners and participants in rental activities are generally deemed to be passive participants. In addition, non-managing LLC members would typically not be treated under the regulations as having a level of involvement that is "regular, continuous, and substantial." However, general partners are likely to satisfy this definition of material participation.

Question 16

How does additional debt or relief of debt affect a partner's basis?
A) Debt has no effect on a partner's basis
B) Relief of debt increases a partner's basis
C) Both additional debt and relief of debt increase a partner's basis
D) Additional debt increases a partner's basis

Accepted Answer

Additional debt increases a partner's basis. When a partnership takes on additional debt, the partners are considered to have contributed their share of the debt. This contribution increases their basis in the partnership. Relief of debt, on the other hand, decreases a partner's basis because the partner's share of the partnership liabilities has been reduced.

Question 17

What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory.

Accepted Answer

The answer of What is the difference between the aggregate...

Question 18

If partnership debt is reduced and a partner is deemed to receive a cash distribution, what impact does the deemed distribution have on the partner if it is in excess of her tax basis?
A) The partner will treat the distribution in excess of her basis as ordinary income
B) The partner will treat the distribution in excess of her basis as capital gain
C) The partner will not ever be taxed on the distribution in excess of her basis
D) The partner will not be taxed on the distribution in excess of her basis until she sells her partnership interest

Accepted Answer

The partner will treat the distribution in excess of her basis as capital gain. This is because distributions from a partnership to a partner that exceed the partner's basis in the partnership are treated as a sale or exchange of the partnership interest, which generally results in capital gain.

Question 19

If a taxpayer sells a passive activity with suspended passive activity losses from prior years, what type of income can be offset by the suspended passive losses in the year of sale?
A) Passive activity income
B) Portfolio income
C) Active business income
D) Any of these types of income can be offset.
E) None of these. The suspended losses disappear when the passive activity is sold.

Accepted Answer

Suspended passive activity losses are available to offset any type of income in the year the passive activity is sold.

Question 20

John, a limited partner of Candy Apple, LP, is allocated $30,000 of ordinary business loss from the partnership. Before the loss allocation, his tax basis is $20,000 and at-risk amount is $10,000. John also has ordinary business income of $20,000 from Sweet Pea, LP as a general partner and ordinary business income of $5,000 from Red Tomato, as a limited partner. How much of the $30,000 loss from Candy Apple can John deduct currently?
A) $5,000
B) $10,000
C) $25,000
D) $30,000

Accepted Answer

John would first compare the $30,000 loss to his tax basis of $20,000. As a result, John would have $10,000 of this loss suspended due to the tax basis limitation. Next, John would compare the remaining $20,000 loss with his $10,000 at-risk amount. Thus, an additional $10,000 of loss would be suspended due to the at-risk limitation leaving $10,000 of loss. Because John is a limited partner in Candy Apple, this loss is a passive activity loss. $5,000 of John's $10,000 passive activity loss from Candy Apple can be used currently to offset his passive income from Red Tomato. The remaining $(5,000) is suspended as a passive activity loss.

Quiz 20: Forming and Operating Partnerships

Which of the following would not be classified as a material participant in an activity?

Which of the following items will affect a partner's tax basis?

What is the correct order for applying the following three items to adjust a partner's tax basis in his partnership interest: (1) Increase for share of ordinary business income, (2) Decrease for share of separately stated loss items, and (3) Decrease for distributions?

Which of the following statements regarding partnerships losses suspended by the tax basis limitation is true?

Does adjusting a partner's basis for tax-exempt income prevent double taxation?

In what order are the loss limitations for partnerships applied?

Which of the following statements regarding a partner's basis adjustments is true?

What type of debt is not included in calculating a partner's at-risk amount?

Which of the following statements regarding the rationale for adjusting a partner's basis is false?

Which person would generally be treated as a material participant in an activity?

How does additional debt or relief of debt affect a partner's basis?

What is the difference between the aggregate and entity theory of partnership taxation? Provide two examples of how partnership tax rules reflect the aggregate theory and two examples of how they reflect the entity theory.

If partnership debt is reduced and a partner is deemed to receive a cash distribution, what impact does the deemed distribution have on the partner if it is in excess of her tax basis?

If a taxpayer sells a passive activity with suspended passive activity losses from prior years, what type of income can be offset by the suspended passive losses in the year of sale?