The December 31, 2011, balance sheet of the RST General Partnership reads as follows. The partners share equally in partnership capital, income, gain, loss, deduction and credit. Ted's adjusted basis for his partnership interest is $40,000. On December 31, 2011, he retires from the partnership, receiving a $60,000 cash payment in liquidation of his interest. The partnership agreement states that $2,500 of the payment is for goodwill. Which of the following statements about this distribution is false?
A) If capital is NOT a material income-producing factor to the partnership, the § 736(a) payment will be $2,500.
B) If capital IS a material income-producing factor, the entire $60,000 payment will be a § 736(b) property payment.
C) The payment for Ted's share of goodwill will create $2,500 of ordinary income to him.
D) The partnership can deduct any amount that is a § 736(a) payment because it will be determined without regard to partnership profits.
E) All statements are false.

Question

The December 31, 2011, balance sheet of the RST General Partnership reads as follows.  The partners share equally in partnership capital, income, gain, loss, deduction and credit. Ted's adjusted basis for his partnership interest is $40,000. On December 31, 2011, he retires from the partnership, receiving a $60,000 cash payment in liquidation of his interest. The partnership agreement states that $2,500 of the payment is for goodwill. Which of the following statements about this distribution is false?
A) If capital is NOT a material income-producing factor to the partnership, the § 736(a) payment will be $2,500. 
B) If capital IS a material income-producing factor, the entire $60,000 payment will be a § 736(b) property payment. 
C) The payment for Ted's share of goodwill will create $2,500 of ordinary income to him. 
D) The partnership can deduct any amount that is a § 736(a) payment because it will be determined without regard to partnership profits. 
E) All statements are false.

Quizplus · Accepted Answer

Option A is true, as per § 736(a), payments made to a retiring partner will be deemed as a guaranteed payment to the extent of the withdrawing partner's share of the income, which is determined as if the partnership sold all its assets at their FMV immediately before the partner's withdrawal. Thus the § 736(a) payment will be $2,500 if the partnership capital is NOT a material income-producing factor to the partnership.

Option B is true for the same logic as the previous option. If capital IS a material income-producing factor, the entire $60,000 payment will be a § 736(b) property payment.

Option C is false as the goodwill payment is specifically mentioned in the partnership agreement. Thus it will reduce Ted's share of any ordinary income.

Option D is true as any amount paid to a retiring partner as a § 736(a) payment will be deductible by the partnership as an ordinary and necessary business expense for the partnership.

Therefore, the correct answer is C.

The December 31, 2011, Balance Sheet of the RST General