Partnership Taxation
Spring 2017
Bogdanski

FINAL EXAMINATION

(Three hours)

INSTRUCTIONS

This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination. At the end of the three hours, you must turn in this set of essay questions in the original envelope in which this set came.

If you are using a computer, unless you have been otherwise expressly authorized by the law school, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.

If you wish to submit handwritten partnership balance sheets with your answers, you must (1) enclose them in the envelope, clearly labeled with your exam number and the question to which they relate, and (2) refer to them in your answers. No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s), and any enclosed balance sheets, will be graded.

Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit. Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.

The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

Unless otherwise instructed, you should assume that:

○ all partners described in the questions are individuals and U.S. residents;

○ all partners and partnerships described in the questions use the calendar year as their taxable year for federal income tax purposes; and

○ all partners and partnerships report their income on the cash method for such purposes.

Any references to “the Code” are to the Internal Revenue Code of 1986, as amended.

QUESTION ONE

(One hour)

LM is a limited liability company with two members, Liz and Mo. Both are managing members. LM’s balance sheet shows the following assets and liabilities:

	Assets			Liabilities
	Basis	Fair market value		Basis	Fair market value
Cash	$ 80,000	$ 80,000	Debt		$ 100,000
Accounts receivable	-0-	150,000
Inventory	80,000	30,000	Members’ equity
Publicly traded stock	40,000	100,000	Liz	$ 200,000	250,000
Land held as investment	200,000	240,000	Mo	200,000	250,000
Total assets	$ 400,000	$ 600,000	Total liabilities	$ 400,000	$ 600,000

None of the assets of LM were contributed to the company by either member. Both members have personally guaranteed LM’s debt. The LM operating agreement, which satisfies the primary test for economic effect under the regulations under Section 704(b) of the Code, provides that all of the profit and loss of LM shall be shared equally by Liz and Mo.

Liz sells her entire interest in LM to Nina, who pays Liz $250,000 cash for the interest. Mo consents to the sale, and it is fully effective under state law to convey Liz’s entire interest to Nina. Nina also guarantees the LM debt, and Liz is released from her guaranty.

Assuming that LM does not elect to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Liz, Mo, Nina, and LM – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

Discuss.

(End of Question 1)

QUESTION TWO

(One hour)

Renee and Sasha form a general partnership, Parco. The partnership agreement of Parco complies with the primary test for economic effect under the regulations under Section 704(b) of the Code. The agreement provides that profits and losses are to be shared equally between Renee and Sasha. To form the partnership, each partner contributes $50,000 cash in exchange for her respective partnership interest.

In its first taxable year, Parco has gross income of $500,000 and deductions of $400,000, resulting in taxable income of $100,000. Parco makes no distributions to the partners.

On the first day of the next year, in a transaction not contemplated when Parco was formed, the partners agree to admit Terry as a new general partner. Terry does not transfer any property to Parco; he receives his interest solely in exchange for his agreement to perform future services in the daily operation of Parco’s business. The interest Terry receives has a fair market value of $200,000.

Immediately prior to the admission of Terry, Parco restates the book values of its assets, increasing them to the assets’ respective fair market values. The same is done with the partners’ capital accounts. After the revaluation, the balance sheet of Parco shows the following assets:

	Basis	Book value
Accounts receivable	-0-	400,000
Land	200,000	400,000
Total assets	$ 200,000	$ 800,000

As Terry is admitted to the partnership, Terry receives a capital account of $200,000 on the books of Parco. The partners agree that this will reduce Renee’s and Sasha’s recently restated capital accounts by $100,000 each. Effective with the admission of Terry, the partners agree that future profits and losses are to be shared as follows: 40 percent to Renee, 30 percent to Sasha, and 30 to Terry.

Shortly after Terry is admitted, Parco collects $400,000 from customers on the accounts receivable shown on the balance sheet.

Assuming that Parco does not elect to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Renee, Sasha, Terry, and Parco – with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to each party; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

Explain.

(End of Question 2)

QUESTION THREE

(One hour)

Afton and Brett form a limited liability company, LLC. Afton, the managing member, contributes $40,000 cash, and Brett, the nonmanaging partner, contributes $160,000 cash. LLC purchases commercial real estate on leased land, paying $200,000 and borrowing $800,000 on a nonrecourse basis from a commercial lender. The terms of the loan require payment of interest only for five years.

The LLC operating agreement allocates all income, gain, and deductions 10 percent to Afton and 90 percent to Brett for five years, after which all such items are to be allocated 55 percent to Afton and 45 percent to Brett. The operating agreement further requires that all allocations are to be reflected in appropriate adjustments to the members’ capital accounts, and that liquidation proceeds are to be distributed in accordance with positive capital account balances. Only Afton is required to restore a capital account deficit. The partnership agreement contains a qualified income offset (as described in the regulations under Section 704(b) of the Code) for Brett and a minimum gain chargeback provision (as also described in the regulations).

The agreement also provides that all nonliquidating distributions will be made 20 percent to Afton and 80 percent to Brett until a total of $200,000 (the members’ original cash contributions) has been distributed; thereafter such distributions will be made equally to Afton and Brett.

LLC depreciates its property using the straight-line method and a valid (you may assume) 10-year recovery period. By coincidence, rental income from the property (LLC’s only income) exactly offsets LLC’s operating expenses (including interest on the nonrecourse debt, but not including depreciation on the building) for each of the first three years of LLC’s operations. Therefore, the entire amount of the depreciation deduction constitutes a net operating loss in each of the three years.

On the last day of the third year of its operations, LLC makes its first distributions to its members: Afton receives $2,000 cash, and Brett receives $8,000 cash.

Assuming that LLC does not elect to be taxed as an association, what are the federal income tax consequences of the transactions just described in the first three years of LLC’s operations, with and without all available elections? Be sure to discuss the amount, timing, and character (capital or ordinary) of each item of income, gain, deduction, or loss to LLC, Afton, and Brett; and each party’s basis in the property or interest which that party holds (actually or constructively), at each stage of the transactions.

Discuss.

(End of examination)

Created by: bojack@lclark.edu
Update:  17 May 17
Expires:  31 Aug 18