Partnership Taxation

Spring 2015

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 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.

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.

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)

KL is a general partnership engaged solely in investment activity. It has not elected to be taxed as an association. Its partners are Ken and Leanne. Ken and Leanne are equal partners in every respect. KL has three assets: $200,000 cash; precious metals held for investment, with an adjusted basis of $400,000 and a fair market value of $600,000; and closely held stock, also held for investment, with an adjusted basis of $1,000,000 and a fair market value of $600,000. Ken and Leanne each have an adjusted basis in his or her respective partnership interest of $800,000; the fair market value of each partnership interest is $700,000. None of the assets of KL was contributed to the partnership by either partner.

Ken and Leanne agree to admit Jason, a securities dealer, as a new general partner. In exchange for a one-third interest in KL, Jason transfers to KL a block of publicly traded stock with a fair market value of $1,000,000. The stock is pledged as collateral security for a nonrecourse, business-related bank loan previously entered into by Jason; the outstanding principal balance on the loan at the time Jason is admitted to KL is $300,000. KL takes the stock subject to the nonrecourse bank debt. Jason’s basis in the stock immediately before the contribution is $120,000. In preparation for Jason’s admission to the partnership, KL revalues its assets and restates their book values at their current fair market values. KL does not change its name as the result of the admission of Jason as a partner.

Later in the year, KL sells the closely held stock to an unrelated party for $570,000 cash. At about the same time, KL sells the publicly traded stock, also to an unrelated party. The buyer of the publicly traded stock pays KL $820,000 and takes the stock subject to the bank debt, which still has an outstanding principal balance of $300,000.

Assuming that KL does not choose to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Ken, Leanne, Jason, and KL – 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)

ABC is a limited liability company that has not elected to be taxed as an association. Capital is a material income-producing factor for ABC. ABC’s operating agreement, which fully complies with the regulations under section 704(b) of the Code, provides that all income, gains. losses, and deductions of ABC are to be shared equally by its three members – Anna, Bill, and Chandra.

ABC has the following balance sheet as of the end of 2015:

	Assets			Liabilities
	Adjusted basis	Fair market value		Adjusted basis	Fair market value
Cash	$ 30,000	$ 30,000	Debt		-0-
Real estate (investment)	135,000	150,000	Members’ capital:
Account receivable	-0-	90,000	Anna	$ 55,000	$ 90,000
			Bill	55,000	90,000
			Chandra	55,000	90,000
			Total members’ capital	$ 165,000	$ 270,000
Total assets	$ 165,000	$ 270,000	Total liabilities	$ 165,000	$ 270,000

Neither the account receivable nor the real estate was contributed to ABC by any member.

On January 1, 2016 – a day on which ABC conducts no business and has no income or deductions – ABC completely liquidates Bill’s interest. In the liquidation, ABC distributes the account receivable to Bill. The LLC continues with Anna and Chandra as equal owners. Bill retires and moves to another city.

Assuming that ABC does not choose to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Anna, Bill, Chandra, and ABC – 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)

On July 1, 2015, Tao and Umi form a general partnership, Firm. Firm does not elect to be taxed as an association. Tao contributes $80,000 cash, and Umi contributes $20,000, to get Firm started. The Firm partnership agreement, which satisfies all of the requirements in the primary test for economic effect under the regulations under section 704(b) of the Code, provides that the profits and losses of Firm are to be shared equally by Tao and Umi as the partners.

Also on July 1, 2015, Firm obtains a recourse loan of $200,000 from a bank. The loan documents call for, and Firm makes, monthly payments of interest; the first principal payment is not due, and is not made, until 2017.

On October 1, 2015, Tao and Umi amend the partnership agreement so that from that date forward, the profits and losses are shared as follows: 60 percent to Tao and 40 percent to Umi.

For the period July 1, 2015 through December 31, 2015, Firm has gross income of $140,000 and deductions of $200,000. It makes no distributions to partners.

Assuming that Firm does not choose to be taxed as an association, what are the federal income tax consequences of the transactions just described – to Tao, Umi, and Firm – 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 examination)

Created by: bojack@lclark.edu
Update:  26 Jan 16
Expires:  31 Aug 17