Assignment 5

1. The AB Partnership purchases plastic components and assembles children's toys. The
assembly operation requires a number of special machines that are housed in a building
the partnership owns. The partnership has depreciated all its property under MACRS. The
partnership sells the toys on account to a number of retail establishments and uses the
accrual method of accounting. Identify any items you think might be classified as
unrealized receivables.
Depreciation recapture potential under Sec. 1245 for the machinery used to produce the

inventory.

2. Can a partner recognize both a gain and a loss on the sale of a partnership interest? If
so, under what conditions?
A partner may recognize both gain and loss on the sale of a partnership interest in the situation

where a partner’s share of the unrealized gain in hot assets is greater than his total gain or loss on

the sale of his partnership interest.

3. Tom is a 55% general partner in the RST Partnership. Tom wants to retire, and the
other two partners, Stacy and Rich, want to continue the partnership business. They agree
that the partnership will liquidate Tom's interest in the partnership by paying him 20% of
partnership profits for each of the next ten years. Explain why Sec. 736 does (or does not)
apply to the partnership's payments to Tom.
The Sec. 736 provisions apply in this scenario since the partnership is not terminating.

4. What is a publicly traded partnership? Are all publicly traded partnerships taxed as
corporations?
A publicly traded partnership (PTP) that has effectively connected taxable income must pay

withholding tax on any distributions of that income made to its foreign partners. A PTP must use

Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and

Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, (Income Code 27)

to report withholding from distributions. The rate of withholding is 37% for noncorporate

partners and 21% for corporate partners

A Publicly Traded Partnership is any partnership an interest in which is regularly traded on an

established securities market or is readily tradable on a secondary market, regardless of the

number of its partners. These rules do not apply to a PTP treated as a corporation under section

7704 of the Internal Revenue Code.

5. Three individuals recently formed Krypton Company as a limited liability company

(LLC). The three individuals—Jeff, Susan, and Richard—own equal interests in the
company, and they all have substantial income from other sources. Krypton is a
manufacturing firm and expects to earn approximately $130,000 of ordinary income and
$30,000 of long-term capital gain each year for the next several years. Jeff will be a full-
time manager and will receive a salary of $60,000 each year. What tax issues should the
owners consider regarding the LLC's initial year of operations?
Ordinary income = $130000
Less: Salaries = $60000
Taxable Income = $70000
Capital Gain = $30000
Total income = $100000
The treatment of tax for the LLC is similar to a partnership firm. LLC pays income tax as well as
self-employment tax of 15.3% on their net business income that flows to the individual return.
Here the taxable income is $100000 of which $70000 flows to the individuals of LLC.
6. Lisa has a $25,000 basis in her partnership interest before receiving a current
distribution of $4,000 cash and land with a $30,000 FMV and a $14,000 basis to the
partnership. Assume that any distribution involving Sec. 751 property is pro rata, that any
pre contribution gains have been recognized before the distribution, and that no Sec. 754
election is in effect.
a. Determine Lisa's recognized gain or loss, Lisa's basis in the distributed property, and
Lisa's ending basis in her partnership interest.

Beginning Basis – Cash Distributed – Basis of land to partnership (to the extent of balance basis
after cash distributed is deducted)
= $25,000-$4,000-$14,000

=$7,000
b. How does your answer to Part a change if the partnership's basis in the land is $24,000
instead of $14,000?
Beginning Basis – Cash Distributed – Basis of land to partnership (to the extent of balance basis
after cash distributed is deducted)
= $25,000-$4,000-$21,000
=$0
c. How does your answer to Part a change if Lisa receives $28,000 cash instead of $4,000
(along with the land)?
Beginning Basis – Cash Distributed – Basis of land to partnership (to the extent of balance basis
after cash distributed is deducted)
= $25,000-$28,000
= - $3,000 (Gain to the partner)
d. How does your answer to Part a change if, in addition to the cash and land, Lisa receives
inventory with a $25,000 FMV and a $10,000 basis and receivables with a $3,000 FMV and
a zero basis?
Beginning Basis – Cash Distributed – Inventory/Receivables basis - Basis of land to partnership
(to the extent of balance basis after cash distributed is deducted)
=$25,000-$4,000-$10,000-$11,000
= $0
e. Suppose that Lisa receives the distribution in Part a from a C corporation instead of a
partnership. The corporation has $100,000 of E&P before the distribution, and Lisa's stock
basis before the distribution is $25,000. What are the tax consequences to Lisa and the C
corporation?
Distributions out of current and accumulated earnings and profits are taxable as ordinary
income dividends to non-corporate shareholders.
Cash distribution of $4,000:
To Shareholders – taxed as normal dividend
To C Corp – No gain is recorded when cash is distributed
Property distribution: Gain ($30,000-$14,000) = $16,000
To Shareholders – Dividend for the shareholders
To C Corp – Gain on distribution