Exam 9: Forming and Operating Partnerships

Correct Answer:

Verified

$$\begin{array}{l}\text { Shoes Galore Partnership }\\\begin{array} { | l | c | c | c | } \hline & \text { Year-End } & \text { Profits } & \text { Capital } \\\hline \text { KBL, Inc. } & 1 / 31 & 25 \% & 25 \% \\\hline \text { AGW, Inc. } & 1 / 31 & 20 \% & 20 \% \\\hline \text { Blaster, Inc } & 3 / 31 & 4 \% & 4 \% \\\hline \text { Shiny Shoes, Inc. } & 6 / 30 & 3 \% & 3 \% \\\hline \text { 24 Individuals } & 12 / 31 & \begin{array} { c } 2 \% \text { each } \\( 48 \% \text { total) }\end{array} & \begin{array} { c } 2 \% \text { each } \\( 48 \% \text { total) }\end{array} \\\hline\end{array}\end{array}$$ Shoes Galore must adopt a 1/31 year end because all of its principal partners use this year-end. A principal partner is a partner having an interest of 5 percent or more in the capital or profits of the partnership. KBL, Inc. and AGW, Inc. are both principal partners because they each own more than a 5% profits and capital interest in Shoes Galore. Blaster, Inc., Shiny Shoes, Inc., and the individual partners are not principal partners because none of them individually owns 5% or more of the profits or capital interests in Shoes Galore.
Shoes Galore does not have a majority interest taxable year because KBL, Inc. and AGW, Inc. together do not own more than 50 percent of the profits and capital interests. Moreover, Shoes Galore does not have a majority interest taxable year because the twenty-four individual investors together do not own more than 50 percent of the profits and capital interests in Shoes Galore.

Correct Answer:

Verified

$$\begin{array} { | l | r | r | r | r | r | } \hline { \text { J\&u Limited Liablity Company } } \\\hline & \text { Basis } & \text { FMV } & & \text { Basis } & \text { FMN } \\\hline \text { Cash } & 20,000 & 20,000 & \begin{array} { r } \text { Account } \\\text { Payable }\end{array} & 7,000 & 7,000 \\\hline \text { Inventory } & 5,000 & 5,000 & \begin{array} { r } \text { Mortgage } \\\text { Payable }\end{array} & 20,000 & 20,000 \\\hline \text { Equipment } & 10,000 & 17,000 & & & \\\hline \text { Building } & 30,000 & 45,000 & \text { A - Capital } & 22,000 & 30,000 \\\hline & & & \text { B - Capital } & 16,000 & 30,000 \\\hline \text { Total Assets } & \mathbf { 6 5 , 0 0 0 } & \mathbf { 8 7 , 0 0 0 } & \begin{array} { r } \text { Total Liab. \& } \\\mathbf { 0 E }\end{array} & \mathbf { 6 6 , 0 0 0 } & \mathbf { 8 7 , 0 0 0 } \\\hline\end{array}$$ If member C received a 1/3 capital interest for her services, the following tax consequences would result:
• A is allocated a $10,000 expense reducing A's FMV capital account to $20,000 and his tax basis capital account to $12,000. His tax basis would include a 1/3 share of the LLC debt or $9,000.
• B is allocated a $10,000 expense reducing B's FMV capital account to $20,000 and his tax basis capital account to $6,000. His tax basis would include a 1/3 share of the LLC debt or $9,000.
• C reports ordinary income of $20,000 as a guaranteed payment for services provided. C's FMV and tax basis capital account will equal $20,000. Her tax basis would include a 1/3 share of the LLC debt or $9,000.
• J&J, LLC-No gain or loss recognized and no adjustments to assets and liabilities. Member's capital accounts are adjusted as indicated.
If member C received a 1/3 profits interest for her services, the following tax consequences would result:
• A - No deduction would be available to member A because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a 1/3 share of the LLC debt or $9,000.
• B - No deduction would be available to member B because member C would not receive anything if the LLC were to liquidate immediately after the contribution. His tax basis would include a 1/3 share of the LLC debt or $9,000.
• C - Member C would not recognize any income because the liquidation value of her partnership interest is zero with a profits interest. Additionally, member C would have $0 in both her FMV and tax basis capital accounts. Her tax basis would include a 1/3 share of the LLC debt or $9,000. From this point forward, C's capital accounts will be adjusted to reflect her share of future LLC profits and losses.
• J&J LLC - No gain or loss recognized and no adjustments to assets and liabilities.