Lesson 2.1.1 Income Measurement & Reporting: Concepts

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Do curso por University of Illinois at Urbana-Champaign

Taxation of Business Entities II: Pass-Through Entities

2 ratings

University of Illinois at Urbana-Champaign

Taxation of Business Entities II: Pass-Through Entities

2 ratings

Curso 4 de 5 em Specialization U.S. Federal Taxation

This course provides an introduction to the U.S. federal income taxation of pass-through business entities, including Subchapter S corporations, partnerships, and limited liability companies. The course focuses on the relevant provisions of Subchapters S and K of the Internal Revenue Code, as well as related Treasury Regulations and judicial opinions, governing the formation, operation, and termination of pass-through entities. Practical in-class study problems facilitate self-discovery of technical tax knowledge along with the development of a variety of professional skills and attitudes.

Na lição

Module 2 Partnership Operations

In this module, you will be introduced to the operations of a partnership. We will examine how the operations of a partnership are a conduit by which transactions “pass through” to the partners. The module focuses on how the partnership measures and allocates the income based on the partner’s distributive share in accordance with the appropriate means of reporting. Next, we will discuss the appropriate adjustments to the partner’s outside tax basis in relation to the income, loss, and liability claims of the partnership. Finally, we will discuss the loss and related party limitations imposed on the partnership.

Lesson 2.1.1 Income Measurement & Reporting: Concepts4:44

Lesson 2.1.2 Income Measurement & Reporting: Applications3:10

Conheça os instrutores

Michael P Donohoe, PhD, CPA
Associate Professor of Accountancy and PwC Faculty Fellow
Department of Accountancy, Gies College of Business

Recall that the tax treatment of partnerships and partners stems

from both the aggregate and entity legal concepts.

For instance, section 701 follows

the aggregate approach by providing that a partnership is not a taxable entity.

Instead, it is treated as a conduit through which income, deductions, credits,

and other items flow through to the partners who

separately report their distributive shares of such items but,

consider a pure pass through environment where

each partner independently determines partnership income,

deductions, tax year, accounting methods,

and other tax attributes.

If left to their own devices,

the results would be pure accounting anarchy.

To minimize confusion, Congress applied

the entity concept for purposes of measuring and reporting partnership income.

Therefore, a partnership follows an informational tax return and is treated

as a separate entity for purposes of administrative and judicial procedures.

For these reasons, section 703(a) requires a partnership to determine it's

own taxable income and provides rules

designed to preserve the character of capital gains,

charitable donations, foreign taxes,

and other items that require special treatment

in the hands of partners for one reason or another.

Similarly, section 702(b) provides that

partnership items that flow through to partners are taxed,

as if such items were realized directly from

the source from which they were realized by the partnership,

or incurred in the same manner as the partnership.

So, what does all this really mean?

It means that partnerships measure and report two types of income;

Ordinary operating income and Separately Stated Items.

In the prior module, you learned that

separately stated items exists because they require special treatment.

However, in this lesson, you will learn more about specific items of income,

both separately stated and ordinary.

You will also learn about guaranteed payments paid by the partnership to a partner.

After learning these concepts,

you will apply them to Sunchaser Shakery.

Ordinary income simply consists of

income or expense items that do not need to be separately stated.

These items are reported on page one of Form

1065 and include items such as gross receipts or sales,

costs of goods sold, salaries and wages,

repairs and maintenance, interest expense, and depreciation.

Ordinary income or losses then carry to line one of

schedule K which reflects the partners' distributive share of partnership items.

Separately stated items are those with

special tax attributes that could affect different partners and different ways.

Therefore, these items cannot be combined with other income or

deductions because they require special tax treatment at the partner level.

Among the several items that pass through to

partners separately are the following examples;

rental activities, guaranteed payments,

portfolio income items such as dividends, interest, income,

and royalties, charitable contributions,

and a variety of property transaction related items.

Again, the Aggregate Legal concept is

a conceptual reason why some items are separately stated.

Ultimately, these items are special because they affect various exclusions, deductions,

and credits at the partner level and must

pass through the partnership without loss of identity,

so that the proper tax treatment for each partner can be determined.

For example, assume an individual is a partner in a partnership

that sold section 1231 assets during the tax year.

As you may recall from an introductory tax course,

gains and losses from all section 1231 assets are netted together.

Only then can the appropriate character be determined,

long term capital gain, or ordinary loss.

However, if a gain or loss on section 1231 assets was

combined with ordinary gains and losses at the partnership level,

the partner would not receive the proper tax treatment which can

be quite favorable when ordinary income passed through the partnership.

Thus, special items are separately stated as they pass through the entity.

Of the separately stated items just mentioned,

one likely stood out as unfamiliar, guaranteed payments.

A guaranteed payment is a payment to a partner of

the partnership for services rendered by the partner,

or for use of the partner's capital.

As the name suggests, these payments are fixed amounts paid to

partners regardless of the partnerships profitability during the year.

Guaranteed payments closely resemble salary payments.

Thus, many partnerships deduct them along with other salaries and wages when paid.

Although included in the ordinary business income or loss of a partnership,

guaranteed payments are separately stated to the partners that receive

them which serves as sort of a wage reporting system for the IRS.

Given their similarity to salary payments,

partners treat them as ordinary income on their tax returns.

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