Partnership Taxation

1. Partnership Taxation Thompson Dunavant PLC

2. Overview

3. Partnerships are Hot! Limited liability corporations (LLC�s) No double taxation Loss flow-through No limitation on # of partners or types No formal requirements to be met Special allocations on K-1 possible Debt included in basis 3

4. Types of Partnerships General K: owned solely by general partners; GP�s have unlimited liability for K debts, rights to participate in mgt, liability for SE taxes on K income. Limited K: one or more limited partners and one or more general partners. Limited partners have limited liability for K debts, NO participation in general management, and do not pay SE taxes on K income. (Older partnerships organized this way.) 4

5. Types of Partnerships LLC: all members have limited liability. Combines corporate benefit of limited liability with benefits of partnership taxation. Like an LP with no GPs! All owners have legal right to participate in management of entity. Member-managed (most) vs. Manager-managed (when have passive inventory) LLP: partners have better liability protection than GP but more liability exposure than LP. LLP partner not liable personally for any malpractice/other tort of another partner (but liable for your own). 5

6. Advantages of K over S Unlike S corporations, partnerships: Provide owners with the ability to contribute assets for an ownership interest tax-free, regardless of the contributing parties' percentage of ownership. Do not usually recognize gain when appreciated assets are distributed to a partner, even if the partner has no basis in the partnership. May have income, expenses, gains, losses, and credits specially allocated among owners. May have the basis of their assets adjusted when an ownership interest is sold or when gain or loss is recognized by a partner as a result of partnership distributions. 6

7. Advantages of K over S Unlike S corporations, partnerships: Allow owners to include their share of partnership liabilities in their basis. Have no restrictions on who may be an owner or on the number of owners. May not lose their elections to be treated as partnerships. Are not subject to any built-in gains tax or passive investment income tax. Are subject to distribution restrictions only for a donee partner, whereas S corporations are subject to rules requiring fair salaries, interest, etc. to all related parties. 7

8. Advantages of S over K Unlike partners, S corporation shareholders: Flow-through income of S corporation (other than salaries) is not subject to self-employment tax. May be employees of their S corporation, with their salaries subject to FICA, and not subject to self-employment tax. Typically have capital gain on the sale of an ownership interest or may qualify for � 1244 ordinary loss. Are not subject to ordinary income when certain capital assets are sold to the S corporation, even if the seller owns more than 50% of the business. 8

9. Check-the-Box Regulations Default Entity: A business that has at least two owners and that is not a corporation under state law (�per se corporation�) is taxed as a partnership. Election: Can elect to be taxed as a C corp by filing Form 8332. Then could elect to be S corp. Replaces historical resemblance test (more corporate characteristics than noncorporate). Default for business that has one owner = disregarded entity.