Question

Bob Short would devote more time to the partnership than would his equal partner Jack Long, it was agreed that Bob would receive a “salary” of $12,000 per year. Bob and Jack agreed to divide the remaining partnership income equally. For the current year, prior to consideration of Bob’s salary, the partnership income was composed of $6,000 long-term capital gain, $2,000 tax-exempt interest, and $8,000 loss from operations. Determine the amount and character of income (loss) reportable by Bob and Jack for the current year.

Answer 1

$8000 Partnership loss from operations is an ordinary business loss arising out of the activity for which the partnership was formed. It should be treated as a regular business income / (loss) and should be reported on Partnership Tax return (Form 1065). However, distributive share of this loss is to be taken to the partner’s distributive share items (Schedule K) for their respective share based on the share of profit or loss. Here, the total $8000 loss from operations is to be reported as a whole amount on Form 1065 and 50% thereof, i.e. $4000 loss each is to be reported on Schedules K to be filed by Bob and Jack respectively.

Tax exempt interest income is not included in the partnership income and hence should not find any place on Form 1065. But this is to be reported on Schedules K of each of the partner (Bob and Jack) individually as “Tax-exempt Interest Income” via Line item 18a of Schedule K under “Other Information” classification.

Long term capital gain is not reported through Form 1065. A partnership in general do not have any income to be taxed but Form 1065 is prepared for the purpose of reporting. The partnership income is passed on to the partners and thereby partners are taxed for their share of partnership income which ultimately increases their tax basis on the partnership. With this logic, capital gains are to be reported on Schedule K as a line item 9a as net long term capital gain (loss). Sometimes it is required to attach Schedule D along with Form 1065.

Partner’s salary is something in the form of a payment for the services rendered by one or more partners. It is treated irrespective of the fact whether the partnership earns any income or not. It should be reported as a deductible expenditure of the partnership and should be shown as “Guaranteed payment to Partners”.

Putting all the information together, we can conclude how much to include as partnership.

Loss from operations                     ($8000)

Guaranteed payment                    $12000

Ordinary business income

(loss)                                            ($20000)