Question

Partner renders services worth $10,000 to Partnership in which he is a partner. Without regard to Partner's services, Partnership has $75,000 of ordinary income and $25,000 of long-term capital gain for the year. Both Partner and Partnership are calendar year taxpayers, but Partner uses the cash method of accounting and Partnership uses the accrual method. Partnership does not make a payment to Partner during the year, but where permitted it accrues the expense, which is currently deductible under Section 162. Determine the tax consequences of the following alternative transactions to Partner and Partnership:

(A)In recognition of his services, Partner is allocated the first $10,000 of partnership profits, which is treated as part of his distributive share.

(B) Section 707(a)(1) applies because the services are unrelated to the everyday conduct of Partnership's activities and are not continuous. See § 267(a)(2) and (e).

(C) Section 707(c) applies because the services are ongoing services related to Partnership's activities but are paid without regard to Partnership income.

(D) Partner is allocated $10,000, which is treated under § 707(a)(2)(A) as a § 707(a)(1) payment.

Answer 1

A. Tax Impact to Partner: partner will not be taxed as the same is treated as a distributive profits and is taxed in the hands of the Partnership.

Tax Impact to Partnership: Partnership will be taxed on $75,000 and also on long term capital gains of $25,000 since the $10,000 is treated as the distributive profits.

B. Tax Impact to Partner: The partner will be taxed for income of $10,000 for his services to the partnership.

Tax Impact to Partnership: The Partnership will be allowed a deduction of $10,000 as an expense. this expense will be treated as a regular normal business transaction per Section 707(a)(1).

C: Tax Impact to Partner: It will be taxed in the hands of the partner with $10,000 as an income under section 61(a)

Tax Impact to Partnership: $10,000 will be allowed as an expense to be deducted from the business income of the partnership provided that the services rendered from the partner is for a regular business transaction and not for a capital expenditure transaction (Section 263).

D: Tax Impact to Partner & Partnership: as per section 707(a)(2)(A)(iii) if the partner has entered into with the partnership the performance of such services and the allocation and distribution, when viewed together, are properly characterized as a transaction occurring between the partnership and a partner acting other than in his capacity as a member of the partnership, such allocation and distribution shall be treated as a transaction. Hence Partnership will be taxed on $65,000 (i.e. 75,000 - 10,000) and the partner will be taxed on $10,000 as his income