Question

Ms. Kim is a general partner who holds a 50% interest in Mustang Partnership. This year, Mustang earned ordinary business income of $200,000 before accounting for any payments to partners. Mustang also received $8,000 in qualified dividend income and $3,000 of municipal bond interest income. During the year, Mustang paid Ms. Kim a $60,000 guaranteed payment for services to the partnership plus an additional cash distribution of $30,000 (assume Mustang made no payments to any other partner). Ms. Kim’s ordinary income tax rate is 25% and long-term capital gain and dividend tax rate is 15%. At the beginning of the year, Ms. Kim’s basis in her Mustang Partnership interest was $270,000.

a. Determine the tax cost of Ms. Kim’s share of Mustang partnership’s income for the year (ignore self-employment tax and the QBI deduction). (15 points)

b. Determine Ms. Kim’s after-tax cash flows from her investment in Mustang partnership for the year. (10 points)

c. Determine Ms. Kim’s basis in her Mustang Partnership interest at the end of the year. (5 points)

Answer 1

a

Guaranteed payments are ordinary income to partner= $60,000 (taxable at 25%)

Share of partnership ordinary income = ($200,000 - $60,000) X 50% = $70,000 (taxable at 25%)

Share of dividend = $8,000 X 50% = $4,000 (taxable at 15%)

Total tax cost = $60,000 X 25% + $70,000 X 25% + $4,000 X 15% = $33,100

Municipal bond interest is tax-exempt

Thus, total tax cost of partnership income is $33,100

b

Cash received from partnership = $60,000 + $30,000 = $90,000

After tax cash flow = $90,000 - $33,100 = $56,900

c

Basis in partnership:

Particulars	Amount
Beginning basis	$        270,000
Add: share of
Net income after guaranteed payment	$          70,000
Ordinary dividends	$            4,000
Municpal bond interest	$            1,500
Less: distributions	$         (30,000)
Ending basis	$        315,500

Ending basis in partnership is $315,500.