Question

Assuming that a partnership normally has a calendar year-end, what should the tax year-end be in the following independent cases? ?

a. Jim, a 70 percent partner, sells his partnership interest to Fred on August 10.

b. On July 13, the partnership sells its office building and moves its business across town.

c. June buys a 15 percent interest in the partnership on May 14.

d. The partnership goes out of business on February 26.

Answer 1

Change in partnership interest, on acquiring, disposing of, or otherwise changing ownership interest leads to change in a partnership tax year.

In such events, it may seem straightforward a transaction becomes complex in terms of the financial and tax implications for all partners involved. Every partner’s annual share of a partnership’s income and gains/losses, as well as deductions and credits, is governed by the partnership agreement.

For tax purposes, the allocation generally must follow the appropriation rule and all tax items must be allocated among partners.

If at least one partner’s interest changes during the year, the partnership must follow one of two approved allocation methods

1. Interim closing
2. Prorata

The choice of method impacts on the partners’ financial return from the partnership, and thus their tax liabilities.

The tax rules refer to such changes as variations in a partner’s interest in a partnership.

Methods:

Generally upon change in partnership interests during a year, the variation creates a time period, within the partnership’s tax year on which to base income allocations.

One variation the tax year into two distinct segments, split based on the actual date of change in partnership i.e. if a calendar-year partnership admits a new partner on June 30, than its first slot extends from January 1 to June 30 and second from July 1 to December 31.

Additional changes henceforth in partnership result in additional slots and each slot can adopt a different method.

Interim Closing Method

In case no agreement between partners, the interim closing method is the default method.

Under the interim closing method, the partnership actually closes its books on the date of the change in partnership interests and allocates income or loss based on the resulting segments which means, for example, based on timing, one slot could actually allocate a capital loss even if the partnership claims a net gain for the year.

Proration Method

The proration method simply allocates share of partnership gains based on the total number of days a partner exists during the year, or the proration period.

Accordingly, following are the answers, assuming partnership agreement existed;

a. Jim, a 70 percent partner, sells his partnership interest to Fred on August 10.

There will be apportionment of profit share gained during the year for period Jan – Aug 10 and Aug 10 – Dec between Jim and Fred

b. On July 13, the partnership sells its office building and moves its business across town.

Partnership stays active with selling office space and there shall be change in registered office of partnership. No impact in existence of partnership.

c. June buys a 15 percent interest in the partnership on May 14.

A change in partnership slot and there shall be apportionment among the partners from Jan 1 – May 14 and May 14 - Dec

d. The partnership goes out of business on February 26.

There shall be full and final apportionment among the partners for Jan 1 – Feb 26.