Question

Part 1 (True/False):

1. Cheri is an S corporation shareholder. She contributes $50,000 in cash for her shares in the corporation. She also loans the corporation $20,000. The limit of her basis for absorbing losses is $50,000.

2. Tom and Mary Watson contribute $1,000,000 to a new business venture. Johan, a German citizen, contributes $500,000 and Gliden, Inc., a corporation incorporated in the State of Illinois, contributes another $500,000. These owners will be unable to elect S corporation status for their new business venture.

3.As a general rule, when a person obtains an interest in partnership capital through rendition of services, ordinary income is recognized to the extent of the fair market value of a capital interest received.   Generally, a future profits only interest is not taxable.

4. Gina receives a guaranteed payment of $30,000 and a cash withdrawal of $10,000 from a partnership. She must reduce her capital account and the basis of her partnership interest by $40,000.

5. A contribution of appreciated property to a partnership is generally a non-taxable event unless the property is subject to liabilities and the partner’s net liability relinquishment (liabilities transferred less liabilities assumed) is greater than the partner’s basis in the transferred property.

6. An S corporation distributes inventory with a basis of $30,000 and a value of $60,000 to its three shareholders who have a total basis of $90,000 in their stock. The corporation recognizes gain on the distribution, the shareholders are taxed on the gain, their bases are increased by the gain recognized, and their bases are reduced by the fair market value of the inventory received.

7. Guaranteed payments represent payments to partners that are fixed at a specified percentage of partnership profits.

8. The XLM Partnership makes the following allocations to partner Nancy for the year: 1) ordinary income of $90,000; 2) tax exempt income of $2,000; 3) and non-deductible expenses of $4,000. Nancy also takes a cash withdrawal of $70,000. Nancy’s outside basis prior to these items is $40,000. After these accounting for these items, Nancy’s outside basis is $60,000.

9. If an S corporation is subject to the built-in gains tax, the corporation pays the entity level tax while the shareholders are still taxed on the pass through gain although that amount is reduced by the entity level taxes due.

Part 2: (Multiple Choices)

1. At January 1, 2016, Jody's basis in her partnership interest was $20,000. Her share of partnership items for the year is as follows: a guaranteed payment of $70,000, a long-term capital gain of $5,000, and an ordinary partnership loss of $20,000. She received a distribution from the partnership of $15,000 during the year. Assuming she materially participates in the partnership, she reports the following for 2016 related to these transactions.

a. Long-term capital gain of $5,000, a nontaxable distribution of $15,000, an ordinary loss of $20,000, and a guaranteed payment of $70,000.

b. Long-term capital gain of $5,000, a nontaxable distribution of $15,000, an ordinary loss of $10,000, a guaranteed payment of $70,000, and has a suspended loss of $10,000.

c. Long-term capital gain of $5,000, a nontaxable distribution of $15,000, an ordinary loss of $0, a guaranteed payment of $70,000, and has a suspended loss of $20,000.

d. none of the above.

2. Lauderdale Consultants Partnership enters into a multi-year termination agreement with, Tina, a departing partner. Which of the following termination payments would not reduce directly future taxable income allocated to the remaining partners of the partnership?

a. Installment payments made to Tina for her share of partnership property (including unstated goodwill)

b. Allocations of future profits to Tina

c. Future guaranteed payments to Tina

d. All of these would reduce future taxable income allocated to other partners

3. Which of the following statements is true?

a. An S corporation may have corporate shareholders.

b. An S corporation may make special allocations of profits

c. An S Corporation cannot have preferred stock.

d. A C corporation must liquidate and recognize gains before switching to S corporation status.

4. Martinsburg Town Partnership has two equal partners with capital accounts and outside bases as follows:

Partner	Capital Account	Outside Basis
Smith	30,000	40,000
Williams	30,000	40,000

The partnership incurs $20,000 of loss and makes a special allocation of $16,000 of the loss to Smith and $4,000 of the loss to Williams. The same allocation is made for both partnership book income and capital account purposes. The partnership agreement provides that, in case of liquidation, a partner must restore any deficit in the partner’s capital account. Which of the following is true about the partnership's allocation of loss?

a. Based on the facts, this special allocation appears to be acceptable.

b. The partnership cannot allocate the loss this way because the partnership must allocate losses equally.

c. The tax allocation cannot be allowed because it lacks economic effect

d. Cannot be determined

use the following information for the following four quiestions:

Talley, Elmer, and Molly will be owners for purposes of profits and capital of a newly formed business. They contribute the following properties to the business:

                        Property             Adj. Basis          Book Value (Fair market value at contribution)

Talley                Cash                 100,000             100,000

Elmer                Equipment         75,000               90,000**

Molly                Inventory           60,000               75,000

**Elmer’s equipment is subject to a $15,000 liability that the business assumes.

Unless otherwise stated by the question, assume this business is a partnership.

The partnership agreement provides for the following provisions:

1) Liquidations are made strictly in accordance with the book value of the partner’s capital account.

2) Although Talley has 40% of the initial value of partnership capital, Talley is a limited partner and will not be allocated any partnership liabilities. Liabilities will be allocated equally to Elmer and Molly.

3) Despite having 40% of the initial partnership capital, Talley will be allocated only 20% of the partnership profits and losses (by partnership agreement) remaining after any optional or required special allocations.

4) Elmer and Molly are each entitled to 40% of partnership profits and losses after any optional or required special allocations.

5. If the business had been formed as an S corporation with the value of the capital contributions representing percentage of stock ownership, which of the following statement is false?

a. The split of profits referred to in the agreement would not have been allowed.

b. The gain on the sale of the inventory would have been allocated 40%, 20%, and 20% to Talley, Elmer, and Molly respectively.

c. The built-in gain would still have to be allocated to Molly.

d. No liabilities would be added to the basis of any owner.

6. Suppose the business is run as a partnership and, within one year, the partnership sells the inventory for $80,000, depreciates the equipment for one year of a straight line basis of five years ($18,000 per year for book purposes and $15,000 per year for tax purposes), pays $6,000 on the equipment liability, has other revenues of $90,000, other expenses of $30,000 (other revenues and expenses are the same for both book and tax purposes) and distributes $5,000 to each owner. All transactions except depreciation are in cash. What is the ending value of Talley’s capital account?

a. $104,400

b. $101,400

c. $109,400

d. some other amount

7. Same facts as Question #38, but the question is: What is the value of Molly’s outside basis after all of these events

a. $93,300

b. $101,300

c. $96,300

d. some other amount

8. What is the taxable amount reported by Talley on her individual tax return as a result of her partnership interest?

a. $5,000 of ordinary income

b. $9,400 of ordinary income

c. $13,000 of ordinary income

d. $9,400 of capital gain

Answer 1

Part 1 (True/False):

1. Cheri is an S corporation shareholder. She contributes $50,000 in cash for her shares in the corporation. She also loans the corporation $20,000. The limit of her basis for absorbing losses is $50,000.

Ans

In S corporation a shareholder’s basis is a measure of the shareholder’s investment in the corporation’s stock. A shareholder’s beginning basis is the cash and adjusted basis of any property contributed to the corporation (or the price paid for the corporate stock)

Hence the limit basis for absorbing loss is $50,000 as she contributed $50,000 for coporation stock

Hence TRUE

2. Tom and Mary Watson contribute $1,000,000 to a new business venture. Johan, a German citizen, contributes $500,000 and Gliden, Inc., a corporation incorporated in the State of Illinois, contributes another $500,000. These owners will be unable to elect S corporation status for their new business venture.

Ans

To elect S corporation status, the corporation must qualify as a “small business corporation” as defined under Internal Revenue Code Section 1361, and its shareholders must consent to this election. A small business corporation is a domestic corporation that may have no more than 100 shareholders who, with limited exception, must be individuals who are not nonresident aliens, and it may have only one class of common stock outstanding

Hence johan is nonresident aliens hence These owners will be unable to elect S corporation status for their new business venture.

Hence TRUE

3.As a general rule, when a person obtains an interest in partnership capital through rendition of services, ordinary income is recognized to the extent of the fair market value of a capital interest received.   Generally, a future profits only interest is not taxable.

Ans

  TRUE when a person obtains an interest in partnership capital through rendition of services, ordinary income is recognized to the extent of the fair market value of a capital interest received.  

4. Gina receives a guaranteed payment of $30,000 and a cash withdrawal of $10,000 from a partnership. She must reduce her capital account and the basis of her partnership interest by $40,000.

Ans

Cash withdrawal of $10,000 from a partnership will reduce reduce her capital account not guaranteed payment which is treated as as a partner's distributive share of ordinary income

Hence False