Question

A, B, and C each contribute $20,000 to form the ABC general partnership. The partnership agreement satisfies the primary test for economic effect under Internal Revenue Code Section 704(b). Partnership profits and losses are allocated 40% to A, 40% to B and 20% to C. The partnership uses its $60,000 cash and borrows an additional $40,000 on a recourse basis and purchases land for $100,000.

(a) How will the $40,000 liability be allocated and what will be each partner’s outside basis?

(b) What result in (a), above, if A, B and C had contributed $10,000, $20,000 and $30,000, respectively, to the ABC partnership?

(c) What result in (a), above, if A and B are limited partners who are not obligated to restore a capital account deficit but the partnership agreement includes a qualified income offset?

(d) What result in (c), above, if A contributes $15,000 of stock to the partnership as security for the liability and all income, gain or loss on the stock is allocated to A? What result if A contributes his $15,000 note as security for the liability?

(e) What result in (c), above, if A personally guarantees the $40,000 liability?

Answer 1

(a) All the profits and losses and therefore all assets and liabilities also, are to divided among the partners as follows:

40% to A, 40% to B and 20% C.

Thus, the liability of $40,000 is also to be divided in the same ratio as above.

Liability of A - 40% of $40,000 = $16,000

Liability of B - 40% of $40,000 = $16,000

Liability of C - 20% of $40,000 = $8,000.

(b) If A, B and C would have conributed $10,000, $20,000 and $30,000 each, then the profits and losses allocation would have be done in the following manner:

20% to A, 40% to B and 40% to C.

Thus, the liability of $40,000 is also to be divided in the same ratio as above.

Liability of A - 20% of $40,000 = $8,000

Liability of B - 40% of $40,000 = $16,000

Liability of C - 40% of $40,000 = $16,000.

(c) There will be no change as there is no capital account deficit as of now.

There be a capital account deficit if A and B has to pay more than what they have brought in or earned. But here they the amount of their liability is less than that. Therefore there is will be no change in answer of (a).

(d) In this case, A will be in a liability of only $1,000 now, whereas B and C will be in a liabilty of $16,000 and $8,000 respectively, and A will receive $15,000 securities worth equivalent amount if tthere is any income from the liability he has contributed his securities for, and the rest of income will be divided among A, B and C in the ratio of 4:4:2.