Creating a Partnership Tax Return
Week 8 Assignment - Creating a Partnership Tax Return
Overview
You are a senior tax accountant in the firm, Ernest & Rainhouse. Joe, a new junior accountant, has just completed an interview with a new client Harry, who is a general partner of Widget Unlimited. Harry is seeking to have Ernest & Rainhouse prepare Widget Unlimited’s Partnership Tax Return. Joe has never prepared a Partnership Tax Return and seeks your help in doing so. Additionally, there are a couple of questions Harry asks that Joe needs your assistance in answering. You are to read the scenario below and then follow the instructions.
Scenario
Henry, Hunter, and Harry formed a partnership (Widget Unlimited) on January 1, 2020. Henry and Hunter each contributed $200,000 and Harry transferred a building he had purchased two years earlier to the partnership. The building had a tax basis of $150,000 and was appraised at $300,000. The building was also encumbered with a $100,000 mortgage. The partners plan to use the building to manufacture, distribute, and sell green and purple widgets.
Harry will work full time operating the business for which he will receive guaranteed payments (not included in expenses) of $5,000 per month. Henry and Hunter will devote less than twelve days a year to the business. At the end of 2020, Widgets Unlimited had made $6,000 in mortgage principal payments. The partnership agreement specifies that Henry, Hunter, and Harry will share in income/loss in the ratio of 3:3:4.
For the first year of operation, the partnership records disclose the following information:
Sales revenue $820,000
Cost of goods sold $735,000
Operating expenses $65,000
Long-term capital gains $3,300
~1231 gains $1,500
Charitable contributions $700
Political campaign donation $500
Municipal bond interest $450
Instructions
Write a 3-5 page paper in which you do the following:
Using the information provided, create a Form 1065: U.S. Return of Partnership Income 2020 for Widgets Unlimited, preparing a Schedule K for Henry, Hunter, and Harry.
Refer to the completed Form 1065 schedule of Henry, Hunter, and Harry's adjusted tax basis immediately after partnership formation and at the end of the first year of operation. Explain in what situations Henry, Hunter, and Harry would need to know the tax basis in their partnerships. Explain how often a partner's tax basis in his partnership needs to be adjusted. Justify your answer with relevant tax code citation.
The tax code specifically enumerates several common separately stated items. Explain which items would be separately stated for partners Henry, Hunter, and Harry. Explain why each should be separately stated, citing relevant tax code for at least three of your identified separately stated items.
Assume Widgets Unlimited initial year of operation resulted in a loss. Explain in what order are the loss limitation rules applied to limit partner's losses from partnerships.
Explain how Henry, Hunter, and Harry would determine whether they are passive participants in Widgets Unlimited when applying the passive activity loss limitation rules.
Use at least two quality sources to support your writing. Choose sources that are credible, relevant, and appropriate. Cite each source listed on your source page at least one time within your assignment. For help with research, writing, and citation, access the library or review library guides.
Produce writing that is clear and well organized and applies appropriate SWS style. Writing contains accurate grammar, mechanics, and spelling.
This course requires the use of Strayer Writing Standards. For assistance and information, please refer to the Strayer Writing Standards link in the left-hand menu of your course. Check with your professor for any additional instructions.
The specific course learning outcomes associated with this assignment:
Create a partnership tax return informed by applicable tax rules and treatments for a specific client.
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Creating a Partnership Tax Return
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Creating a Partnership Tax Return
A partnership tax return is filed through the IRS (Internal Revenue Service) form 1065. This discussion is on the creation of a Partnership Tax Return for Widget Unlimited, a partnership formed by Henry, Hunter, and Harry, on January 1, 2020. Schedule K form will also be filled since the partnership is required to submit it. In this scenario, a couple of questions regarding a Partnership Tax Return, asked by Harry, will be answered.
The Partnership Tax Return form (Form 1065) reports Widget Unlimited’s net income, in addition to other relevant financial items mainly drawn from its income statement. The company’s Form 1065 entries are presented below;
The following are the explanatory notes in arriving at the items to be filled out in the form;
* Charitable contributions and political campaign donations are not allowable expenses.
* Part of the value of the building encumbered with a $100,000 mortgage is considered a partner loan to the business whose mortgage interest is an interest expense. The $6,000 made in mortgage principal payments is a capital expenditure therefore not an allowable expense.
* The $5,000 monthly payments to Harry are benefits due directly to the partner and are not allowable in determining the net income on Form 1065, but are included in Schedule K under Guaranteed payments.
Schedule K entries are presented below;
The following are the explanatory notes in arriving at the items in the above schedule;
* The $5,000 monthly payments totaling $60,000 are benefits paid directly to Harry.
* Other income of $4,800 comprises Long-term Capital Gains of $3,300 and ~1231 gains of $1,500.
One of the situations in which partners will need to know their tax basis is for the determination of their gains or losses in the partnership (§741). This information will help in calculating the allowable partners’ distributive share of the gains or losses to determine their tax liability. This amount is different from the values shown in the individual partners’ capital accounts. In the case of Widget Unlimited, the tax basis for the building contributed by Harry is $150,000 at the beginning of the year and will be reduced by the amount of mortgage principal payments allowable for tax basis at the end of the year.
Another situation in which partners will need to know the tax basis is when the partnership has disposed of their interest in the partnership and the partners need to determine their loss or gain from such a dis...