Question

Richard Powers and Jane Keckley, two professionals in the finance area, have worked for Eberhart Leasing for a number of years. Eberhart Leasing is a company that leases high-tech medical equipment to hospitals. Richard and Jane have decided that, with their financial expertise, they might start their own company to provide consulting services to individuals interested in leasing equipment. One form of organization they are considering is a partnership. If they start a partnership, each individual plans to contribute P2 million in cash. In addition, Richard has a used IBM computer that originally cost P148,000, which he intends to invest in the partnership. The computer has a present market value of P60,000 Although both Richard and Jane are financial wizards, they do not know a great deal about how a partnership operates. As a result, they have come to you for advice. Answer the following: 1. What are the major disadvantages of starting a partnership? 2. What type of document is needed for a partnership, and what should this document contain? 3. Both Richard and Jane plan to work full-time in the new partnership They believe that net income or net loss shou ld be shared equally. However, they are wondering how they can provide compensation to Richard Powers for his additional investment of the computer. What would you tell them? 4. Richard is not sure how the computer equipment should be reported on his tax return. What would you tell him? 5. As indicated above, Richard and Jane have worked together for a number of years. Richard's skills complement Jane's and vice versa. If one of them dies, it will be very difficult for the other to maintain the business, not to mention the difficulty of paying the deceased partner's estate for his or her partnership interest. What would you advise them to do?

Answer 1

1.

• the liability of the partners for the debts of the business is unlimited
• each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for their share of the partnership debts as well as being liable for all the debts
• there is a risk of disagreements and friction among partners and management
• each partner is an agent of the partnership and is liable for actions by other partners
• if partners join or leave, you will probably have to value all the partnership assets and this can be costly.

2.

  

A partnership is easy to form since no complex business formalities are required to be fulfilled. Partnership registration is not compulsory and in at the discretion of the partners whether they want to register the /s/documents-required-partnership-registration-indiapartnership firm or not.But a partnership firm cannot avail legal benefits if it is not registered, hence it is always advisable to register it. Documents required for partnership formation (whether registered or not) are:-

• Partnership Deed
• Documents of Firm
• Documents of Partners
• Additional Documents in case of Registration
• GST Registration
• Current Bank Account

3.

  

The partnership agreement may specify that partners should be compensated for services they provide to the partnership and for capital invested by partners.

For example, one partner contributed more of the assets, and works full-time in the partnership, while the other partner contributed a smaller amount of assets and does not provide as much services to the partnership.

Compensation for services is provided in the form of salary allowance. Compensation for capital is provided in the form of interest allowance. Amount of compensation is added to the capital account of the partner.

To illustrate, assume that a partner received $500 as an interest allowance. The amount is included in the net income/loss distribution entry when the books are closed to the capital accounts at year end:

4.   

1. Prepare Form 1065, U.S. Return of Partnership Income. ...
2. Prepare Schedule K-1. ...
3. File Form 1065 and Copies of the K-1 Forms. ...
4. File State Tax Returns.
5. File personal tax returns.

5.

  

The death of a partner in a two-person partnership will terminate the partnership for federal tax purposes if it results in the partnership's immediately winding up its business (Sec. 708(b)(1)(A)). If this occurs, the partnership's tax year closes on the partner's date of death. Similarly, the death of a partner in a two-person partnership generally will cause the technical termination of the partnership under Rev. Rul. 99-6. The regulations, however, provide two exceptions that prevent an immediate termination of the partnership of a two-person partnership upon a partner's death.

A two-person partnership does not terminate upon a partner's death if the deceased partner's successor in interest (usually the estate) continues to share in the partnership's profits or losses (Regs. Sec. 1.708-1(b)(1)(I)). The partnership's tax year does not close, and the partner's distributive share of partnership income from the date of death through the end of the partnership tax year is reported on the tax return of the successor in interest (Regs. Sec. 1.706-1(a)). Likewise, if a partnership begins or continues to make liquidating payments to a deceased partner's successor in interest under the provisions of Sec. 736, the successor in interest is treated as a partner until the deceased partner's interest in the partnership has been completely liquidated (Regs. Sec. 1.736-1(a)(1)(ii)). In a two-person partnership, the partnership does not terminate, nor does the partnership year end (other than the partnership's normal tax year), until the final liquidating payment is made to the successor in interest (Regs. Sec. 1.736-1(a)(6)).

If the clients wish to continue a two-partner partnership after a partner's death, the practitioner should consider making the following recommendations to ensure continuation:

1. The operating agreement or the liquidation agreement should indicate the interest of the deceased partner is to be retired by a series of liquidating payments made by the partnership. Ideally, the agreement should state the payments are made under Sec. 736.
2. When the interest is retired, the partnership books should reflect the elimination of the deceased partner's interest in capital and the establishment of a payable to the partner's successor in interest. All subsequent payments made to retire the interest should reduce the payable.
3. Partnership tax returns should be filed as long as payments are being made to the deceased partner's successor in interest.
4. All payments for the deceased partner's interest in the partnership should be made from the partnership's business account and not from the remaining partner's personal account.