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My free tax 31. My free tax   Tax on Unearned Income of Certain Children Table of Contents What's New Introduction Useful Items - You may want to see: Which Parent's Return To UseParents Who Do Not File a Joint Return Parent's Election To Report Child's Interest and DividendsEffect of Making the Election Figuring Child's Income Figuring Additional Tax Tax for Certain Children Who Have Unearned IncomeProviding Parental Information (Form 8615, lines A–C) Step 1. My free tax Figuring the Child's Net Unearned Income (Form 8615, Part I) Step 2. My free tax Figuring Tentative Tax at the Parent's Tax Rate (Form 8615, Part II) Step 3. My free tax Figuring the Child's Tax (Form 8615, Part III) What's New Net Investment Income Tax. My free tax . My free tax  For tax years beginning after December 31, 2012, a child whose tax is figured on Form 8615 may be subject to the Net Investment Income Tax (NIIT). My free tax NIIT is a 3. My free tax 8% tax on the lesser of the net investment income or the excess of the child's modified adjusted gross income (MAGI) over the threshold amount. My free tax Use Form 8960, Net Investment Income Tax, to figure this tax. My free tax For more information on NIIT, go to www. My free tax irs. My free tax gov and enter “Net Investment Income Tax” in the search box. My free tax Introduction This chapter discusses the following two rules that may affect the tax on unearned income of certain children. My free tax If the child's interest and dividend income (including capital gain distributions) total less than $10,000, the child's parent may be able to choose to include that income on the parent's return rather than file a return for the child. My free tax (See Parent's Election To Report Child's Interest and Dividends , later. My free tax ) If the child's interest, dividends, and other unearned income total more than $2,000, part of that income may be taxed at the parent's tax rate instead of the child's tax rate. My free tax (See Tax for Certain Children Who Have Unearned Income , later. My free tax ) For these rules, the term “child” includes a legally adopted child and a stepchild. My free tax These rules apply whether or not the child is a dependent. My free tax Useful Items - You may want to see: Publication 929 Tax Rules for Children and Dependents Form (and Instructions) 8615 Tax for Certain Children Who Have Unearned Income 8814 Parents' Election To Report Child's Interest and Dividends Which Parent's Return To Use If a child's parents are married to each other and file a joint return, use the joint return to figure the tax on the child's unearned income. My free tax The tax rate and other return information from that return are used to figure the child's tax as explained later under Tax for Certain Children Who Have Unearned Income . My free tax Parents Who Do Not File a Joint Return For parents who do not file a joint return, the following discussions explain which parent's tax return must be used to figure the tax. My free tax Only the parent whose tax return is used can make the election described under Parent's Election To Report Child's Interest and Dividends . My free tax Parents are married. My free tax   If the child's parents file separate returns, use the return of the parent with the greater taxable income. My free tax Parents not living together. My free tax   If the child's parents are married to each other but not living together, and the parent with whom the child lives (the custodial parent) is considered unmarried, use the return of the custodial parent. My free tax If the custodial parent is not considered unmarried, use the return of the parent with the greater taxable income. My free tax   For an explanation of when a married person living apart from his or her spouse is considered unmarried, see Head of Household in chapter 2. My free tax Parents are divorced. My free tax   If the child's parents are divorced or legally separated, and the parent who had custody of the child for the greater part of the year (the custodial parent) has not remarried, use the return of the custodial parent. My free tax Custodial parent remarried. My free tax   If the custodial parent has remarried, the stepparent (rather than the noncustodial parent) is treated as the child's other parent. My free tax Therefore, if the custodial parent and the stepparent file a joint return, use that joint return. My free tax Do not use the return of the noncustodial parent. My free tax   If the custodial parent and the stepparent are married, but file separate returns, use the return of the one with the greater taxable income. My free tax If the custodial parent and the stepparent are married but not living together, the earlier discussion under Parents not living together applies. My free tax Parents never married. My free tax   If a child's parents have never been married to each other, but lived together all year, use the return of the parent with the greater taxable income. My free tax If the parents did not live together all year, the rules explained earlier under Parents are divorced apply. My free tax Widowed parent remarried. My free tax   If a widow or widower remarries, the new spouse is treated as the child's other parent. My free tax The rules explained earlier under Custodial parent remarried apply. My free tax Parent's Election To Report Child's Interest and Dividends You may be able to elect to include your child's interest and dividend income (including capital gain distributions) on your tax return. My free tax If you do, your child will not have to file a return. My free tax You can make this election only if all the following conditions are met. My free tax Your child was under age 19 (or under age 24 if a full-time student) at the end of the year. My free tax Your child had income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends). My free tax The child's gross income was less than $10,000. My free tax The child is required to file a return unless you make this election. My free tax The child does not file a joint return for the year. My free tax No estimated tax payment was made for the year, and no overpayment from the previous year (or from any amended return) was applied to this year under your child's name and social security number. My free tax No federal income tax was taken out of your child's income under the backup withholding rules. My free tax You are the parent whose return must be used when applying the special tax rules for children. My free tax (See Which Parent's Return To Use , earlier. My free tax ) These conditions are also shown in Figure 31-A. My free tax Certain January 1 birthdays. My free tax   A child born on January 1, 1995, is considered to be age 19 at the end of 2013. My free tax You cannot make this election for such a child unless the child was a full-time student. My free tax   A child born on January 1, 1990, is considered to be age 24 at the end of 2013. My free tax You cannot make this election for such a child. My free tax Full-time student. My free tax   A full-time student is a child who during some part of each of any 5 calendar months of the year was enrolled as a full-time student at a school, or took a full-time on-farm training course given by a school or a state, county, or local government agency. My free tax A school includes a technical, trade, or mechanical school. My free tax It does not include an on-the-job training course, correspondence school, or school offering courses only through the Internet. My free tax How to make the election. My free tax   Make the election by attaching Form 8814 to your Form 1040. My free tax (If you make this election, you cannot file Form 1040A or Form 1040EZ. My free tax ) Attach a separate Form 8814 for each child for whom you make the election. My free tax You can make the election for one or more children and not for others. My free tax Effect of Making the Election The federal income tax on your child's income may be more if you make the Form 8814 election. My free tax Rate may be higher. My free tax   If your child received qualified dividends or capital gain distributions, you may pay up to $100 more tax if you make this election instead of filing a separate tax return for the child. My free tax This is because the tax rate on the child's income between $1,000 and $2,000 is 10% if you make this election. My free tax However, if you file a separate return for the child, the tax rate may be as low as 0% (zero percent) because of the preferential tax rates for qualified dividends and capital gain distributions. My free tax Deductions you cannot take. My free tax   By making the Form 8814 election, you cannot take any of the following deductions that the child would be entitled to on his or her return. My free tax The additional standard deduction if the child is blind. My free tax The deduction for a penalty on an early withdrawal of your child's savings. My free tax Itemized deductions (such as your child's investment expenses or charitable contributions). My free tax Reduced deductions or credits. My free tax   If you use Form 8814, your increased adjusted gross income may reduce certain deductions or credits on your return including the following. My free tax Deduction for contributions to a traditional individual retirement arrangement (IRA). My free tax Deduction for student loan interest. My free tax Itemized deductions for medical expenses, casualty and theft losses, and certain miscellaneous expenses. My free tax Credit for child and dependent care expenses. My free tax Child tax credit. My free tax Education tax credits. My free tax Earned income credit. My free tax Penalty for underpayment of estimated tax. My free tax   If you make this election for 2013 and did not have enough tax withheld or pay enough estimated tax to cover the tax you owe, you may be subject to a penalty. My free tax If you plan to make this election for 2014, you may need to increase your federal income tax withholding or your estimated tax payments to avoid the penalty. My free tax See chapter 4 for more information. My free tax Figuring Child's Income Use Form 8814, Part I, to figure your child's interest and dividend income to report on your return. My free tax Only the amount over $2,000 is added to your income. My free tax The amount over $2,000 is shown on Form 8814, line 6. My free tax Unless the child's income includes qualified dividends or capital gain distributions (discussed next), the same amount is shown on Form 8814, line 12. My free tax Include the amount from Form 8814, line 12, on Form 1040, line 21. My free tax Enter “Form 8814” on the dotted line next to line 21. My free tax If you file more than one Form 8814, include the total amounts from line 12 of all your Forms 8814 on Form 1040, line 21. My free tax Capital gain distributions and qualified dividends. My free tax   If your child's dividend income included any capital gain distributions, see Capital gain distributions under Figuring Child's Income in Publication 929, Part 2. My free tax If your child's dividend income included any qualified dividends, see Qualified dividends under Figuring Child's Income in Publication 929, Part 2. My free tax Figuring Additional Tax Use Form 8814, Part II, to figure the tax on the $2,000 of your child's interest and dividends that you do not include in your income. My free tax This tax is added to the tax figured on your income. My free tax This additional tax is the smaller of: 10% × (your child's gross income − $1,000), or $100. My free tax Include the amount from line 15 of all your Forms 8814 in the total on Form 1040, line 44. My free tax Check box a on Form 1040, line 44. My free tax Figure 31-A. My free tax Can You Include Your Child's Income On Your Tax Return? Please click here for the text description of the image. My free tax Figure 31–A. My free tax Can You Include Your Child's Income On Your Tax Return? Tax for Certain Children Who Have Unearned Income If a child's interest, dividends, and other unearned income total more than $2,000, part of that income may be taxed at the parent's tax rate instead of the child's tax rate. My free tax If the parent does not or cannot choose to include the child's income on the parent's return, use Form 8615 to figure the child's tax. My free tax Attach the completed form to the child's Form 1040 or Form 1040A. My free tax When Form 8615 must be filed. My free tax   Form 8615 must be filed for a child if all of the following statements are true. My free tax The child's investment income was more than $2,000. My free tax The child is required to file a return for 2013. My free tax The child either: Was under age 18 at the end of the year, Was age 18 at the end of the year and did not have earned income that was more than half of his or her support, or Was over age 18 and under age 24 at the end of the year, was a full-time student, and did not have earned income that was more than half of his or her support. My free tax At least one of the child's parents was alive at the end of 2013. My free tax The child does not file a joint return for 2013. My free tax These conditions are also shown in  Figure 31-B. My free tax Earned income. My free tax   Earned income includes salaries, wages, tips, and other payments received for personal services performed. My free tax It does not include unearned income as defined later in this chapter. My free tax Support. My free tax   Your child's support includes all amounts spent to provide the child with food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. My free tax To figure your child's support, count support provided by you, your child, and others. My free tax However, a scholarship received by your child is not considered support if your child is a full-time student. My free tax See chapter 3 for details about support. My free tax Certain January 1 birthdays. My free tax   Use the following chart to determine whether certain children with January 1 birthdays meet condition 3 under When Form 8615 must be filed. My free tax Figure 31-B. My free tax Do You Have To Use Form 8615 To Figure Your Child's Tax? Please click here for the text description of the image. My free tax Figure 31-B. My free tax Do You Have To Use Form 8615 To Figure Your Child's Tax?    IF a child was born on. My free tax . My free tax . My free tax THEN, at the end of 2013, the child is considered to be. My free tax . My free tax . My free tax January 1, 1996 18* January 1, 1995 19** January 1, 1990 24*** *This child is not under age 18. My free tax The child meets condition 3 only if the child did not have earned income that was more than half of the child's support. My free tax  **This child meets condition 3 only if the child was a full-time student who did not have earned income that was more than half of the child's support. My free tax  ***Do not use Form 8615 for this child. My free tax Providing Parental Information (Form 8615, lines A–C) On Form 8615, lines A and B, enter the parent's name and social security number. My free tax (If the parents filed a joint return, enter the name and social security number listed first on the joint return. My free tax ) On line C, check the box for the parent's filing status. My free tax See Which Parent's Return To Use at the beginning of this chapter for information on which parent's return information must be used on Form 8615. My free tax Parent with different tax year. My free tax   If the parent and the child do not have the same tax year, complete Form 8615 using the information on the parent's return for the tax year that ends in the child's tax year. My free tax Parent's return information not known timely. My free tax   If the information needed from the parent's return is not known by the time the child's return is due (usually April 15), you can file the return using estimates. My free tax   You can use any reasonable estimate. My free tax This includes using information from last year's return. My free tax If you use an estimated amount on Form 8615, enter “Estimated” on the line next to the amount. My free tax    When you get the correct information, file an amended return on Form 1040X, Amended U. My free tax S. My free tax Individual Income Tax Return. My free tax   Instead of using estimates, you can get an automatic 6-month extension of time to file if, by the date your return is due, you file Form 4868, Application for Automatic Extension of Time To File U. My free tax S. My free tax Individual Income Tax Return. My free tax Extensions are discussed in chapter 1. My free tax Step 1. My free tax Figuring the Child's Net Unearned Income (Form 8615, Part I) The first step in figuring a child's tax using Form 8615 is to figure the child's net unearned income. My free tax To do that, use Form 8615, Part I. My free tax Line 1 (unearned income). My free tax   If the child had no earned income, enter on this line the adjusted gross income shown on the child's return. My free tax Adjusted gross income is shown on Form 1040, line 38, or Form 1040A, line 22. My free tax Form 1040EZ cannot be used if Form 8615 must be filed. My free tax   If the child had earned income, figure the amount to enter on Form 8615, line 1, by using the worksheet in the instructions for the form. My free tax   However, if the child has: excluded any foreign earned income, deducted either a loss from self-employment, or deducted a net operating loss from another year, then use the Alternate Worksheet for Form 8615, Line 1, in Publication 929 to figure the amount to enter on Form 8615, line 1. My free tax Unearned income defined. My free tax   Unearned income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. My free tax It includes taxable interest, dividends (including capital gain distributions), capital gains, unemployment compensation, the taxable part of social security and pension payments, and certain distributions from trusts. My free tax Unearned income includes amounts produced by assets the child obtained with earned income (such as interest on a savings account into which the child deposited wages). My free tax Nontaxable income. My free tax   For this purpose, unearned income includes only amounts the child must include in total income. My free tax Nontaxable unearned income, such as tax-exempt interest and the nontaxable part of social security and pension payments, is not included. My free tax Income from property received as a gift. My free tax   A child's unearned income includes all income produced by property belonging to the child. My free tax This is true even if the property was transferred to the child, regardless of when the property was transferred or purchased or who transferred it. My free tax   A child's unearned income includes income produced by property given as a gift to the child. My free tax This includes gifts to the child from grandparents or any other person and gifts made under the Uniform Gift to Minors Act. My free tax Example. My free tax Amanda Black, age 13, received the following income. My free tax Dividends — $800 Wages — $2,100 Taxable interest — $1,200 Tax-exempt interest — $100 Net capital gains — $100 The dividends were qualified dividends on stock given to her by her grandparents. My free tax Amanda's unearned income is $2,100. My free tax This is the total of the dividends ($800), taxable interest ($1,200), and net capital gains ($100). My free tax Her wages are earned (not unearned) income because they are received for work actually done. My free tax Her tax-exempt interest is not included because it is nontaxable. My free tax Trust income. My free tax   If a child is the beneficiary of a trust, distributions of taxable interest, dividends, capital gains, and other unearned income from the trust are unearned income to the child. My free tax   However, for purposes of completing Form 8615, a taxable distribution from a qualified disability trust is considered earned income, not unearned income. My free tax Line 2 (deductions). My free tax   If the child does not itemize deductions on Schedule A (Form 1040), enter $2,000 on line 2. My free tax   If the child does itemize deductions, enter on line 2 the larger of: $1,000 plus the portion of the child's itemized deductions on Schedule A (Form 1040), line 29, that are directly connected with the production of unearned income entered on line 1, or $2,000. My free tax Directly connected. My free tax   Itemized deductions are directly connected with the production of unearned income if they are for expenses paid to produce or collect taxable income or to manage, conserve, or maintain property held for producing income. My free tax These expenses include custodian fees and service charges, service fees to collect taxable interest and dividends, and certain investment counsel fees. My free tax   These expenses are added to certain other miscellaneous itemized deductions on Schedule A (Form 1040). My free tax Only the amount greater than 2% of the child's adjusted gross income can be deducted. My free tax See chapter 28 for more information. My free tax Example 1. My free tax Roger, age 12, has unearned income of $8,000, no other income, no adjustments to income, and itemized deductions of $300 (net of the 2% limit) that are directly connected with his unearned income. My free tax His adjusted gross income is $8,000, which is entered on Form 1040, line 38, and on Form 8615, line 1. My free tax Roger enters $2,000 on line 2 because that is more than the total of $1,000 plus his directly connected itemized deductions of $300. My free tax Example 2. My free tax Eleanor, age 8, has unearned income of $16,000 and an early withdrawal penalty of $100. My free tax She has no other income. My free tax She has itemized deductions of $1,050 (net of the 2% limit) that are directly connected with the production of her unearned income. My free tax Her adjusted gross income, entered on line 1, is $15,900 ($16,000 − $100). My free tax The amount on line 2 is $2,050. My free tax This is the larger of: $1,000 plus the $1,050 of directly connected itemized deductions, or $2,000. My free tax Line 3. My free tax   Subtract line 2 from line 1 and enter the result on this line. My free tax If zero or less, do not complete the rest of the form. My free tax However, you must still attach Form 8615 to the child's tax return. My free tax Figure the tax on the child's taxable income in the normal manner. My free tax Line 4 (child's taxable income). My free tax   Enter on line 4 the child's taxable income from Form 1040, line 43, or Form 1040A, line 27. My free tax   However, if the child files Form 2555 or 2555-EZ to claim the foreign earned income exclusion, housing exclusion, or housing deduction, see the Form 8615 instructions or Pub. My free tax 929. My free tax Line 5 (net unearned income). My free tax   A child's net unearned income cannot be more than his or her taxable income. My free tax Enter on Form 8615, line 5, the smaller of line 3 or line 4. My free tax This is the child's net unearned income. My free tax   If zero or less, do not complete the rest of the form. My free tax However, you must still attach Form 8615 to the child's tax return. My free tax Figure the tax on the child's taxable income in the normal manner. My free tax Step 2. My free tax Figuring Tentative Tax at the Parent's Tax Rate (Form 8615, Part II) The next step in completing Form 8615 is to figure a tentative tax on the child's net unearned income at the parent's tax rate. My free tax The tentative tax at the parent's tax rate is the difference between the tax on the parent's taxable income figured with the child's net unearned income (plus the net unearned income of any other child whose Form 8615 includes the tax return information of that parent) and the tax figured without it. My free tax When figuring the tentative tax at the parent's tax rate on Form 8615, do not refigure any of the exclusions, deductions, or credits on the parent's return because of the child's net unearned income. My free tax For example, do not refigure the medical expense deduction. My free tax Figure the tentative tax on Form 8615, lines 6 through 13. My free tax Note. My free tax If the child or parent has any capital gains or losses, get Publication 929 for help in completing Form 8615, Part II. My free tax Line 6 (parent's taxable income). My free tax   Enter on line 6 the parent's taxable income from Form 1040, line 43, Form 1040A, line 27, or Form 1040EZ, line 6. My free tax   If the Foreign Earned Income Tax Worksheet (in the Form 1040 instructions) was used to figure the parent's tax, enter the amount from line 3 of that worksheet instead of the parent's taxable income. My free tax Line 7 (net unearned income of other children). My free tax   If the tax return information of the parent is also used on any other child's Form 8615, enter on line 7 the total of the amounts from line 5 of all the other children's Forms 8615. My free tax Do not include the amount from line 5 of the Form 8615 being completed. My free tax Example. My free tax Paul and Jane Persimmon have three children, Sharon, Jerry, and Mike, who must attach Form 8615 to their tax returns. My free tax The children's net unearned income amounts on line 5 of their Forms 8615 are: Sharon — $800 Jerry — $600 Mike — $1,000 Line 7 of Sharon's Form 8615 will show $1,600, the total of the amounts on line 5 of Jerry's and Mike's Forms 8615. My free tax Line 7 of Jerry's Form 8615 will show $1,800 ($800 + $1,000). My free tax Line 7 of Mike's Form 8615 will show $1,400 ($800 + $600). My free tax Other children's information not available. My free tax   If the net unearned income of the other children is not available when the return is due, either file the return using estimates or get an extension of time to file. My free tax See Parent's return information not known timely , earlier. My free tax Line 11 (tentative tax). My free tax   Subtract line 10 from line 9 and enter the result on this line. My free tax This is the tentative tax. My free tax   If line 7 is blank, skip lines 12a and 12b and enter the amount from line 11 on line 13. My free tax Also skip the discussion for lines 12a and 12b that follows. My free tax Lines 12a and 12b (dividing the tentative tax). My free tax   If an amount is entered on line 7, divide the tentative tax shown on line 11 among the children according to each child's share of the total net unearned income. My free tax This is done on lines 12a, 12b, and 13. My free tax Add the amount on line 7 to the amount on line 5 and enter the total on line 12a. My free tax Divide the amount on line 5 by the amount on line 12a and enter the result, as a decimal, on line 12b. My free tax Example. My free tax In the earlier example under Line 7 (net unearned income of other children), Sharon's Form 8615 shows $1,600 on line 7. My free tax The amount entered on line 12a is $2,400, the total of the amounts on lines 5 and 7 ($800 + $1,600). My free tax The decimal on line 12b is  . My free tax 333, figured as follows and rounded to three places. My free tax   $800 = . My free tax 333     $2,400   Step 3. My free tax Figuring the Child's Tax (Form 8615, Part III) The final step in figuring a child's tax using Form 8615 is to determine the larger of: The total of: The child's share of the tentative tax based on the parent's tax rate, plus The tax on the child's taxable income in excess of net unearned income, figured at the child's tax rate, or The tax on the child's taxable income, figured at the child's tax rate. My free tax This is the child's tax. My free tax It is figured on Form 8615, lines 14 through 18. My free tax Alternative minimum tax. My free tax   A child may be subject to alternative minimum tax (AMT) if he or she has certain items given preferential treatment under the tax law. My free tax See Alternative Minimum Tax (AMT) in chapter 30. My free tax    For more information on who is liable for AMT and how to figure it, see Form 6251, Alternative Minimum Tax—Individuals. My free tax For information on special limits that apply to a child who files Form 6251, see Certain Children Under Age 24 in the Instructions for Form 6251. My free tax Prev  Up  Next   Home   More Online Publications
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My free tax Publication 541 - Main Content Table of Contents Forming a PartnershipOrganizations Classified as Partnerships Family Partnership Partnership Agreement Terminating a PartnershipIRS e-file (Electronic Filing) Exclusion From Partnership Rules Partnership Return (Form 1065) Partnership DistributionsSubstantially appreciated inventory items. My free tax Partner's Gain or Loss Partner's Basis for Distributed Property Transactions Between Partnership and PartnersGuaranteed Payments Sale or Exchange of Property Contribution of Property Contribution of Services Basis of Partner's InterestAdjusted Basis Effect of Partnership Liabilities Disposition of Partner's InterestSale, Exchange, or Other Transfer Payments for Unrealized Receivables and Inventory Items Liquidation at Partner's Retirement or Death Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)Partnership Item. My free tax Small Partnerships and the Small Partnership Exception Small Partnership TEFRA Election Role of Tax Matters Partner (TMP) in TEFRA Proceedings Statute of Limitations and TEFRA Amended Returns and Administrative Adjustment Requests (AARs) How To Get Tax Help Forming a Partnership The following sections contain general information about partnerships. My free tax Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. My free tax However, a joint undertaking merely to share expenses is not a partnership. My free tax For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. My free tax The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. My free tax Organizations formed after 1996. My free tax   An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. My free tax An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. My free tax An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. My free tax An insurance company. My free tax Certain banks. My free tax An organization wholly owned by a state, local, or foreign government. My free tax An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). My free tax Certain foreign organizations identified in section 301. My free tax 7701-2(b)(8) of the regulations. My free tax A tax-exempt organization. My free tax A real estate investment trust. My free tax An organization classified as a trust under section 301. My free tax 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. My free tax Any other organization that elects to be classified as a corporation by filing Form 8832. My free tax For more information, see the instructions for Form 8832. My free tax Limited liability company. My free tax   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. My free tax Unlike a partnership, none of the members of an LLC are personally liable for its debts. My free tax An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301. My free tax 7701-3. My free tax See Form 8832 and section 301. My free tax 7701-3 of the regulations for more details. My free tax A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. My free tax Organizations formed before 1997. My free tax   An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832. My free tax Community property. My free tax    Spouses who own a qualified entity (defined later) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. My free tax They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. My free tax A change in reporting position will be treated for federal tax purposes as a conversion of the entity. My free tax   A qualified entity is a business entity that meets all the following requirements. My free tax The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a possession of the United States. My free tax No person other than one or both spouses would be considered an owner for federal tax purposes. My free tax The business entity is not treated as a corporation. My free tax   For more information about community property, see Publication 555, Community Property. My free tax Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. My free tax Family Partnership Members of a family can be partners. My free tax However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. My free tax If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest. My free tax If capital is not a material income-producing factor, they joined together in good faith to conduct a business. My free tax They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. My free tax Capital is material. My free tax   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. My free tax Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. My free tax Capital is not material. My free tax   In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. My free tax Capital interest. My free tax   A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations. My free tax The owner withdraws from the partnership. My free tax The partnership liquidates. My free tax   The mere right to share in earnings and profits is not a capital interest in the partnership. My free tax Gift of capital interest. My free tax   If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions. My free tax It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. My free tax The donee's distributive share of partnership income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. My free tax Purchase. My free tax   For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. My free tax The fair market value of the purchased interest is considered donated capital. My free tax For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). My free tax Example. My free tax A father sold 50% of his business to his son. My free tax The resulting partnership had a profit of $60,000. My free tax Capital is a material income-producing factor. My free tax The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. My free tax The $24,000 must be allocated to the father as compensation. My free tax Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. My free tax The son's share of partnership profit cannot be more than $18,000. My free tax Business owned and operated by spouses. My free tax   If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. My free tax If so, they should report income or loss from the business on Form 1065. My free tax They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. My free tax However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. My free tax Qualified Joint Venture Election. My free tax   A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. My free tax A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. My free tax   Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore does not have a Form 1065 filing requirement. My free tax All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. My free tax Each spouse takes into account his or her respective share of these items as a sole proprietor. My free tax Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). My free tax For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (i. My free tax e. My free tax , based on their respective interests in the venture). My free tax   If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. My free tax Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. My free tax   This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. My free tax However, this may not be true if either spouse exceeds the social security tax limitation. My free tax   For more information on qualified joint ventures, go to IRS. My free tax gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. My free tax ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. My free tax The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. My free tax The agreement or modifications can be oral or written. My free tax Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. My free tax This filing date does not include any extension of time. My free tax If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. My free tax Terminating a Partnership A partnership terminates when one of the following events takes place. My free tax All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. My free tax At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner. My free tax Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period. My free tax See section 1. My free tax 708-1(b) of the regulations for more information on the termination of a partnership. My free tax For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. My free tax 708-1(c) and 1. My free tax 708-1(d) of the regulations. My free tax Date of termination. My free tax   The partnership's tax year ends on the date of termination. My free tax For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. My free tax For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. My free tax Short period return. My free tax   If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. My free tax The return is due the 15th day of the fourth month following the date of termination. My free tax See Partnership Return (Form 1065), later, for information about filing Form 1065. My free tax Conversion of partnership into limited liability company (LLC). My free tax   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. My free tax The conversion is not a sale, exchange, or liquidation of any partnership interest; the partnership's tax year does not close; and the LLC can continue to use the partnership's taxpayer identification number. My free tax   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. My free tax Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. My free tax If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. My free tax For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. My free tax   The same rules apply if an LLC classified as a partnership is converted into a partnership. My free tax IRS e-file (Electronic Filing) Please click here for the text description of the image. My free tax e-file Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically (e-file). My free tax Other partnerships generally have the option to file electronically. My free tax For details about IRS e-file, see the Form 1065 instructions. My free tax Exclusion From Partnership Rules Certain partnerships that do not actively conduct a business can choose to be completely or partially excluded from being treated as partnerships for federal income tax purposes. My free tax All the partners must agree to make the choice, and the partners must be able to compute their own taxable income without computing the partnership's income. My free tax However, the partners are not exempt from the rule that limits a partner's distributive share of partnership loss to the adjusted basis of the partner's partnership interest. My free tax Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. My free tax Investing partnership. My free tax   An investing partnership can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following requirements. My free tax They own the property as co-owners. My free tax They reserve the right separately to take or dispose of their shares of any property acquired or retained. My free tax They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. My free tax Each separate participant can delegate authority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. My free tax Operating agreement partnership. My free tax   An operating agreement partnership group can be excluded if the participants in the joint production, extraction, or use of property meet all the following requirements. My free tax They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. My free tax They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. My free tax They do not jointly sell services or the property produced or extracted. My free tax Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than one year. My free tax However, this exclusion does not apply to an unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. My free tax Electing the exclusion. My free tax   An eligible organization that wishes to be excluded from the partnership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. My free tax This filing date includes any extension of time. My free tax See Regulations section 1. My free tax 761-2(b) for the procedures to follow. My free tax Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. My free tax The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. My free tax The return must be signed by a general partner. My free tax If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. My free tax A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes. My free tax See the Instructions for Form 1065 for more information about who must file Form 1065. My free tax Partnership Distributions Partnership distributions include the following. My free tax A withdrawal by a partner in anticipation of the current year's earnings. My free tax A distribution of the current year's or prior years' earnings not needed for working capital. My free tax A complete or partial liquidation of a partner's interest. My free tax A distribution to all partners in a complete liquidation of the partnership. My free tax A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. My free tax If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. My free tax Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. My free tax Effect on partner's basis. My free tax   A partner's adjusted basis in his or her partnership interest is decreased (but not below zero) by the money and adjusted basis of property distributed to the partner. My free tax See Adjusted Basis under Basis of Partner's Interest, later. My free tax Effect on partnership. My free tax   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. My free tax The partnership may be able to elect to adjust the basis of its undistributed property. My free tax Certain distributions treated as a sale or exchange. My free tax   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. My free tax Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. My free tax Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. My free tax   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. My free tax   This treatment does not apply to the following distributions. My free tax A distribution of property to the partner who contributed the property to the partnership. My free tax Payments made to a retiring partner or successor in interest of a deceased partner that are the partner's distributive share of partnership income or guaranteed payments. My free tax Substantially appreciated inventory items. My free tax   Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the partnership's adjusted basis for the property. My free tax However, if a principal purpose for acquiring inventory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. My free tax Partner's Gain or Loss A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. My free tax Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. My free tax If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. My free tax For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. My free tax Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. My free tax Example. My free tax The adjusted basis of Jo's partnership interest is $14,000. My free tax She receives a distribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. My free tax Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. My free tax Any gain on the land will be recognized when she sells or otherwise disposes of it. My free tax The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. My free tax Marketable securities treated as money. My free tax   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. My free tax This treatment, however, does not generally apply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. My free tax   The amount treated as money is the security's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: The partner's distributive share of the gain that would be recognized had the partnership sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over The partner's distributive share of the gain that would be recognized had the partnership sold all such securities it still held after the distribution at the fair market value in (1). My free tax   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. My free tax Loss on distribution. My free tax   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. My free tax The adjusted basis of the partner's interest in the partnership exceeds the distribution. My free tax The partner's entire interest in the partnership is liquidated. My free tax The distribution is in money, unrealized receivables, or inventory items. My free tax   There are exceptions to these general rules. My free tax See the following discussions. My free tax Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. My free tax Distribution of partner's debt. My free tax   If a partnership acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under the rules discussed in Partner's Basis for Distributed Property, later). My free tax   The partner is treated as having satisfied the debt for its fair market value. My free tax If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distributed, the partner may have to include the excess amount in income as canceled debt. My free tax   Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its adjusted issue price. My free tax Net precontribution gain. My free tax   A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. My free tax   The gain recognized is the lesser of the following amounts. My free tax The excess of: The fair market value of the property received in the distribution, over The adjusted basis of the partner's interest in the partnership immediately before the distribution, reduced (but not below zero) by any money received in the distribution. My free tax The “net precontribution gain” of the partner. My free tax This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribution, and held by the partnership immediately before the distribution, were distributed to another partner, other than a partner who owns more than 50% of the partnership. My free tax For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. My free tax   The character of the gain is determined by reference to the character of the net precontribution gain. My free tax This gain is in addition to any gain the partner must recognize if the money distributed is more than his or her basis in the partnership. My free tax For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. My free tax Effect on basis. My free tax   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. My free tax Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. My free tax See Basis of Partner's Interest , later. My free tax   The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. My free tax Exceptions. My free tax   Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in determining the amount of the excess distribution or the partner's net precontribution gain. My free tax For this purpose, the partner's previously contributed property does not include a contributed interest in an entity to the extent its value is due to property contributed to the entity after the interest was contributed to the partnership. My free tax   Recognition of gain under this rule also does not apply to a distribution of unrealized receivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier. My free tax Partner's Basis for Distributed Property Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. My free tax However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. My free tax Example 1. My free tax The adjusted basis of Emily's partnership interest is $30,000. My free tax She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. My free tax Her basis for the property is $20,000. My free tax Example 2. My free tax The adjusted basis of Steve's partnership interest is $10,000. My free tax He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. My free tax His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). My free tax Complete liquidation of partner's interest. My free tax   The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. My free tax Partner's holding period. My free tax   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. My free tax If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. My free tax Basis divided among properties. My free tax   If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distributed to the partner. My free tax For property distributed after August 5, 1997, allocate the basis using the following rules. My free tax Allocate the basis first to unrealized receivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjusted basis in the item immediately before the distribution. My free tax If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. My free tax Allocate any remaining basis to properties other than unrealized receivables and inventory items by assigning a basis to each property equal to the partnership's adjusted basis in the property immediately before the distribution. My free tax If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. My free tax If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. My free tax Allocating a basis increase. My free tax   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. My free tax If the basis increase is less than the total unrealized appreciation, allocate it among those properties in proportion to their respective amounts of unrealized appreciation. My free tax Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. My free tax Example. My free tax Eun's basis in her partnership interest is $55,000. My free tax In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. My free tax Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. My free tax Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. My free tax To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). My free tax This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). My free tax She first allocates $35,000 to property A (its unrealized appreciation). My free tax The remaining $5,000 is allocated between the properties based on their fair market values. My free tax $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. My free tax Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). My free tax Allocating a basis decrease. My free tax   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. My free tax Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. My free tax If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. My free tax Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). My free tax Example. My free tax Armando's basis in his partnership interest is $20,000. My free tax In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. My free tax Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. My free tax Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. My free tax To figure his basis in each property, Armando first assigns bases of $15,000 to property C and $15,000 to property D (their adjusted bases to the partnership). My free tax This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). My free tax He allocates the entire $10,000 to property D (its unrealized depreciation). My free tax Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). My free tax Distributions before August 6, 1997. My free tax   For property distributed before August 6, 1997, allocate the basis using the following rules. My free tax Allocate the basis first to unrealized receivables and inventory items included in the distribution to the extent of the partnership's adjusted basis in those items. My free tax If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. My free tax Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. My free tax Partner's interest more than partnership basis. My free tax   If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inventory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the partnership interest. My free tax Special adjustment to basis. My free tax   A partner who acquired any part of his or her partnership interest in a sale or exchange or upon the death of another partner may be able to choose a special basis adjustment for property distributed by the partnership. My free tax To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. My free tax Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. My free tax   If a partner chooses this special basis adjustment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjustment to basis. My free tax However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. My free tax   The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to depreciation, depletion, or amortization. My free tax If the choice does not have to be made for the distribution year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. My free tax   A partner choosing this special basis adjustment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. My free tax The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. My free tax Example. My free tax Chin Ho purchased a 25% interest in X partnership for $17,000 cash. My free tax At the time of the purchase, the partnership owned inventory having a basis to the partnership of $14,000 and a fair market value of $16,000. My free tax Thus, $4,000 of the $17,000 he paid was attributable to his share of inventory with a basis to the partnership of $3,500. My free tax Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, inventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. My free tax The value of the inventory received was 25% of the value of all partnership inventory. My free tax (It is immaterial whether the inventory he received was on hand when he acquired his interest. My free tax ) Since the partnership from which Chin Ho withdrew did not make the optional adjustment to basis, he chose to adjust the basis of the inventory received. My free tax His share of the partnership's basis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). My free tax The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of partnership gain or loss on disposition. My free tax The total to be allocated among the properties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). My free tax His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). My free tax The remaining $11,500 is allocated to his new basis for the other property he received. My free tax Mandatory adjustment. My free tax   A partner does not always have a choice of making this special adjustment to basis. My free tax The special adjustment to basis must be made for a distribution of property (whether or not within 2 years after the partnership interest was acquired) if all the following conditions existed when the partner received the partnership interest. My free tax The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. My free tax If there had been a liquidation of the partner's interest immediately after it was acquired, an allocation of the basis of that interest under the general rules (discussed earlier under Basis divided among properties) would have decreased the basis of property that could not be depreciated, depleted, or amortized and increased the basis of property that could be. My free tax The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. My free tax Required statement. My free tax   Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjustment is mandatory, the partnership must provide a statement to the partner. My free tax The statement must provide information necessary for the partner to compute the special basis adjustment. My free tax Marketable securities. My free tax   A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding discussions, is increased by any gain recognized by treating the securities as money. My free tax See Marketable securities treated as money under Partner's Gain or Loss, earlier. My free tax The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. My free tax Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. My free tax These transactions include the following. My free tax Performing services for, or transferring property to, a partnership if: There is a related allocation and distribution to a partner, and The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the capacity of a partner. My free tax Transferring money or other property to a partnership if: There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and The transfers together are properly characterized as a sale or exchange of property. My free tax Payments by accrual basis partnership to cash basis partner. My free tax   A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. My free tax However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. My free tax Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. My free tax A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. My free tax This treatment is for purposes of determining gross income and deductible business expenses only. My free tax For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. My free tax Guaranteed payments are not subject to income tax withholding. My free tax The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. My free tax They are also listed on Schedules K and K-1 of the partnership return. My free tax The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. My free tax Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. My free tax Generally, organizational and syndication expenses are not deductible by the partnership. My free tax However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). My free tax Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. My free tax Minimum payment. My free tax   If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. My free tax Example. My free tax Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. My free tax The partnership has net income of $20,000. My free tax Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). My free tax The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). My free tax Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. My free tax If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. My free tax Self-employed health insurance premiums. My free tax   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. My free tax The partnership can deduct the payments as a business expense, and the partner must include them in gross income. My free tax However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. My free tax   A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. My free tax The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. My free tax For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. My free tax Including payments in partner's income. My free tax   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. My free tax Example 1. My free tax Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard to the income of the partnership. My free tax Her distributive share of the partnership income is 10%. My free tax The partnership has $50,000 of ordinary income after deducting the guaranteed payment. My free tax She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her individual income tax return for her tax year in which the partnership's tax year ends. My free tax Example 2. My free tax Lamont is a calendar year taxpayer who is a partner in a partnership. My free tax The partnership uses a fiscal year that ended January 31, 2013. My free tax Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. My free tax He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. My free tax Payments resulting in loss. My free tax   If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. My free tax The partner separately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. My free tax Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. My free tax Losses. My free tax   Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. My free tax   If the sale or exchange is between two partnerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduction of a loss is allowed. My free tax   The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. My free tax   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. My free tax If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. My free tax Gains. My free tax   Gains are treated as ordinary income in a sale or exchange of property directly or indirectly between a person and a partnership, or between two partnerships, if both of the following tests are met. My free tax More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). My free tax The property in the hands of the transferee immediately after the transfer is not a capital asset. My free tax Property that is not a capital asset includes accounts receivable, inventory, stock-in-trade, and depreciable or real property used in a trade or business. My free tax More than 50% ownership. My free tax   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. My free tax An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned proportionately by, or for, its shareholders, partners, or beneficiaries. My free tax An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. My free tax For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. My free tax If a person is considered to own an interest using rule (1), that person (the “constructive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. My free tax However, if a person is considered to own an interest using rule (2), that person is not treated as actually owning that interest in reapplying rule (2) to make another person the constructive owner. My free tax Example. My free tax Individuals A and B and Trust T are equal partners in Partnership ABT. My free tax A's husband, AH, is the sole beneficiary of Trust T. My free tax Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. My free tax As a result, A is a more-than-50% partner. My free tax This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. My free tax More information. My free tax   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. My free tax Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. My free tax This applies whether a partnership is being formed or is already operating. My free tax The partnership's holding period for the property includes the partner's holding period. My free tax The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. My free tax The exchange is not subject to the rules explained later under Disposition of Partner's Interest. My free tax Disguised sales. My free tax   A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met. My free tax The distribution would not have been made but for the contribution. My free tax The partner's right to the distribution does not depend on the success of partnership operations. My free tax   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. My free tax However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. My free tax If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. My free tax Form 8275 required. My free tax   A partner must attach Form 8275, Disclosure Statement, (or other statement) to his or her return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. My free tax For exceptions to this requirement, see section 1. My free tax 707-3(c)(2) of the regulations. My free tax   A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership. My free tax   Form 8275 must include the following information. My free tax A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. My free tax A description of the transferred property or money, including its value. My free tax A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. My free tax See section 1. My free tax 707-3(b)(2) of the regulations for a description of the facts and circumstances considered in determining if the transfers are a disguised sale. My free tax Contribution to partnership treated as investment company. My free tax   Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. My free tax   A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. My free tax These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. My free tax For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. My free tax Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. My free tax   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. My free tax Contribution to foreign partnership. My free tax   A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. My free tax Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. My free tax The fair market value of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000. My free tax   The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. My free tax See the form instructions for more information. My free tax Basis of contributed property. My free tax   If a partner contributes property to a partnership, the partnership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. My free tax Allocations to account for built-in gain or loss. My free tax   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. My free tax The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. My free tax This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. My free tax   The partnership can use different allocation methods for different items of contributed property. My free tax A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. My free tax See section 1. My free tax 704-3 of the regulations for allocation methods generally considered reasonable. My free tax   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. My free tax If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. My free tax However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. My free tax Example. My free tax Areta and Sofia formed an equal partnership. My free tax Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with a fair market value of $10,000 and an adjusted basis of $4,000. My free tax The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. My free tax In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. My free tax Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. My free tax To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. My free tax However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. My free tax The entire $400 must be allocated to Areta. My free tax Distribution of contributed property to another partner. My free tax   If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. My free tax   The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. My free tax This amount is the difference between the property's basis and its fair market value at the time of contribution. My free tax The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. My free tax Appropriate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss. My free tax Disposition of certain contributed property. My free tax   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. My free tax Unrealized receivables. My free tax If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. My free tax Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. My free tax When reading the definition, substitute “partner” for “partnership. My free tax ” Inventory items. My free tax If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. My free tax Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. My free tax Capital loss property. My free tax If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. My free tax The capital loss is limited to the amount by which the partner's adjusted basis for the property exceeded the property's fair market value immediately before the contribution. My free tax Substituted basis property. My free tax If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction. My free tax Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. My free tax Capital interest. My free tax   A capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in a complete liquidation of the partnership. My free tax This determination generally is made at the time of receipt of the partnership interest. My free tax The fair market value of such an interest received by a partner as compensation for services must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. My free tax The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. My free tax   The fair market value of an interest in partnership capital transferred to a partner as payment for services to the partnership is a guaranteed payment, discussed earlier. My free tax Profits interest. My free tax   A profits interest is a partnership interest other than a capital interest. My free tax If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. My free tax However, this does not apply in the following situations. My free tax The profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease. My free tax Within 2 years of receipt, the partner disposes of the profits interest. My free tax The profits interest is a limited partnership interest in a publicly traded partnership. My free tax   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. My free tax Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. My free tax If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. My free tax Any increase in a partner's individual liabilities because of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. My free tax Interest acquired by gift, etc. My free tax   If a partner acquires an interest in a partnership by gift, inheritance, or under any circumstance other than by a contribution of money or property to the partnership, the partner's basis must be determined using the basis rules described in Publication 551. My free tax Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). My free tax The basis of an interest in a partnership is increased or decreased by certain items. My free tax Increases. My free tax   A partner's basis is increased by the following items. My free tax The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. My free tax The partner's distributive share of taxable and nontaxable partnership income. My free tax The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. My free tax Decreases. My free tax   The partner's basis is decreased (but never below zero) by the following items. My free tax The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. My free tax The partner's distributive share of the partnership losses (including capital losses). My free tax The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. My free tax This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. My free tax The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. My free tax Partner's liabilities assumed by partnership. My free tax   If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability assumed by the other partners. My free tax This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. My free tax The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. My free tax See Effect of Partnership Liabilities , later. My free tax Example 1. My free tax Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. My free tax The partnership assumed payment of the mortgage. My free tax The basis of Ivan's interest is: Adjusted basis of contributed property $8,000 Minus: Part of mortgage assumed by other partners (80% × $4,000) 3,200 Basis of Ivan's partnership interest $4,800 Example 2. My free tax If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. My free tax The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or exchange of a partnership interest. My free tax However, this gain would not increase the basis of his partnership interest. My free tax Book value of partner's interest. My free tax   The adjusted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. My free tax Example. My free tax Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. My free tax His partner contributes $1,000 cash. My free tax While each partner has increased his capital account by $1,000, which will be re