Thus, most contributions and distributions are tax-free, but transfers of partnership assets or interests to non-partners generally are taxable. A corollary of tax transparency is the general equality of aggregate inside and outside bases.“Inside basis” is the partnership‟s adjusted basis in its assets, while outside basis is a partner‟s adjusted basis in his partnership interest.A shareholder’s basis in his S corporation stock is increased by the share of the S corporation income that is passed through to the shareholder.This effectively gives the shareholder a credit to apply against the earned income when it is ultimately distributed to the shareholder, ensuring that the income is only taxed once.This Portfolio contains (1) a discussion of the computation of §751(a) ordinary gain when a partner sells or exchanges a partnership interest, (2) a discussion of how distributions from a partnership are (or potentially are) to be analyzed under §751(b), in particular in light of the possible application of the principles under §704(c) concerning built-in gain and built-in loss properties, and (3) a complete analysis of the definition of §751(a ) and §751(b) property. Example 25: Distribution of Excess § 751(b) Property Resulting in the Recognition of Capital Loss to the Distributee Partner and Ordinary Income to the Partnership IV. The portfolio recognizes that much of the analysis under §751(b) for complex situations has become more uncertain over time because guidance under §751(b), primarily in the form of regulations published in 1956, has lagged behind legislative and regulatory developments in related areas. S., University of Virginia, Mc Intire School of Commerce (1985), Beta Alpha Psi; J. Author, Selected Federal Income Tax Issues Arising in Technology Ventures and Business Transactions Involving Technology or Facilitated by the Internet — A Transactional Perspective; with Steven R. It should not be difficult to figure out how to tax two individuals who contribute equal amounts of cash to start a joint business in which each will own a one-half interest.
The amount so recharacterized roughly corresponds to the amount of ordinary income the partnership would have if it sold the §751(a) property, thus preventing a partner from converting into a capital gain the ordinary income that would pass through if the partnership sold the property. Step 7: Determine the Federal Income Tax Consequences of the Portion of the Partnership Distribution That Is Not a § 751(b) Exchange 9. Partnership Property Subject to Basis Reduction Under § 1017 c.
The shareholder’s basis is decreased (but not below zero) by the shareholder’s share of the S corporation’s items of loss and deduction, nondeductible expenses (except expenses that are not chargeable to the capital account), depletion deduction for oil and gas property, and distributions to the shareholder that are not made from accumulated earnings and profits.
This helps ensure that the shareholder only benefits once from reductions in income earned by the S corporation.
To the extent that a distribution is made from the corporation’s earnings and profits, it is taxed to the shareholder as a dividend. The portion of the distribution that is not considered a dividend is applied first to reduce the shareholder’s basis in the corporation’s stock. Any remaining portion is treated as gain from the sale or exchange of property (capital gain). Important Note: If a shareholder assumes a liability or takes property subject to a liability, the amount of the distribution is reduced by the amount of the liability. Special rules also apply at the corporate level. Special rules apply to distributions to a shareholder in exchange for the shareholder’s stock (redemptions).
Instead of being treated as dividends, redemptions are treated as a sale or exchange of the stock by the shareholder. The distinction can be important when the long-term capital gains rates (which apply to redemptions) are higher than the tax rates on dividends.