5. Partners are not entitled to a deduction instead and decrease their basis in the partnership. Fines and penalties are nondeductible items that cannot be deducted by the partners. However, fines and penalties do reduce the partners’ basis in the partnership.

The partner’s basis in the partnership must be always be reduced to $0 on liquidation of partnership interest. Therefore, the basis of distributed asset (after distribution of cash) is always equal to the partner’s ending basis in the partnership at the time of distribution.

Treated as a separately stated item by the partnership and potentially deductible by the partners.: In addition to regular MACRS depreciation, taxpayers are allowed a special Section 179 deduction for personal property purchased and placed in business. For tax years beginning after 2017, the TCJA has modified the section 179 expensing election to increase the maximum amount that may be deducted to $1 million (up from $500,000). This is recorded as a separately stated item by the partnership on Schedule K of Form 1065 as the deduction on the individual tax returns could be restricted if net loss exists or the deduction creates a net loss.

3. $10,000 - As Lane created an irrevocable trust for his aunt in which the income interest is immediately accessible to her without restriction, it qualifies as a gift of present interest and can be partially offset by the annual exclusion of $16,000. The remaining interest of $10,000 ($26,000 - $16,000) will be taxable to Lane in Y1 for gift tax purpose.
   
   

the interest will be paid every year for next five years. As she is going to have an immediate access to the interest, it will be a gift of present interest

4. False - Irrespective of a liquidating or a non-liquidating distribution of property (other than cash), no gain or loss is recognized by the distributee partner. In cases where the basis of the distributed property is in excess of the basis of the partner, the adjusted basis of the distributed property is stepped down to the pre-distribution basis of the partner such that the net result of the distribution is zero.

Note 2: Patent that was initially contributed to the S corporation by Ross is received at the adjusted basis of Ross of $10,000. No gain or loss is recognized at the time of contribution of property to S Corporation. A subsequent distribution to shareholder is at the FMV of the patent of $15,000; i.e., shareholder basis is now $15,000 in the patent. This is a taxable transaction to the corporation, treated as sale of property to shareholder. The corporation recognizes a capital gain of $5,000, difference between FMV of $15,000 and basis of $10,000. Additionally, since the corporation was previously a C corporation with AEP and appreciated property was distributed to shareholder within 5 years of S election, the corporation would be subject to a penalty tax (Built-in-gains tax) of 21%. This computation is however ignored for this question.

Note 1: Sale of used equipment with a basis of $0 and SP of $20,000 resulted in a realized gain of $20,000. Since basis is zero at the time of sale, we can assume that the entire purchase price of $90,000 must have been taken as depreciation expense until the time of sale. Recognized gain is the smaller of actual gain realized or depreciation allowed or allowable. In this case, the depreciation recapture is $20,000. This gain is treated as Section 1245 ordinary gain.

B4) $0 - A shareholder of an S Corporation acquires debt basis from the loans made by the shareholder to the S Corp. By offering a personal guarantee on a loan provided to the corporation by a bank, doesn’t provide a debt basis to the guaranteeing shareholders until the guarantee is enforced and the shareholder makes a payment to satisfy the guaranteed liability.

3. To prevent the conversion of ordinary income into capital gain property, gain or loss is treated as ordinary income when the partnership disposes of unrealized receivables or tangible property that was inventory in the hands of the contributor. Any pre-contribution built-in-gain is allocated 100% to the contributing partner. Gains realized over and above the built-in-gain is allocated to other partners.
   
   

As Mr. Bill Gates contributed the receivables to the partnership, the realization of them, will first result in the allocation of pre-contribution gain to him followed by allocation of any additional gain if realized. The accounts receivable had a zero basis to both Bill and the partnership on the date of contribution. Upon realization of the accounts receivable of $30,000, the full amount is allocated to Bill as ordinary income. Likewise, for Ms. Jane Austen, any built-in-gain on sale of inventory is allocated 100% to her. The inventory had a basis of $12,500 to both Jane and the partnership on contribution. Upon sale of inventory for $30,000, a gain of $17,500 was realized, of which $12,500 (FMV $25,000 - Basis $12,500) is the built-in-gain that is 100% allocated to Jane. The remaining gain of $5,000 is allocated to all the partners in the ratio of 5:3:2.

4. Her guaranteed payment is the amount by which the minimum payment is more than the distributive share of partnership income before taking into account the guaranteed payment. The applicable guaranteed payment for the current year is $15,080.

The receivables have a zero tax basis until realization and at the point of realization, they no longer have any bearing on the contributing partner's basis.

Based on this it can be concluded that he meets the requirement of material participation rules and that the income is active income to Bernie. This can be further reinforced, by understanding the material participation rules in the Temporary Regulations provided by IRS:

(ii) Participation by the taxpayer constitutes substantially all of the participation for that activity

(iii) Taxpayer participated in the activity is more than 100 hours, compared to the participation of other individuals

(iv) The activity is a significant participation activity, and taxpayer participated in all significant participation activities for more than 500 hours.

(v) Taxpayer materially participated in any 5 (not consecutive) of the last 10 years in the activity.

(vi) In case of a personal service activity, the taxpayer should have been active during any of the 3 preceding tax years.

Since Joy and Rhea are lineal descendants of Bernie Simon, they are related parties and the stock holdings of Joy and Rhea would be attributed to Simon, to determine his total ownership in the S Corporation.

Passive investment income for the purpose of the technical termination test or excess PII tax includes gross receipts derived from passive rents, royalties, dividends, interests, annuities, and the gain from the sale or exchange of stock or securities. An S Corporation would be subject to PII tax or technical termination if more than 25% of the gross receipts are from passive income and the corporation has C corp. AEP at the end of each of the 3 years.

This penalty tax or technical termination, as a result of the excess PII, can be avoided by accelerating gross receipts, without increasing PII. An election to by pass AAA in distribution can be made, which allows any distributions to first come out of AEP, instead of AAA such that the AEP can be eliminated in the earliest possible year and the excess PII can be avoided altogether. The shareholders, would however be subject to tax on the dividend income. Also, if the excess passive income is due to high rental income, then participation level in the rental activity can be increased to make it non-passive.

Total section 179 deduction is limited to the taxable income from the active conduct of any trade or business during the year. Any unused section 179 deduction is carried forward to the future years. The cost of computers is $50,000 of which $3,800 is expensed under Section 179. The remaining $46,200 must be carried forward to future years.

Since, Ruth has received the retirement payment in installments; she will recognize gain to the extent distribution exceeds her basis. A retiring partner continues as a partner until his interest has been completely liquidated by partnership distributions. In Yr1, she has received $18,320 ($10,000 + $8,320 debt relief) which is less than her basis of $19,504, therefore, none of the amount will be recognized as gain in Yr1. In Yr2, she received another $10,000 when her basis was $1,184, accordingly, she will recognize a gain of $8,816 out of which $2,249 will be an ordinary gain and $6,567 will be capital gain. In Yr 3, on receipt of the 3rd installment of $10,000, she will recognize $2,551 as ordinary gain and the remaining $7,449 as capital gain.

Property distributions are considered after distribution of cash

Property is always distributed at the inside basis of the partnership, irrespective of its FMV

For non-liquidating distributions, where the basis of the partner is less than that of the distributed property, the inside basis of the property is adjusted such that, the partner’s basis is not reduced below zero.

When a family member receives a gift of capital interest in a partnership in which capital is the material income producing factor, the donee's distributive share of partnership income is subject to the following conditions.

(i) It must be figured after reducing the partnership income by reasonable compensation for services rendered by the donor to the partnership.

(ii) The donee's distributive share cannot be proportionately greater than the donor's distributive share attributable to the donor's capital.

In this case, John gave a 15% capital interest in the partnership to Alex. The partnership income after allocation of compensation to John ($15,000) is $232,650. Of this at least 35% Or $81,400 approx.., must be allocated to John. Alex's share of partnership profit cannot be more than $81,400.