Question 6 Alex and Pam are carrying on a business as partners. The partnership

Question

Question 6 Alex and Pam are carrying on a business as partners. The partnership agreement provides that Alex is to be paid an annual salary of $50,000. The balance is to be distributed equally between Alex and Pam. The partnership agreement also provides that in the case of losses, the partners are to share the losses equally. The partnership's assessable income for the income year is $60,000. Deductible expenses are $80,000. (10 marks) Required: What are the tax consequences for the partnership and each partner?

Explanation / Answer

According to the Subchapter K of Chapter 1 of the U.S. Internal Revenue Code , A pertneship firm is a "flow through entity" It means that such firm doesnt pay taxes on its income but rather tax is paid by distributive owners.

So, in the given Question:

In the hand of the Partnership:

Nothing will be taxable , since partners are liable to pay tax. However, Partnership firm can claim the deduction of the salary paid to Alex as per the Partnership agreement.

Tax Treatment In the hands of Partners :

Alex: Following items shall be included in the income of Alex

- Salary received of $ 50,000 from partnership firm.

- Share in the profit (Income ) $ 30,000

Pam: Following items shall be included in the income of Pam:

-  - Share in the profit (Income ) $ 30,000

Note: Please see that $60,000 is the assessable income (not revenue) of the partnership. Income arises after deduction of expenses from revenue. So, expenses are already deducted to arrive at the income of $60,000.

- Since losses are divided in the equal ratios, profit will be shared in the same ratio.

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