Harry and Sally are considering forming a partnership. Both taxpayers use the ca

Question

Harry and Sally are considering forming a partnership. Both taxpayers use the calendar year and are cash basis taxpayers. The partnership will not be a tax shelter. The partners are uncertain as to whether the partnership should use the cash or accrual method of accounting. Also, the idea of a tax deferral in the first year of operations has led them to consider using a June 30 fiscal year-end for the partnership. As their tax adviser, identify the issues that must be considered in selecting an accounting method and tax year for the partnership.

Explanation / Answer

SInce neither partners and partnership is not a tax shelter , the partnership can select any accounting method - cash or accrual. if the partnership uses the accrual method of accounting in determining its income , the partner will be taxed on partnership revenues from all closed transaction. In this regard it does not matter cash has been received by the partnership and whether or not partner uses accrual method on their indiviual return. thus if the partnership adopts accrual method for tax purposes the partners may be faced with reporting and paying taxes on partnership income much before cash is available for distribution

Regarding june 30 fiscal year end the desired tax deferral has a little chance of sucess . Under law the partnership must use calender unless the harry and sally can conviece the department that business purpose exists for a tax year other than calender year . The partnership may also elect to use tax year other than reuqired tax year if the deferred period is 3 months or less and if the partnership agrees to deposit tax on the deferred income at specific tax rate

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