1. Charles Heston retires from the Ben Hur Partnership when his basis in his par
ID: 2484988 • Letter: 1
Question
1. Charles Heston retires from the Ben Hur Partnership when his basis in his partnership interest is $70,000, including his $10,000 share of liabilities.
2. The Partnership is in the business of providing crisis management services for local residences and residents. At the date of Charles’s retirement, the partnership’s balance sheet is as follows:
Partnership’s Basis FMV
Assets:
Cash $ 50,000 $ 50,000
Receivables 0 0
Equipment 40,000 50,000
Building 90,000 100,000
Land 30,000 70,000
Total Assets $210,000 $270,000
Liabilities & Capital:
Liabilities $ 30,000 $ 30,000
Capital
Ernest 60,000 $ 80,000
Ehrlich 60,000 80,000
Bergman 60,000 80,000
Total Liabilities + Capital $210,000 $ 270,000
3. If the equipment were sold today, the entire gain would be section 1245 ordinary income.
4. The building has been depreciated using the straight line method.
5. Mr. Heston will receive payments of $20,000 cash plus 5% of the partnership’s ordinary income for each of the next five years.
6. The partnership agreement specifies that goodwill will be paid for when a partner retires. Ben Hur Partnership and Mr. Heston agree that the partnership has $21,000 in goodwill he retires and that he will be paid his one-third share of such goodwill.
Required:
(1) Determine the amount and character of the income Charles must report for each of the next five years. In addition, determine the amount and character of the tax consequences of his retirement to the partnership and the remaining partners for the next five years. (Assume that the partnership earns $100,000 of ordinary income in each of the next five years.)
In these two determinations, it is important to provide the observer with the impacts of these issues in a manner which shows that any impact to the retiring partner will also have an impact to the remaining partners. In this effort, an example of differing consequences to Charles and to the partnership would be appropriate.
(2)Finally, create different scenarios where there could be a better solution for the retiring partner and the remaining partners by re-structuring the proposed transaction. (Note, your senior manager is a stickler for citations and will consider a lack of perfect citations a clue to a lack of research skills.)
Explanation / Answer
Solution.
(1)
Tax impact for Charles:
*Capital Gain Income = $20000*5 (Payments other the Income-linked) - $70000 (Basis in parnership) = $30000
**Ordinary taxable income = $7000 (Share of goodwill) + $5000 (Income linked payments)
Tax impact for Partnership and other partners:
Remaining partners in partnership will be able to deduct amount paid to retiring partners (i.e., 5% of $100000 = $5000) each year as Ordinary business expense from its ordinary profits (as it has been taxed for retiring partner).
Distributive shares of partnership income or guaranteed payments payments are included in income by the recipient. Remaining partners who continue to make guaranteed payments to satisfy the partnership's liability to a retired partner can deduct the payments as a business expense in the year paid.
For example if in above case instead of 5%, Charles would have received 10% each year then the remaining partners would have deducted 10% (amount paid to Charles) as expense during the year.
(2)
Scenario 1. In the given case Charles will have to pay tax on capital gain of $30000. This liability can be deferred if the payment made to retiring partner above his basis is linked to profits of firm. Like in this case instead of 5% p.a., if 11% p.a. is paid to Charles then the remaining partners can claim deduction of $11000 instead of $5000 p.a. And liability of Charles for capital gain tax can also be deferred this way.
Scenario 2. Amount of goodwill paid to Charles can also be linked to profits and expense can be claimed by partners.
Year 1 Year 2 Year 3 Year 4 Year 5 Capital Gain Income $30000* - - - - Ordinary Taxable Income $12000** $5000 $5000 $5000 $5000Related Questions
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