Tax Aspects of Partnerships - Research Paper Example

This paper will explore the various dimensions of taxation as applied to partnerships in the United States. The material in this paper is not intended as a treatise but rather as a brief explanation of the matter only. The major rules dealing with taxation in partnerships are enshrined in the United States Internal Revenue Code under Chapter 1, sub Chapter K. However, the application of K-1 rules is subservient to declarations of partnership under Form 1065 that documents the various transactions of the partnership entity4.

The aim of the method is to ensure that the declarations of income and transaction presented by the entity in question are verifiable against the partners’ declarations. Individually, the partners are provided with K-1 schedules that they need to fill out on their own to report their personal income levels. However, this is far easier said than done since the partners may be involved in more than one entity and it may not be simple to segregate incomes from various entities among other problems.

The first step in calculating applicable taxes is to measure the income attributable to the overall partnership5 and then for this income to be segregated as per the various partners. The share of each partner in the entity’s income or loss is determined in accordance with the partnership agreement6. Once a partnership agreement has been drafted, the independent character of the partners is considered as overruled such as in Bellis v. United States7. In case that the partnership agreement fails to provide for a distribution, then the partner’s share is determined by the partner’s partnership interest in the entity8.

Additionally, partnership interest for any partner may be calculated using capital accounts of the respective partner9. When dealing with partnership income measurement, certain income sources need to be treated separately in order to arrive at individual partner income. Exclusions from collective income may occur in areas such as charitable contributions, foreign tax payments etc. which in general are personal concerns of the involved partners. In contrast, if charitable spending is done from the platform of the partnership using individual contributions of partners, the spending is not considered to be deductible from taxation.

The recent decision on Dunlap et al. v. Commissioner10 makes it clear that any charitable donations from a partnership platform, even if executed by individual partners, must be considered an act of the partnership. However, foreign income derived from partnerships such as through controlled foreign corporations is still subject to tax such as explained in Brown Group Inc. v. Commissioner11. The basic contention is to separate partner income from partnership income. Although a list of items is available that may be subject to exclusion but guidelines remain unclear and open to differing interpretations.

This in turn tends to complicate the separation of income items to be used for income measurement. It may not always be possible to separate such sources of income and loss as expounded in the recent decision of Whitehouse Hotel Limited Partnership v. Commissioner12 where the partnership was unable to classify its income sources properly under law. Another aspect is items that are not liable to deductions as long as they