Schedule K-1

A partnership chooses to use the accrual method of accounting and a particular depreciation method for its assets. How do these entity-level choices affect the individual partners when they report their K-1 items?

1. A.Each partner may independently choose to recompute her allocated share of partnership items using her own preferred accounting method and depreciation method on her personal return.Wrong. Partners cannot substitute their own methods for entity-level elections; the K-1 items are computed once, uniformly, at the partnership level.
2. B.These elections apply only to general partners; limited partners may each independently select their own methods for the items allocated to them.Wrong. Entity-level elections bind all partners equally, general or limited; there is no such general-partner-only limitation.
3. C.These elections must be renewed and separately approved by each partner every year before they apply to that partner's allocated items.Wrong. Entity-level elections do not require annual per-partner renewal or approval.
4. D.These elections are made once, at the entity level, and bind all partners uniformly on their K-1s; an individual partner cannot substitute her own personal accounting method or depreciation method for the items the partnership allocates to her.Correct. Entity-level elections like accounting method and depreciation method bind every partner uniformly.

Why: These elections are made once, at the entity level, and bind all partners uniformly on their K-1s; an individual partner cannot substitute her own personal accounting method or depreciation method for the items the partnership allocates to her.

What is the function of IRS Form 1065 in a limited partnership program?

1. A.It is the return on which the partnership computes and pays its own federal income taxWrong. No tax is computed on it, because the conduit owes none at the entity level.
2. B.It is the statement the partnership sends to each limited partner showing that partner's shareWrong. That describes the Schedule K-1, a per-partner document rather than a program-wide filing.
3. C.It is the informational return reporting program results, from which each Schedule K-1 is drawnCorrect. It discloses the program's results to the IRS without generating an entity-level tax.
4. D.It is the election a partnership files in order to be taxed as a corporation insteadWrong. No entity classification election is being made; this is an annual reporting filing.

Why: Form 1065 is the partnership's informational return. It reports the program's results to the IRS but computes no tax at the entity level, because the partnership owes none. Each partner's allocated share of those results is carried onto a Schedule K-1, which the partnership furnishes to that partner for use on an individual return. If the entity did owe tax on its own profits, it would not be filing an informational return at all.

An investor reviewing a limited partnership offering wants to know exactly how the general partner will be compensated and how income, loss, capital gain and cash distributions will be divided among the partners. Which document fixes those terms?

1. A.The agreement of limited partnershipCorrect. That document fixes compensation and every allocation and distribution term.
2. B.The subscription agreement signed by the investorWrong. It records the commitment and representations of the investor, not the economics of the program.
3. C.The annual Schedule K-1 furnished to each partnerWrong. It reports what was allocated for a year rather than establishing how allocations are made.
4. D.The dealer agreement between the sponsor and selling firmsWrong. That paper governs selling compensation, a different subject from partner allocations.

Why: The agreement of limited partnership is the constitutional document of the program. It identifies the types of partners, states the capital contribution obligations, sets the allocation of income, loss, capital gain and cash distributions, and fixes the compensation of the general partner. Other documents in the offering describe or report on those terms but do not establish them. Changing any of that economics means amending the partnership agreement, which is one of the matters the limited partners may vote on.

An individual purchases a limited partnership interest on the secondary market but has not yet been formally admitted as a substituted limited partner under the partnership agreement's admission procedures; she holds only an assignee interest with an economic right to the income but without full voting or management rights. Does she still receive a Schedule K-1 and report her share of the partnership's tax items?

1. A.Yes -- tax allocation generally follows economic entitlement to the partnership's items, so an assignee with a genuine economic interest in the partnership's income still receives a K-1 and reports her allocable share, even without formal admission as a full partner.Correct. Tax allocation follows economic entitlement, so an assignee with a genuine economic interest still receives K-1 allocations.
2. B.No -- only a formally admitted, substituted limited partner under the partnership agreement's procedures can be allocated any tax items; an assignee has no reportable income until formal admission is complete.Wrong. Formal admission under the partnership agreement is a separate matter from tax allocation, which follows economic entitlement.
3. C.Yes, but only half of her economic share is reportable until formal admission is complete, with the other half deferred to a later year.Wrong. There is no such 50 percent deferral rule tied to formal admission status.
4. D.No -- the seller who transferred the interest to her continues to be allocated and taxed on the income for as long as her admission remains incomplete, regardless of who now holds the economic interest.Wrong. Once the economic interest has genuinely transferred, tax allocation follows the new economic holder, not the prior holder.

Why: Tax allocation generally follows economic entitlement to the partnership's items, so an assignee with a genuine economic interest in the partnership's income still receives a K-1 and reports her allocable share, even without formal admission as a full partner.