Q1. How may the Partners’ Shares of Profit, Loss, and Capital be Reported in Cases Where the Partnership Agreement Does Not Express Such Items as Percentages?
A1. The following is provided as an example of a reasonable method of calculating partners’ percentage shares of profit, loss, and capital for purposes of completing Form 1065 Schedule B questions 3 and 4, and for purposes of completing Schedule K-1 item J, for tax years ending on or after December 31, 2008.
As provided in the instructions to Form 1065, if the partnership agreement does not express the partners’ shares of profit, loss, and capital as fixed percentages, the partnership may use a reasonable method in arriving at such percentages as long as such method is consistent with the partnership agreement and is applied consistently from year to year.
This example is provided solely for purposes of assisting the partnership return preparer in calculating the partners’ percentage shares of profit, loss, and capital as required by Schedule K-1 item J and Schedule B, questions 3 and 4.
Partners A and B are partners in Partnership AB. At the beginning of 2008, Partner A and Partner B had capital account balances of $2,000 and $667, respectively. The AB Partnership Agreement requires capital accounts to be maintained in accordance with section 704(b).
The partnership agreement does not express the partners’ shares of profit, loss, and capital as fixed percentages. In 2008, Partnership AB adopts the following method for determining the percentages of capital, profit, and loss to be used in completing Schedule K-1, item J and Schedule B, questions 3 and 4.
Partnership AB computes the partners’ end of tax year percentages of capital by dividing each partner’s positive capital account balance on the last day of the partnership’s tax year by the total positive capital account balances on the last day of the partnership’s tax year and expressing the result as a percentage. Partnership AB reports a negative capital account balance as a zero percentage. Partnership AB reports the prior end of tax year percentages of capital as the beginning of tax year percentages of capital.
Partnership AB computes the partners’ percentages of profit for the tax year as each partner’s share of items which increased partnership capital during the tax year, other than contributions to capital. Partnership AB computes the partners’ percentages of loss for the tax year as each partner’s share of items which decreased partnership capital during the tax year, other than distributions.
The Partnership Agreement allocates section 704(b) profits and losses for the tax year as follows: 1) first to Partner A as a preferred return on capital equal to 5% of Partner A’s beginning capital balance, 2) then 80% to Partner A and 20% to Partner B until Partner A is allocated profits equal to an aggregate10% preferred return on Partner A’s beginning capital balance. Any residual profits or losses are allocated 60% to Partner A and 40% to Partner B. Allocations of taxable income or loss follow the section 704(b) allocations, and Partnership AB uses the section 704(c) traditional method to account for any differences between section 704(b) profits and losses and tax profits and losses.
For the tax year ended December 31, 2008, Partnership AB generated $1,000 of section 704(b) profits and $900 in taxable income. In accordance with the AB partnership agreement, Partner A is allocated $665 of section 704(b) profits as follows: 1) $100 of the first $100 of profits to equal a 5% preferred return on Partner A’s beginning capital, 2) an additional $100 of the next $125 of profits equal an aggregate 10% preferred return on Partner A’s beginning capital, and 3) $465 of the remaining $775 in profits, which is equal to 60% of Partnership AB’s residual profits. Partnership AB allocates all tax items to follow the section 704(b) allocations, with the exception of a $100 capital loss which was solely allocated to Partner A under section 704(c).
Partnership AB
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A
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B
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Total
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Beginning Capital
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$2,000 |
$ 667 |
$2,667 |
Preferred Return
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200 |
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200 |
Residual Profit
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465 |
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465 |
Amount Allocated to B
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335 |
335 |
End of Year Capital
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$2,665 |
$1,002 |
$3.667 |
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Percentage of Capital
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72.68% |
27.32% |
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Profit Percentages
Partner A’s percentage share of partnership profits for the tax year is 66.5% [$665 divided by $1,000]. Partner B’s percentage share of profits for the tax year is 33.5% [$335 divided by $1,000].
Loss Percentages
Partner A’s percentage share of partnership losses for the year is 0.0%. Even though a $100 loss was allocated to Partner A under section 704(c), this loss did not impact his section 704(b) capital account. Thus, because he was allocated no losses that would impact capital accounts, his percentage share is zero. Likewise, Partner B was allocated no losses that would impact his section 704(b) capital account and Partner B’s percentage share of partnership losses for the year is 0.0%.
Capital Percentages
Partner A’s share of total section 704(b) capital at the end of the tax year is $2,665 [$2,000 plus $665]. Partner A’s share of capital computed as a percentage of total partnership section 704(b) capital is 72.68% [$2,665 divided by $3,667]. Partner B’s share of total section 704(b) capital at the end of the tax year is $1,002 [$667 plus $335]. Partner B’s share of capital computed as a percentage of total partnership section 704(b) capital is 27.32 % [$1,002 divided by $3,667].
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