Capital only partnership interest

Technical topics regarding tax preparation.
#1
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Have a client that has a partnership. Client was allocated all gains/losses and 40% of capital on initial 1065 return (done by another "accountant"). Client's partner is allocated a 60% capital interest, but no other interests. Client's partner (Mr. Capital) contributed some funds (cash of $80k, according to the return), but is not on the bank accounts, doesn't participate in the business activities, and otherwise has no interest in the partnership.

I've read through the court rulings on debt v. equity in a partnership setting, and this smells more like debt than equity. Also, Mr. Capital is stating that somehow his contributions to the partnership allowed him to take a $30k tax deduction in the year of the contribution -- which further seems to make his contribution feel like debt since the basis of the debt v. equity cases seem to be that the partnership was only entered into so that a tax deduction can be had.

Two questions:

1) Ignoring the tax deduction comment from Client and Mr. Capital, I don't think this is a partnership. Thoughts?

2) What tax deductions would Mr. Capital, who only contributed capital, be allowed take? By the way things are being explained to me, I think he took a bad debt deduction, but he's not forthcoming about his personal income tax returns. There weren't any start-up costs (and only $5k for that), only $8k of PP&E... I can't think of any way a tax deduction could be had.

Thanks for taking the time to read/respond. I'm a little perplexed.
 

#2
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Is there a partnership agreement?
 

#3
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Its not uncommon for a service partner to be allocated all or most profits - perhaps with some kind of waterfall provisions - for example all profit up to $X, and then 50% after that. However, losses should generally follow equity splits, allocating losses to someone without contributions would generally create a negative capital account balance, which creates additional issues.
 

#4
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Think Tax wrote:Is there a partnership agreement?


No, they don't have a written partnership agreement in place.
 

#5
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homegr0wn wrote:
Think Tax wrote:Is there a partnership agreement?


No, they don't have a written partnership agreement in place.


Without a written agreement in place, you can't do your job as the tax preparer (assuming you are contemplating taking over the preparation of this return). It would be that agreement that would allow you to answer the question as to whether a partnership actually exists. The definition of a partnership is two (or more) persons coming together to share in the profits of a business operation. If only one person is getting all the profits, they don't have a partnership by this definition.

However, the capital partner may be looking to share in the appreciation of the enterprise and gather their profits via gain on sale. That might fly. I've seen that in real estate ventures. To do that, though, a written agreement needs to be established. I'd bail if they aren't willing to write it down.
~Captcook
 

#6
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CaptCook wrote:
homegr0wn wrote:
Think Tax wrote:Is there a partnership agreement?


No, they don't have a written partnership agreement in place.


Without a written agreement in place, you can't do your job as the tax preparer (assuming you are contemplating taking over the preparation of this return). It would be that agreement that would allow you to answer the question as to whether a partnership actually exists. The definition of a partnership is two (or more) persons coming together to share in the profits of a business operation. If only one person is getting all the profits, they don't have a partnership by this definition.

However, the capital partner may be looking to share in the appreciation of the enterprise and gather their profits via gain on sale. That might fly. I've seen that in real estate ventures. To do that, though, a written agreement needs to be established. I'd bail if they aren't willing to write it down.


Yeah, this is for a restaurant so I don't think the equity upside would be significant. I've already had some questions about the legitimacy of this business (they couldn't provide proof that the initial capital investments were deposited in any of the business banking accounts). That combined with the tax deduction on an equity investment (which I still can't rationalize a reason how such a deduction could occur) and general shadiness had me pulling the plug on taking over the p'ship taxes.

The engagement did raise some interesting questions, which is why I wanted to get some feedback. Always good to be prepared for the next client with a similar structure.
 

#7
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If there's no partnership agreement, UPA as adopted by the state applies and you can do your job as a tax preparer.
 

#8
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CreditMyDebit wrote:If there's no partnership agreement, UPA as adopted by the state applies and you can do your job as a tax preparer.


This appears to be one of those instances where one must ask: Just because I CAN, does that mean I SHOULD?

If I have a 50-50 or equally owned real estate partnership with no special allocations or anything out of the ordinary, I'm comfortable filing a partnership tax return reflecting these dynamics.
When a situation arises that clearly has special allocations between partners, I insist a document be provided explicitly describing the agreement. Preparing a return without such explicit direction just begs for misunderstanding and the tax preparer will be squarely in the crosshairs. No thank you.
~Captcook
 


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