In our previous article, we looked at how partnerships are formed. Now, we are looking at the basis and distributions features of a partnership. Ownership in a partnership is determined by a partner’s basis, which can be similar to how shareholders have stock in a corporation.
Partner’s Basis
When establishing a partnership, partners contribute capital through cash or assets like an office. The combined value of the adjusted basis of assets and cash contributed is considered a partner’s basis in the partnership. The basis determines a partner’s percentage share in a partnership. For example:
Dan contributes to the “TruFriends” partnership $4000 in cash and a 1998 Honda Civic worth $2300. Jon contributes 3 desktop computers with desks and chairs, all worth $6000 plus $2000 in cash. Dan’s basis in the partnership is $6300. Jon’s basis is $8000. The total basis of “TruFriends” is $14,300, with Jon having a 56% basis and Dan having a 44% basis.
A partner’s basis can increase or decrease (but never below zero) through events such as additional contributions to the partnership or distributions paid out to a partner.
Partner Distributions
Partners are paid out in distributions that affect their adjusted basis in a partnership. This can include withdrawals, distributions based on partnership earnings from the year, or even guaranteed payments from a partnership agreement.
Distributions decrease a partner’s adjusted basis in a partnership. However, unless it is a liquidating distribution to disassociate a partner, the partner’s basis cannot go below zero. For example:
After a year of running “TruFriends”, the partners get a guaranteed payment of $1000 per their partnership agreement plus 50% of the year’s profits of $3000. Given the facts from the previous example, Dan’s adjusted basis in the firm changes from $6,300 to $3,800. Jon’s basis changes from $8,000 to $5,500.
Partnership Filings
Even as a pass-through entity, partnerships still must file with the IRS by using Form 1065. Form 1065 informs the IRS on a partnership’s distributions, assets, revenues, and other information.
While this is just a general snapshot of partnership operations, each partnership has its own circumstances and questions to handle. Contact us at MiklosCPA if you have a specific question! We are an accounting and tax firm that has helped many small and mid-sized businesses with partnership questions. If you enjoyed this article, please follow us on our social media pages for future updates.