1065 : Capital Account Explanations Needed
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viewpoint, does a "Capital Account" consist of exactly?
I am interested in answering Section J in the K-1, which asks:
1. Partner's capital account at the beginning of the year
2. Capital contributed during the year
3. Withdrawals and distributions
For simplicity sake, let's say that the partnership has 2
partners, each with 50% share of profits, expenses, etc.,
and that the partnership has over the years purchased $1,000
worth of capital equipment, which represent all assets of
the business. Some items have been amortized, and the cost
of these items has been recovered over time. Some items were
deducted in section 179 deductions, recovering their costs.
Now, ten years later, the section 179 deductions and the
scheduled depreciation of these items would seem to provide
a quite low adjusted basis. For simplicity sake, let's say
that the adjusted basis of the original $1,000 now is $100.
Let's also say that each partner contributed $500 to the
partnership's bank account at the beginning of the tax year,
so that there was $1,000 in the partnership bank account at
the beginning of this year.
Now, here are the questions:
1. Is cash in the partnership bank account at the beginning
of the year considered part of the partner's Capital
account? (in this case, $500 each partner)
2. Is the formula for determining the adjusted basis:
(Partner's share %) X (total items purchase price MINUS
section 179 deduction taken MINUS depreciation deduction
taken or that could have been taken to date)?
3. If each partner puts in cash during the year to keep the
partnership going, is that considered capital contributed
during the year?
4. Are distributed profits to each partner (not guaranteed
payments) considered a withdrawal or distribution?
5. What is the official meaning of "capital contributed
during the year?" (does this include cash in bank?)
6. What is the official meaning of "Withdrawals and
distributions?" (What's included, what notable items not
included?)
7. Book value is not being asked here, right?
Thanks in advance for your help
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Brian Collie
> Could someone please define for me what, from a 1065
> viewpoint, does a "Capital Account" consist of exactly?
Get thee to an accountant ASAP!
Gene E. Utterback, EA
If this isn't a class homework assignment I truly pity the
client for whom this return is being done! Seriously, if
you are preparing a 1065 and have to ask these questions you
have NO business doing a partnership return. I'm sure that
most tax pros will agree with me when I say that partnership
taxation is among the most complicated and convoluted areas
of taxation.
To answer each section and subsection of your question would
take up way more time and bandwidth that I'm willing to
commit to. In short, the partner's capital account is
ROUGHLY equivalent to the Retained Earnings of a
corporation, except that it is divided among the partners.
Each contribution (cash or property) and income (pro rata
share) will increase the capital account and each withdrawal
(cash or property) and losses and nondeductible items (pro
rata share) will decrease the capital account - for each
partner.
Your question really is extremely broad. If you are a not a
tax pro and are trying to do this return I highly recommend
you get professional help. If you really think you can
handle this you should at least get a pro for the first year
and have them explain to you in detail what they've done. I
have done this in my practice but be advised that the time
it takes for me to answer detailed quesions sufficiently to
allow you to prepare the return in the future gets billed at
my hourly rates. The questions you ask would require at
least 30 to 60 minutes to explain - ASSUMING that the
explaination doesn't raise any other questions and assuming
you can pick up on the nuances and don't spend much time
with too many "why is it done that way?" type of questions.
If this is a class homework assignment, all that you need to
know should be contained in your text book.
Good luck,
Gene E. Utterback, EA
KenB
> Could someone please define for me what, from a 1065
> viewpoint, does a "Capital Account" consist of exactly?
>
> I am interested in answering Section J in the K-1, which asks:
> 1. Partner's capital account at the beginning of the year
> 2. Capital contributed during the year
> 3. Withdrawals and distributions
>
> For simplicity sake, let's say that the partnership has 2
> partners, each with 50% share of profits, expenses, etc.,
> and that the partnership has over the years purchased $1,000
> worth of capital equipment, which represent all assets of
> the business.
You may be thinking too hard about this. In the simplest
application, the capital account is the total of all partner
capital contributions (not loans) put into the partnership,
increased by partnership net income or decreased by
partnership net losses, and reduced by any cash distributed
to the partner (not guaranteed payments). Each year builds
on the last such that the cumulative ending balance
generally equals net book value (equity).
(Or is this the harder way to think about it?)
> Some items have been amortized, and the cost
> of these items has been recovered over time. Some items were
> deducted in section 179 deductions, recovering their costs.
> Now, ten years later, the section 179 deductions and the
> scheduled depreciation of these items would seem to provide
> a quite low adjusted basis. For simplicity sake, let's say
> that the adjusted basis of the original $1,000 now is $100.
>
> Let's also say that each partner contributed $500 to the
> partnership's bank account at the beginning of the tax year,
> so that there was $1,000 in the partnership bank account at
> the beginning of this year.
>
> Now, here are the questions:
> 1. Is cash in the partnership bank account at the beginning
> of the year considered part of the partner's Capital
> account? (in this case, $500 each partner)
Yes but only in addition to adjusted basis of all other
assets less liabilities at the beginning of the year. The
partner's % can be applied to the total only if each partner
contributed and withdrew capital equally over the years. I
would recommend keeping track of each partner's capital
account each year even if it is not required because it can
be difficult to reconstruct.
> 2. Is the formula for determining the adjusted basis:
> (Partner's share %) X (total items purchase price MINUS
> section 179 deduction taken MINUS depreciation deduction
> taken or that could have been taken to date)?
Yes, but Partner's % doesn't apply at this level (see above).
> 3. If each partner puts in cash during the year to keep the
> partnership going, is that considered capital contributed
> during the year?
>
Yes.
> 4. Are distributed profits to each partner (not guaranteed
> payments) considered a withdrawal or distribution?
Yes, but note that the corresponding profit is an increase.
In other words, if the partnership has $12,345 income and
distributes $12,345 to the partners then the capital account
does not change.
> 5. What is the official meaning of "capital contributed
> during the year?" (does this include cash in bank?)
Don't know official meaning, but you should think in terms
of cash put into the general funds of the partnership by the
partners during the year. It is the act of puttng in the
cash, not the amount of cash left.
> 6. What is the official meaning of "Withdrawals and
> distributions?" (What's included, what notable items not
> included?)
Generally a withdrawal/distribution is any payment to a
partner other than loan repayments or guaranteed payments to
partners. Various nondeductible expenses or benefits might
also be treated as distributions and therein it can become
complicated to determine each partner's share of the total
capital account.
> 7. Book value is not being asked here, right?
The total capital is effectively net book value. It gets
more difficult calculating each partners share of the total
capital (ie, Sched J on K-1). If capital contributions and
withdrwawals have always been pro-rata then it may be fair
to simply give each partner their % of the total. It can be
much more complicated given the flexibity of partnerships.
> Thanks in advance for your help
If it helps? Good luck.
Thomas E. Healy
Without an understanding of partnership accounting outside
of the tax situation, I think that any explanation will be
over your head. With that in mind, here are my answers:
No.
> 2. Is the formula for determining the adjusted basis:
> (Partner's share %) X (total items purchase price MINUS
> section 179 deduction taken MINUS depreciation deduction
> taken or that could have been taken to date)?
No. Adjusted basis of an asset is calculated without refence
to the individual partners.
> 3. If each partner puts in cash during the year to keep the
> partnership going, is that considered capital contributed
> during the year?
Yes.
> 4. Are distributed profits to each partner (not guaranteed
> payments) considered a withdrawal or distribution?
The profits reported on Schedule K-1 are not distributions.
Cash and other property can be distributed.
> 5. What is the official meaning of "capital contributed
> during the year?" (does this include cash in bank?)
It has the same meaning as non-tax accounting capital
contributions.
> 6. What is the official meaning of "Withdrawals and
> distributions?" (What's included, what notable items not
> included?)
Typically, cash and other property make up distributions.
Sometimes the partnership assumes a partner's liabilities,
which has the same effect as a distribution to the partner.
> 7. Book value is not being asked here, right?
Correct.
Tom
--Solving your tax and business problems with
Professional Service...Personal Attention
Email: t...@tomhealycpa.com
Web: http://www.tomhealycpa.com
Richard J. Di Bernardo
> Could someone please define for me what, from a 1065
> viewpoint, does a "Capital Account" consist of exactly?
I guess I, too, was confused a few times when I was a young
student years ago. So rather than referring you to your
text book, I'll be a little more generous.
Often elementary accounting textbooks start with
proprietorships then move on to corporations. Students may
have difficulty relating the concepts of "net equity"
(proprietor's or shareholders') to a partnership.
A capital account consists of each partner's share of:
1. Partners "capital" contributions (analogous to common &
Pfd stock and Paid in capital accounts for a
corporation). Includes initial and subsequent
contributions of cash and other assets, less liabilities
assumed by the partnership relating to the transfer of
the assets to the partnership.
2. All net income/loss to date (analogous to a retained
earnings account)--All the stuff ever recorded on the P&L
since inception.
3. Any amounts from #1 and #2 above paid back or distributed
back to the partners (Distributions). You can give them
back their own money or give them the earnings.
Unfortunately, there are many terms in accounting, tax,
business and economics with different meanings (connotations
and denotations):
Capital gain/loss (tax-precise definition)
Capital budgeting (finance)
Capital (economic sense - the machine used in production)
to capitalize an expenditure - accounting
to capitalize a business - business, finance
Don't get confused - identify the context.
"Capital" in the sense of a partners capital account is just
the net equity of the partnership (assets minus liabilities,
and is analogous to the stockholder's equity section of a
balance sheet). However, generally unlike a corporation,
there is the need to divvy-up these amounts to each partner.
Except for a liquidation, I have not identified the need to
identify each shareholder's interest or share of the
corporation's stockholders' equity.
Whether the amounts in the capital account represent tax
basis is another issue. It doesn't always. This can be
very confusing.
Example: You and I form a equal partnership (share profits
50-50). I contribute a building now worth $100,000. I
bought it 20 years ago for $20,000 (my cost = tax basis).
You contribute $100,000 cash to equalize the values of our
initial capital contributions.
GAAP says the value of the bldg should be reflected in the
capital accounts:
Capital Accounts Tax Basis
(Books= Section J)
Cash 100,000 100,000
Bldg 100,000 20,000
If we immediately terminate the partnership and sell the
bldg for its value ($100,000), the books show no gain or
loss. However the tax return would show a $80,000 gain
($100,000 sales proceeds minus $20,000 basis). We have
$200,000 cash (no other assets)--you get $100,000 and I get
$100,000. Should you report half of the $80,000 gain on
your tax return? I hope not.
This is just a little taste of the complexity of partnership
taxation and why there is the need, unlike corporations, to
keep considerable detail of the partners' capital accounts
(either in the formal books or in "off-books" schedules).
> I am interested in answering Section J in the K-1, which asks:
> 1. Partner's capital account at the beginning of the year
> 2. Capital contributed during the year
> 3. Withdrawals and distributions
>
> For simplicity sake, let's say that the partnership has 2
> partners, each with 50% share of profits, expenses, etc.,
> and that the partnership has over the years purchased $1,000
> worth of capital equipment, which represent all assets of
> the business. Some items have been amortized, and the cost
Don't focus on each asset or item. The sum of all the
capital accounts detailed for each partner in Section J(each
partner has one) equals the net equity (assets minus
liabilities) of the partnership.
Schedule J is analogous to a summary of the Stockholder's
equity section of a balance sheet for a corporation.
> of these items has been recovered over time. Some items were
> deducted in section 179 deductions, recovering their costs.
> Now, ten years later, the section 179 deductions and the
> scheduled depreciation of these items would seem to provide
> a quite low adjusted basis. For simplicity sake, let's say
> that the adjusted basis of the original $1,000 now is $100.
>
> Let's also say that each partner contributed $500 to the
> partnership's bank account at the beginning of the tax year,
> so that there was $1,000 in the partnership bank account at
> the beginning of this year.
>
> Now, here are the questions:
> 1. Is cash in the partnership bank account at the beginning
> of the year considered part of the partner's Capital
> account? (in this case, $500 each partner)
It is an asset. Add together all the assets, subtract all
the liabilities, and the difference is the sum of all the
partner's capital accounts (net equity).
> 2. Is the formula for determining the adjusted basis:
> (Partner's share %) X (total items purchase price MINUS
> section 179 deduction taken MINUS depreciation deduction
> taken or that could have been taken to date)?
For a specific asset, yes. If you sell the asset you need
to know this. The purchase price would be the amount on the
balance sheet. Don't do this for each asset if you want to
determine partner's capital. Remember the basic accounting
formula: (All) assets minus (all) liabilities equals net
equity (and equals Schedule J). In the context of a
partnership, net equity is "partners' capital."
> 3. If each partner puts in cash during the year to keep the
> partnership going, is that considered capital contributed
> during the year?
If there is the understanding that the amounts are "capital"
(not a debt or obligation of the partnership that legally
has to be paid back, but rather amounts the partners risk
with the venture), yes. The amounts could be loans (a
liability). Ask yourself, "If this were a corporation,
would I book the receipt of this cash to the equity
accounts: common/pfd stock or paid in capital?"
> 4. Are distributed profits to each partner (not guaranteed
> payments)
Guaranteed payments are already deducted in arriving at the
net income (like any other expense)
> considered a withdrawal or distribution?
Yes.
> 5. What is the official meaning of "capital contributed
> during the year?" (does this include cash in bank?)
Well not "official," I hope this helps: Net assets (assets
minus liabilities assumed by the partnership) transferred by
a partner to the partnership during the tax year, with the
understanding that he/she may never recoup this amount. It
represents "risk capital." Generally, if the partnership
loses this money, the partners don't have a claim against
the partnership or other partners to get back their money.
If the cash came from the partner's personal assets,
represents monies that the partners intend to subject to the
risk of the business (no obligation of being repaid-unlike a
loan), and was deposited during the current year, yes.
> 6. What is the official meaning of "Withdrawals and
> distributions?" (What's included, what notable items not
> included?)
See the first question - generally any outflows from the
partnership of cash or other assets to the partners, that
come from #1 and #2.
> 7. Book value is not being asked here, right?
WRONG! When you add up all of the partners capital accounts
you have net book value (or net equity: all assets minus all
liabilities).
The capital accounts should be the capital accounts on the
partnership's books.
It is not your fault that you are so confused. There is a
quote (I think by Justice Learned Hand) that says something
like partnership taxation is difficult to those who have not
been introduced to the intricacies and mysteries of
Subchapter K (where the partnership tax laws are located in
the tax code).
I hope that this helps.
What college are you attending?
--
Richard J. Di Bernardo, CPA, MS (Tax)
San Francisco, CA