Video: Effect of Income and Withdrawals on Partner Basis

In this lesson, explore the essential tax concepts of partner basis as Nick Palazzolo, CPA, breaks down how income and withdrawals affect a partner's investment in a partnership. He clarifies the effects of both taxable income and non-taxable withdrawals on the partner's capital account and tax basis. Nick illustrates these principles using practical examples, such as how a partner's tax basis increases with their share of undistributed partnership income but decreases with money received as withdrawals. Emphasizing the significance of understanding basis, Nick explains how it influences a partner's taxable gain or loss on the sale or liquidation of their partnership interest, as well as the deduction of partnership losses. This foundational knowledge is not only pivotal for the exam but also for grasping the broader financial implications in partnership dealings.

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Video Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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Pretty simple slide. One of the most simple slides you'll see. Just a reminder, the effect of income and withdrawals on partner basis. So what is going to increase basis? That is gonna be income. Income is taxable. Now, withdrawal is generally non-taxable and they will decrease your basis. This is a reminder, again, we're gonna see lots of examples how this all works, but understanding the difference between income and contributions, and let's say losses, distributions, all of those possible effects on taxability, on your basis, on your capital account. All right, building on that a little bit further with some examples, income is gonna increase a partner's tax basis in the partnership. Now, when the partnership earns income, this income is allocated to each partner according to their share in the partnership. Even though the income may not be immediately distributed to the partners, their share of the income increases their tax basis in the partnership. Now, for instance, let's say that John is a partner in ABC Partnership. John's got an initial basis of $10,000. In the current year, John's share of the partnership income is $4,000. Now, even if John doesn't receive the $4,000 as a cash distribution, his basis in ABC Partnership would increase by $4,000 to a new total of $14,000. For withdrawals or distributions, these are typically going to decrease the partner's tax basis in the partnership, and they're usually not treated as taxable income. This is money that was taxed earlier. You're just now getting it in cash. They are viewed as a return of capital to the partner. Example continuing from the previous scenario, assume that ABC Partnership distributes $2,000 to John. The distribution is not considered taxable income to John. Instead, it will reduce his basis in the partnership, so

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