Posted: October 20th, 2022

South-Western Federal Taxation Comprehensive Volume 2014

PROBLEM 5—PARTNERSHIP (FORM 1065)On January 1, 2004, the Branson Company (EIN 22–2222222) and Porto Engineering, Inc. (EIN 33–3333333), formed Branto, LLC (an equally owned jointventure). During its first four years, the LLC worked with the U.S. Departmentof Homeland Security and the National Transportation Safety Board to designand develop a specific device for airport passenger screening. Porto providesengineering expertise, and Branson provides high-tech manufacturing, selling,and distribution expertise. Early in 2008, the two governmental agencies recommended the product. In 2009, Branto’s screening device is being succesfullymarketed, sold, delivered, and installed in airports around the United States.The LLC uses the accrual method of accounting and the calendar year forreporting purposes. Its current address is 3750 Airport Boulevard, Seattle, WA,98124. The following information was taken from the trial balance supporting theLLC’s GAAP-basis (audited) financial statements for the 2009 calendar year:Revenues:Sales revenuesInterest incomeTotal revenues$28,000,00050,000$40,050,000Amounts related to cost of goods sold:Beginning inventoryMaterials purchasesLaborAdditional § 263A costsOther costs: Various itemsBook depreciationLess: Ending inventoryTotal amounts re: work-in-progress:$ 2,000,0002,000,0003,000,000–0–2,700,0001,275,000(3,000,000)$19,975,000www.cengage.com/taxation/swftOther costs not related to production:Salaries and wagesTaxes and licensesCharitable contributionsInterest expenseMeals and entertainment (subject to 50% disallowance)Travel expensesEmployee benefit programsInsurance (including key employee life insurance of $100,000)Legal and professional feesOffice expensesSales and promotion expensesUtilitiesWarranty expense (increase to reserves; not fixed and determinable)Total other costs disbursements$ 1,000,000300,000100,000200,0001,200,000800,000300,000300,000600,0002,000,0002,500,000800,000300,000$10,400,000Net income per books and GAAP-basis audited financial statements$ 9,675,000The beginning and ending GAAP-basis balance sheets for the LLC were asfollows at December 31, 2009:Beginning$EndingCashAccounts receivableInventoriesU.S. government obligationsLandBuildings and equipmentAccumulated depreciationTotal assets975,000620,0002,000,0001,000,000600,0008,000,000(6,375,000)$6,820,000$ 1,825,000150,0003,000,0001,000,000600,00011,000,000(7,650,000)$9,925,000Accounts payableOther current liabilities:Operating line of credit (guaranteed by LLC members)Warranty reserves (not guaranteed by members)Mortgage notes on buildingCapital, Branson CompanyCapital, Porto Engineering, Inc.Total liabilities and capital$$420,0001,000,000200,0001,000,0002,100,0002,100,000$6,820,000350,0002,000,000500,00003,537,5003,537,500$9,925,000The LLC uses the lower of cost or market method for valuing inventory. Branto issubject to § 263A; for simplicity, assume § 263A costs are reflected in the samemanner for book and tax purposes. Branto did not change its inventory accountingmethod during the year. There were no writedowns of inventory items, and Brantodoes not use the LIFO method.The LLC claimed $2,499,270 of depreciation expense for tax purposes (bookdepreciation is $1,275,000). All tax depreciation expense should be reported onSchedule A. The LLC placed $3 million of assets in service during the current year;this exceeds the threshold for eligibility for a § 179 deduction. Tax depreciationamounts reflect bonus depreciation deductions (and these assets are not subject toAMT adjustments). Depreciation for assets placed in service in prior years creates anadjustment of ($276,900) for AMT purposes. (This is a negative amount—bookdepreciation for these assets is greater than tax depreciation.)All borrowings were used exclusively for business operations; consequently, noneof the interest expense is considered investment interest expense. The LLCmembers were required to guarantee the debt related to the operating line ofcredit. The accounts payable, accrued warranty claim liabilities, and the mortgagewere not guaranteed by the members. The mortgage relates to the real property andis considered qualified nonrecourse financing. The partners share equally in allLLC liabilities, because all initial contributions and all ongoing allocations anddistributions are pro rata.No guaranteed payments were paid to either of the LLC members. Instead, themembers each withdrew $3.4 million of cash during the year. The LLC has nevermade a distribution to the partners of noncash property. Cash distributions were notsubject to the disclosure requirements of Reg. § 1.707–8. The LLC has not made a§ 754 election and had no transactions during the current year that would warrantsuch an election. None of the members sold any portion of their interests in theLLC during the year.During the current tax year, the LLC did not sell or acquire intangible assets,restructure debt, or distribute any property received in a like-kind exchange. It didnot change any accounting method for tax or financial reporting purposes. BothLLC members are U.S. Subchapter C corporations. The LLC’s operations areentirely restricted to the United States, and all sales were to U.S. businesses. TheLLC had no foreign operations, no foreign bank accounts, and no interest in anyforeign trusts or other LLCs. The LLC is not publicly traded and is not a statutorytax shelter. The LLC is not required to file Form 8918; there were no ‘‘reportabletransactions.’’The LLC’s activities are eligible for the domestic production activities deduction(DPAD). For simplicity, assume the LLC’s qualified production activities income is$9.5 million. Employer’s production-related W–2 wages are $10 million.The IRS’s business code for ‘‘Other specialty trade contractors’’ is 238900. TheLLC files its tax return in Ogden, Utah. Branson Company is located at 3750 AirportBoulevard, Seattle, WA 98124 (the same as the LLC’s address). Porto Engineering,Inc., is located at 42100 Highway 980 West, Tacoma, WA 98401. The LLC membercorporations are each owned by several unrelated individual taxpayers. BransonCompany is the tax matters partner. The LLC has not been audited by the IRS andhas not filed Form 8893 for any tax years.The capital account reconciliation on the partners’ Schedules K–1 is prepared ona GAAP basis. The LLC is required to file Schedule M–3, Form 8916–A(Supplemental Attachment to Schedule M–3), and Schedule C with its Form 1065.Schedule L must be prepared on a financial reporting basis.a. Prepare pages 1–5 of Form 1065 for Branto, LLC. Do not prepare Form 4562.Leave any items blank where insufficient information has been provided. Prepare supporting schedules as necessary if adequate information is provided.b. Prepare Schedule M–1, Form 8916–A (page 1), and Schedule C. Hint: You willfind four book-tax differences (two temporary differences and two permanentdifferences).c. Prepare Schedule K–1 for 50% LLC member Branson Company.

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