 Hello and welcome to this session. This is Professor Farhad in which you would look at CPA exam questions, specifically that deal with the regulation section. These topics will be covered on a typical undergraduate or graduate entity or corporate accounting course and specifically I'm going to be focusing on partnership. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance, excel tutorial, as well as CPA questions. If you like my lectures, please like them, share them. If they benefit you, it means they might benefit other people. Share the wealth, connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to supplement your accounting education or especially your CPA exam. This is a partial view of my catalog on my website where you have additional resources for your accounting courses as well your CPA, CMA, EA exam. So in today's session, I'm going to look at several questions that deal with specifically partnership and this topic is covered heavily. It's an important concept on the CPA exam. This is how the AI CPA tries to see, test your knowledge. So when they give you a question about the partnership, partnership, we all agree it's a major topic on the CPA exam. Actually, all topics are major, important, but certain topics are more heavily weighted. So if they give you a question about partnership, let's assume we have three type of questions, easy, medium, and difficult. And let's assume they gave you an easy question, you get it right. They may throw at you another medium question. If you get it right too, they might say this individual, they know their partnership and they may move on to another topic and stop testing you about partnership. Let's assume they give you an easy partnership question, like really obvious partnership question you should get right and you got wrong. The system says, okay, this individual does not understand partnership. Let's give them another easy question or a medium question just to see if they answered that question by mistake or not. And if you answered that question incorrectly again, then they start to zoom that you have a weakness in a major area and now you're heading toward a grade below 75. So the point I'm trying to make is this, you need to understand your major topics, all topics, but especially your major topics like partnership. And the reason is because the test is adaptive. They know which topics you are struggling with and they will bombard you with questions until they say, look, we're not going to pass this individual. This individual is not comfortable with a partnership or S corporation or the cash flow or leases or the fur taxes. Therefore, what you should do is if you want to increase your knowledge, visit my website. I explain everything in details in contrast to a CPA review course where they review the material with you. They assume you know it. I don't assume anything. That's the beauty of my website. Let's go ahead and dive into the first question to see how we would approach these questions and what should be on the lookout for. This partnership has sales revenue of 450,000. This is their sales revenue and they had operating expenses of 350 dividend revenue of 8,000, charitable contribution of 6,000 and 12,000 of capital loss. Therefore, the partnership has a net income of 90,000. What is the partnership ordinary income for tax purposes? There's a lot of information in this question. So you have to have an understanding of several things before you can answer this question properly. First, we are dealing with a partnership. That's fine. They're giving us sales revenue 450 operating expenses 350. Then they're giving us other items. They're giving us other items such as dividend revenue of 8,000, charitable contribution of 6,000 and capital losses of 12. And they're giving us one more piece of information to confuse us more is net income of 90,000. So they're asking us about the ordinary income for tax purposes. So you have to go through three different things in order to properly answer this question. So the first is they're asking us specifically ordinary income for tax purposes. What does that mean? It means you have to know that the only thing that's going to be deducted on the 1065 on the partnership is the operating expenses. And the only revenue is the sales revenue. And this is why I highlighted them in yellow. So we're going to take 350 minus 450. And that's going to give us 100,000. Now you might be saying, hold on a second. Then they say net income of 90,000. This net income, when we say net income, when we use this language, this is for financial accounting purposes. This is for gap purposes. If for gap purposes they had 90,000, there's a $10,000 difference somewhere. We cannot reconcile this difference here. They're not even asking us to do so. But the point is they're trying to throw that number to confuse you. Therefore, your ordinary income is 100,000. So hold on a second. What do I do with the dividend revenue? What do I do with the charitable contribution? What do I do with the capital loss? If you don't know what you're doing with those, don't sit for the CPA exam yet. Those are separately stated item, and they're going to be allocated separately to the partners. So they're asking about the ordinary income. The ordinary income that's going to be for tax purposes is 100,000. The blue ones are allocated separately, separately stated items. If you don't know those, I suggest don't sit for the exam yet. Otherwise, if you understand this question, I would say you have a good basic starting point for the exam. As I mentioned, all these topics I cover in details on my website. Let's take a look at this question. Which of the following is correct? Recording partnership tax return? One, no tax return is due with the filing of a partnership tax return, even if the partnership earned profit and access of 50,000. So the question is, hold on a second. No tax due with the filing of the partnership made then 50,000. And the question is, yes. The question is, there's no tax due period. The partnership don't pay any taxes. You have to understand this. The partnership don't pay any taxes. Why not? The partnership is only an informational return. It's a tax return, but only it's informational. It's a form of 1065. So you have to understand whether you earned 50,000, a million, 5 million, or $1, there's no tax due. The partnership don't pay any taxes. Therefore, one is correct. I can take out immediately B and I can take out D. And I have to look at number two to see if number two is correct. Then it's both A, one and two. A partner tax return is filed on a 1040 on a form 1065. Yes, it's filed on a form 1065. I'm going to show you the form on the next page. So both of them are correct. So no tax return. And here we go. So to make kind of, I like when students can see things. And if you inspect this 1065 form, there is no place where you pay taxes on your ordinary income. So what you have to do, usually you pay taxes on the profit. So notice you get to ordinary business loss. You look interest due, interest due under the logback period, interest due under the lookback method, so on and so forth. But there's no place where the partnership pay income taxes. There's taxes and licenses, those part of your operating business, but not taxes on ordinary income. The partnership don't pay any taxes. The partnership itself don't pay any taxes. Now, if you're looking at form 1020, not 1020S, you will see when we do, when you look at 1020, form 1020, not 1020S, you will see that they have place where they pay taxes, where they pay taxes. Let's take a look at this question. And a partnership, a fixed payment. So what's the answer here? We said both. Yes, we said both. Yes. And a partnership, a fixed payment made to a partner for services provided to the partnership is known as what? So what do we know as a fixed payment made to the partner? Is it called a normal distribution? Is it called a guaranteed payment? And this, this topic, give students hard time, especially guaranteed payment. Like students don't understand what a guaranteed payment is and what is a normal distribution. And it's very important because they sound similar. The partnership is given money, but how it's treated, it's totally different. So you have to understand. So the best way to understand this is to go back to the form 1065. And here's what I want you to see. I want you to zoom in on line 10. Okay, right here. I'm going to highlight line 10. And as you can see on line 10, clearly, it says guarantee payment. And as you can see too, it's part of the deduction. So simply put, on line 10, guaranteed payment to partners is a business deduction. Okay. So let's go back. Guarantee payment is a business deduction. So what's a guaranteed payment? A guaranteed payment is a fixed payment made to a partner for services provided. Here's how the guaranteed payment works. Simply put, simply put, when you are a partner in a partnership, you may be devoting a lot of your time. In other words, that's all what you do for a living. Or the majority of your time, you're devoting it to a partnership. So what you do, you will agree with the partners. The partners agree among themselves. For example, I devote 100% of my time to the partnership. You don't. You do have a full-time job and you devote maybe five hours a week. Well, what I do to live, to pay rent, to pay mortgage, to buy food, I need a guaranteed payment. Therefore, the guaranteed payment is a fixed amount to a partner for services provided, regardless of the profit of the partnership. Okay. So this is what a guaranteed payment is. It's different than a normal distribution, which we'll talk about normal distribution in a moment. Guarantee payment, as you already know, it is deductible for the partnership. You remember online, I just showed you, online 10. You can physically see online 10, it's deductible. Now, what you need to know, this guaranteed payment is included as taxable for the partner. Obviously, it's taxable for the partner. It's taxable. So it goes to them as taxes. So if the partnership paid them 50,000, it's taxable to them as income. Okay. So the guaranteed payment is taxable. So this is the definition. So it's normal distribution, the same as guaranteed payment. And the answer is absolutely not. Distribution is when the partnership distributes money to the partner or distributes asset. The first thing we need to know, that's not deductible. It's not tax deductible. So in other words, it's not. So notice this one is deductible. The guaranteed payment is deductible. I'm sorry, the pen is giving me hard time. And taxable. The normal distribution, the ND, not deductible. And first, let's make sure it's not deductible. You can scan all the deduction and you don't see a normal distribution. And not taxable. Now, you should know not taxable what not taxable means. It means when you distribute something to me, it's not taxable. Hold on a second. Are you saying I'm receiving stuff from the partnership and it's not taxable? And the answer is yes. And you should know that's the case, because if you understand that the partnership is a pass through entity, it means everything that you're getting, it's already been taxed. Therefore, it's not taxable. Therefore, let's go back to answer this question. What do we call a fixed payment made to a partner for services provided? We call it guaranteed payment. And the answer is B as in boy, not normal distribution. Normal distribution is totally different. There are two different things. Normal distribution versus guaranteed payment, something that you need to be very familiar with. Tax exempt interest income received by a partnership will have what effect on the basis of each partner and the partnership? Okay. Let's take a look at the answer choices. Increase the basis. That sounds good. Thereby making the tax exempt income taxable. No, tax exempt income is not taxable. We take out a decrease the basis. No, it doesn't increase the basis. If you receive income, it's going to increase your basis. Have no effect on the basis. It has effect on the basis. It increased the basis. And still tax exempt income is not taxable. So it's good. So you'd receive the income. It increased your basis, which reduce your gains down the road. And it's not taxable. That's not bad. Good deal, right? The answer is D. It increased your basis, although it's not taxable. Let's take a look at this question. If a partnership is being liquidated, which of the following is correct? Now we're talking about partnership liquidation. Again, I do have lectures about partnership liquidation. And you need to know how partnership liquidation work. So they're asking us here, a partner may, a partner may, the partnership may, the partnership may. They're asking us two questions about the partner and two questions about the partnership. And which of the following is correct? They're asking us which one is correct. So basically they want to see if we know how to, how do we treat a partner and a partnership in a liquidation situation. A partner may report again, but not a loss on the liquidation. No, they would report again if they receive more than their basis. That's true, but they would report also a loss. Therefore, A is not correct. A partner may report a loss, but not again. No, they could report both again and a loss. If they receive less than their basis, they would report a loss. So A and B are out. So simply put, a partner would report again or loss. Not a big deal. Now let's talk about the partnership. The partnership may report again, but not a loss on a liquidation. Or the partnership may report neither again nor a loss. And you need to know the partnership itself. The partnership itself would report neither again, nor a loss on a liquidation. Not the partners, the business itself. Because remember, the partnership don't pay any taxes. Okay, so they don't report any gain or any loss. Therefore, the answer is D. So the partner would experience gains and losses. The partnership don't because the partnership don't pay. That's the nature of the partnership. They don't have any gain or losses. Again, I would like to remind you to kind of, if you want to reinforce these concepts, check out my website, farhatlectures.com. I do have an entity tax course in which I cover the partnership in depth. That's additional questions and I have plenty of resources for the CPA exam rack. Study hard, good luck and stay safe during those coronavirus days.