South-Western Federal Taxation Comprehensive Volume 2014
need solution. please thanks.
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 joint
venture). During its first four years, the LLC worked with the U.S. Department
of Homeland Security and the National Transportation Safety Board to design
and develop a specific device for airport passenger screening. Porto provides
engineering 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 succesfully
marketed, sold, delivered, and installed in airports around the United States.
The LLC uses the accrual method of accounting and the calendar year for
reporting purposes. Its current address is 3750 Airport Boulevard, Seattle, WA,
98124. The following information was taken from the trial balance supporting the
LLC’s GAAP-basis (audited) financial statements for the 2009 calendar year:
Amounts related to cost of goods sold:
Additional § 263A costs
Other costs: Various items
Less: Ending inventory
Total amounts re: work-in-progress:
Other costs not related to production:
Salaries and wages
Taxes and licenses
Meals and entertainment (subject to 50% disallowance)
Employee benefit programs
Insurance (including key employee life insurance of $100,000)
Legal and professional fees
Sales and promotion expenses
Warranty expense (increase to reserves; not fixed and determinable)
Total other costs disbursements
Net income per books and GAAP-basis audited financial statements
The beginning and ending GAAP-basis balance sheets for the LLC were as
follows at December 31, 2009:
U.S. government obligations
Buildings and equipment
Other current liabilities:
Operating line of credit (guaranteed by LLC members)
Warranty reserves (not guaranteed by members)
Mortgage notes on building
Capital, Branson Company
Capital, Porto Engineering, Inc.
Total liabilities and capital
The LLC uses the lower of cost or market method for valuing inventory. Branto is
subject to § 263A; for simplicity, assume § 263A costs are reflected in the same
manner for book and tax purposes. Branto did not change its inventory accounting
method during the year. There were no writedowns of inventory items, and Branto
does not use the LIFO method.
The LLC claimed $2,499,270 of depreciation expense for tax purposes (book
depreciation is $1,275,000). All tax depreciation expense should be reported on
Schedule 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 depreciation
amounts reflect bonus depreciation deductions (and these assets are not subject to
AMT adjustments). Depreciation for assets placed in service in prior years creates an
adjustment of ($276,900) for AMT purposes. (This is a negative amount—book
depreciation for these assets is greater than tax depreciation.)
All borrowings were used exclusively for business operations; consequently, none
of the interest expense is considered investment interest expense. The LLC
members were required to guarantee the debt related to the operating line of
credit. The accounts payable, accrued warranty claim liabilities, and the mortgage
were not guaranteed by the members. The mortgage relates to the real property and
is considered qualified nonrecourse financing. The partners share equally in all
LLC liabilities, because all initial contributions and all ongoing allocations and
distributions are pro rata.
No guaranteed payments were paid to either of the LLC members. Instead, the
members each withdrew $3.4 million of cash during the year. The LLC has never
made a distribution to the partners of noncash property. Cash distributions were not
subject 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 warrant
such an election. None of the members sold any portion of their interests in the
LLC 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 did
not change any accounting method for tax or financial reporting purposes. Both
LLC members are U.S. Subchapter C corporations. The LLC’s operations are
entirely restricted to the United States, and all sales were to U.S. businesses. The
LLC had no foreign operations, no foreign bank accounts, and no interest in any
foreign trusts or other LLCs. The LLC is not publicly traded and is not a statutory
tax shelter. The LLC is not required to file Form 8918; there were no ‘‘reportable
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. The
LLC files its tax return in Ogden, Utah. Branson Company is located at 3750 Airport
Boulevard, 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 member
corporations are each owned by several unrelated individual taxpayers. Branson
Company is the tax matters partner. The LLC has not been audited by the IRS and
has not filed Form 8893 for any tax years.
The capital account reconciliation on the partners’ Schedules K–1 is prepared on
a 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 will
find four book-tax differences (two temporary differences and two permanent
c. Prepare Schedule K–1 for 50% LLC member Branson Company.