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File state for free Publication 541 - Main Content Table of Contents Forming a PartnershipOrganizations Classified as Partnerships Family Partnership Partnership Agreement Terminating a PartnershipIRS e-file (Electronic Filing) Exclusion From Partnership Rules Partnership Return (Form 1065) Partnership DistributionsSubstantially appreciated inventory items. File state for free Partner's Gain or Loss Partner's Basis for Distributed Property Transactions Between Partnership and PartnersGuaranteed Payments Sale or Exchange of Property Contribution of Property Contribution of Services Basis of Partner's InterestAdjusted Basis Effect of Partnership Liabilities Disposition of Partner's InterestSale, Exchange, or Other Transfer Payments for Unrealized Receivables and Inventory Items Liquidation at Partner's Retirement or Death Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)Partnership Item. File state for free Small Partnerships and the Small Partnership Exception Small Partnership TEFRA Election Role of Tax Matters Partner (TMP) in TEFRA Proceedings Statute of Limitations and TEFRA Amended Returns and Administrative Adjustment Requests (AARs) How To Get Tax Help Forming a Partnership The following sections contain general information about partnerships. File state for free Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. File state for free However, a joint undertaking merely to share expenses is not a partnership. File state for free For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. File state for free The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. File state for free Organizations formed after 1996. File state for free   An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. File state for free An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. File state for free An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. File state for free An insurance company. File state for free Certain banks. File state for free An organization wholly owned by a state, local, or foreign government. File state for free An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). File state for free Certain foreign organizations identified in section 301. File state for free 7701-2(b)(8) of the regulations. File state for free A tax-exempt organization. File state for free A real estate investment trust. File state for free An organization classified as a trust under section 301. File state for free 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. File state for free Any other organization that elects to be classified as a corporation by filing Form 8832. File state for free For more information, see the instructions for Form 8832. File state for free Limited liability company. File state for free   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. File state for free Unlike a partnership, none of the members of an LLC are personally liable for its debts. File state for free An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301. File state for free 7701-3. File state for free See Form 8832 and section 301. File state for free 7701-3 of the regulations for more details. File state for free A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. File state for free Organizations formed before 1997. File state for free   An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832. File state for free Community property. File state for free    Spouses who own a qualified entity (defined later) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. File state for free They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. File state for free A change in reporting position will be treated for federal tax purposes as a conversion of the entity. File state for free   A qualified entity is a business entity that meets all the following requirements. File state for free The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a possession of the United States. File state for free No person other than one or both spouses would be considered an owner for federal tax purposes. File state for free The business entity is not treated as a corporation. File state for free   For more information about community property, see Publication 555, Community Property. File state for free Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. File state for free Family Partnership Members of a family can be partners. File state for free However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. File state for free If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest. File state for free If capital is not a material income-producing factor, they joined together in good faith to conduct a business. File state for free They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. File state for free Capital is material. File state for free   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. File state for free Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. File state for free Capital is not material. File state for free   In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. File state for free Capital interest. File state for free   A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations. File state for free The owner withdraws from the partnership. File state for free The partnership liquidates. File state for free   The mere right to share in earnings and profits is not a capital interest in the partnership. File state for free Gift of capital interest. File state for free   If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions. File state for free It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. File state for free The donee's distributive share of partnership income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. File state for free Purchase. File state for free   For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. File state for free The fair market value of the purchased interest is considered donated capital. File state for free For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). File state for free Example. File state for free A father sold 50% of his business to his son. File state for free The resulting partnership had a profit of $60,000. File state for free Capital is a material income-producing factor. File state for free The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. File state for free The $24,000 must be allocated to the father as compensation. File state for free Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. File state for free The son's share of partnership profit cannot be more than $18,000. File state for free Business owned and operated by spouses. File state for free   If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. File state for free If so, they should report income or loss from the business on Form 1065. File state for free They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. File state for free However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. File state for free Qualified Joint Venture Election. File state for free   A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. File state for free A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. File state for free   Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore does not have a Form 1065 filing requirement. File state for free All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. File state for free Each spouse takes into account his or her respective share of these items as a sole proprietor. File state for free Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). File state for free For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (i. File state for free e. File state for free , based on their respective interests in the venture). File state for free   If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. File state for free Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. File state for free   This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. File state for free However, this may not be true if either spouse exceeds the social security tax limitation. File state for free   For more information on qualified joint ventures, go to IRS. File state for free gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. File state for free ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. File state for free The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. File state for free The agreement or modifications can be oral or written. File state for free Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. File state for free This filing date does not include any extension of time. File state for free If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. File state for free Terminating a Partnership A partnership terminates when one of the following events takes place. File state for free All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. File state for free At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner. File state for free Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period. File state for free See section 1. File state for free 708-1(b) of the regulations for more information on the termination of a partnership. File state for free For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. File state for free 708-1(c) and 1. File state for free 708-1(d) of the regulations. File state for free Date of termination. File state for free   The partnership's tax year ends on the date of termination. File state for free For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. File state for free For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. File state for free Short period return. File state for free   If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. File state for free The return is due the 15th day of the fourth month following the date of termination. File state for free See Partnership Return (Form 1065), later, for information about filing Form 1065. File state for free Conversion of partnership into limited liability company (LLC). File state for free   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. File state for free The conversion is not a sale, exchange, or liquidation of any partnership interest; the partnership's tax year does not close; and the LLC can continue to use the partnership's taxpayer identification number. File state for free   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. File state for free Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. File state for free If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. File state for free For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. File state for free   The same rules apply if an LLC classified as a partnership is converted into a partnership. File state for free IRS e-file (Electronic Filing) Please click here for the text description of the image. File state for free e-file Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically (e-file). File state for free Other partnerships generally have the option to file electronically. File state for free For details about IRS e-file, see the Form 1065 instructions. File state for free Exclusion From Partnership Rules Certain partnerships that do not actively conduct a business can choose to be completely or partially excluded from being treated as partnerships for federal income tax purposes. File state for free All the partners must agree to make the choice, and the partners must be able to compute their own taxable income without computing the partnership's income. File state for free However, the partners are not exempt from the rule that limits a partner's distributive share of partnership loss to the adjusted basis of the partner's partnership interest. File state for free Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. File state for free Investing partnership. File state for free   An investing partnership can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following requirements. File state for free They own the property as co-owners. File state for free They reserve the right separately to take or dispose of their shares of any property acquired or retained. File state for free They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. File state for free Each separate participant can delegate authority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. File state for free Operating agreement partnership. File state for free   An operating agreement partnership group can be excluded if the participants in the joint production, extraction, or use of property meet all the following requirements. File state for free They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. File state for free They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. File state for free They do not jointly sell services or the property produced or extracted. File state for free Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than one year. File state for free However, this exclusion does not apply to an unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. File state for free Electing the exclusion. File state for free   An eligible organization that wishes to be excluded from the partnership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. File state for free This filing date includes any extension of time. File state for free See Regulations section 1. File state for free 761-2(b) for the procedures to follow. File state for free Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. File state for free The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. File state for free The return must be signed by a general partner. File state for free If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. File state for free A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes. File state for free See the Instructions for Form 1065 for more information about who must file Form 1065. File state for free Partnership Distributions Partnership distributions include the following. File state for free A withdrawal by a partner in anticipation of the current year's earnings. File state for free A distribution of the current year's or prior years' earnings not needed for working capital. File state for free A complete or partial liquidation of a partner's interest. File state for free A distribution to all partners in a complete liquidation of the partnership. File state for free A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. File state for free If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. File state for free Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. File state for free Effect on partner's basis. File state for free   A partner's adjusted basis in his or her partnership interest is decreased (but not below zero) by the money and adjusted basis of property distributed to the partner. File state for free See Adjusted Basis under Basis of Partner's Interest, later. File state for free Effect on partnership. File state for free   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. File state for free The partnership may be able to elect to adjust the basis of its undistributed property. File state for free Certain distributions treated as a sale or exchange. File state for free   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. File state for free Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. File state for free Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. File state for free   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. File state for free   This treatment does not apply to the following distributions. File state for free A distribution of property to the partner who contributed the property to the partnership. File state for free Payments made to a retiring partner or successor in interest of a deceased partner that are the partner's distributive share of partnership income or guaranteed payments. File state for free Substantially appreciated inventory items. File state for free   Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the partnership's adjusted basis for the property. File state for free However, if a principal purpose for acquiring inventory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. File state for free Partner's Gain or Loss A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. File state for free Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. File state for free If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. File state for free For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. File state for free Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. File state for free Example. File state for free The adjusted basis of Jo's partnership interest is $14,000. File state for free She receives a distribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. File state for free Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. File state for free Any gain on the land will be recognized when she sells or otherwise disposes of it. File state for free The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. File state for free Marketable securities treated as money. File state for free   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. File state for free This treatment, however, does not generally apply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. File state for free   The amount treated as money is the security's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: The partner's distributive share of the gain that would be recognized had the partnership sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over The partner's distributive share of the gain that would be recognized had the partnership sold all such securities it still held after the distribution at the fair market value in (1). File state for free   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. File state for free Loss on distribution. File state for free   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. File state for free The adjusted basis of the partner's interest in the partnership exceeds the distribution. File state for free The partner's entire interest in the partnership is liquidated. File state for free The distribution is in money, unrealized receivables, or inventory items. File state for free   There are exceptions to these general rules. File state for free See the following discussions. File state for free Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. File state for free Distribution of partner's debt. File state for free   If a partnership acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under the rules discussed in Partner's Basis for Distributed Property, later). File state for free   The partner is treated as having satisfied the debt for its fair market value. File state for free If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distributed, the partner may have to include the excess amount in income as canceled debt. File state for free   Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its adjusted issue price. File state for free Net precontribution gain. File state for free   A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. File state for free   The gain recognized is the lesser of the following amounts. File state for free The excess of: The fair market value of the property received in the distribution, over The adjusted basis of the partner's interest in the partnership immediately before the distribution, reduced (but not below zero) by any money received in the distribution. File state for free The “net precontribution gain” of the partner. File state for free This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribution, and held by the partnership immediately before the distribution, were distributed to another partner, other than a partner who owns more than 50% of the partnership. File state for free For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. File state for free   The character of the gain is determined by reference to the character of the net precontribution gain. File state for free This gain is in addition to any gain the partner must recognize if the money distributed is more than his or her basis in the partnership. File state for free For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. File state for free Effect on basis. File state for free   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. File state for free Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. File state for free See Basis of Partner's Interest , later. File state for free   The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. File state for free Exceptions. File state for free   Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in determining the amount of the excess distribution or the partner's net precontribution gain. File state for free For this purpose, the partner's previously contributed property does not include a contributed interest in an entity to the extent its value is due to property contributed to the entity after the interest was contributed to the partnership. File state for free   Recognition of gain under this rule also does not apply to a distribution of unrealized receivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier. File state for free Partner's Basis for Distributed Property Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. File state for free However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. File state for free Example 1. File state for free The adjusted basis of Emily's partnership interest is $30,000. File state for free She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. File state for free Her basis for the property is $20,000. File state for free Example 2. File state for free The adjusted basis of Steve's partnership interest is $10,000. File state for free He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. File state for free His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). File state for free Complete liquidation of partner's interest. File state for free   The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. File state for free Partner's holding period. File state for free   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. File state for free If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. File state for free Basis divided among properties. File state for free   If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distributed to the partner. File state for free For property distributed after August 5, 1997, allocate the basis using the following rules. File state for free Allocate the basis first to unrealized receivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjusted basis in the item immediately before the distribution. File state for free If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. File state for free Allocate any remaining basis to properties other than unrealized receivables and inventory items by assigning a basis to each property equal to the partnership's adjusted basis in the property immediately before the distribution. File state for free If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. File state for free If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. File state for free Allocating a basis increase. File state for free   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. File state for free If the basis increase is less than the total unrealized appreciation, allocate it among those properties in proportion to their respective amounts of unrealized appreciation. File state for free Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. File state for free Example. File state for free Eun's basis in her partnership interest is $55,000. File state for free In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. File state for free Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. File state for free Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. File state for free To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). File state for free This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). File state for free She first allocates $35,000 to property A (its unrealized appreciation). File state for free The remaining $5,000 is allocated between the properties based on their fair market values. File state for free $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. File state for free Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). File state for free Allocating a basis decrease. File state for free   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. File state for free Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. File state for free If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. File state for free Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). File state for free Example. File state for free Armando's basis in his partnership interest is $20,000. File state for free In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. File state for free Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. File state for free Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. File state for free To figure his basis in each property, Armando first assigns bases of $15,000 to property C and $15,000 to property D (their adjusted bases to the partnership). File state for free This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). File state for free He allocates the entire $10,000 to property D (its unrealized depreciation). File state for free Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). File state for free Distributions before August 6, 1997. File state for free   For property distributed before August 6, 1997, allocate the basis using the following rules. File state for free Allocate the basis first to unrealized receivables and inventory items included in the distribution to the extent of the partnership's adjusted basis in those items. File state for free If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. File state for free Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. File state for free Partner's interest more than partnership basis. File state for free   If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inventory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the partnership interest. File state for free Special adjustment to basis. File state for free   A partner who acquired any part of his or her partnership interest in a sale or exchange or upon the death of another partner may be able to choose a special basis adjustment for property distributed by the partnership. File state for free To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. File state for free Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. File state for free   If a partner chooses this special basis adjustment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjustment to basis. File state for free However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. File state for free   The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to depreciation, depletion, or amortization. File state for free If the choice does not have to be made for the distribution year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. File state for free   A partner choosing this special basis adjustment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. File state for free The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. File state for free Example. File state for free Chin Ho purchased a 25% interest in X partnership for $17,000 cash. File state for free At the time of the purchase, the partnership owned inventory having a basis to the partnership of $14,000 and a fair market value of $16,000. File state for free Thus, $4,000 of the $17,000 he paid was attributable to his share of inventory with a basis to the partnership of $3,500. File state for free Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, inventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. File state for free The value of the inventory received was 25% of the value of all partnership inventory. File state for free (It is immaterial whether the inventory he received was on hand when he acquired his interest. File state for free ) Since the partnership from which Chin Ho withdrew did not make the optional adjustment to basis, he chose to adjust the basis of the inventory received. File state for free His share of the partnership's basis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). File state for free The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of partnership gain or loss on disposition. File state for free The total to be allocated among the properties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). File state for free His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). File state for free The remaining $11,500 is allocated to his new basis for the other property he received. File state for free Mandatory adjustment. File state for free   A partner does not always have a choice of making this special adjustment to basis. File state for free The special adjustment to basis must be made for a distribution of property (whether or not within 2 years after the partnership interest was acquired) if all the following conditions existed when the partner received the partnership interest. File state for free The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. File state for free If there had been a liquidation of the partner's interest immediately after it was acquired, an allocation of the basis of that interest under the general rules (discussed earlier under Basis divided among properties) would have decreased the basis of property that could not be depreciated, depleted, or amortized and increased the basis of property that could be. File state for free The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. File state for free Required statement. File state for free   Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjustment is mandatory, the partnership must provide a statement to the partner. File state for free The statement must provide information necessary for the partner to compute the special basis adjustment. File state for free Marketable securities. File state for free   A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding discussions, is increased by any gain recognized by treating the securities as money. File state for free See Marketable securities treated as money under Partner's Gain or Loss, earlier. File state for free The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. File state for free Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. File state for free These transactions include the following. File state for free Performing services for, or transferring property to, a partnership if: There is a related allocation and distribution to a partner, and The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the capacity of a partner. File state for free Transferring money or other property to a partnership if: There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and The transfers together are properly characterized as a sale or exchange of property. File state for free Payments by accrual basis partnership to cash basis partner. File state for free   A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. File state for free However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. File state for free Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. File state for free A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. File state for free This treatment is for purposes of determining gross income and deductible business expenses only. File state for free For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. File state for free Guaranteed payments are not subject to income tax withholding. File state for free The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. File state for free They are also listed on Schedules K and K-1 of the partnership return. File state for free The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. File state for free Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. File state for free Generally, organizational and syndication expenses are not deductible by the partnership. File state for free However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). File state for free Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. File state for free Minimum payment. File state for free   If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. File state for free Example. File state for free Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. File state for free The partnership has net income of $20,000. File state for free Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). File state for free The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). File state for free Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. File state for free If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. File state for free Self-employed health insurance premiums. File state for free   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. File state for free The partnership can deduct the payments as a business expense, and the partner must include them in gross income. File state for free However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. File state for free   A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. File state for free The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. File state for free For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. File state for free Including payments in partner's income. File state for free   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. File state for free Example 1. File state for free Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard to the income of the partnership. File state for free Her distributive share of the partnership income is 10%. File state for free The partnership has $50,000 of ordinary income after deducting the guaranteed payment. File state for free She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her individual income tax return for her tax year in which the partnership's tax year ends. File state for free Example 2. File state for free Lamont is a calendar year taxpayer who is a partner in a partnership. File state for free The partnership uses a fiscal year that ended January 31, 2013. File state for free Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. File state for free He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. File state for free Payments resulting in loss. File state for free   If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. File state for free The partner separately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. File state for free Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. File state for free Losses. File state for free   Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. File state for free   If the sale or exchange is between two partnerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduction of a loss is allowed. File state for free   The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. File state for free   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. File state for free If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. File state for free Gains. File state for free   Gains are treated as ordinary income in a sale or exchange of property directly or indirectly between a person and a partnership, or between two partnerships, if both of the following tests are met. File state for free More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). File state for free The property in the hands of the transferee immediately after the transfer is not a capital asset. File state for free Property that is not a capital asset includes accounts receivable, inventory, stock-in-trade, and depreciable or real property used in a trade or business. File state for free More than 50% ownership. File state for free   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. File state for free An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned proportionately by, or for, its shareholders, partners, or beneficiaries. File state for free An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. File state for free For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. File state for free If a person is considered to own an interest using rule (1), that person (the “constructive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. File state for free However, if a person is considered to own an interest using rule (2), that person is not treated as actually owning that interest in reapplying rule (2) to make another person the constructive owner. File state for free Example. File state for free Individuals A and B and Trust T are equal partners in Partnership ABT. File state for free A's husband, AH, is the sole beneficiary of Trust T. File state for free Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. File state for free As a result, A is a more-than-50% partner. File state for free This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. File state for free More information. File state for free   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. File state for free Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. File state for free This applies whether a partnership is being formed or is already operating. File state for free The partnership's holding period for the property includes the partner's holding period. File state for free The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. File state for free The exchange is not subject to the rules explained later under Disposition of Partner's Interest. File state for free Disguised sales. File state for free   A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met. File state for free The distribution would not have been made but for the contribution. File state for free The partner's right to the distribution does not depend on the success of partnership operations. File state for free   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. File state for free However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. File state for free If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. File state for free Form 8275 required. File state for free   A partner must attach Form 8275, Disclosure Statement, (or other statement) to his or her return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. File state for free For exceptions to this requirement, see section 1. File state for free 707-3(c)(2) of the regulations. File state for free   A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership. File state for free   Form 8275 must include the following information. File state for free A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. File state for free A description of the transferred property or money, including its value. File state for free A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. File state for free See section 1. File state for free 707-3(b)(2) of the regulations for a description of the facts and circumstances considered in determining if the transfers are a disguised sale. File state for free Contribution to partnership treated as investment company. File state for free   Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. File state for free   A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. File state for free These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. File state for free For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. File state for free Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. File state for free   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. File state for free Contribution to foreign partnership. File state for free   A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. File state for free Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. File state for free The fair market value of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000. File state for free   The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. File state for free See the form instructions for more information. File state for free Basis of contributed property. File state for free   If a partner contributes property to a partnership, the partnership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. File state for free Allocations to account for built-in gain or loss. File state for free   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. File state for free The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. File state for free This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. File state for free   The partnership can use different allocation methods for different items of contributed property. File state for free A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. File state for free See section 1. File state for free 704-3 of the regulations for allocation methods generally considered reasonable. File state for free   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. File state for free If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. File state for free However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. File state for free Example. File state for free Areta and Sofia formed an equal partnership. File state for free Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with a fair market value of $10,000 and an adjusted basis of $4,000. File state for free The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. File state for free In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. File state for free Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. File state for free To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. File state for free However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. File state for free The entire $400 must be allocated to Areta. File state for free Distribution of contributed property to another partner. File state for free   If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. File state for free   The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. File state for free This amount is the difference between the property's basis and its fair market value at the time of contribution. File state for free The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. File state for free Appropriate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss. File state for free Disposition of certain contributed property. File state for free   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. File state for free Unrealized receivables. File state for free If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. File state for free Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. File state for free When reading the definition, substitute “partner” for “partnership. File state for free ” Inventory items. File state for free If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. File state for free Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. File state for free Capital loss property. File state for free If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. File state for free The capital loss is limited to the amount by which the partner's adjusted basis for the property exceeded the property's fair market value immediately before the contribution. File state for free Substituted basis property. File state for free If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction. File state for free Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. File state for free Capital interest. File state for free   A capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in a complete liquidation of the partnership. File state for free This determination generally is made at the time of receipt of the partnership interest. File state for free The fair market value of such an interest received by a partner as compensation for services must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. File state for free The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. File state for free   The fair market value of an interest in partnership capital transferred to a partner as payment for services to the partnership is a guaranteed payment, discussed earlier. File state for free Profits interest. File state for free   A profits interest is a partnership interest other than a capital interest. File state for free If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. File state for free However, this does not apply in the following situations. File state for free The profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease. File state for free Within 2 years of receipt, the partner disposes of the profits interest. File state for free The profits interest is a limited partnership interest in a publicly traded partnership. File state for free   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. File state for free Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. File state for free If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. File state for free Any increase in a partner's individual liabilities because of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. File state for free Interest acquired by gift, etc. File state for free   If a partner acquires an interest in a partnership by gift, inheritance, or under any circumstance other than by a contribution of money or property to the partnership, the partner's basis must be determined using the basis rules described in Publication 551. File state for free Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). File state for free The basis of an interest in a partnership is increased or decreased by certain items. File state for free Increases. File state for free   A partner's basis is increased by the following items. File state for free The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. File state for free The partner's distributive share of taxable and nontaxable partnership income. File state for free The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. File state for free Decreases. File state for free   The partner's basis is decreased (but never below zero) by the following items. File state for free The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. File state for free The partner's distributive share of the partnership losses (including capital losses). File state for free The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. File state for free This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. File state for free The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. File state for free Partner's liabilities assumed by partnership. File state for free   If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability assumed by the other partners. File state for free This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. File state for free The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. File state for free See Effect of Partnership Liabilities , later. File state for free Example 1. File state for free Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. File state for free The partnership assumed payment of the mortgage. File state for free The basis of Ivan's interest is: Adjusted basis of contributed property $8,000 Minus: Part of mortgage assumed by other partners (80% × $4,000) 3,200 Basis of Ivan's partnership interest $4,800 Example 2. File state for free If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. File state for free The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or exchange of a partnership interest. File state for free However, this gain would not increase the basis of his partnership interest. File state for free Book value of partner's interest. File state for free   The adjusted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. File state for free Example. File state for free Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. File state for free His partner contributes $1,000 cash. File state for free While each partner has increased his capital account by $1,000, which will be re
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The Defense Finance and Accounting Services oversees payments to Department of Defense servicemembers, employees, vendors and contractors. The Defense Finance and Accounting Services also provides Department of Defense decision makers with business intelligence, finance and accounting information.

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File state for free 32. File state for free   Child and Dependent Care Credit Table of Contents Reminders Introduction Useful Items - You may want to see: Tests To Claim the CreditQualifying Person Test Earned Income Test Work-Related Expense Test Joint Return Test Provider Identification Test How To Figure the CreditFiguring Total Work-Related Expenses Earned Income Limit Dollar Limit Amount of Credit How To Claim the CreditTax credit not refundable. File state for free Employment Taxes for Household Employers Reminders Taxpayer identification number needed for each qualifying person. File state for free  You must include on line 2 of Form 2441 the name and taxpayer identification number (generally the social security number) of each qualifying person. File state for free See Taxpayer identification number under Qualifying Person Test, later. File state for free You may have to pay employment taxes. File state for free  If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer who has to pay employment taxes. File state for free Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. File state for free See Employment Taxes for Household Employers , later. File state for free Introduction This chapter discusses the credit for child and dependent care expenses and covers the following topics. File state for free Tests you must meet to claim the credit. File state for free How to figure the credit. File state for free How to claim the credit. File state for free Employment taxes you may have to pay as a household employer. File state for free You may be able to claim the credit if you pay someone to care for your dependent who is under age 13 or for your spouse or dependent who is not able to care for himself or herself. File state for free The credit can be up to 35% of your expenses. File state for free To qualify, you must pay these expenses so you can work or look for work. File state for free This credit should not be confused with the child tax credit discussed in chapter 34. File state for free Dependent care benefits. File state for free   If you received any dependent care benefits from your employer during the year, you may be able to exclude from your income all or part of them. File state for free You must complete Form 2441, Part III, before you can figure the amount of your credit. File state for free See Dependent Care Benefits under How To Figure the Credit, later. File state for free Useful Items - You may want to see: Publication 501 Exemptions, Standard Deduction, and Filing Information 503 Child and Dependent Care Expenses 926 Household Employer's Tax Guide Form (and Instructions) 2441 Child and Dependent Care Expenses Schedule H (Form 1040) Household Employment Taxes W-7 Application for IRS Individual Taxpayer Identification Number W-10 Dependent Care Provider's Identification and Certification Tests To Claim the Credit To be able to claim the credit for child and dependent care expenses, you must file Form 1040 or Form 1040A, not Form 1040EZ, and meet all the following tests. File state for free The care must be for one or more qualifying persons who are identified on Form 2441. File state for free (See Qualifying Person Test . File state for free ) You (and your spouse if filing jointly) must have earned income during the year. File state for free (However, see Rule for student-spouse or spouse not able to care for self under Earned Income Test, later. File state for free ) You must pay child and dependent care expenses so you (and your spouse if filing jointly) can work or look for work. File state for free (See Work-Related Expense Test , later. File state for free ) You must make payments for child and dependent care to someone you (and your spouse) cannot claim as a dependent. File state for free If you make payments to your child, he or she cannot be your dependent and must be age 19 or older by the end of the year. File state for free You cannot make payments to: Your spouse, or The parent of your qualifying person if your qualifying person is your child and under age 13. File state for free (See Payments to Relatives or Dependents under Work-Related Expense Test, later. File state for free ) Your filing status may be single, head of household, or qualifying widow(er) with dependent child. File state for free If you are married, you must file a joint return, unless an exception applies to you. File state for free (See Joint Return Test , later. File state for free ) You must identify the care provider on your tax return. File state for free (See Provider Identification Test , later. File state for free ) If you exclude or deduct dependent care benefits provided by a dependent care benefits plan, the total amount you exclude or deduct must be less than the dollar limit for qualifying expenses (generally, $3,000 if one qualifying person was cared for or $6,000 if two or more qualifying persons were cared for). File state for free (If two or more qualifying persons were cared for, the amount you exclude or deduct will always be less than the dollar limit, since the total amount you can exclude or deduct is limited to $5,000. File state for free See Reduced Dollar Limit under How To Figure the Credit, later. File state for free ) These tests are presented in Figure 32-A and are also explained in detail in this chapter. File state for free Figure 32-A. File state for free Can You Claim the Credit? Please click here for the text description of the image. File state for free Figure 32-A Can You Claim the Credit? Qualifying Person Test Your child and dependent care expenses must be for the care of one or more qualifying persons. File state for free A qualifying person is: Your qualifying child who is your dependent and who was under age 13 when the care was provided (but see Child of divorced or separated parents or parents living apart, later), Your spouse who was not physically or mentally able to care for himself or herself and lived with you for more than half the year, or A person who was not physically or mentally able to care for himself or herself, lived with you for more than half the year, and either: Was your dependent, or Would have been your dependent except that: He or she received gross income of $3,900 or more, He or she filed a joint return, or You, or your spouse if filing jointly, could be claimed as a dependent on someone else's 2013 return. File state for free Dependent defined. File state for free   A dependent is a person, other than you or your spouse, for whom you can claim an exemption. File state for free To be your dependent, a person must be your qualifying child (or your qualifying relative). File state for free Qualifying child. File state for free   To be your qualifying child, a child must live with you for more than half the year and meet other requirements. File state for free More information. File state for free   For more information about who is a dependent or a qualifying child, see chapter 3. File state for free Physically or mentally not able to care for oneself. File state for free   Persons who cannot dress, clean, or feed themselves because of physical or mental problems are considered not able to care for themselves. File state for free Also, persons who must have constant attention to prevent them from injuring themselves or others are considered not able to care for themselves. File state for free Person qualifying for part of year. File state for free   You determine a person's qualifying status each day. File state for free For example, if the person for whom you pay child and dependent care expenses no longer qualifies on September 16, count only those expenses through September 15. File state for free Also see Yearly limit under Dollar Limit, later. File state for free Birth or death of otherwise qualifying person. File state for free   In determining whether a person is a qualifying person, a person who was born or died in 2013 is treated as having lived with you for more than half of 2013 if your home was the person's home for more than half the time he or she was alive in 2013. File state for free Taxpayer identification number. File state for free   You must include on your return the name and taxpayer identification number (generally the social security number) of the qualifying person(s). File state for free If the correct information is not shown, the credit may be reduced or disallowed. File state for free Individual taxpayer identification number (ITIN) for aliens. File state for free   If your qualifying person is a nonresident or resident alien who does not have and cannot get a social security number (SSN), use that person's ITIN. File state for free The ITIN is entered wherever an SSN is requested on a tax return. File state for free To apply for an ITIN, see Form W-7. File state for free   An ITIN is for tax use only. File state for free It does not entitle the holder to social security benefits or change the holder's employment or immigration status under U. File state for free S. File state for free law. File state for free Adoption taxpayer identification number (ATIN). File state for free   If your qualifying person is a child who was placed in your home for adoption and for whom you do not have an SSN, you must get an ATIN for the child. File state for free File Form W-7A, Application for Taxpayer Identification Number for Pending U. File state for free S. File state for free Adoptions. File state for free Child of divorced or separated parents or parents living apart. File state for free   Even if you cannot claim your child as a dependent, he or she is treated as your qualifying person if: The child was under age 13 or was not physically or mentally able to care for himself or herself, The child received over half of his or her support during the calendar year from one or both parents who are divorced or legally separated under a decree of divorce or separate maintenance, are separated under a written separation agreement, or lived apart at all times during the last 6 months of the calendar year, The child was in the custody of one or both parents for more than half the year, and You were the child's custodial parent. File state for free   The custodial parent is the parent with whom the child lived for the greater number of nights in 2013. File state for free If the child was with each parent for an equal number of nights, the custodial parent is the parent with the higher adjusted gross income. File state for free For details and an exception for a parent who works at night, see Pub. File state for free 501. File state for free   The noncustodial parent cannot treat the child as a qualifying person even if that parent is entitled to claim the child as a dependent under the special rules for a child of divorced or separated parents. File state for free Earned Income Test To claim the credit, you (and your spouse if filing jointly) must have earned income during the year. File state for free Earned income. File state for free   Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment. File state for free A net loss from self-employment reduces earned income. File state for free Earned income also includes strike benefits and any disability pay you report as wages. File state for free   Generally, only taxable compensation is included. File state for free However, you can elect to include nontaxable combat pay in earned income. File state for free If you are filing a joint return and both you and your spouse received nontaxable combat pay, you can each make your own election. File state for free (In other words, if one of you makes the election, the other one can also make it but does not have to. File state for free ) You should figure your credit both ways and make the election if it gives you a greater tax benefit. File state for free Members of certain religious faiths opposed to social security. File state for free   Certain income earned by persons who are members of certain religious faiths that are opposed to participation in Social Security Act programs and have an IRS-approved form that exempts certain income from social security and Medicare taxes may not be considered earned income for this purpose. File state for free See Earned Income Test in Publication 503. File state for free Not earned income. File state for free   Earned income does not include: Pensions and annuities, Social security and railroad retirement benefits, Workers' compensation, Interest and dividends, Unemployment compensation, Scholarship or fellowship grants, except for those reported on a Form W-2 and paid to you for teaching or other services, Nontaxable workfare payments, Child support payments received by you, Income of nonresident aliens that is not effectively connected with a U. File state for free S. File state for free trade or business, or Any amount received for work while an inmate in a penal institution. File state for free Rule for student-spouse or spouse not able to care for self. File state for free   Your spouse is treated as having earned income for any month that he or she is: A full-time student, or Physically or mentally not able to care for himself or herself. File state for free (Your spouse also must live with you for more than half the year. File state for free )   If you are filing a joint return, this rule also applies to you. File state for free You can be treated as having earned income for any month you are a full-time student or not able to care for yourself. File state for free   Figure the earned income of the nonworking spouse described under (1) or (2) above as explained under Earned Income Limit , later. File state for free   This rule applies to only one spouse for any one month. File state for free If, in the same month, both you and your spouse do not work and are either full-time students or not physically or mentally able to care for yourselves, only one of you can be treated as having earned income in that month. File state for free Full-time student. File state for free   You are a full-time student if you are enrolled at a school for the number of hours or classes that the school considers full time. File state for free You must have been a full-time student for some part of each of 5 calendar months during the year. File state for free (The months need not be consecutive. File state for free ) School. File state for free   The term “school” includes high schools, colleges, universities, and technical, trade, and mechanical schools. File state for free A school does not include an on-the-job training course, correspondence school, or school offering courses only through the Internet. File state for free Work-Related Expense Test Child and dependent care expenses must be work-related to qualify for the credit. File state for free Expenses are considered work-related only if both of the following are true. File state for free They allow you (and your spouse if filing jointly) to work or look for work. File state for free They are for a qualifying person's care. File state for free Working or Looking for Work To be work-related, your expenses must allow you to work or look for work. File state for free If you are married, generally both you and your spouse must work or look for work. File state for free One spouse is treated as working during any month he or she is a full-time student or is not physically or mentally able to care for himself or herself. File state for free Your work can be for others or in your own business or partnership. File state for free It can be either full time or part time. File state for free Work also includes actively looking for work. File state for free However, if you do not find a job and have no earned income for the year, you cannot take this credit. File state for free See Earned Income Test , earlier. File state for free An expense is not considered work-related merely because you had it while you were working. File state for free The purpose of the expense must be to allow you to work. File state for free Whether your expenses allow you to work or look for work depends on the facts. File state for free Example 1. File state for free The cost of a babysitter while you and your spouse go out to eat is not normally a work-related expense. File state for free Example 2. File state for free You work during the day. File state for free Your spouse works at night and sleeps during the day. File state for free You pay for care of your 5-year-old child during the hours when you are working and your spouse is sleeping. File state for free Your expenses are considered work-related. File state for free Volunteer work. File state for free    For this purpose, you are not considered to be working if you do unpaid volunteer work or volunteer work for a nominal salary. File state for free Work for part of year. File state for free   If you work or actively look for work during only part of the period covered by the expenses, then you must figure your expenses for each day. File state for free For example, if you work all year and pay care expenses of $250 a month ($3,000 for the year), all the expenses are work-related. File state for free However, if you work or look for work for only 2 months and 15 days during the year and pay expenses of $250 a month, your work-related expenses are limited to $625 (2½ months × $250). File state for free Temporary absence from work. File state for free   You do not have to figure your expenses for each day during a short, temporary absence from work, such as for vacation or a minor illness, if you have to pay for care anyway. File state for free Instead, you can figure your credit including the expenses you paid for the period of absence. File state for free   An absence of 2 weeks or less is a short, temporary absence. File state for free An absence of more than 2 weeks may be considered a short, temporary absence, depending on the circumstances. File state for free Example. File state for free You pay a nanny to care for your 2-year-old son and 4-year-old daughter so you can work. File state for free You become ill and miss 4 months of work but receive sick pay. File state for free You continue to pay the nanny to care for the children while you are ill. File state for free Your absence is not a short, temporary absence, and your expenses are not considered work-related. File state for free Part-time work. File state for free   If you work part-time, you generally must figure your expenses for each day. File state for free However, if you have to pay for care weekly, monthly, or in another way that includes both days worked and days not worked, you can figure your credit including the expenses you paid for days you did not work. File state for free Any day when you work at least 1 hour is a day of work. File state for free Example 1. File state for free You work 3 days a week. File state for free While you work, your 6-year-old child attends a dependent care center, which complies with all state and local regulations. File state for free You can pay the center $150 for any 3 days a week or $250 for 5 days a week. File state for free Your child attends the center 5 days a week. File state for free Your work-related expenses are limited to $150 a week. File state for free Example 2. File state for free The facts are the same as in Example 1 except the center does not offer a 3-day option. File state for free The entire $250 weekly fee may be a work-related expense. File state for free Care of a Qualifying Person To be work-related, your expenses must be to provide care for a qualifying person. File state for free You do not have to choose the least expensive way of providing care. File state for free The cost of a paid care provider may be an expense for the care of a qualifying person even if another care provider is available at no cost. File state for free Expenses are for the care of a qualifying person only if their main purpose is the person's well-being and protection. File state for free Expenses for household services qualify if part of the services is for the care of qualifying persons. File state for free See Household services , later. File state for free Expenses not for care. File state for free   Expenses for care do not include amounts you pay for food, lodging, clothing, education, and entertainment. File state for free However, you can include small amounts paid for these items if they are incidental to and cannot be separated from the cost of caring for the qualifying person. File state for free   Child support payments are not for care and do not qualify for the credit. File state for free Education. File state for free   Expenses for a child in nursery school, preschool, or similar programs for children below the level of kindergarten are expenses for care. File state for free Expenses to attend kindergarten or a higher grade are not expenses for care. File state for free Do not use these expenses to figure your credit. File state for free   However, expenses for before- or after-school care of a child in kindergarten or a higher grade may be expenses for care. File state for free   Summer school and tutoring programs are not for care. File state for free Example 1. File state for free You take your 3-year-old child to a nursery school that provides lunch and educational activities as a part of its preschool childcare service. File state for free The lunch and educational activities are incidental to the childcare, and their cost cannot be separated from the cost of care. File state for free You can count the total cost when you figure the credit. File state for free Example 2. File state for free You place your 10-year-old child in a boarding school so you can work full time. File state for free Only the part of the boarding school expense that is for the care of your child is a work-related expense. File state for free You can count that part of the expense in figuring your credit if it can be separated from the cost of education. File state for free You cannot count any part of the amount you pay the school for your child's education. File state for free Care outside your home. File state for free   You can count the cost of care provided outside your home if the care is for your dependent under age 13 or any other qualifying person who regularly spends at least 8 hours each day in your home. File state for free Dependent care center. File state for free   You can count care provided outside your home by a dependent care center only if the center complies with all state and local regulations that apply to these centers. File state for free   A dependent care center is a place that provides care for more than six persons (other than persons who live there) and receives a fee, payment, or grant for providing services for any of those persons, even if the center is not run for profit. File state for free Camp. File state for free   The cost of sending your child to an overnight camp is not considered a work-related expense. File state for free The cost of sending your child to a day camp may be a work-related expense, even if the camp specializes in a particular activity, such as computers or soccer. File state for free Transportation. File state for free   If a care provider takes a qualifying person to or from a place where care is provided, that transportation is for the care of the qualifying person. File state for free This includes transportation by bus, subway, taxi, or private car. File state for free However, transportation not provided by a care provider is not for the care of a qualifying person. File state for free Also, if you pay the transportation cost for the care provider to come to your home, that expense is not for care of a qualifying person. File state for free Fees and deposits. File state for free   Fees you paid to an agency to get the services of a care provider, deposits you paid to an agency or preschool, application fees, and other indirect expenses are work-related expenses if you have to pay them to get care, even though they are not directly for care. File state for free However, a forfeited deposit is not for the care of a qualifying person if care is not provided. File state for free Example 1. File state for free You paid a fee to an agency to get the services of the nanny who cares for your 2-year-old daughter while you work. File state for free The fee you paid is a work-related expense. File state for free Example 2. File state for free You placed a deposit with a preschool to reserve a place for your 3-year-old child. File state for free You later sent your child to a different preschool and forfeited the deposit. File state for free The forfeited deposit is not for care and so is not a work-related expense. File state for free Household services. File state for free   Expenses you pay for household services meet the work-related expense test if they are at least partly for the well-being and protection of a qualifying person. File state for free   Household services are ordinary and usual services done in and around your home that are necessary to run your home. File state for free They include the services of a housekeeper, maid, or cook. File state for free However, they do not include the services of a chauffeur, bartender, or gardener. File state for free See Household Services in Publication 503 for more information. File state for free   In this chapter, the term housekeeper refers to any household employee whose services include the care of a qualifying person. File state for free Taxes paid on wages. File state for free   The taxes you pay on wages for qualifying child and dependent care services are work-related expenses. File state for free See Employment Taxes for Household Employers , later. File state for free Payments to Relatives or Dependents You can count work-related payments you make to relatives who are not your dependents, even if they live in your home. File state for free However, do not count any amounts you pay to: A dependent for whom you (or your spouse if filing jointly) can claim an exemption, Your child who was under age 19 at the end of the year, even if he or she is not your dependent, A person who was your spouse any time during the year, or The parent of your qualifying person if your qualifying person is your child and under age 13. File state for free Joint Return Test Generally, married couples must file a joint return to take the credit. File state for free However, if you are legally separated or living apart from your spouse, you may be able to file a separate return and still take the credit. File state for free Legally separated. File state for free   You are not considered married if you are legally separated from your spouse under a decree of divorce or separate maintenance. File state for free You may be eligible to take the credit on your return using head of household filing status. File state for free Married and living apart. File state for free   You are not considered married and are eligible to take the credit if all the following apply. File state for free You file a return apart from your spouse. File state for free Your home is the home of a qualifying person for more than half the year. File state for free You pay more than half the cost of keeping up your home for the year. File state for free Your spouse does not live in your home for the last 6 months of the year. File state for free Costs of keeping up a home. File state for free   The costs of keeping up a home normally include property taxes, mortgage interest, rent, utility charges, home repairs, insurance on the home, and food eaten at home. File state for free   The costs of keeping up a home do not include payments for clothing, education, medical treatment, vacations, life insurance, transportation, or mortgage principal. File state for free   They also do not include the purchase, permanent improvement, or replacement of property. File state for free For example, you cannot include the cost of replacing a water heater. File state for free However, you can include the cost of repairing a water heater. File state for free Death of spouse. File state for free   If your spouse died during the year and you do not remarry before the end of the year, you generally must file a joint return to take the credit. File state for free If you do remarry before the end of the year, the credit can be claimed on your deceased spouse's return. File state for free Provider Identification Test You must identify all persons or organizations that provide care for your child or dependent. File state for free Use Form 2441, Part I, to show the information. File state for free If you do not have any care providers and you are filing Form 2441 only to report taxable income in Part III, enter “none” in line 1, column (a). File state for free Information needed. File state for free   To identify the care provider, you must give the provider's: Name, Address, and Taxpayer identification number. File state for free   If the care provider is an individual, the taxpayer identification number is his or her social security number or individual taxpayer identification number. File state for free If the care provider is an organization, then it is the employer identification number (EIN). File state for free   You do not have to show the taxpayer identification number if the care provider is a tax-exempt organization (such as a church or school). File state for free In this case, enter “Tax-Exempt” in the space where Form 2441 asks for the number. File state for free   If you cannot provide all of the information or if the information is incorrect, you must be able to show that you used due diligence (discussed later) in trying to furnish the necessary information. File state for free Getting the information. File state for free   You can use Form W-10 to request the required information from the care provider. File state for free If you do not use Form W-10, you can get the information from one of the other sources listed in the instructions for Form W-10 including: A copy of the provider's social security card, A copy of the provider's completed Form W-4 if he or she is your household employee, A copy of the statement furnished by your employer if the provider is your employer's dependent care plan, or A letter or invoice from the provider if it shows the information. File state for free    You should keep this information with your tax records. File state for free Do not send Form W-10 (or other document containing this information) to the Internal Revenue Service. File state for free Due diligence. File state for free   If the care provider information you give is incorrect or incomplete, your credit may not be allowed. File state for free However, if you can show that you used due diligence in trying to supply the information, you can still claim the credit. File state for free   You can show due diligence by getting and keeping the provider's completed Form W-10 or one of the other sources of information just listed. File state for free Care providers can be penalized if they do not provide this information to you or if they provide incorrect information. File state for free Provider refusal. File state for free   If the provider refuses to give you their identifying information, you should report on Form 2441 whatever information you have (such as the name and address). File state for free Enter “See Attached Statement” in the columns calling for the information you do not have. File state for free Then attach a statement explaining that you requested the information from the care provider, but the provider did not give you the information. File state for free Be sure to write your name and social security number on this statement. File state for free The statement will show that you used due diligence in trying to furnish the necessary information. File state for free U. File state for free S. File state for free citizens and resident aliens living abroad. File state for free   If you are living abroad, your care provider may not have, and may not be required to get, a U. File state for free S. File state for free taxpayer identification number (for example, an SSN or EIN). File state for free If so, enter “LAFCP” (Living Abroad Foreign Care Provider) in the space for the care provider's taxpayer identification number. File state for free How To Figure the Credit Your credit is a percentage of your work-related expenses. File state for free Your expenses are subject to the earned income limit and the dollar limit. File state for free The percentage is based on your adjusted gross income. File state for free Figuring Total Work-Related Expenses To figure the credit for 2013 work-related expenses, count only those you paid by December 31, 2013. File state for free Expenses prepaid in an earlier year. File state for free   If you pay for services before they are provided, you can count the prepaid expenses only in the year the care is received. File state for free Claim the expenses for the later year as if they were actually paid in that later year. File state for free Expenses not paid until the following year. File state for free   Do not count 2012 expenses that you paid in 2013 as work-related expenses for 2013. File state for free You may be able to claim an additional credit for them on your 2013 return, but you must figure it separately. File state for free See Payments for prior year's expenses under Amount of Credit in Publication 503. File state for free    If you had expenses in 2013 that you did not pay until 2014, you cannot count them when figuring your 2013 credit. File state for free You may be able to claim a credit for them on your 2014 return. File state for free Expenses reimbursed. File state for free   If a state social services agency pays you a nontaxable amount to reimburse you for some of your child and dependent care expenses, you cannot count the expenses that are reimbursed as work-related expenses. File state for free Example. File state for free You paid work-related expenses of $3,000. File state for free You are reimbursed $2,000 by a state social services agency. File state for free You can use only $1,000 to figure your credit. File state for free Medical expenses. File state for free   Some expenses for the care of qualifying persons who are not able to care for themselves may qualify as work-related expenses and also as medical expenses. File state for free You can use them either way, but you cannot use the same expenses to claim both a credit and a medical expense deduction. File state for free   If you use these expenses to figure the credit and they are more than the earned income limit or the dollar limit, discussed later, you can add the excess to your medical expenses. File state for free However, if you use your total expenses to figure your medical expense deduction, you cannot use any part of them to figure your credit. File state for free    Amounts excluded from your income under your employer's dependent care benefits plan cannot be used to claim a medical expense deduction. File state for free Dependent Care Benefits If you receive dependent care benefits, your dollar limit for purposes of the credit may be reduced. File state for free See Reduced Dollar Limit , later. File state for free But, even if you cannot take the credit, you may be able to take an exclusion or deduction for the dependent care benefits. File state for free Dependent care benefits. File state for free   Dependent care benefits include: Amounts your employer paid directly to either you or your care provider for the care of your qualifying person while you work, The fair market value of care in a daycare facility provided or sponsored by your employer, and Pre-tax contributions you made under a dependent care flexible spending arrangement. File state for free Your salary may have been reduced to pay for these benefits. File state for free If you received benefits as an employee, they should be shown in box 10 of your Form W-2. File state for free See Statement for employee , later. File state for free Benefits you received as a partner should be shown in box 13 of your Schedule K-1 (Form 1065) with code O. File state for free Enter the amount of these benefits on Form 2441, Part III, line 12. File state for free Exclusion or deduction. File state for free   If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. File state for free Your employer can tell you whether your benefit plan qualifies. File state for free To claim the exclusion, you must complete Part III of Form 2441. File state for free You cannot use Form 1040EZ. File state for free   If you are self-employed and receive benefits from a qualified dependent care benefit plan, you are treated as both employer and employee. File state for free Therefore, you would not get an exclusion from wages. File state for free Instead, you would get a deduction on Form 1040, Schedule C, line 14; Schedule E, line 19 or 28; or Schedule F, line 15. File state for free To claim the deduction, you must use Form 2441. File state for free   The amount you can exclude or deduct is limited to the smallest of: The total amount of dependent care benefits you received during the year, The total amount of qualified expenses you incurred during the year, Your earned income, Your spouse's earned income, or $5,000 ($2,500 if married filing separately). File state for free The definition of earned income for the exclusion or deduction is the same as the definition used when figuring the credit except that earned income for the exclusion or deduction does not include any dependent care benefits you receive. File state for free See Earned Income Limit, later. File state for free    You can choose to include your nontaxable combat pay in earned income when figuring your exclusion or deduction, even if you choose not to include it in earned income for the earned income credit or the credit for child and dependent care expenses. File state for free Statement for employee. File state for free   Your employer must give you a Form W-2 (or similar statement) showing in box 10 the total amount of dependent care benefits provided to you during the year under a qualified plan. File state for free Your employer will also include any dependent care benefits over $5,000 in your wages shown on your Form W-2 in box 1. File state for free Effect of exclusion on credit. File state for free   If you exclude dependent care benefits from your income, the amount of the excluded benefits: Is not included in your work-related expenses, and Reduces the dollar limit, discussed later. File state for free Earned Income Limit The amount of work-related expenses you use to figure your credit cannot be more than: Your earned income for the year if you are single at the end of the year, or The smaller of your or your spouse's earned income for the year if you are married at the end of the year. File state for free Earned income is defined under Earned Income Test , earlier. File state for free For purposes of item (2), use your spouse's earned income for the entire year, even if you were married for only part of the year. File state for free Separated spouse. File state for free   If you are legally separated or married and living apart from your spouse (as described under Joint Return Test , earlier), you are not considered married for purposes of the earned income limit. File state for free Use only your income in figuring the earned income limit. File state for free Surviving spouse. File state for free   If your spouse died during the year and you file a joint return as a surviving spouse, you may, but are not required to, take into account the earned income of your spouse who died during the year. File state for free Community property laws. File state for free   You should disregard community property laws when you figure earned income for this credit. File state for free You or your spouse is a student or not able to care for self. File state for free   Your spouse who is either a full-time student or not able to care for himself or herself is treated as having earned income. File state for free His or her earned income for each month is considered to be at least $250 if there is one qualifying person in your home, or at least $500 if there are two or more. File state for free Spouse works. File state for free   If your spouse works during that month, use the higher of $250 (or $500) or his or her actual earned income for that month. File state for free Spouse qualifies for part of month. File state for free    If your spouse is a full-time student or not able to care for himself or herself for only part of a month, the full $250 (or $500) still applies for that month. File state for free You are a student or not able to care for self. File state for free   These rules also apply if you are a student or not able to care for yourself and you are filing a joint return. File state for free For each month or part of a month you are a student or not able to care for yourself, your earned income is considered to be at least $250 (or $500). File state for free If you also work during that month, use the higher of $250 (or $500) or your actual earned income for that month. File state for free Both spouses qualify. File state for free   If, in the same month, both you and your spouse are either full-time students or not able to care for yourselves, only one spouse can be considered to have this earned income of $250 (or $500) for that month. File state for free Dollar Limit There is a dollar limit on the amount of your work-related expenses you can use to figure the credit. File state for free This limit is $3,000 for one qualifying person, or $6,000 for two or more qualifying persons. File state for free If you paid work-related expenses for the care of two or more qualifying persons, the applicable dollar limit is $6,000. File state for free This $6,000 limit does not need to be divided equally among them. File state for free For example, if your work-related expenses for the care of one qualifying person are $3,200 and your work-related expenses for another qualifying person are $2,800, you can use the total, $6,000, when figuring the credit. File state for free Yearly limit. File state for free   The dollar limit is a yearly limit. File state for free The amount of the dollar limit remains the same no matter how long, during the year, you have a qualifying person in your household. File state for free Use the $3,000 limit if you paid work-related expenses for the care of one qualifying person at any time during the year. File state for free Use $6,000 if you paid work-related expenses for the care of more than one qualifying person at any time during the year. File state for free Reduced Dollar Limit If you received dependent care benefits that you exclude or deduct from your income, you must subtract that amount from the dollar limit that applies to you. File state for free Your reduced dollar limit is figured on Form 2441, Part III. File state for free See Dependent Care Benefits , earlier, for information on excluding or deducting these benefits. File state for free Example 1. File state for free George is a widower with one child and earns $24,000 a year. File state for free He pays work-related expenses of $2,900 for the care of his 4-year-old child and qualifies to claim the credit for child and dependent care expenses. File state for free His employer pays an additional $1,000 under a dependent care benefit plan. File state for free This $1,000 is excluded from George's income. File state for free Although the dollar limit for his work-related expenses is $3,000 (one qualifying person), George figures his credit on only $2,000 of the $2,900 work-related expenses he paid. File state for free This is because his dollar limit is reduced as shown next. File state for free   George's Reduced Dollar Limit 1) Maximum allowable expenses for one qualifying person $3,000 2) Minus: Dependent care benefits George excludes from income −1,000 3) Reduced dollar limit on expenses George can use for the credit $2,000 Example 2. File state for free Randall is married and both he and his wife are employed. File state for free Each has earned income in excess of $6,000. File state for free They have two children, Anne and Andy, ages 2 and 4, who attend a daycare facility licensed and regulated by the state. File state for free Randall's work-related expenses are $6,000 for the year. File state for free Randall's employer has a dependent care assistance program as part of its cafeteria plan, which allows employees to make pre-tax contributions to a dependent care flexible spending arrangement. File state for free Randall has elected to take the maximum $5,000 exclusion from his salary to cover dependent care expenses through this program. File state for free Although the dollar limit for his work- related expenses is $6,000 (two or more qualifying persons), Randall figures his credit on only $1,000 of the $6,000 work-related expense paid. File state for free This is because his dollar limit is reduced as shown next. File state for free   Randall's Reduced Dollar Limit 1) Maximum allowable expenses for two qualifying persons $6,000 2) Minus: Dependent care benefits Randall selects from employer's cafeteria plan and excludes from income −5,000 3) Reduced dollar limit on expenses Randall can use for the credit $1,000 Amount of Credit To determine the amount of your credit, multiply your work-related expenses (after applying the earned income and dollar limits) by a percentage. File state for free This percentage depends on your adjusted gross income shown on Form 1040, line 38, or Form 1040A, line 22. File state for free The following table shows the percentage to use based on adjusted gross income. File state for free   IF your adjusted gross income is: THEN the percentage is:       Over   But not over         $0   $15,000   35%       15,000   17,000   34%       17,000   19,000   33%       19,000   21,000   32%       21,000   23,000   31%       23,000   25,000   30%       25,000   27,000   29%       27,000   29,000   28%       29,000   31,000   27%       31,000   33,000   26%       33,000   35,000   25%       35,000   37,000   24%       37,000   39,000   23%       39,000   41,000   22%       41,000   43,000   21%       43,000   No limit   20%   How To Claim the Credit To claim the credit, you can file Form 1040 or Form 1040A. File state for free You cannot claim the credit on Form 1040EZ. File state for free Form 1040 or 1040A. File state for free   You must complete Form 2441 and attach it to your Form 1040 or 1040A. File state for free Enter the credit on Form 1040, line 48, or Form 1040A, line 29. File state for free Limit on credit. File state for free   The amount of credit you can claim is generally limited to the amount of your tax. File state for free For more information, see the Instructions for Form 2441. File state for free Tax credit not refundable. File state for free   You cannot get a refund for any part of the credit that is more than this limit. File state for free Recordkeeping. File state for free You should keep records of your work-related expenses. File state for free Also, if your dependent or spouse is not able to care for himself or herself, your records should show both the nature and the length of the disability. File state for free Other records you should keep to support your claim for the credit are described earlier under Provider Identification Test . File state for free Employment Taxes for Household Employers If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. File state for free If you are a household employer, you will need an employer identification number (EIN) and you may have to pay employment taxes. File state for free If the individuals who work in your home are self-employed, you are not liable for any of the taxes discussed in this section. File state for free Self-employed persons who are in business for themselves are not household employees. File state for free Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. File state for free If you use a placement agency that exercises control over what work is done and how it will be done by a babysitter or companion who works in your home, the worker is not your employee. File state for free This control could include providing rules of conduct and appearance and requiring regular reports. File state for free In this case, you do not have to pay employment taxes. File state for free But, if an agency merely gives you a list of sitters and you hire one from that list, and pay the sitter directly, the sitter may be your employee. File state for free If you have a household employee, you may be subject to: Social security and Medicare taxes, Federal unemployment tax, and Federal income tax withholding. File state for free Social security and Medicare taxes are generally withheld from the employee's pay and matched by the employer. File state for free Federal unemployment (FUTA) tax is paid by the employer only and provides for payments of unemployment compensation to workers who have lost their jobs. File state for free Federal income tax is withheld from the employee's total pay if the employee asks you to do so and you agree. File state for free For more information on a household employer's tax responsibilities, see Publication 926 and Schedule H (Form 1040) and its instructions. File state for free State employment tax. File state for free   You may also have to pay state unemployment tax. File state for free Contact your state unemployment tax office for information. File state for free You should also find out whether you need to pay or collect other state employment taxes or carry workers' compensation insurance. File state for free For a list of state unemployment tax agencies, visit the U. File state for free S. File state for free Department of Labor's website. File state for free A link to that website is in Publication 926, or you can find it with an online search. File state for free Prev  Up  Next   Home   More Online Publications