Dr. Thomas is a hedge fund manager. After speaking with his attorney, he contributed several office buildings, which he had previously owned as sole proprietor, to a new Thomas Partnership in which he became a one-third general partner. He gave the remaining limited partnership interests to his 2 daughters, Julie and Martha. When the partnership was formed last year, the girls were 14 and 16. The real estate is extremely profitable and well-managed. Dr. Thomas regularly consults with a full-time hired manager about the business, but neither of his daughters has any dealings with the partnership. Under the terms of the partnership agreement, the girls cannot sell their partnership interest to anyone but their father. Distributions from the partnership have been sizeable, and Dr. Thomas has insisted that the girls put all their distributions into a college trust fund.
Last year, the partnership’s first return was filed by Mr. Richmond, a partner in the regional CPA firm of Specter and Parker. Mr. Richmond has been Dr. Thomas’s accountant for a decade, but he decided to retire. Dr. Thomas’s business is extremely profitable and is an important part of the client base of this CPA firm. Mr. Henderson, the young partner who has taken over Dr. Thomas’s account, asked William, a second-year staff accountant, to prepare the current year’s partnership return.
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William has done considerable research and is positive that the Thomas Partnership does not qualify as a partnership at all because the father has retained too much control over the daughters’ interests. William briefly confided his concerns to Mr. Richmond. Mr. Richmond said he was really rushed in the prior year when he filed the partnership return and admitted he never looked into the question of whether the arrangement met the requirements for being taxed as a partnership. After hearing more of the details, Mr. Richmond confirmed that William’s conclusion was probably correct. Dr. Thomas’s tax bill will be significantly larger if he has to pay tax on 100% of the partnership’s income.
When William approached Mr. Henderson with his conclusions, Mr. Henderson was concerned because Dr. Thomas was already unhappy that Mr. Richmond was no longer preparing his returns. He was worried that a large tax increase would make him even more unhappy. Mr. Henderson responded, “My first thought is just to leave well enough alone and file the partnership return. Are you positive, William, that this will not qualify as a partnership? Think about it and let me know tomorrow.”