Intuit Academy Tax Practice Exam

In tax terms, how are distributions from a partnership generally treated?

1. As taxable income regardless of contributions

2. As a reduction of the basis of the partnership interest

3. As an exclusion from taxable income

4. They cannot be reported on a tax return

The correct answer is: As a reduction of the basis of the partnership interest

Distributions from a partnership are generally treated as a reduction of the basis of the partner's partnership interest. This means that when a partner receives a distribution, it does not count as taxable income to the partner at the time of the distribution. Instead, the distribution reduces the partner's basis in their partnership interest. When a partner has a basis in the partnership and receives a distribution, this amount is subtracted from their basis. If the distribution exceeds the basis in the partnership interest, the excess amount may then be treated as taxable income. This mechanism allows the partner to receive distributions without immediate tax implications, as long as it does not exceed their investment in the partnership. This treatment reflects the underlying principle that partnerships are pass-through entities, meaning that income, deductions, and other tax attributes flow through to the partners, and the timing of taxation can depend on the partner’s basis in the partnership rather than the mere occurrence of a distribution.