The Correct Answer and Explanation is:
The correct answer is $30,000.
Here is a detailed explanation:
The key to solving this problem lies in understanding how partnerships are taxed in the United States. A partnership is considered a “pass through” entity. This means the business itself does not pay federal income taxes on its profits. Instead, the profits and losses are passed directly through to the individual partners, who then report this information on their personal income tax returns.
Each partner is responsible for paying taxes on their distributive share of the partnership’s net income. This is true regardless of how much cash is actually distributed to them during the year. The amount of income a partner must report is determined by their ownership percentage as outlined in the partnership agreement.
In this case, Frick and Frack are equal partners in F&F Industries, which means they each have a 50% stake in the company’s profits and losses. The partnership generated a total net income of $60,000 for the year. To find Frack’s reportable income, we multiply the total net income by his ownership percentage:
$60,000 (Total Net Income) x 50% (Frack’s Share) = $30,000
The $7,000 cash distribution that Frack received is a separate event for tax purposes. This distribution is generally considered a return of capital and is not taxable income to Frack. It reduces his basis in the partnership, but it does not affect the amount of profit he must report. Therefore, the $7,000 figure is irrelevant for calculating his taxable income from the partnership’s operations for the year. Frack must report his $30,000 share of the company’s earnings on his individual tax return.
