Final answer:
Katie's receipt of an unrestricted partnership interest in TR partnership valued at $25,000 for her services is likely taxable as ordinary income, assuming she received a capital interest and not merely a profits interest. Option third is the correct answer.
Step-by-step explanation:
When Katie receives an unrestricted partnership interest valued at $25,000 for her expertise in multimedia presentations and begins working for the TR partnership, her tax treatment of this transaction is determined by the Internal Revenue Code and regulations governing partnership taxation. Generally, the contribution of services to a partnership in exchange for an interest in the partnership's capital could be considered a taxable event.
Under typical circumstances, if one receives a partnership interest in exchange for services, this interest is treated as compensation and is therefore taxable as ordinary income at fair market value. Thus, if Katie's partnership interest is a profits interest for her future services, it might be eligible for special tax treatment and could potentially be treated as a nontaxable event. However, if the partnership interest represents an interest in the current capital of the partnership, then Katie would have taxable compensation equal to the fair market value of the interest received.
Now, considering Katie received an unrestricted partnership interest, the likelihood is that the $25,000 represents an immediate increase in her wealth equal to the fair market value of the interest, and thus should be reported as ordinary income on her tax return for the current year.
The correct treatment for the receipt of the partnership interest by Katie is: