Partnership XY, an equal 50/50 partnership, generates $10,000 in ordinary income and a $5,000 capital gain for a taxable year prior to making any payments to its partners. If partner X were to be paid $15,000 for services rendered to XY that were continuous, related to the function of the partnership, and not in the nature of a capital expenditure, then what is the result to X, Y, and XY?

A) XY may deduct the $15,000 paid to X, but not in excess of its $10,000 in ordinary income, so it will end up with $0 of ordinary income for the year and a $5,000 capital gain. XY may deduct the remaining $5,000 of its payment to X once it has generated more income in a future year under the rules for net operating losses. Partner X will recognize $15,000 of ordinary income and a $2,500 capital gain. Partner Y will recognize a $2,500 capital gain.

B) XY may deduct the $15,000 paid to X, so it will end up with a $5,000 ordinary loss and a $5,000 capital gain for the year. Both partners split XYs items equally, so both recognize a $2,500 ordinary loss and a $2,500 capital gain. In addition, X must recognize the $15,000 received as compensation for services as ordinary income.

C) XY may deduct the $15,000 paid to X, so it will end up with net income of $0. As a result, neither partner will have to recognize any gain or loss from the partnerships operations, but X will still have to recognize the $15,000 received as compensation for services as ordinary income.

D) XY may not deduct the $15,000 paid to X because distributions to partners are not deductible by a partnership. Therefore, XY ends up with ordinary income of $10,000 and a capital gain of $5,000 for the year. Both partners recognize $5,000 of ordinary income and a $2,500 capital gain. If the distribution to X exceeds Xs basis in the partnership, then X will recognize capital gain to the extent of the excess.