Georgio Enterprises is a limited partnership that operates a chain of family restaurants. The partnership was profitable from its inception and is now generating consistent annual pre-tax profits of $1,000,000.
The partnership includes 20 limited partners, each of whom contributed $60,000 when the venture began. The limited partners, as a group, share 40% of Georgio’s annual profits. As the partnership has not expanded for several years, most of the annual profits are distributed to the partners within six months of the year end.
Most of the limited partners are individuals who are subject to a marginal personal tax rate of 45%.
Required:
1. What is the annual after-tax return on investment for each limited partner?
2. If Georgio Enterprises had been organized as a corporation, how would the rate of return to the investors differ? Show calculations.
3. Assume that Georgio Enterprises (as a limited partnership) made an annual cash distribution sufficient only to cover each limited partner’s tax liability, and retained the balance for expansion. How would the investors’ after-tax returns be affected by this, considering that in order to realize their investment they may have to sell their partnership interest for an increased value? Would the return on investment be different if Georgio were a corporation and paid no dividends?