Partnerships and Income Tax – Staring into the Abyss of IRS Form 1065

Partnerships and Income Tax – Staring into the Abyss of IRS Form 1065 and its accompanying regulations is a challenge, not for the faint of heart.

The first question I always ask partners in on-going partnerships looking for bookkeeping, accounting, payroll and tax prep services is … what happened to the last person with the keys? There is always a fascinating story to be told about a severed relationship from incompetence to embezzlement to scorned mistress but generally has to do with someone getting tired and looking at retirement.

Side bar – the average age of the average tax professional in Colorado is 68.

The first question I always ask partners looking to start a new partnership is … what is the exit strategy. Most have never thought about one which seemingly leads to the blank stare I get in response.

In my 18 years in practice the only partnerships that experience success are entered into with an exit strategy in mind and a detailed work plan to achieve incremental goals in route to that exit strategy. All other partnerships have failed, most due to partner hubris, greed and/or inevitably, spousal disputes.

Guess who makes money when a partnership fails? Lawyers and tax accountants needed to clean up the mess that ensues without well thought out agreements.

The next questions I ask of all my partners in all the partnerships I consider serving gets nuance and deep into the weeds. If you are actively thinking about forming a partnership or if you own a partnership interest in which you actively participate (or simply passively invest) knowing the answers to these questions below is a best practice.

• What type of entity structure is the partnership? There are difference between the 5 general types generally governed by state law or international law.
• Do the partners have US Social Security Numbers, Taxpayer Identification Numbers, or US Federal Employer Identification Numbers?
• What is the partnership’s profit motive? What does it ‘do’?
• What software is used to maintain the partnership books?
• Who is the responsible party for the partnership’s books and records?
• What accounting method does the partnership use?
• Are the financial accounts reconciled on a regular basis?
• Does the partnership have employees?
• Does the partnership engage independent contractors?
• Does the partnership maintain an inventory?
• Does the partnership own title to any assets domestic or outside the US?
• Does the partnership have financial accounts outside the US?
• Is the partnership a partner in any other other partnerships domestic and/or outside the US?
• Is the partnership a shareholder of any corporations domestic or outside the US?
• Has the partnership ever received a distribution from, or been a grantor of, or transferor to a domestic of foreign trust?
• Does the partnership own any real estate in the US?
• Is the partnership fully compliant with all US tax filings?
• Does the partnership aggregate activities as per IRC 465 for ‘at-risk’ purposes?
• Does the partnership aggregate activities as per IRC 469 for ‘passive activity’ purposes?
• Does the partnership have total receipts for the current tax year exceeding $250,000 US?
• Does the partnership’s total assets for the current tax year exceed $1,000,000 US?
• Have the partner’s capital accounts been properly maintained since partnership formation?
• Has each partners ‘inside’ and ‘outside’ basis been tracked and accordingly adjusted as needed?
• Has the partnership ever made an IRC 754 election adjusting partnership basis?
• Is the partnership debt recourse, non-recourse or qualified non-recourse?
• Is the partnership a publicly traded partnership as defined by IRC 469(k)(2)
• Has the partnership had any debt cancelled?
• Has the partnership ever filed IRS Form 8918 Material Advisor Disclosure Statement
• Has the partnership ever distributed property received in a ‘like/kind’ exchange as per IRC 1031?
• Has the partnership ever distributed to partners property either as tenancy-in-common or undivided interest?
• Is the partnership required to file IRS Form 8858 – Information Return with respect to Foreign Disregarded entities?
• Has the partnership file IRS Form 8805 Foreign Partner’s Information Statement of IRC 1446 Withholding Tax for effectively connected income?
• Are any partners a ‘deemed’ foreign government as per IRC 892
• Is the partnership required to file IRS Form 5471
• Has the partnership made any payments that would require it to file IRS Form 1042 and 1042-S as per IRC 1441 thru 1464 or IRC 1471 thru 1474?
• Is the partnership required to file IRS Form 8938– specified foreign financial assets?
• Is the partnership an IRC 721(c)entity as defined by US Treasury Regulation 1.721(c)-1(b)(14)?
• Has the partnership paid or accrued any interest or royalty for which one or more partners are not allowed a deduction under IRC 267A?
• Does the partnership have an election as per IRC163(j) for any real property trade or business or any farming business?
• Does the partnership own a pass-through entity with current or prior year carryover excess business interest expense?
• Does the partnership have (or has had in the previous 3 years) average annual gross receipts in excess of $26,000,000US as defined by IRC 448(c)
• Is the partnership required to file IRS Form 8990 as a deemed tax shelter?
• Has the partnership been elected out of the centralized partnership audit regime as per IRC 6221(b)?

If you might be compelled to get deeper into the weeds, hit me back.