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Tax Law 97

Description of Form

A partnership does not pay federal taxes on its income. Instead, it apportions the income to the various partners in accordance with the terms of the partnership agreement and reports each partner's share of the partnership income (or loss) on a form K-1. Each partner then reports his or her share of the partnership income or loss on his or her (or its) own tax return. Certain items of partnership income and certain partnership deductions are combined with similar items on the return of the partner - such as charitable contributions or the IRC Section 179 deduction for equipment purchases.

A partnership is required to file an annual form 1065 and to prepare K-1 forms to report any income or losses to each partner. A limited partnership may also be required to file an annual report with a state agency in addition to state income tax returns. Some states impose a franchise tax on limited partnerships or LLCs as if it were a corporation.

Most public accountants should have the necessary software to prepare partnership tax returns and the K-1 forms. If the accountant that you know doesn't have the required software, it basically means he or she has very little experience with this type of entity. Take my word for this. You don't want someone to learn about partnership tax rules at your expense. Get a tax preparer who is already doing partnership returns for other clients.

A Small Partnership Doesn't Have To File Partnership Returns

Bob Matthews, one of our subscribers, sent me an eMail memo taking issue with my comments in the July, 1995 issue of APS about the need to file a partnership tax return for a family partnership.

According to Bob, "A partnership isn't required to file an IRS form 1065 if it has 'reasonable cause' not to file. However, each partner must (still) report his share of (any) income or loss."

Tax code section 6231 describes a "small partnership".

Tax code section 6033 points out that small partnerships are exempt from the penalty ($50 per partner per month) for late filing or non filing.

Code section 6698 states that, "A domestic partnership, composed of 10 or fewer non-corporate partners, and in which each partner's share of each partnership item is the same as his share of every other item, is not subject to the penalty if the ... partners establish, when requested by the IRS, that all partners have fully reported their shares of the income, deductions and credits of the partnership on their timely filed ... tax returns."

I appreciate the tip by Bob. Not having to file the form 1065 can save some money if the partnership's income is not hard to allocate to the various partners. Just be prepared to send a form letter to the IRS if the partnership gets a computer form letter asking why a return hasn't been filed. This is likely to happen if the IRS has received an information return reporting some income for the partnership, but the IRS hasn't received a partnership return.

However, another reason why it may be best to file a return is to establish that the partnership is conducting itself as a bone fide business. That may forestall some arguments later on, about whether the partnership has a business purpose. (APS9508)

Additional Exemptions For Filing A Partnership Return

Milton Miller, a CPA in New York passed on the following comment to me.

"Your July and August (1995) issues tell of situations in which there is no need to file 1065 returns for family partnerships. Internal Revenue Code 761-2 tells of (other) situations where there may be an 'Exclusion of certain unincorporated organizations from all or part of Subchapter K (the partnership rules) application. (These include) an investment only entity, or a joint production, extraction or use of property organization, (which) may make an election not to file form 1065."

My thanks to Milton for passing this on. According to Commerce Clearing House, this code section requires that each owner must also have the right to dispose of his interest in the property separately and that the exception is only available if the income of the members of the organization (or the co-owners) can be adequately determined without the computation of partnership taxable income. (APS9511)

For each tax form, the IRS is required to provide an estimate of the time that is required for the taxpayer to keep records, to read the instructions, to prepare the form and to prepare it for mailing to the IRS. It appears that the IRS bases their estimates on minimum amount of time required for each part of the process and that the taxpayer is a tax professional. Here are their estimates for the average filing time for each part of the process of preparing the estate tax return.These estimates are the sum of the separate estimates for each of the various schedules. Thus, these amounts presume that the return would involve every supporting schedule that could be required with the estate tax return.

Stages of the Process	Time Required
Recordkeeping	9 hours, 40 minutes
Reading the instructions	6 hours, 44 minutes
Preparing the form	11 hours, 14 minutes
Copying, collating and mailing	8 hours, 45 minutes
Total time	36 hours, 23 minutes

Does it seem a little ludicrous that the IRS estimates the time required to read the instructions is about 2/3 of the estimated recordkeeping time and about 1/2 of the time required to prepare the form? If an estate had assets that would require the preparation of every supporting schedule in the estate tax return, it would take a skilled professional with a good quality computer system a lot more than the estimate given by the IRS.

There are no separate tax rates for partnerships.

Tax Data

IRS Publications

For a copy of the following IRS publications, visit their web site at

http://www.irs.ustreas.gov/prod/forms_pubs/index.html

Link on the section for IRS publications and select

* Publication 334 - Tax Guide For Small Business
* Publication 553 - Self Employment Tax
* Publication 560 - Retirement Plans for The Self Employed
* Publication 583 - Starting a Business and Keeping Records
* Publication 541 - Partnerships

Taxpayers' Relief Act of 1997 -

Section IX - Miscellaneous Provisions - Part E-1
Section X - Revenue Provisions - Part 1
Section XII-C - Partnership Simplification Provisions

Further details about legal methods of tax avoidance are available in our subscriber's web site. Changes in the tax laws and research reports on how to avoid excessive taxes are provided in our monthly newsletter - Vern Jacobs' Tax Solutions

About the author:

Vernon Jacobs is a CPA/CLU who works as a tax author and consultant. He writes Vern Jacob s' Tax Solutions, is the author of The Jacobs Report on Asset Protection Strategies, and serves as the Tax Editor for OFFSHORE, an eJournal. He has “big six” CPA experience and spent 12 years as a senior financial executive for an insurance company. He’s been the software columnist for Personal Financial Planning for five years. His email address is vkj@rpifs.com and his web site is http://www.rpifs.com/apvkj.htm He can be reached by phone or fax at (913) 362-9667.