TAX NEWS - DECEMber 2009

IRS Tax: IRS Form 1065 Frequently Asked Questions web page has been updated

IRS Form 1065 Frequently Asked Questions web page has been updated

- Updates have been added to posted 1065 FAQs Q6, Q8, Q14, and Q29.
- Cross-references have been added to posted 1065 FAQs Q4, Q16, and Q17.



Q4: For purposes of reporting a partner's percentage ownership of capital on Form 1065 Schedule K-1, Item J, is the following a reasonable method for reporting the partners' ownership percentages as of the end of the partnerships' 2008 tax year?

Facts: Partners A, B, and C are partners in partnership P. The P partnership agreement does not specify the partners' percentage shares of profit, loss, or capital. Instead, the partnership agreement provides for allocations of profits and losses based on a complex formula which takes into consideration activity thresholds and targets which causes profit allocations to vary. P's partnership agreement requires that capital accounts be maintained in accordance with section 704(b) and specifically provides for a deficit restoration obligation (DRO).

For the partnership's tax year ending in 2008, the partners' respective capital account balances are as follows:

Partner A, $75
Partner B, $50
Partner C ($25) (deficit)

Partnership P considers the following to be a reasonable method of computing the partner's ending capital percentage amounts for purposes of Schedule K-1, item J.

Partnership P reports total end of year partners' capital of $100, consisting of positive capital account balances totaling $125 (A's $75 capital plus B's $50 capital) less C's $25 capital deficit. Partnership P reports that partners A, B, and C own 60 percent, 40 percent, and zero percent, respectively, of partnership capital at the end of the partnership's tax year, determined as follows:

- Partner A's 60 percent is determined by dividing his $75 positive ending capital account balance by total positive ending capital of $125.
- Partner B's 40 percent, is determined by dividing his $50 positive ending capital account balance by total positive ending capital of $125.
- Partner C would receive no net distribution of capital if the partnership were to liquidate at the end of its 2008 tax year. Instead partner C would have to contribute capital to the partnership because of his deficit restoration obligation (DRO). Therefore, solely for purposes of computing the percentage amounts shown of Schedule K-1, item J, C's ending positive capital account percentage is treated as equal to zero.

A4: Solely for purposes of completing Schedule K-1, item J, partnership P's method of computing the ending partners' capital account percentages is reasonable if the method is followed consistently from year to year.



Q6: For purposes of the requirement in the Form 1065 Schedule K-1, Item J, instruction at page 24, first paragraph, last sentence referring to "multiple changes in the profit and loss sharing percentage during the year" should the phrase "change" be interpreted as applying only to changes in ownership resulting from sale, purchase, transfer, contribution, or distribution as distinguished from changes which occur because of fluctuations in profit allocations during the year due to formula methods specified in the partnership agreement?

Facts: Without the requested clarification my client partnership will have to prepare an enormous attachment to each of its Schedules K-1, as such, allocations may fluctuate many times during the year as the variables on which they are based (profit targets of a certain activity, etc.) change. The partnership agreement does not provide for fixed percentages in the partnership profit, loss, and capital. One partner sold part of his interest on two different dates during the year.

A6: Yes. For purposes of the requirement in the Form 1065 Schedule K-1, Item J, instruction at page 24, first paragraph, last sentence referring to "multiple changes in the profit and loss sharing percentage during the year," the phrase "change" for this purpose does not apply to changes which occur because of fluctuations in profit allocations during the year due to formula methods specified in the partnership agreement.

The partnership must report on Schedules Item J the percentage interest at the beginning and end of year in profit, loss, and capital for each partner. In cases where the partner has multiple changes in ownership, the multiple change attachment to the K-1 is necessary but only listing dates and percentages for actual changes in ownership.



Q8: Partnership A has over 100 partners. The partnership agreement does not express the partners' percentage interests as fixed percentages. The partnership wishes to send tax year 2008 Form 1065 Schedules K-1 to partners in March 2009 with a blank Item J. The partnership proposes that it will adopt a reasonable method for reporting ownership percentages on Item J before the extended due date of the return and include percentages on Item J of the Schedules K-1 included with the Form 1065 that will be filed with IRS prior to the extended due date. Is it permissible for Partnership A to send 2008 Schedules K-1 to partners with a blank Item J?

A8:
No. The tax year 2008 Form 1065 Schedules K-1 sent to partners in 2009 must include a completed Item J and must be consistent with those filed with the Form 1065. The instructions for Form 1065 Schedule K-1, Item J, provide that if the partnership agreement does not express the partners' percentage interests as fixed percentages, the partnership may use a reasonable method in arriving at each percentage for the purpose of completing Item J as long as such method is consistent with the partnership agreement and is applied consistently from year to year.



Q14: The partnership agreement for Partnership A does not express the partners' shares of profit, loss, or capital as fixed percentages. For tax year 2008, Partnership A adopted a reasonable method for determining the partners' end of year percentage shares of profit, loss, and capital for purposes of completing Schedule K-1, Item J. Under its method, the ending percentages shown on Schedule K-1 item J for 2008 will be reported as the beginning of year percentages for 2009.
 
For tax year 2007, Partnership A did not report the partners' percentage shares of profit, loss, or capital on Schedule K-1 at the end of the year. Rather, Partnership A reported "per agreement" instead of providing percentages for each partner. May Partnership A report "per agreement" as the beginning of year percentage share of profit, loss, and capital for the 2008 Form 1065 Schedules K-1 Item J for each partner?
 
A14: No. Partnership A may not report "per agreement" as the beginning of year percentage share of profit, loss, and capital for the 2008 Form 1065 Schedules K-1 Item J for each partner. Specific percentage shares must be determined in a manner consistent with the partnership agreement.
 
The instructions for Form 1065 Schedule K-1 Item J provide that if the partnership agreement does not express the partners' percentage interests as fixed percentages, the partnership may use a reasonable method in arriving at each percentage for the purpose of completing Item J as long as such method is consistent with the partnership agreement and is applied consistently from year to year.

For the current year, it is generally acceptable to show the ending partner percentages from the prior year as the beginning of year percentage shares for the current tax year. However, if the end of year partners' shares of profit, loss, and capital were not stated as percentages, then the reasonable method adopted for tax year 2008 may be applied as of the end of tax year 2007 to determine percentage shares at the beginning of 2008 tax year.



Q16: Must the end of tax year capital accounts percentage reported on Form 1065 Schedule K-1 Item J be computed from capital accounts determined on the same basis as the end of tax year capital account balances reported in Item L? The partnership agreement does not provide for fixed capital percentage shares.
 
A16: Yes. If the partnership agreement does not provide for fixed capital percentage shares, the end of tax year capital account percentage reported on Item J must be determined on the same basis as the end of tax year capital account balance reported on Item L, and the amounts reported on both Item J and Item L must be consistent with the partnership agreement. If the Item L end of year capital account balance for one or more partners is negative under the selected reporting method, the Item J end of tax year capital account percentage for such partners may be reported as zero and the end of year capital account percentage for all other partners with positive end of year capital account balances may be reported as a percentage of the total capital account balances for those partners.



Q17: May negative percentages be reported on Form 1065 Schedules K Item J as end of year percentage shares of profit, loss, or capital?
 
A17:
No. Each percentage should be positive and between zero percent and 100 percent. The totals for profit, loss and capital should add to 100 percent across all partners unless zero for all partners.



Q29: What should Partnership A report as the beginning of year percentage share of profit and loss for each partner on the 2008 Form 1065 Schedules K-1 Item J under the following facts?

Facts: The partnership agreement for Partnership A does not express the partners' shares of profit, loss, or capital as fixed percentages. For tax year 2008, Partnership A adopted a reasonable method for determining the partners' end of year percentage shares of profit, loss, and capital for purposes of completing Schedule K-1, Item J. Under its method, the ending percentages shown on Schedule K-1 item J for 2008 will be reported as the beginning of year percentages for 2009.

For tax year 2007, Partnership A did not report the partners' percentage shares of profit, loss, or capital on Schedule K-1 at the end of the year. Rather, Partnership A reported "per agreement" instead of providing percentages for each partner.

Posted 1065 FAQ Q14 directs that if the end of tax year 2007 partners' shares of profit, loss, and capital were not stated as percentages, then the reasonable method adopted for tax year 2008 may be applied as of the end of tax year 2007 to determine percentage shares at the beginning of the 2008 tax year.

The partnership has made its best efforts to apply the reasonable method adopted for tax year 2008 as of the end of tax year 2007 to determine percentage shares at the beginning of the 2008 tax year, but has determined that it is unable to compute percentage shares for profit and for loss as of the end of tax year 2007 under the 2008 reasonable method and is therefore unable to compute the percentage shares for profits and loss at the beginning of tax year 2008. Partnership A is able to determine the end of tax year 2007 percentage shares for capital and therefore is able to determine the beginning of tax year 2008 percentage shares for capital.

A29: If Partnership A is unable to determine the beginning of year percentage shares of profit and loss for the 2008 Form 1065 Schedules K-1 Item J for each partner, it should indicate "Unknown" as the beginning of tax year 2008 percentage shares, and report the end of tax year 2008 percentage shares determined under the reasonable method adopted for 2008.

With respect to partner capital, the beginning of tax year 2008 percentage shares are readily determinable, and must be reported as must the end of tax year percentage shares.

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