federal schedule k-1: mastering -...

Federal Schedule K-1: Mastering the Compliance Challengespresents p g

Determining and Reporting a Partner's Income, Credits and Deductions presents

A Live 110-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features:Matt Bower, Manager, Washington National Tax, Pass-Throughs Group, Deloitte Tax, Washington, D.C.Sarah Staudenraus, Partner, Pass-Throughs and Special Industries Group, KPMG, Washington, D.C.

Joe Schlueter, Tax Principal, LarsonAllen, Minneapolis

Tuesday, December 22, 2009

The conference begins at:1 pm Easternp12 pm Central

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F d l S h d l K 1 M t i thFederal Schedule K-1: Mastering the Compliance Challenges Webinar

Dec. 22, 2009

Matt Bower Sarah StaudenrausDeloitte Tax [email protected] [email protected]

Joe SchlueterLarsonAllen

[email protected]

Today’s Program

• Routine Reporting Matters On Schedule K-1, slides 3 through 17 (Matt Bower, Sarah Staudenraus)Bower, Sarah Staudenraus)

• Matters Related To Schedule K-1, slides 18 through 41 (Joe Schlueter, Sarah Staudenraus Matt Bower)Sarah Staudenraus, Matt Bower)

• Non-Recurring And Complex Matters, slides 42 through 55 (Joe S hl t S h St d )Schlueter, Sarah Staudenraus)

2

Routine Reporting Matters On S h d l K 1Schedule K-1

3

Keeping Proper Books And Records

• What is a “partnership,” for U.S. purposes?– A contractual relationship may create a separate entity for federal

income tax purposes. See Reg. § 301.7701-1(a)(2)– The facts and circumstances must be considered to determine

whether a partnership is created for U.S. purposes. See Culbertson, 337 U.S. 733 (1949); Luna, 42 T.C. 1067 (1964)

44

Keeping Proper Books And RecordsKeeping Proper Books And Records (Cont.)

• Partner vs. partnership itemsGeneral rule: The income or expense must be reported on the– General rule: The income or expense must be reported on the return of the partner or the partnership, as the case may be, regardless of who collects the income or pays the expense

– Capital accounting and special allocations– Capital accounting and special allocations• Focus on economic arrangement of the partners

55

Accounting For Investments In Lower-Tier Partnerships: Draft K-1s

UTP

LTP

• Partnership UTP owns an interest in Partnership LTP• Partnership UTP is filing its Form 1065 and does not have a final

Schedule K 1 from LTPSchedule K-1 from LTP• What are UTP’s reporting requirements?

66

Is UPT A TEFRA Partnership?Is UPT A TEFRA Partnership?

Non-TEFRA partnerships: No Schedule K-1

• AICPA Statement 4 provides that you may use estimates, if not prohibitedAICPA Statement 4 provides that you may use estimates, if not prohibited by statute or rule, to prepare a return, if it is not practical to get exact numbers and you determine that the estimate is reasonable on your known facts and circumstances

• The estimate should not imply greater accuracy than exists

Th f il t h S h d l K 1 b “ l i t ” th t• The failure to have a Schedule K-1 may be an “unusual circumstance” that should be disclosed to the taxing authority

77

Is UPT A TEFRA Partnership? (Cont.)p ( )

TEFRA partnership: No Schedule K-1

• Form 8082 (Notice of Inconsistent Treatment or Request for Administrative Adjustment)

• Instructions provide that you must file Form 8082 if:– Taxpayer believes an item was not properly reported by the pass-

through entity, orthrough entity, or– Pass-through entity has not filed a return or given the taxpayer the

required schedule by the time the taxpayer is required to file its tax return, and the taxpayer must include items on its return

• Thus, if you are filing with estimates, you must include a Form 8082– What about draft Schedule K-1s?

88

IS UPT A TEFRA Partnership? (Cont.)

• Sect. 6222(a) requires that the partner’s treatment of all partnership items be ( ) q p p pconsistent with the treatment of the items by the partnership in all respects, including:– Amount,

Ti i d– Timing, and – Characterization

S t 6222(b) i th t t i f th• Sect. 6222(b) requires the partner to inform the IRS of all partnership items that are treated inconsistently– Notification is given by filing Form 8082

99

Implications If UPT Does Not File Form 8082Implications If UPT Does Not File Form 8082

• Failure to file Form 8082 and notify the IRS of any inconsistency in filing

IRS may assess the tax attributable to the inconsistent treatment by– IRS may assess the tax attributable to the inconsistent treatment by computational adjustment

– Taxpayer has no right to challenge the merits of the deficiencyA d fi i b bj t t li lt d S t– Any deficiency may be subject to a negligence penalty under Sect. 6662

1010

Implications If UPT Does File Form 8082 (Cont.)

• Filing of Form 8082 to notify the IRS of any inconsistency in filing– An assessment of tax can only be made as a result of a partnership

proceeding, or by notifying the partner that all partnership items arising from the partnership will be treated as non-partnership items

– The IRS has the option of converting partnership items to non-partnership items

– If the IRS converts the items to non-partnership items, any asserted deficiency will be subject to the notice of deficiency rules

• Partner may challenge item in Tax Court or Refund Courts

1111

Schedule B “Up The Chain”Schedule B Up The Chain Ownership Disclosures

• Q2: Was any partner in the partnership a disregarded entity, a partnership, a trust, an S corporation, an estate, or nominee or a similar

?person?– Expands on the 2007 question, which only inquired as to whether

any partners in the partnership were also partnerships– If the answer to this question is “yes,” then the partner is subject to

TEFRA

1212

Schedule B “Up The Chain”Schedule B Up The Chain Ownership Disclosures (Cont.)

• Q3a: Did any foreign or domestic corporation, partnership, or trust own, directly or indirectly, an interest of 50% or more in the profit, loss, or capital of the partnership at the end of the tax year? – Allows the IRS to indentify potential filing requirements for Form

5472

1313


• Q3b: Did any individual or estate own, directly or indirectly, an interest of 50% or more in the profit, loss, or capital of the partnership at the end of the tax year? – Look to maximum percentage of ownership in profit, loss or

capital at the end of the year for Q3a and Q3b

1414


• Q4a: Did the partnership own directly 20% or more, or own, directly or indirectly, 50% or more of the total voting power of all classes of stock entitled to vote of any foreign or domestic corporation at the end of the tax year? – Allows the IRS to identify potential filing requirements for Form

5471

1515

Partnership Elections And Disclosures

• Effects of a technical termination– Partnership returns– Accounting elections

• What is a valid Sect. 754 election?– Must have a “sale or exchange” of a partnership interest, or– Applicable distribution

1616

Partnership Elections And DisclosuresPartnership Elections And Disclosures (Cont.)

• Disguised sale disclosure– Contribution/distribution within two years – presumed to be a

disguised saledisguised sale– Form 8275 or disclosure statement required. See Reg. § 1.707-8(a)

• Foreign partnership returns– First-year elections– Schedule O– Sect. 6038B penalties

1717

Matters Related To Schedule K-1Matters Related To Schedule K 1

1818

Reporting Direct Partner IdentifyingReporting Direct Partner Identifying Information

• The partnership is required to report• The partnership is required to report direct partner information– LLC members?

I t t h ld b di d d– Interests held by disregarded entities?

1919

The Schedule K-1 Capital Accounts

2020

The Schedule K-1 Capital Accounts p(Cont.)

• Most important: Understand what you are working with• Most important: Understand what you are working with– Sect. 704(b)

• Economic-based capital accounts• Represents the essence of the contractual agreement• Tied to tax basis accounting except for:

– Assets contributed/distributed with tax basis/FMV differential

– Capital account revaluation situations• With rare exception, it is NOT tied to GAAPWith rare exception, it is NOT tied to GAAP

2121

The Schedule K-1 Capital Accounts (Cont.)

• Most important: Understand what you are working with– Tax basis

• Based on historic tax cost• Does NOT represent the economics of deal (if assets other than

cash have been contributed/distributed)

– GAAP• Reflects neither economic deal nor historic tax cost

T i ll i t f K 1 t ti b d f• Typically convenient for K-1 presentation, based on source of financial statement info for tax prep software

2222


• What Form 1065 instructions require– Schedule L: Should agree with partnership books and records

– Schedule M-2: Tax basis or 704(b) for M-2 and K-1 item L*• * If different from Schedule L, attach schedule

– Schedule K-1 Item L: Check box for use of:• Tax basis• GAAP• 704(b)• Other

23

Other

23


• Standard compliance practices:– Schedule L: From books and records that “bridge” into tax prep

software

– Schedule M-2: Ties to Schedule L

– Schedule K-1 Item L: Typically flows from and ties to M-2 data

– Reconciling schedules: Typically not attached

2424


• What is really important– Whatever is reported on Schedule K-1 Item L, make sure the correct

box is checked.– Maintain Sect. 704(b) capital account schedules (separate from tax

return)• As required by regulations and the operating agreementAs required by regulations and the operating agreement

– Maintain correct tax basis schedules (for the partners’ interests in the partnership

2525

Partner Liability AllocationsPartner Liability Allocations

2626

Partner Liability Allocations (Cont )Partner Liability Allocations (Cont.)

• Importance of liability (K-1) information

P t ’ h f t hi li biliti i l d d i b i– Partner’s share of partnership liabilities are included in basis calculation

• Affects the ability to claim losses• Affect whether distributions are taxable

– Affects character of loss claimed by partner if partnership interest is abandoned

2727


• What liabilities are includedWhat liabilities are included– Any obligation that:

• Creates or increases the basis in assetsGi i t i di t d d ti• Gives rise to an immediate deduction, or

• Gives rise to an expense that is not deductible in computing taxable income and is not chargeable to capital

– Includes standard debts and liabilities, payables, accrued expenses (for accrual basis taxpayer)

– Would not include cash basis payables, for example

2828

Partner Liability Allocations (Cont )Partner Liability Allocations (Cont.)• Characterization of liabilities

“C t ti li id ti ” th tili d– “Constructive liquidation” theory utilized• All assets, including cash, deemed worthless• All debts and obligations due• Who pays or who bears economic risk of loss?

– Non-recourse: If no partner (or person related to a partner) bears economic risk of loss

• Note: LLC liabilities default to non-recourse classification– Recourse: If any partner (or person related to a partner) bears

economic risk of loss, liability is recourse to that partnereconomic risk of loss, liability is recourse to that partner

2929


• Allocation of liabilities– Recourse

All t d t th t th t b i i k f l• Allocated to the partner that bears economic risk of loss• Allocated to the partner that is related to a non-partner that

bears economic risk of loss• If more than one partner bears economic risk of loss, allocated

among such partners proportionate to risk

3030


• Allocation of liabilitiesAllocation of liabilities– Non-recourse

• Three-tier allocation structure:

1. In accordance with partner’s share of partnership minimum gain

2. In accordance with partner’s share of Sect. 704(c) gain3. Excess allocated in accordance with partner’s share of

partnership profits

• The third tier is the default allocation rule

3131

Partner Liability Allocations (Cont.)y ( )• Qualified non-recourse financing

– This is the third category listed on the K-1– QNR financing is financing that:

• No partner (or related party) is personally liable for repayment• Borrowed for use in an activity of holding real property, andy g p p y,

– Is loaned or guaranteed by a federal, state, or local government, or

– Is borrowed from a “qualified person,” which generallyIs borrowed from a qualified person, which generally includes any person (entity) actively and regularly engaged in the business of lending money (i.e. a bank, savings & loan, etc.))

– Importance of QNR classification is that that it provides “at-risk” tax basis, which enhances ability to claim losses

3232

Overview Of The Schedule K-1Overview Of The Schedule K-1 Reporting Presentation

• Sect. 703 requires a partnership to separately state each partner’s di ib i h f i d ib d i S 702( )distributive share of items described in Sect. 702(a)

• The Schedule K-1 is designed to support the separate statement of items of gains, income, loss and deduction that commonly are subject to special treatment at the individual partner leve.– Partner instructions are also prepared for an individual partner

3333

Schedule K-1 Reporting (Cont.)Schedule K 1 Reporting (Cont.)

Consider 469 rules

Partner iincome

Portfolio income

Portfolio deductions

3434

Classification And Reporting IncomeClassification And Reporting Income Items

• The taxable income of a partnership is computed in the same manner as in the case of an individual. See Sect. 703(a)as in the case of an individual. See Sect. 703(a)

B tt li t i t l t t d it• Bottom line net income vs. separately stated items– Generally, partnership-level characterization

3535

Classification And Reporting IncomeClassification And Reporting Income Items (Cont.)

• General rule: Report to partners any information that may be required• General rule: Report to partners any information that may be required to apply particular provisions of the Code to the partner with respect to items related to the partnership

3636

Guaranteed Paymentsy

X Management

LLC $ 100 payment$ 100 payment

• Payments to a partner for services, or for the use of capital, are

LLC $ 100 payment for services

$ 100 payment for capital

y p pconsidered “guaranteed payments” to the extent the payments are determined “without regard to the income of the partnership.” Sect. 707(c)– Partner capacity payments?– What about payments made with regard to gross income?

3737

Guaranteed Payments (Cont.)y ( )• Ordinary income to the payee

– Does not affect recipient partner’s capital accountp p p

• Deductible/capitalizable by the partnershipExpense reduces partners’ capital account– Expense reduces partners’ capital account

• Recipient partner includes guaranteed payment in income for his bl i h i hi hi h d h hi bltaxable year, with or within which ends the partnership taxable year

during which the partnership pays or accrues the payment– Inclusion thus based on partnership’s method of accounting

3838

Guaranteed Payments (Cont.)y ( )

“A t t l hi lf”• “A partner cannot employee himself”

• Thus, guaranteed payments for services:– Are not reportable on Form W-2– Are not subject to income tax withholding, FICA or FUTA tax– Are subject to SE taxAre subject to SE tax– Remember “hidden” guaranteed payments such as benefits paid on

behalf of the service partner (e.g., health benefits)

3939

Guaranteed Payments: “Both an E A d A I It B ”Expense And An Income Item Be”

EXPENSEEXPENSE

INCOME

EXPENSE

• Guaranteed payments are reflected on Schedule K and K-1 as both a partnership expense and an income item

EXPENSE

4040

partnership expense and an income item

Guaranteed Payments: A Practical N tNote

• Schedule M-1 (and M-3) will require an adjustment to add back a guaranteed

4141

payment.

Non-Recurring And Complex Matters

4242

Expanding Reach Of IRS InstructionsExpanding Reach Of IRS Instructions

• IRS has started a process of posting FAQs on its Web site:• IRS has started a process of posting FAQs on its Web site: www.irs.gov.

D i 2009 t fili t t d ith b t 15 ti di• During 2009 tax filing season started with about 15 postings regarding 1065 FAQs; now has 41

• Key issue presented is: What weight of authority do these postings have?

4343

Meaningless Complexity? Partner’s Sh Of P fit L A d C it lShare Of Profit, Loss And Capital

4444

Schedule K-1, Item J:IRS Frequently Asked Questions

• IRS frequently asked question• IRS frequently asked question– Provides example of “reasonable method” where partnership agreement

does not express the partner’s share of profit, loss and capital as a fixed percentagepercentage

• FAQ uses Sect. 704(b) capital, net profits and net losses• FAQ does not address whether “tax basis” reporting of these items

ld l b blcould also be reasonable– Method must be consistent with the partnership agreement– Method must be applied consistently from year to year

4545

Schedule K-1, Item JIRS Frequently Asked Questions (Cont.)

C hi h bl h d f h ?• Can a partnership change reasonable methods from one year to the next?– Yes, provided the new method is reasonable, and the partnership attaches

a statement to its Form 1065– The attached statement should include the following:

• An explanation why the change was necessary, and• A schedule comparing each partner’s end-of-year % interests in p g p y

profit, loss and capital as reported for the current year; and how it would have been reported using the method from the prior year

– Method must still be consistent with the partnership agreement p p g– Method must be applied consistently from that point forward

4646

Schedule K-1, Item JProfit, Loss And Capital Percentages

• Unusual relative profit- or loss-sharing situations– Partnerships where some partners receive net profit allocation,

but other partners receive net loss allocationbut other partners receive net loss allocation• “Tracking” allocations?• Sect. 704(c) allocations?• Sect. 743(b) adjustments?• Regulatory allocations?

– No FAQ guidance

4747

Schedule K-1, Item JProfit, Loss And Capital Percentages , p g

(Cont.)

• Partner concerns– Ratios presented vary with partners’ perceived sharing ratiosp y p p g

• Partnership concernsPrivacy concerns– Privacy concerns

– Legal concerns– Timing constraints in determining the required information– IRS intended use of information unknown, affecting ability to ascertain

most reasonable method

4848

Tax Year 2009 Reporting UpdateTax Year 2009 Reporting Update

S h d l B “ h h i ” hi di l d• Schedule B “up-the-chain” ownership disclosures moved to new Schedule B-1

• Schedule K-1 disclosure now required for contributions of property with a value that is different from adjusted tax basis (e.g., Sect. 704(c) property)• Instructions contemplate schedule of each asset contributed

• Other?

4949

2009 Reporting Update: COD Income2009 Reporting Update: COD Income Deferral – Elections And Reporting

• Under Sect. 108(i), COD income can be deferred under some circumstances

• Deferral requirements under Sect. 108(i) include the following:Deferral requirements under Sect. 108(i) include the following:– Taxpayer holds “applicable debt instrument”– ADI “reacquired” in 2009 or 2010– Reacquisition brings about COD income for taxpayerReacquisition brings about COD income for taxpayer– Taxpayer elects to defer COD income under Sect. 108(i)

• Rev. Proc. 2009-37 gives additional guidance, election procedures and reporting requirementsreporting requirements

• Applicable debt instruments are issued by C corporation or any other “person” (e.g. partnership) in connection with trade or business involving that person

50

involving that person

50

2009 Reporting Update: COD Income Deferral – Elections And Reporting

(Cont.)( )• For purposes of acquisition of an ADI, “acquisition” covers:

– Cash acquisitionsExchanges for other debt instruments– Exchanges for other debt instruments

– Exchanges for corporate stock or partnership interests– Contributions to capital– Holder’s forgiveness of instrument– Others

• “Reacquistion” covers:– Acquisitions of ADI by debtor/obligator, or related person to

debtor/obligator

51


(Cont.)( )• For elective deferral purposes, acceleration events include death of

taxpayer, liquidation or sale of taxpayer assets, ending of taxpayer’staxpayer, liquidation or sale of taxpayer assets, ending of taxpayer s business or sale/exchange/redemption of interest in pass-through entity

• Election made by partnership– Irrevocable– Irrevocable– Deferred COD can’t be excluded under another provision

• Allocated to partners on discharge date, deferred at partner level• Liability reduction• OID deferral

52


(Cont.)( )• Elective deferral provisions (Cont.)• Election procedures• Automatic 12 month extension• Automatic 12-month extension• Explicit allowance of acquisitions of non-cash property• Partial elections allowed

– Can elect to defer only part of COD– Partnership can determine included, deferred portions of individual

partner’s COD separately• Ongoing reporting by electing partnership

53


(Cont.)( )• Deferral to 2014 of CODI, when it will be taxed over five years,

available when borrower or related party buys back debt; QSUB can buy parent’s debts or vice versa

• Number of events can trigger early recognition of deferred gain (e.g. pass-through’s sale of interest)pass through s sale of interest)

• Election may not be optimal if NOLs could offset CODI

• A number of unanswered questions remain about the deferral– Fallback is always to comply with terms of Rev. Proc. 2009-37

54

Sect. 108(i) Election ProceduresOverviewOverview

Election Year Reporting Subsequent Year Reporting

S ti 108(i) S ti 108(i) A lSection 108(i)Election Statement

Section 108(i) Annual Information Statement

Schedule K-1 Coding Schedule K-1 Coding

Section 108(i) Election Information Statement for

Partners

Section 108(i) Annual Information Statement for

Partners

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