From Thomson-Reuters and the Pinnacle CPA Advisory Group —
To our Clients and Friends,
The IRS sets up compliance campaigns to address areas where it believes there are significant issues. In other words, these are areas where the IRS thinks there is an opportunity to collect underreported tax.
Its latest campaign focuses on distributions to partners that are more than their tax basis in the partnership (their outside basis). In announcing this campaign, the IRS said little, other than “Partners that report distributions from partnerships must have adequate outside basis, as determined pursuant to IRC Section 731(a), in order to receive liquidating or non-liquidating distributions not subject to gain recognition.”
This is not a surprising development, given that the IRS has two other campaigns in place focused on a partner’s outside basis, in addition to requiring partnerships to report more and more information about partners and their basis on the annual partnership return.
How basis affects tax bills
If you are partner in a partnership (or a member of an LLC classified as a partnership), outside basis can affect your tax bill in several ways.
First, it can potentially limit the amount of passed-through partnership loss that you can deduct for the year. Second, distributions that are more than your outside basis are taxable. Finally, your gain or loss on the sale or liquidation of a partnership interest depends on your outside basis.
The IRS clearly believes that some partners are not reporting the correct basis amount and, as a result, are underreporting income and gains. So, you can expect them to start looking at the returns that partners file.
The first thing you need to know is that partners, not the partnership, are responsible for documenting their outside basis if the IRS ever looks at their return.
Like most things tax-related, the rules for computing basis start off relatively simple, but there are a lot of special rules, and in some situations, things can get complicated fast.
In general, your outside basis in a partnership is increased by (1) cash and property you contribute to the partnership, (2) increases in your share of partnership liabilities, and (3) your share of partnership income.
It is decreased by (1) the amount of cash and property distributed to you, (2) decreases in your share of partnership liabilities, and (3) your share of partnership losses.
Most of the information you need to compute this key figure is reported to you each year by the partnership on Schedule K-1. See IRS FAQ section on Schedule K-1.
If you obtained your partnership interest other than by contributing cash, you will need additional information.
Contact Pinnacle CPA Advisory Group
If you have any questions or would like us to help you compute your outside basis in a partnership (or partnerships), contact our tax experts at the Pinnacle CPA Advisory Group. Reach us by calling our office at (614) 942-1990, sending email to info@cpaagi.com, or just fill out the Contact form on this website at cpaagi.com/contact.