• Nicol Bays

Partnership's Income Taxable Regardless of Receipt

Many clients have come to me with a K1 and said, "Do I have to pay taxes on this even though I haven't received a dime?" And my answer is always, "Yes." As unfair as it seems, it follows with the accrual method of accounting. Your K1 is a representation of your investment in a business, and if that business is making a net profit, then that means your investment has grown. (A small bit of math, if you will: if you own 50% of an LLC or Partnership, then that means that if the company makes a net profit of $50,000, you have a claim to $25,000. This is the amount that should be listed on your K1 for that year.) Also, vice versa, if the company takes a loss, you have a certain percentage of the loss attributed to you.

There has recently been a tax court case that ended with this being the verdict as well. The taxpayer in the case owned a 1/3 interest in a 2-member LLC that purchased, leased, and sold real estate. She was sent a K1, which accounted for her share of the firm's income (interest, operational, etc.) which included a $1,073,000 gain. This means, for all my math people, a gain of $357,666.31 listed on her K1 at minimum. She argued that she had not received any of the funds, so she was therefore not liable for the taxes due. The tax court found NOT in her favor and she was indeed liable for those taxes. (Dodd, TC Memo. 2021-118).

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