Partnership Sale – Confusion Over 1065 Filings
To give some context, I have an Accounting background and currently own businesses. While I don’t claim to know everything, I like to seek clarity when something seems off. I have an external firm handling the filing of a 1065 for my partnership, where two partners joined and two exited through a sale.
Throughout the first three quarters, the partnership experienced a modest gain, but we faced a significant loss in Q4 with the new partners on board. The firm in charge of filing the taxes has averaged the losses based on the amount of time each partner owned their stake during the year, rather than when those losses actually occurred. This approach results in substantial losses being allocated to the partners who sold their shares on September 30, while the new partners who only took over for the last quarter appear to be unaffected.
Can anyone help clarify the basis for this calculation? It seems incorrect to me. In my experience with financial Accounting, it’s been standard practice to treat the period as a split prorated year, with the sale date acting as the dividing line. Shouldn’t this situation be handled similarly?
I would greatly appreciate any insights or advice. Thank you!
One response
It sounds like you’re grappling with a situation that’s not uncommon when dealing with partnership taxation, especially around transitions of partners. You’re correct that the timing of the partnership interest transfer is crucial in determining how income and losses are allocated for tax purposes.
Under IRS rules for partnerships, the allocation of income and losses typically happens in a way that reflects the partners’ interest in the partnership during the taxable year. The method your external firm is using—averaging the losses over the entire year rather than splitting them based on the ownership period—can lead to an uneven distribution of losses.
For partnerships, especially when partners are coming and going, the IRS allows for the partnership agreement to dictate how profits and losses are allocated, but if that’s not explicitly addressed, the default rules usually apply. In this case, treating the year as two segments (the period before the transfer and after) makes a lot of sense as it would better reflect the economic reality of each partner’s involvement.
To clarify:
Prorated Allocation: It’s common for partnerships to allocate profits and losses based on time owned or the actual economic contributions of each partner. Your understanding of treating it as a “split prorated year” seems to align with this principle and would generally be more reflective of the changes in ownership.
Consult Your Agreement: Review the partnership agreement to see if it specifies the method of allocation during changes of partners. If it does, the external firm should follow that structure.
Check IRS Guidelines: The IRS has specific guidelines on how to handle partnership transactions, especially when interests change throughout the year. If you’re still unsure, referring to IRS Publication 541 (Partnerships) can provide clarity.
It might be worth discussing your concerns directly with the external firm, especially if the current calculation leads to inequities among the partners. Additionally, if you feel the firm is not providing a reasonable methodology, you might want to consider getting a second opinion from another tax professional who specializes in partnership tax matters.