Partnership K-1 losses and gains

why not ask the IRS. I've found them always polite and responsive. (But, I live near one of their offices and can easily go ask questions in Person).

In theory you can do that. In practice it's not always the best practice.

A study done several years ago had people call into the IRS six times with the same question. Each time the questions were answered by different people. And each and every time (for the most part) all the answers were wrong.

If you get a wrong answer from someone at the IRS, and follow what they say, you are just as wrong as if you had thought it up yourself. By law you are not allowed to rely on anything someone at the IRS tells you, unless it is in an official rule or revenue ruling (or letter ruling if you were the one who asked for it).

I was consulted by a person once who, as an 18 year old in the military overseas, was away from home for the first time. He had to file a tax return for the first time, and it confused him. He checked the box asking the IRS to compute his taxes, which they did.

Then later the IRS decided that they had gotten it wrong, and the kid owed more taxes. Not only that, they added interest and penalties.

Are you saying that the K-1 income from your wife's business in the general partnership would be passive income next year? How come?

Passive activity losses can generally only be offset against passive gains from the same activity. Otherwise they are suspended until you dispose of the passive activity.

Therefore, what you are proposing won't work.

Ira Smilovitz

"...can only be offset against passive gains from the same activity."

"From the same activity." How so? I thought the passive stuff all gets netted together.

It's a psychological counseling business for which she does all the work. If we split the ownership and income 50/50, I'm thinking that her portion would be active and mine would be passive.

Alan

I'm pretty sure that all the passive gains and losses are indeed netted together. Schedule E Part II has the forms where multiple investments can be entered on line 28 and totals on line 29.

Alan

Yes, but you have to go through Form 8592 first before you get to Schedule E, Part II,

Ira Smilovitz

Are you sure you can be an (co-)owner of a psychological counseling business without be licensed yourself?

Ira Smilovitz

See the US Supreme Court decision in Lucas vs Earl, 281 US 111 (1930) and all subsequent tax cases that reference it. It deals with the creation of the assignment of income doctrine. The court said that that income from services is taxed to the party who performed the services. Oliver Wendell Holmes delivered the majority opinion and it contains a very famous quotation: "The fruits cannot be attributed to a different tree from that on which they grew."

Additionally, the IRS would also probably argue that under IRC §

704(b)(2)and its Treas. Reg. § 1.704-1(b)(1)(I) tax allocations in a partnership agreement will not be honored if they lack "substantial economic effect."

I think we don't have to go to SCOTUS to answer this one. There's a provision right there in the IRC, at Section 469(h)(5) that says this:

"(5) Participation by spouse In determining whether a taxpayer materially participates, the participation of the spouse of the taxpayer shall be taken into account."

I think what this means is that in our scenario the husband can't not be a material participant in his wife's practice, for passive loss purposes under the tax code, given that the wife is a material participant.

Good question. Thanks.

Surprisingly perhaps, unlike accounting, the state does not require a license to open a counseling practice. My wife needs (and has) a certification as a licensed social worker, which is needed for her to receive insurance payments but, as far as I know, that is not required from the government's point of view.

I'll try to investigate further.

Alan

Thank you Ira.

I couldn't find 8592, but it looks like you meant to say 8582.

I looked at it.

Taxes give me such a headache.

Alan

I haven't tried to find and read the Supreme Court decision, but if I understand your summary of it, it looks like it blows away my idea.

I may have to just forget about all of the losses.

Thanks.

Alan

Thanks lotax.

Putting it in the simplest terms, if my wife and I form a general partnership from her counseling business, does that mean we can or cannot offset income from the partnership against passive losses from an investment?

To do so, do I have to declare my wife as receiving active income and me as receiving passive income?

If I do have to do that, is it forbidden by the tax code quotation above?

I do some work for her business, mainly keeping her computers running, backing up data, solving computer problems, showing her how to use software, etc. But it's usually no more than a few hours a week, often less.

Thanks.

Alan

In simplest terms, it means that if you form a partnership with your spouse and the partnership generates its income through the services of one spouse, the other spouse cannot receive passive income from the partnership. The income must be nonpassive. Additionally, from your last response, providing any services to the partnership such as IT support, generally would make your income from the partnership nonpassive even in the case where your wife wasn't the service-providing partner. (There are some exceptions.)

Getting back to the starting point of this whole exercise, you can't use your passive losses to offset the nonpassive income from your wife's services regardless of the entity form under which she provides the services.

Ira Smilovitz

Your interpretation is not correct. What it means is: When one spouse is operating a business, you determine whether there has been material participation by that taxpayer by looking at both spouses' participation. You can have two spouses in a partnership and only one spouse with material participation. The other spouse can have zero participation.

All that said, my original reply still stands when it comes to performing services. The USSC citation and all tax cases that subsequently followed it will not allow for the assignment of income to the spouse in this case. Bear in mind that if this was allowed, the spouse performing services would "evade" paying SE tax.

Alan says "The other spouse can have zero participation."

Not the way I read it. See the related regulation:

(3) Participation of spouse. In the case of any person who is a married individual (within the meaning of section 7703) for the taxable year, any participation by such person's spouse in the activity during the taxable year (without regard to whether the spouse owns an interest in the activity and without regard to whether the spouses file a joint return for the taxable year) shall be treated, for purposes of applying section 469 and the regulations thereunder to such person, as participation by such person in the activity during the taxable year.

I don't see *any* mention in there about which spouse is "operating the business" and I'm pretty sure this applies both ways, to and from each spouse to the other spouse. You have any resource for this?

Got it.

Thanks.

Alan