TALKING TAX REFORM - FIXING THE LIMITED PARTNERSHP K-1

It seems appropriate on Halloween to discuss one of the scariest items involved with 1040 preparation.

 

I have said it before and I will say it again.  I HATE K-1s.  Specifically, the K-1s, always late, for limited partnership investments.

 

In almost all cases, unless there is a substantial investment, the financial tax benefits of these type of investments, if there are any, are wiped out by the cost of the additional work to actually prepare the investor’s individual tax returns.

 

I very seriously believe that brokers receive a higher commission for selling these investments, and often brokerage houses instruct their brokers to sell specific limited partnership investments to clients.  I also firmly believe that there are alternative mutual fund investments that provide the same, or perhaps better, investment returns.

 

If all we had to deal with were items in boxes 1 through 10 and 12 – business income, interest, dividends, capital gains, and the Section 179 deduction – it would be ok.  The instructions on Page 2 of the Form K-1 clearly indicate what line on series 1040 forms and schedules on which to enter these numbers.  The problem with these GD forms concerns the items of “other income” and “other deductions”.

 

For example, under “other income” the referenced internal supplemental statements reference Internal Revenue Code Sections 475, 988, and 1256, cancellation of debt, other portfolio income, and other income (not specifically identified).  For most of these items the instructions say “See the Partner’s Instructions”. 

 

“Portfolio income” is interest, dividends, royalties, and capital gains.  Sometimes the “other income” boxes detail specifically references “interest, dividends, and capital gains”.  Why is this income not included in the boxes in the first 10 that specifically identify interest, dividends, royalties, and long and short-term capital gains?  Are these items reported on Form 1040 Schedules, B, D or E, or are they merely “other income” reported on Form 1040 Line 21?  Or do they go elsewhere?

 

“Other deductions” refers to Internal Revenue Code Sections 59(e)(2) and 743, pass-thru deductions, royalty deductions, and, again not specifically identified, other deductions.  Again, we are told to “See the Partner’s Instructions”.  While I would expect “royalty deductions” are entered on Page 1 of Schedule E, where do the rest of these deductions go?

 

Of course, the taxpayer investor has absolutely no idea what these things mean – nor do they, for the most part, give a rat’s hind quarters.  They just give the multiple K-1s to their tax preparer, often as they arrive (usually after April 15^th) and expect us to figure it out.

 

The “framework” for tax “reform” talks of doing away with business “loopholes”.  The answer to fixing the dreaded limited partnership K-1 would be to do away with all the “loopholes” and Internal Revenue Code Sections that create the confusing and convoluted components of “other income” and “other deductions” identified above, and have ONE net income item for either “ordinary business income(loss)” or “net rental income(loss)” to report all “non-portfolio” income and deductions, include all portfolio income from all sources in the appropriate boxes 5 through 10, and limit “other deductions” to the traditional Section 179 deduction, charitable contributions, investment interest, and miscellaneous “portfolio” expenses.  I hope this is part of what the “framework” is talking about.

 

I would be interested in hearing from other tax pros about the dreaded limited partnership investment K-1.

 

TTFN