Sunday, November 12, 2006

ERRONEOUS K-1s

Taxpayers sometimes receive erroneous K-1s, showing the wrong partner, shareholder, or beneficiary being allocated items of income and/or expense. The issuing entity may not always be cooperative in filing a correction with the IRS. What should a taxpayer do if he or she receives one, showing net income, and cannot get the issuer to correct it in a timely manner?

Ignoring the K-1 is one choice - that is, don’t report anything from the K-1 on the taxpayer’s tax return. The potential problem with this is IRS computer matching programs - the IRS’ computer may try to match the K-1 items with the taxpayer’s tax return - if the income items are not present this could trigger an inquiry from the IRS, or perhaps even an audit if the amounts are large enough.

One method that tax preparers have successfully used is to report the K-1 items on the taxpayer’s tax returns. Then, a corresponding negative entry is included (often referred to as a nominee entry), showing such amount being directed to the proper person if known, and their taxpayer identification number. In this way, if the IRS’ computers attempt to match, the K-1 items will show up and the computer will not flag a mismatch.

Some CPA’s suggest, however, that another method of dealing with this is to file a Form 8082 with the return, including details of the proper recipient of the K-1 on the form.

Whatever course of action is undertaken, the taxpayer doing this should keep records on the item, in case of future inquiries or audit. The taxpayer should also put the issuer on notice of the error, so at a minimum the issuer should not repeat the error in the following year.
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