Posted by: jkalinski | December 30, 2016

Tax Court Update: Distributive Share of Partnership Income is Taxable Even If You Do Not Receive It by JONATHAN KALINSKI

The Tax Court issued a reminder that a partner’s distributive share of partnership income is taxable to the partner even if he never actually receives money.[1]  Also, ignoring your tax professional’s advice does not constitute “reasonable cause”.

Walter Mack, a partner at a New York law firm received a K-1 showing his distributive share of income as $479,743.[2]  He reported $75,000 as income, claiming that under New York State law he was required to use the rest to pay his firm’s expenses in an effort to keep the firm from going out of business.[3]

Mr. Mack’s position was that because of the 2008 recession, other partners could not cover the firm’s expenses so he needed to step in. Mr. Mack sought the advice of tax professionals who advised him that although the tax law might be unfair, he needed to report his entire distributive share as income.  He decided to ignore their advice and “face the consequences”.[4]  He prepared his own return and reported a total of $75,000 from his firm.

Not surprisingly, the IRS audited Mr. Mack and issued a Notice of Deficiency, adding an accuracy-related penalty to the unreported income. The IRS filed for summary judgment and the Court granted the motion.  Summary judgment is not used in Tax Court nearly as much as state courts or Federal District Courts, and is usually seen in Collection Due Process cases.  This case shows that it can be used effectively in a deficiency case, where the facts are not really in dispute.

The result in this case is obvious, but a reminder that income does not have to actually be received to be taxable. The Court notes that Mr. Mack’s did not allege that his firm failed to claim expenses, which would have reduced its income and therefore his distributive share.  It also points out that if Mr. Mack’s putting his share back into the firm was a capital contribution, that it is not deductible.

This case also highlights that ability to pay is not a winning argument in a deficiency case. That might be an argument raised with a revenue agent or appeals officer in the hopes that they will choose to settle the case, but the Tax Court will not consider it.  Ability to pay is of course an argument for collections and could come before the Court through a Collection Due Process case.

Finally, to no one’s surprise, the Court held the Macks liable for the accuracy-related penalty. The opinion puts it perfectly.

“Mr. Mack admits that tax professionals explained to him that the tax law required him (albeit “unfairly”, they said) to report his share of the partnership income (and advised him to dissolve the firm in order to stay in compliance with his own tax obligations), and that he disregarded their advice and affirmatively decided not to do so but instead to “face the consequence”. The accuracy-related penalty is now part of that consequence.”

JONATHAN KALINSKI specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world.  He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.

Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters.  Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters.  Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.

[1] Mack v. Commissioner, T.C. Memo. 2016-229.

[2] Id.

[3] Id.

[4] Id.

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