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Level 5

Profit Percentage on 1065

Husband and Wife LLC filing 1065 and CA 568.

 

Can change profit percentages between years (e.g., 50/50 to 80/20 to 30/70 etc.)?  Are there any issues with doing that?  (I want to) CPAs in the past just allocated profits differently than the stated 50/50 percent, and included a statement that it was proportional share of aggregate.

 

 

9 Replies
Level 20

Profit Percentage on 1065

You asked and answered your own question. And FYI ... the 1065 is now late and the late filing penalties are accruing so file ASAP.
Level 5

Profit Percentage on 1065

I didn't fully answer it.  So yes the past CPAs sometime distributed differently than the reported profit percentage, and included a statement.  However, TT does't play well doing that.  It does if I change the ending year profit percentage to match the proportional distributions.  So the question is: Is changing the profit percentages kosher?

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Level 20

Profit Percentage on 1065


@HydroSci wrote:

So the question is: Is changing the profit percentages kosher?


If specified in the partnership agreement (probably doubtful) and it has economic substance.

 

[you must have a substantial purpose other than the reduction of tax liability, and also an economic effect other than the tax effect of the change]

 

Level 5

Profit Percentage on 1065

I have read that.  Thank you.  Note that in CA a partnership agreement can be oral.  Our purpose is to make the benefits of the business more equitable by building up more equivalent amounts in tax deferred retirement accounts.  Past deferrals contributed more to one than the other.  Now we want to fix that.  Not sure where that falls.  But we both agree that that would be a good idea.

 

And yes I am late! My accountant became ill - in good faith I waited for him to get better - but time is up and past.  

Level 14

Profit Percentage on 1065

I would walk very carefully down this path.  Any allocation other than based on the partners interest in the partnership (known as PIP) must have substantial economic effect (SEE).  The regulations that cover this area are voluminous and understood by very few.

 

While CA may allow for an oral partnership agreement, that doesn't mean anything to the IRS.  As stated above, unless you have a special allocation drafted in your partnership agreement, and can prove to the IRS that the special allocation meets the SEE test,  the IRS will use the default PIP allocation.

 

Additionally, your reasoning of building up more equivalent amounts in the tax deferred retirement accounts does not sound like it would pass the substantial economic effect test.

 

I believe you are playing roulette here and would not prevail if audited.

Level 8

Profit Percentage on 1065

In general, you can change profits allocations for a year up to the due date of that year's partnership return, not including extensions. So March 15 for a calendar-year partnership. So a change after year-end can be kosher, up to a certain point, and assuming it's permitted by your partnership agreement.

 

Whether the profits allocations will be effective is another issue. Your partnership will either comply with a SEE safe harbor or PIP. Most recent partnership agreements don't comply with SEE; an easy but not conclusive check is to look at the liquidation provision in the partnership agreement. If liquidation is in accordance with positive capital accounts, then you might be in SEE. If not, you're probably in PIP.

 

If you're in PIP, then the question is whether the new profits allocations will be respected. If you're balancing income allocations among partners because they weren't in alignment with the business deal, then that may work. If the partners involved both hold through retirement accounts, then any tax gaming is pretty attenuated. You really want to make sure that the tax allocations track real shifts in the partnership's economics--who gets what in terms of distributions. Your accountant, or the lawyer who did the partnership agreement, may be able to help in that respect.

Level 8

Profit Percentage on 1065

@Rick19744, you wrote that, "While CA may allow for an oral partnership agreement, that doesn't mean anything to the IRS." Kind of a footnote, but this statement is not correct. Oral partnership agreements, and oral modifications of written partnership agreements, are effective if permitted under the partnership agreement and state law.

Level 14

Profit Percentage on 1065

Another one of your "less than helpful' responses that do nothing but add to confusion for individuals looking for help in this complicated area.

Level 8

Profit Percentage on 1065

Doesn't it add confusion to misstate or garble what the law is? The poster might think that an oral modification that works under CA law doesn't work for tax purposes. But that's exactly wrong under the partnership regulations. If the poster made an effective state-law oral modification of their partnership agreement in early 2019, your advice would cause them to misfile their (already late) 1065.

 

If you're misstating the law intentionally to "help" someone, it seems like the person you're trying to help isn't the poster. If you weren't aware that oral modifications can be effective for tax, then you should acknowledge the mistake. If you think that it will be too hard to prove that an oral modification occurred, then you should correct your post. Taxpayers have been successful in proving such things, and poster's facts are open enough that the rules should be presented fairly.