By Jane McCurdy, CPA
The IRS Form 1065, U.S. Return of Partnership Income, is the tax return that partnerships must file annually. Beginning with the 2009 tax year, partnerships are required to answer two new questions when filing Form 1065.
- At the end of the tax year, did any entity or individual have, directly or indirectly, an ownership interest of 50% or more in the partnership?
- At the end of the tax year, did the partnership own 20% or more directly of the stock of a corporation or interest in another partnership; or did the partnership own 50% or more, directly or indirectly, of the stock of a corporation or interest in another partnership?
These two questions essentially ask for a chain of ownership involving the partnership. On the surface, these questions would appear straightforward. However, in addition to looking at the direct ownership, one must consider the constructive ownership rules. These rules are defined in Internal Revenue Code Section 267(c). Basically, these new rules mean that the partnership must look "up and down the chain" of ownership in entities and must also look at family relationships. These concepts are best illustrated through some examples:
Corporation A owns, directly, an interest of 50% of Partnership B. Corporation A also owns, directly, an interest of 15% in Partnership C. Partnership B owns, directly an interest of 70% in Partnership C. So, we've got the following ownerships:
As a result, Corporation A owns, directly or indirectly, 50% of Partnership C (15% directly and 35% indirectly through its ownership of Partnership B). Partnership C should report on the 2009 Form 1065 that it is owned 50% by Corporation A and 70% by Partnership B.
Note: Ownership percentages of direct and indirect ownership can exceed 100%.
Individual A owns 50% of Partnership X. Individual B, the daughter of A, does not own any part of Partnership X, but she does own 80% of Partnership Y. Partnership Y owns 30% of Partnership X. Therefore, the following ownerships exist:
Individual A owns, directly or indirectly, 74% of Partnership X (50% directly and 24% indirectly through his relationship to his daughter and her ownership in Partnership Y, which owns part of Partnership X). Partnership X should report on the 2009 Form 1065 that it is owned 74% by Individual A.
Note: Another anomaly of these constructive ownership rules is that the ownership shown on Schedule B might not always agree to the ownership shown on the Schedule K-1 for that partner.
Partnership A owns a 45% interest in Partnership B. Partnership A owns 15% of Partnership C and Partnership B owns 85% of Partnership C. So, the following ownership structures exist:
Partnership A owns, directly, a 45% interest in Partnership B and directly and indirectly a 53% interest in Partnership C (15% directly and 38% indirectly through its ownership of Partnership B). What is shown on Partnership A's Form 1065 is 45% interest in Partnership B (since that is a more than 20% direct ownership) and a 53% interest in Partnership C (since that is a more than 50% direct or indirect ownership). This example illustrates the look-through principle that must be used in answering these questions. At first glance, one might think that Partnership C does not need to be disclosed because Partnership A only owns less than 20%, but further inspection of the "chain of ownership" reveals the need to include Partnership C on the Form 1065.
What all this means for the preparation of 2009 partnership tax returns in the coming months is that the partnerships will need to consider not only their direct owners but also ask questions about who owns their partners or who is related to their partners as well as what do they own. Feel free to contact Jane McCurdy at [email protected] for additional information.
About the author
Jane McCurdy, CPA, is a senior manager in the tax department of Camp Hill, PA-based McKonley & Asbury specializing in non-profit, individual, and partnership tax services.