NEW YORK (HedgeWorld.com)--New York State Society of Certified Public Accountants proposed a more detailed version of Schedule K-1 to facilitate the Internal Revenue Service's effort to match income provided by partnerships and limited liability companies to information reported on tax returns from their partners, including hedge fund investors.
The IRS instituted a K-1 matching program in 2001 to identify under-reporting by such taxpayers, but because of the difficulty in matching certain income flows, this resulted in many people mistakenly being accused of not reporting income despite having complied with the rules.
In response to taxpayer complaints, the agency stopped sending these notices. The United States General Accounting Office is assessing the program at the request of the Senate Committee on Finance. "Sending under-reporter notices to compliant taxpayers wastes taxpayers' time and money," GAO stated in a report on this issue.
NYSSCPA is suggesting a more informative form that breaks out the various types of income aggregated as "other income" in the current K-1 schedule, such as non-portfolio short-term and long-term capital gains. The hope is that this will help the IRS match partnership and investor information, thus reducing instances of compliant taxpayers showing up as potential cheats on the IRS's computers.
"For most partnerships, the current Schedule K-1 is fine," said Leon M. Metzger, a member of the task force that drafted the alternative schedule. "But partnerships with more complex reporting needs, like hedge funds, might prefer to use the long form."
The most often used option for reporting non-portfolio income in the current form is the line seven "other" category. For example, there is no separate line to report mark-to-market income, Mr. Metzger explained. The IRS looks for a single number in the income tax return, but the various components are in different places. The proposed K-1 identifies these separately so that the IRS computer can match them.
"This way, fewer honest taxpayers will be snagged, and the IRS will not waste enforcement resources," said Mr. Metzger. "This is a win-win solution both for taxpayers who comply with the law and for the IRS."
He emphasized that the proposed long form would be an alternative rather than a replacement for reporting tax information. Those partnerships that find the current form adequate for their needs could continue to use it.