Partnership Reporting

[wizbang30]

I have a client who had an operating agreement to form an LLC in IL. My client was the general manager of the Partnership. The former CPA filed a 1065 in 2006, while both partners were being paid salaries through a payroll service, so they both received a K-1 and a W-2 from the Company. The other partner according to the agreement could not authorize any invoice over $5k. The other partner (while my client was out of the country) went to the office and wrote himself a $25k check and Voluntarily Withdrew from the Company. After further review of the accounting records he was paying his wife through a temp agency, getting paid per-diem while charging actual expense to a company credit card, etc. I can't find anything that is real clear about how to report these items. A police report has been filed and a federal lawsuit is being considered. I know that I will have to amend the 941's for the partners salaries for 2006 & 2007. However, I don't know how to report these items. This happened in 5/07, so I am wondering If I should file a 1065 for 1/07 to 5/07 and report the money he "scammed" from the partnership on his K-1 as self employment income (box 14) and attach a statement for the IRS explaining the calculation because it wont be 49% of the money on the 1065?
The other problem (as it is with all of our clients) is this client does not want to get audited, and he is reluctant to amend any returns but I believe I have to either advise him to amend or withdrawl from the engagement, because it would be wrong?

I am new to this website and found it while trying to figure the problem out, I would appreciate any opinions that anyone has.

James, CPA

[Bees Knees]

a few ideas...

If the guy skipped town on 5/7/2007, you technically have a partnership termination on that date and the 1065 should be closed out on that date. The problem is you now have a late 1065 return, as the due date for filing the final return has already passed.

I’m not sure I would go amending any 941s. First off, partners are not employees, and therefore reporting any amount on a W-2 is wrong. If 2006 is a done deal, leave it alone.

If you want to allocate embezzled income to the skipping partner, do it through guaranteed payments. It’s subject to SE tax, and it does not have to be based on the partner’s ownership percentage of profits and losses. I’d also include 2007 W-2 wages as guaranteed payments, as well as the per diem as it was not an authorized accountable plan.

[wizbang30]

Embezzled money as guaranteed payments makes sense

There is an attorney involved who advised my client that the partnership didnt't technically dissolve and that he needed to file on a calendar year basis. I got involved after the fact. I told the attorney I thought the 2007 1065 return should have already been filed, then i would file the 2553 to make the SMLLC so he can start being taxed as a corp.

The "other" partner also received a salary in 2007, which to report as guaranteed payments would have to include his net wages and the 2007 941's would have to be amended. I am thinking that if I don't amend both years I could be held liable.

I appreciate the ideas, I have never filed a return with embezzled money involved. Also to top it off the guy is now working for my clients competition, so the lawsuit will be about that also, that why I want to make sure the reporting makes sense if the returns have to argued in court or the "other" partner files an 8082 and the return gets reviewed.

Once again thanks for the ideas....

[Bees Knees]

Non-tax advice…

If the partner who skipped town is now working for the competition, and there is going to be a lawsuit over the embezzled funds, then name the competitor in the lawsuit as well and claim the competitor had something to do with it. Even if you can’t prove it and the competitor is just an innocent bystander, it will cause friction between the competitor and their new employee, as the competitor will have to defend itself against the claim. The competitor is in fact obtaining unfair advantage by hiring the ex-partner who knows your company secrets. The competitor getting dragged into the lawsuit could speed up any kind of settlement your client will eventually receive.

[DaveO]

Good advice Bees

Non-tax advice…

If the partner who skipped town is now working for the competition, and there is going to be a lawsuit over the embezzled funds, then name the competitor in the lawsuit as well and claim the competitor had something to do with it. Even if you can’t prove it and the competitor is just an innocent bystander, it will cause friction between the competitor and their new employee, as the competitor will have to defend itself against the claim. The competitor is in fact obtaining unfair advantage by hiring the ex-partner who knows your company secrets. The competitor getting dragged into the lawsuit could speed up any kind of settlement your client will eventually receive.

I like the way you think!

[wizbang30]

That is great advice...

I have spent so many hours reviewing this companies books and trying to figure out the best way to help my client recover through his tax return, I just left the rest to the attorney. Thanks, Bees......I will tell this guy to call you for legal advice in the future....

I guess the question I have now is if I should provide a statement with the return or just amend the 2007 941's, report the net wages he received (as well as the embezzled amounts) as guaranteed payments on the 2007 1065 and see what happens.......

[Golden Rocket]

Partnership is Terminated

...for tax purposes if 50% or more of the ownership turns over. If the departing partner was a 50% partner, this partnership terminated when the partner withdrew.

If May 7th is the defining date, the partnership terminated then. Lawyer may not be aware of this - he wouldn't be the first lawyer who didn't know. There may be perfectly logistical reasons for the lawyer to pursue in the way he sees fit, but for filing purposes, the partnership is over.

Notice I stated "if May 7th is the defining date." If the circumstances do not lock you into that date, you might file as the attorney recommends.

[les grans]

What the Code sez...

What the Code says is this:

"STATUTE
(a) General rule
For purposes of this subchapter, an existing partnership shall be considered as continuing if it is not terminated.
(b) Termination
(1) General rule
For purposes of subsection (a), a partnership shall be considered as terminated only if -
(A) no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or
(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

[aside] Why does it say "a" sale or exchange? I'm sure it can be any number of sales and/or exchanges the total of which is half or more of the interests in capital and profits....

[Bees Knees]

(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.

[aside] Why does it say "a" sale or exchange? I'm sure it can be any number of sales and/or exchanges the total of which is half or more of the interests in capital and profits....

Embezzling could be considered exchanging your partnership interest for cash stolen.

Who in their right mind would think they are still a partner after screwing the other guy?

[BOB W]

No real damage is done reporting partners' salaries on a 941/w-2, although improper as it is. I would use guaranteed payments for all else. It is called "KISS". Don't complicate an already complicated situation.
If you insist on changing the 941s', the LLC will be getting a refund of SS & Fed/State W/H taxes of the partners back into the LLC. That could be good and bad. The leaving partner could be counting on those withheld taxes. This could set "You" up with problems with the leaving partner.

The bothersome question that remaines over this whole issue is, What does his Capital Account show? Would/could the $25,000 just be a return of capital???????, although an unauthorized withdrawal.

I would do as Bees said, involve as many parties as posible in your legal suit. They are probably guilty anyway.
And if by some slim chance they are not, it will let the new company know what a slime bucket their new employee is.

__________________________________________________ ____________________________
If you don't like any of these answers, stick around there will be more to come

[JON]

You better talk to the attorney

If you are sueing the other partner for amounts he took-how can you call them compensation, return of capital or any other type of expense. I think the amounts are due from him. The partnership termination issue is more complicated then presented here. Do you even want the partner out if he owes money back to the partnership. I think you have to find out who is sueing who. If everyone was 50/50 who had or has control? I think accounting and tax will follow what is legally going to happen. Do you want the partnership to terminate? Can you terminate it, whithout the consent of the other partner? Is it your responsibility to continue the partnership? Who has claim to to what assets and liabilities when it terminates.

[wizbang30]

The "other" partner

only owned 49% and he did "voluntarily withdrawl" from the partnership as of 5/2007, however since there wasn't a "more than" 50% withdrawl, the attorney advised that the partnership did not terminate as of 5/31 so the return was not due till 2008.....

In the Operating Agreement if the partner "voluntarily withdrew" he was in breach of the agreement (which only stated that they split the profits of the company, nothing about guarunteed payments) and did not have any right in the event of a liquidation of the company.

The company was formed in 2006, there was only $3k as capital from each partner, the rest of the capital was recourse debt (loan signed by both partners) and had a loss reported on the K-1, and had wages reported (which the CPA who did my clients taxes offset the loss against the W-2 income) so there are a lot of "issues" that are going on besides the lawsuit.

I have typed up every scenerio from reporting it just like they did last year (w/o the embezzelled funds) to amending everything and letting the "other" partner deal with the IRS...it just seems that every scenario ends up with my client having repercusions from it and they all point to an IRS audit....

I was even thinking of advising that he report the amount of loss from the previous year as SE income in the current year since the company paid the loan off. I have beat my head against the wall with this one, and I feel like there is no right answer.....just a difficult choice.....

I appreciate all of the comments.........this is one I should probably just walk away from, but it will be interesting to see how it comes out..........

[Bees Knees]

only owned 49% and he did "voluntarily withdrawl" from the partnership as of 5/2007, however since there wasn't a "more than" 50% withdrawl, the attorney advised that the partnership did not terminate as of 5/31 so the return was not due till 2008.....

There are two ways a partnership terminates:

1) Sale or exchange of at least 50% of the total interest in a partnership within a 12-month period...
2) Partnership operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. [IRC Sec. 708]

If your partnership only had two partners, and the 49% partner voluntarily withdrew, then the 51% partner is no longer carrying on a business in a partnership because Reg. Sec. 301.7701-2(c)(1) says a partnership must have at least two members. Thus, the minute you go down to one partner, it is no longer an operation continued by any of its partners in a partnership under Section 708. It is an operation continued by one of its former partners in a single member entity, such as a sole proprietorship, or a corporation, if elected. Thus, the partnership is still terminated as of May, 2007.

[Davc]

Non-tax advice…

If the partner who skipped town is now working for the competition, and there is going to be a lawsuit over the embezzled funds, then name the competitor in the lawsuit as well and claim the competitor had something to do with it. Even if you can’t prove it and the competitor is just an innocent bystander, it will cause friction between the competitor and their new employee, as the competitor will have to defend itself against the claim.

Hmmmm..... How would you like it if people told your clients to sue you? Along the lines of "He may be innocent, but he'll settle to avoid going to court".

[Nashville]

Compensation

A warning against allowing the misappropriated amounts paid through payroll to stand, so as to avoid re-filing 941s and creating upheavals in payroll records.

Amounts paid to a party through payroll are considered compensation for services earned. Not for stolen amounts of money. The stigma attached to a W-2 is that it was money earned by the "sweat of their brow" and they would thus be entitled to it.

Yes, allowing the payroll to stand solves some of the problems. No re-filing of payroll tax returns, no delving into old payroll records. Confiscated amounts are guaranteed to be deductible, and also taxable to the recipients, so there is a measure of sweetness in knowing that they will have to pay tax on the stolen money. But I don't know that you can afford to let the records show that they were paid for actual work and not theft.