September 2002

Schedule K-1 Update

Earlier this year, the IRS began and completed the initial phase of the first matching program of Schedule K-1 forms from partnerships, S corporations, and trusts to individual returns. The IRS may make enhancements to the program based on preliminary feedback and evaluation. The IRS has said it will continue to work with stakeholders, especially tax practitioners, to refine the initiative. It remains committed to improving compliance on information reporting on K-1s, and therefore ensuring fairness to all taxpayers, while imposing the least possible burden on taxpayers covered by K-1s.

The IRS ceased issuing notices on August 1, 2002, to taxpayers for tax year 2000 on Schedule K-1 matching issues. Notices issued beforehand are legally valid and will be processed as usual; taxpayers and practitioners receiving these notices should respond as indicated.

In November, the IRS expects to have sufficient data from closed cases to begin determining possible enhancements to the program. It plans to review the accuracy of the screen-out process and the level of no-change rates. The IRS is expected to work closely with external stakeholders once the data gathering and analysis are completed to develop future policy and procedures for the matching program. Matching of tax year 2001 returns is expected to continue as scheduled, with refinements incorporated in the interim.

The IRS will still use K-1 information to enhance compliance in the following applications:

• The Substitute for Return program used to address nonfilers
• The information reviewed by the IRS’s Lead Development Center, which identifies abusive scheme promoters and users
• The classification and selection of business and individual returns for examination through a more complete understanding of related flow-through entities.

The IRS offers the following suggestions when preparing tax returns:

• Adequately identify amended K-1 forms. The flow-through entity issuing the K-1 should clearly mark these as amended. Individuals are not required to attach the K-1 to their returns. Therefore, the only way an individual can inform the IRS about an amended K-1 is to attach a schedule or explanation.
• Adequately identify estimated K-1 forms.
• Avoid netting information unless adequate schedules or explanations are attached. Properly treat and report related expenses and avoid netting flow-through related expenses against any K-1 income item. Additionally, passive activity loss or other loss carryovers that have been netted against ordinary flow-through income or losses should be explained on a schedule such as Form 8582, Passive Activity Loss Limitation.