Partnership Disputes and Your Taxes: What You Need to Know

Partnerships are taxed as pass-through entities. In effect, this means that the profits (and losses) from the business “pass” directly to the partner. Each partner is then responsible for reporting the income and paying tax on their individual return. This raises an important question: How do you deal with taxes when partnership income is under dispute? It is a complicated question that always depends on the unique circumstances of the case. That being said, taxes should never be disregarded. Here, our Miami partnership dispute attorneys highlight three things keys you should know about partnership disputes and federal tax regulations.

Disputes about Partnership Income and Taxation: An Overview

1. The IRS (Usually) Counts Received income as Taxable Income—Unless There are Significant Restrictions
   

First and foremost, it is important to clarify one of the basic IRS regulations regarding disputed income. As a general rule, the IRS requires taxpayers—business partners and otherwise—to report all income that they have received, even if that income is still subject to an unresolved dispute. A taxpayer who has already received disputed income should generally treat that income as taxable income if there are no restrictions on how the funds can be used. If there are significant restrictions—such as if the funds are placed in an escrow account—then a taxpayer may wait to pay taxes on the income until it is actually received. 

2. Partnership Income is More Complicated: Distributive Shares of Income are Taxable, Actual Distribution is Not Required
   

In light of the general principle mentioned above, you might assume that disputed partnership income is not taxable as long there are still significant outstanding restrictions on it. However, that is not necessarily true. Disputed partnership income is more complicated. The reason for this is that partnership income is taxable income even without an actual distribution. Under federal tax regulations (26 CFR § 1.702-1), business partners must report their distributive shares of partnership income even without an actual distribution.  

3. The Key Factor: Internal Disputes vs. Third Party Disputes
   

Here is a general summary of what these IRS regulations mean for disputed partnership income and taxes:

• Business partners who have unrestricted access to partnership income should report the earnings to the IRS and pay taxes.
• Business partners involved in an internal dispute over partnership income still need to report income and pay their share of taxes, even if that income has not actually been distributed to any individual partnership. In other words, the partnership as an entity cannot avoid paying taxes because of an internal dispute.
• A business partnership involved with an outside third party may be able to delay reporting and paying taxes on income that is currently restricted (in an escrow account) related to the dispute.
  

Call Our Florida Partnership Disputes Attorneys for Immediate Help

At Pike & Lustig, LLP, our Florida partnership law attorneys strive to provide quality, solutions-driven guidance and support to our clients. If you have any questions about partnership disputes and tax obligations, we are available to help. Call us now for a fully confidential initial consultation. From our offices in Miami and West Palm Beach, we represent business partners throughout Southeastern Florida.