I received a call from a client (who I will call Joe) that his partner was bought out about 8 months ago in November and he had decided to elect S corporation status but had received a letter back from the IRS of rejection. The partnership technically terminated back on October 31 of the previous year and the tax return filings were overdue.

First, by Joe trying to do his own tax work, he has caused himself to waste cash dollars through taxes and penalties not to mention stress.

What Joe needed to know is that as soon as he bought out his partner, the partnership died because it requires two partners.

Fortunately, I normally receive a phone call when there is a death of one of two partners or a partner is buying out another partner.

Or, l see a partnership end when there is a death of one of the partner and there is a buy sell agreement.

Or, when one partner who owns over 50% of the partnership sells to a new partner, a “technical termination” occurs. The definition of a “technical termination” is within a 12 month period there is a sale or exchange of 50% or more of the total interest in partnership capital and profits.

What is the effect of this a “technical termination”?

Existing partnership is deemed to transfer all assets and liabilities to a new partnership in exchange for an interest in new partnership.

The old partnership is deemed to transfer interest in new partnership to partners. Basically, there isn’t a change but IRS can assess late filing penalties for failure to file the terminating partnership on time.

The new partnerships basis in its assets is identical to the basis of the assets in the old partnership. Generally there is no gain or loss in recognized by the partners in technical termination.

However, there are two tax returns, one pre-termination period final return and a second one which is called “post termination period” initial return. So, the problem is failure to file on time the original termination of the old partnership. If there were 4 partners and the return is 10 months late, how much would the late filing penalty be? $7,800!

You will see that most things stay the same when the old partnership ends and the new partnership commences.

Do you continue the same federal ID#? Yes!

Do the fixed assets and accumulated depreciation change? No!

So, what happens when one partner dies?

The estate trust can continue on as a partner as long as liquidating payments are being paid. Of a buy sale agreement funded by insurance occurs, then the estate trust is no longer a partner.

So what is the take away?

When liquidating the partnership, you must file the 1065 partnership tax returns within 3.5 months (without extension) or there will be an assessment of $195 per month per partner! And although we have had success with abatement of penalty, it is not guaranteed.

What about failure to convert to an S corporation? Joe needed to establish a new federal ID# and elect S corporation status immediately on November 1. By trying to use the old partnership federal ID#, Joe gets taxed as a sole proprietorship and all of the income is subject to not just income tax but double FICA/Medicare tax too!

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009