Taxable or not?

[Mike]

Client has a K-1 for a family partnership (1065) with investment income, gains, etc. The K-1 also has an amount in box 11 A, for misc income which turns out to be noted as "return of investment fees". The investment fees are always a 2% misc itemized deduction and the client has never been able to deduct them as they never reach the 2% threshold. Is this amount included as taxable income?

[kcjenkins]

The K-1 Line 11A would be income. Don't mix that up with investment fees that the client pays, this would be investment fees refunded to the partnership, which would normally be taxable because they had been deducted as an expense in a prior period. Similar to state tax refund being taxable if you itemized and deducted them in the prior year.

[Mike]

However, these fees were never deducted because they were 2% misc itemized fees and never enought to be over 2%. The investment fees are always passed through on line 13 J and deducted by the taxpayer, if able. For this client, he is not able to deduct them.

If the refund is taxable the client is taxed on a refund that was never deducted. Is this a supportable position?

[lbbwest]

If the taxpayer never deducted them in previous years, the return of the fees would not be taxable.

[OldJack]

I agree with KC that this is taxable income even though the taxpayer may not have been able to deduct any prior year fee expense of this nature. The fee expense of prior years is immaterial to this being reported as income in this year.

[RJM]

IMO Mike and lbbwest are correct. This is a tax benefit rule issue. You can support it with a statement on the return. On large ones, I have attached the "inconsistent treatment" form with a statement explaining, and never received notices. This is only supportable if you are certain the P/S accountant is passing thru the fees as misc itemized dedux, tho. -Bob

[Mike]

Thanks all. I am sure that the investment expenses being refunded have never been deducted, since I have done all returns for this client since the partnership was formed. I'm contacting the partnership preparer to get confirmation that the same expenses being refunded are the ones being reported as 2% portfolio deductions. If so, I'll attach a statement and leave them out.