The PA Dept. of Revenue (DOR) is disallowing individuals to claim losses from out-of-state partnerships and S Corporations that do not file a partnership (or S Corp) tax return with PA. For example, let’s say you invest in 2 out-of-state partnerships. Let’s assume that neither partnership is required to file a tax return with PA as no taxable activities were performed in PA by either partnership.
To illustrate the affect on a PA individual taxpayer, assume you receive a K-1 from partnership #1 showing $10,000 of partnership income. You receive a K-1 from partnership #2 showing an $8,000 loss. Your PA-40 tax return is prepared and the $8,000 loss is offset against the $10,000 income, resulting in $2,000 of income on your PA-40. This is the correct way to compute your taxable income.
However, the PA DOR will deny your netting the two K-1s and will send you a tax deficiency letter saying that you underpaid your PA personal income taxes. The PA notice will show that you have $10,000 of income from out-of-state partnerships. While PA is happy to accept the K-1 that shows income, it will not accept the K-1 showing an $8,000 loss because it has no way of verifying the loss since partnership #2 does not file a partnership return with PA.
While PA residents investing in partnerships/S Corps that generate losses and that conduct no activities in PA can request the partnership/S Corp to file a partnership/corporate return with PA, that request will likely fall on deaf ears. Why? Because most taxpayers are loathe filing tax returns in tax jurisdictions if none are due.
Thus, what are PA residents to do? A possible alternative is to include with the filing of the PA-40 tax return a copy of the federal K-1 and to prepare a pro forma PA 20/65 business tax return along with a pro forma PA K-1. This additional paperwork will mean that more time is spent on preparing a PA tax for PA residents who invest in partnerships/S Corps that generate losses but are not required to file a tax return in PA. PA residents may also have to think twice about investing in such entities in the future.
If you want to discuss your personal tax planning and tax preparation concerns with an experienced tax professional, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation. You can also schedule a consultation at Click Here.