Originally published on Forbes.com.
Nik Richie growing tired of being a “cubicle warrior” doing credit card processing had an inspiration. Noting the success of “reality TV”, he thought that “reality internet” might be a thing. So he started a gossip blog called “dirtyscottsdale.com” which focused among other things on “the cool kids in Scottsdale who thought they were celebrities”. “The dirty”, being something of a universal phenomenon, the blog has evolved (probably not quite the right word) into thedirty.com, which before you click you should know does not appear to have much in the way of edification associated with it.
In its short life Dirty World LLC has already been involved in landmark litigation in the First Amendment area, as the Sixth Circuit overturned a judgement won by a cheerleader for the Cincinnati BengalsBusiness, sole proprietorship income of $46,036 from Lamas Richie Productions, LLC. The return did not include a Schedule E, Supplemental Income and Loss, and it did not otherwise report any income or loss stemming from petitioner’s 41% limited partnership interest in Dirty World.
Unfortunately, in September DW would file a partnership return that allocated $25,417 to Nik. There had been no distributions. Apparently they did not send Nik his K-1. First, he heard of it was when his return was audited.
He Owes The Tax
The principle that your distributive share of partnership income is included in your taxable income is a very strong one.
Petitioner conceded at trial that he held a 41% limited partnership interest in Dirty World during 2011, and his Schedule K-1 shows 41% as his distributive share of the partnership’s profits. Dirty World filed a Form 1065 reporting for 2011 ordinary business income of $61,992. This return was signed by Mr. Grdina, who was effectively the controlling partner, and petitioner has provided no reason to believe that this figure was incorrect. Petitioner must report his 41% distributive share of Dirty World’s profits, or $25,417, even though no distributions were made to him during 2011.
Dirty World did not file its Form 1065 for 2011 until September 2012, six months after petitioners filed their individual return. The partnership’s failure to supply petitioners with a timely Schedule K-1, however, does not relieve them of their obligation to include in income petitioner’s distributive share of the partnership’s profits. As noted earlier, “ partner is taxable on her distributive share of partnership income regardless of whether she receives it or is even aware of its existence.”
Although petitioner testified that Dirty World had losses for prior years, he introduced no evidence at trial concerning the magnitude of those losses or the existence of any loss carryforward to 2011. We accordingly have no alternative but to sustain respondent’s determination that petitioner’s distributive share of Dirty World’s business income constituted taxable income to petitioners for 2011
So Nik owes the $7,097 tax. On the bright side, he won on the 20% accuracy penalty. I note that Nik and his spouse were representing themselves, which is logical given the small stakes. It is still surprising that nothing was done with respect to the prior year losses. Assuming that Nik had put no money in the entity upfront, losses in the first two years would have been suspended by the at-risk rules and available to offset the 2011 income. Getting the earlier K-1s does not seem like it would have been much of a project.
This Could Happen To You
The LLC is a preferred entity for many businesses and it will quite often be taxed as a partnership. If you become a non-controlling member, you need to pay attention to the possibility that you might have reportable income but no cash to pay the Lew Taishoff in his coverage titled Not My Kind Of Blog notes
That’s why any properly drafted partnership agreement or organic documents of any entity taxable as a partnership will always contain a provision that the partnership must distribute to all partners enough cash to pay taxes[.
Always may be overstating it a bit, but the principle is sound.
If you are as evil-minded as I am it might occur to you that a General Partner might stick it to you by “specially allocating” income to you while making it clear, off the record, that there will never be any distributions. If you have a good reason for disagreeing with a K-1, one form of recourse is to file Form 8082 and report what you think is right. Unless you do that not following the K-1 is close to per se negligence.
Other Coverage
As noted Lew Taishoff covered the decision engaging in perhaps just a bit of click-envy.
Nik was a blogger, but his blog, unlike mine, was fantastically successful. He posted local gossip and then branched out nationally.
I console myself with the thought that, once again, virtue is its own reward.
However, I cannot in good conscience entitle this blog “Dirty Taxes”.
Tax Notes has something but that is behind a paywall and you should know by now I am not a big spender. So this might qualify as a breaking story. I’m way behind in my review of cases, but I picked this up from Lew Taishoff, who is quick to jump on Tax Court decisions.
(According to the Tax Court decision, Nik’s original website was called “thedirtyscottsdale.com”. However, a tweet I received from Nik stated the original site was called “dirtyscottsdale.com”.)