Discussion:Franchise Fees and need for amended return

Here are the facts:

I just took on a new client(Partnership tax return)who is requesting I file his 2006 taxes (he does not like his prior accountant...not sure why). While reviewing his 2005 Form 1065 tax return I noticed his prior accountant amortized the franchise fee on a 5 year timeframe. I knew this was wrong, for it should have been 15 yrs.

Here are all the problems: 2005 was the first year of franchise. In 2006 , my client settled (legally) with the franchisor and is no longer a franchisee. However, my client is still running the same company, but not as a franchise. It was the ONLY Sec 197 and is completely disposed of Dec 2006 (so it is more than one year)and since completely disposed of I plan on taking a SEC 1231 ordinary loss for the remaining unamortized franchise fee in 2006.

My question is, since the 2005 overstated amortization, I believe I should be amending the Partnership 2005 tax return...which will flow through to 1040...so the 2005 Form 1040 also needs to be amended. This will change the amount to Sec 1231 in 2006. The Partnership is made up of two partners. Also....and very importantly....in 2005 the company had a $150K loss. So I am wondering....do I really need to amend 2005 Form 1065 and two K1s and Form 1040...which will reduce the 2005 by approx $7K....or should I just file 2006 and disclose in both the FORM 1065 and 1040 the problem of the overstated amortization in 2005.

The partners are the same in both years...as is the allocation of the loss. I am trying to keep the costs to my client as low as possible and of course if there is a way to not have to file an amended return that is the way I would to go.

All responses will be GREATLY appreciated.

Diane Offutt

Woodstock, Georgia 30189

I am not answering your specific question, but I can tell you what I've done in a similar situation. For several years I prepared a consolidated corporate return, which had a NOL carryforward that went back several years. In some years the corporation had taxable income and was able to deduct part of the NOL carryforward; in other years it had taxable loss which increased the C/F. The corporations were owned by one family that had several other partnerships, trusts, etc. with related transactions in all directions, and frequently we would find mistakes that had been made in prior years that affected several of the family entities. In almost all cases, I adjusted the NOL carryforward with disclosure re the change, the year it occurred and the items that were affected. It's possible that no one at the IRS ever looked at it closely enough to question my procedure, but over 10+ years the return was never audited by either the IRS or the states in which I filed.

I hope this gives you some guidance. It does seem a shame to amend all those returns. Do you prepare the other partner's return, and/or do you know the effect of the change on the other 1040 involved?

Melanie

Thank you for your response. No, I do not prepare the other partner's return. I know for a fact she has not filed a return for 2005 or 2006. I am not sure when she intends to file, but I am not involved in her decision. As for my client, rather than amend the returns and have him incur additional fees I think I will just file a form 8275 Disclosure Statement when preparing 2006. I will include a copy of the Disclosure statement in the other partner's K1 so she is aware of the status.

Thank you again for sharing your experience with me. I appreciated it very much.

Diane Offutt

No, there is no significant 1040 tax deficiency for my client. The overstated amortization was in the amount of approx $7K. My client's portion would be $3.5K. The company had a net loss of $150K (shared equally between the partners)and on my client's 05 return the accountant took the $75K loss. The net result is a NOL. So on 2006 tax return I could adjust the NOL carryforward to the correct amount (add back the $3.5K) and send a note to the other partner for her to do the same...and NOT file a form 8275?? What do you think?

Diane Offutt

I would consider just reporting a smaller 1231 loss on 1065 under the "allowed or allowable" concept, disclosing nothing extra on 1065. A partnership should fix its prior years' even timing errors and notify partners via corrected K-1 where other people do one or more of the 1040s. Their tax effects would be unknown. However, here, the other dude ain't filed for 2005, so I wouldn't feel much obligation to help them out. That would include not telling him and thus potentially his preparer anything. We just didn't spot the prior year mistake -- the "Sergeant Schultz" approach. :-) Others may have a better suggestion, but would the problem here be who's going to pay for amending a 1065 we didn't do? 100% your client/partner under joint/several liability? Ain't fair at all, not even effectively 1/2 via a partnership check, if no tax effect on the 1040 you do.

Thanks again.....You have put my mind at ease..

Diane