The IRS is Targeting Partnership Basis Computations

In every recent IRS examination of a partnership and/or its partners in which I have been involved, the IRS has asked for information to support the computation of the partners' basis in the partnership. It is critical that a partnership maintain very good records to support the basis computations, especially if the partners are deducting partnership losses. In a recent Tax Court case, Langlois v. Commissioner, T.C. Memo. 2025-12, the taxpayer learned a hard lesson when the Tax Court ruled that the taxpayer had failed to establish his basis in his partnerships and not only denied the partnership losses but also imposed a 20% accuracy-related penalty.

In Langlois, the taxpayer invested in two partnerships, a storm response business (Forbearance) and a hair salon (Hair Station). On his 2015 Form 1040, Mr. Langlois deducted partnership losses from both Forbearance and Hair Station. The IRS examined Mr. Langlois' 2015 tax return and disallowed the deductions because Mr. Langlois did not produce any documentation showing that he had sufficient adjusted basis in either partnership at the end of 2015 to deduct the losses under IRC Section 704(d).

IRC Section 704(d) allows a partner to deduct his share of a partnership's loss for a taxable year to the extent of the adjusted basis of his partnership interest at the end of the year. If a partner cannot establish his adjusted basis in the partnership, he cannot deduct the partnership losses. In Langlois, in order to determine Mr. Langolis's adjusted basis, the Court said it was necessary to look at the taxpayer's initial capital contributions, subsequent contributions, assumptions of partnership liabilities and annual distributive share of partnership income or losses since the partnership began.

Unfortunately, according to the Court, Mr. Langlois failed to provide credible evidence of his adjusted basis in both Forbearance and Hair Station in 2015. The Court said Mr. Langlois "stumbles from the start, as nothing in the record indicates the amount of his initial capital contribution for either partnership" and he failed to support his claims that he made additional contributions to either business. With respect to Forbearance, Mr. Langlois "introduced a digital dump truck of receipts for all manner of expenses, reflecting payments in cash and from many credit cards across multiple states." The Court said it would not sort through voluminous evidence to decide whether the taxpayer substantiated each expense, and even if it did, the taxpayer failed to connect the receipts to the business' expenses. The documentation to support basis in Hair Station was likewise rejected by the Court.

The lesson from Langlois is that from the outset of a partnership, good records should be maintained, especially records that support a partner's adjusted basis when there are partnership losses. Now is the time, before the IRS asks for them, to make sure records regarding basis are complete.

If you have any questions about this article or any civil or criminal tax matter, please contact me at (214) 749-2456.