K-1 Mismatch Notices: Why the IRS Says Your Return Does Not Match Your Schedule K-1

You reported your partnership or S corporation income. You used the K-1 the business gave you. And now the IRS says you underreported. How can that be?

Usually it is not about whether you reported the income. It is about whether what you reported matches what the entity told the IRS. Those are not always the same thing, and the law generally sides with the entity's return.

How the IRS Catches a K-1 Mismatch

When a partnership files Form 1065 or an S corporation files Form 1120-S, the K-1 data for each owner goes to the IRS too. The IRS then compares that data with the owner's individual return through its Automated Underreporter program.

IRM 4.19.3.8.12 describes K-1 income as "conduit income" and explains how it is matched. K-1 data from Form 1065 and Form 1120-S is identified as its own document type, and the data is broken out by income type: ordinary business income, rental income, royalties, interest, dividends, capital gains, guaranteed payments, and more. The IRM directs employees to consider each element separately. Reporting the interest from a K-1 correctly does not resolve unreported ordinary income from the same K-1.

A few other points from the IRM explain why mismatches happen:

• Schedules K-1 are not required to be attached to your individual return, so the IRS works from the entity's data, not yours.
• Employees are told to review the entire return and attachments, because K-1 income may be reported somewhere other than where the system expects.
• When more than one K-1 record exists from the same entity for the same person, the IRM generally treats the record with the latest "On File Date" as valid. An amended K-1 the entity filed with the IRS can change what you are being matched against.

The resulting notice is usually a proposed adjustment notice, such as a CP2000. General CP2000 strategy is beyond this guide. The point here is the K-1-specific rules that sit underneath it.

The Consistency Rules Behind the Notice

Partners: IRC 6222

For partnerships subject to the centralized audit regime, IRC 6222(a) requires each partner to treat partnership-related items on the partner's return consistently with the partnership return. Treas. Reg. 301.6222-1(a)(1) says consistency is required in all respects: amount, timing, and characterization.

Here is the part that surprises people. The regulation says a partner is not consistent if the partner's return matches the K-1 the partnership furnished but does not match the partnership return actually filed. Example 3 in the regulation describes exactly that: the K-1 attached to the partnership return shows one loss amount, the K-1 sent to the partner shows a larger one, and the partner who used the larger one is inconsistent.

If you are inconsistent and did not tell the IRS, IRC 6222(b) allows any resulting underpayment to be assessed as if it were a math error. The usual procedure for requesting abatement of a math error assessment under IRC 6213(b)(2) does not apply. More detail is in our guide to consistent reporting under Section 6222.

S corporation shareholders: IRC 6037(c)

S corporation shareholders have a parallel rule. IRC 6037(c)(1) requires consistency with the corporate return. If a shareholder is inconsistent without filing a statement identifying the inconsistency, IRC 6037(c)(3) treats the adjustment as arising from a mathematical or clerical error.

Common Reasons the Numbers Do Not Match

• The K-1 you got differs from the one the entity filed. Drafts, late corrections, and software errors all cause this.
• The entity filed an amended return with amended K-1s and you never updated your own return.
• Netting. The IRM notes that taxpayers sometimes net Section 179 expense or losses against income on Schedule E. If the netting is not clear on the return, the system may flag it.
• Wrong place on the return. Guaranteed payments, portfolio income, royalties, or capital gains reported somewhere other than where the matching expects to find them.
• The entity never filed. Under Treas. Reg. 301.6222-1(a)(3), a partner's treatment of items from a partnership that did not file is per se inconsistent.

How to Respond

1. Read the deadline on the notice. Proposed adjustment notices have response dates. Missing them narrows your options.
2. Get the K-1 the entity actually filed. Ask the partnership or S corporation for a copy of what was submitted with the return, and whether any amended return was filed.
3. Compare line by line. Match each income type on the notice to where it appears on your return.
4. If you reported it, show where. Respond with the schedule and line references and an explanation.
5. If the K-1 sent to you was wrong, use the election in IRC 6222(c)(2). A partner who reported consistently with the K-1 furnished by the partnership can elect to be treated as having notified the IRS of the inconsistency. Under Treas. Reg. 301.6222-1(d)(2), the election must be filed in writing with the IRS office named in the notice within 60 days after the date of the notice, clearly identified as an election under IRC 6222(c)(2)(B), signed, and accompanied by a copy of the K-1 you received and the IRS notice. IRC 6037(c)(2)(B) contains a similar election for S corporation shareholders.
6. If the entity's filed return is wrong, the fix is at the entity level. The partner instructions for Schedule K-1 say to notify the partnership, ask for a corrected K-1, not to change the items on your copy, and to make sure the partnership sends the corrected K-1 to the IRS.

That last step is where partnerships under the centralized audit regime run into trouble. Under IRC 6031(b), K-1 information generally cannot be amended after the return's due date. The partnership's route is an administrative adjustment request under IRC 6227. See our guide to administrative adjustment requests and what to do with an amended or late K-1.

When You Disagree With the Entity

Sometimes you believe the entity's return is wrong and it will not fix it. You still have a path. IRC 6222(c)(1) and IRC 6037(c)(2) let you report the item your way if you file a statement identifying the inconsistency. The Schedule K-1 instructions identify Form 8082 as that statement, filed with your original or amended return.

Under Treas. Reg. 301.6222-1(c)(3), the protection covers only the items you identify, so list every item. Also note Treas. Reg. 301.6222-1(c)(5): once the IRS mails a notice of administrative proceeding to the partnership for that year, you can no longer file a notice of inconsistent treatment except as the modification rules allow. Filing Form 8082 also invites a closer look at your position, so it should be supportable. If your mismatch is part of a larger examination, this overview of IRS audits may help.

Basis and loss limits can also look like a mismatch when they are really a separate issue. Our guide to partner loss limitations explains those rules.

If you have a K-1 mismatch notice, call the Law Offices of Darrin T. Mish, P.A. in Tampa, Florida at 813-229-7100. The IRS is not matching you against the K-1 in your hand. It is matching you against the one in its files.