Welcome and thanks for your question!
Sorry to hear about your daughter's situation. If your daughter is receiving a K-1, then the business is structured/taxed as either an S corporation or partnership
. Because both S Corps and partnerships are not taxed at the federal
level, their owners receive K-1s reporting
their share of the profits and losses. The owners are required to report the numbers on the K-1 on their personal return
, regardless of whether the owner received any payment on these profits. So, unfortunately, your daughter does need to report the income
even though her ex-husband is not paying her.
Owners that materially participate
in the business are allowed to deduct their losses to the extent they have basis. Owners that do not materially participate are treated as passive owners and the IRS
limits their abilities to deduct losses. Passive activity rules state
that all income must be reported but losses are only deductible
to the extent the individual
has passive income
from other activities. Unfortunately, if your daughter is not a material participant and does not have other sources of passive income, her share of the losses are not deductible. However, losses limited by the passive activity rules do carry over to future years and can be deducted against future income. Any unused losses become fully deductible in the year a business is disposed of through a sale or otherwise.
The question is - does your daughter meet the material participation criteria? If she does, then she would be able to deduct her losses, assuming she has basis. IRS Publication 925
lists 7 tests
to determine if they materially participate in the business for a particular year.
Now, a little bit of good news - Because owners are taxed on profits regardless if they personally received any payments, they have the ability to take tax-free distributions in future years to the extent they have "basis" in their investment. Basis can be a complicated calculation depending on the circumstances, but generally would be your daughter's initial investment in the business plus/minus her share of accumulated profits/losses less any distributions she received . Your daughter may receive a basis calculation as part of her K-1 package, as I know many accountants include it as a standard part of the K-1 packages they provide.
I wish I could have offered you better news, but please let me know if you need clarification or if you have further questions on this subject and I will gladly assist you further.