Partner tax basis capital account reporting required for 2020

| 10/29/2020
Partner tax basis capital account reporting required for 2020

On Oct. 22, the IRS released an early draft of the instructions for Form 1065, “U.S. Return of Partnership Income,” for tax year 2020, which includes rules for partnerships to calculate and report each partner’s capital account balance for 2020 on a Schedule K-1, “Partner’s Share of Current Year Income, Deductions, Credits, and Other Items.”

Background

The instructions require partnerships to report partner capital accounts using a tax basis method. Reporting a partner’s capital account under any other method, such as using GAAP or Section 704(b), no longer will be permitted.

The instructions generally also require use of a single approach – the transactional approach – for purposes of determining tax basis. Under the transactional approach tax basis method outlined in the instructions, partnerships report partner contributions, the partner’s share of net income or loss, withdrawals and distributions, and other increases or decreases using tax basis principles.

A partnership is required to report a partner’s beginning balance of tax capital in a manner generally consistent with figuring the partner's adjusted tax basis in its partnership interest, without considering any IRC 743(b) basis adjustments. The instructions acknowledge that the partner's ending capital account as reported using the tax basis method might not equal the partner's adjusted tax basis in its partnership interest as a result of partnership liabilities and partner-specific adjustments.

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Partnerships that did not prepare 2019 Schedule K-1s using the tax basis method or that have not been maintaining capital accounts using a tax basis method may determine each partner’s beginning capital account for 2020 using either the modified outside basis method, the modified previously taxed capital method, or the Section 704(b) method.

Adoption of the transactional approach to determine tax basis is a result of comments received from practitioners in response to Notice 2020-43, which was released in June 2020. Notice 2020-43 requires use of tax basis capital accounts beginning in 2020 and permits only two ways of computing a partner’s tax basis capital account: the modified outside basis method and the modified previously taxed capital method. Comments, including those submitted by Crowe, recommended that the IRS allow computation of tax basis using a transactional approach.

Looking ahead

A news release announcing the draft instructions states that penalties will not be assessed for errors in reporting partner beginning capital account balances on Schedule K-1s if the partnership takes ordinary and prudent business care in following the form instructions to calculate and report the beginning capital account balances. According to the news release, penalty relief is in addition to reasonable cause relief that might apply for incorrect reporting of a beginning capital account balance.

The new capital account reporting rules are effective for the current tax year. As a result, partnerships should review their capital account methodology now to make sure their reporting will be compliant when they file their 2020 Schedule K-1s in 2021, which are due March 15, 2021, for calendar year partnerships that do not request an extension.

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Phil Malnar