2020 was a challenging year for business owners. The COVID-19 pandemic and subsequent lockdowns forced many businesses to go remote, furlough employees, and apply for PPP loans to stay afloat. For many businesses, owners had to shut down operations permanently. All these factors add several complexities to the 2020 tax season, especially to partnerships.
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.”
What is partner’s capital account basis and how does it work?
Partner capital account basis measures the equity investment in the partnership.
The instructions on Form 1065 require partnerships to report partner capital accounts using a tax basis method. The instructions generally also require the use of a single approach — the transactional approach — to determine 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 due to partnership liabilities and partner-specific adjustments.