The IRS has proposed a number of changes to the 2019 Form 1065, “U.S. Return of Partnership Income,” and the related Schedule K-1 that generally would require partnerships to provide significantly more information to the IRS and partners. Practitioners and taxpayers have expressed concern regarding the increased compliance burden imposed by the proposed changes and the lack of a transition period.
The draft of the 2019 Form 1065 requires partnerships to provide more detail regarding:
- Loss limitations
- Business interest expenses, including application of IRC Section 163(j)
- U.S. gain of foreign partners
- Transfers between partnerships and partners
- Application of the “at-risk” rules under IRC Section 465
- Application of the passive activities under IRC Section 469
The changes proposed for the 2019 Schedule K-1 include the following:
- Partner’s capital accounts reporting. Prior to the 2019 tax year, partnerships could report partners’ capital accounts using tax basis, U.S. GAAP, Section 704(b) book, or “other” with explanation. The draft Schedule K-1 requires that a partner’s capital account use only the tax basis. According to the Schedule K-1 instructions, tax basis means a partner’s inside tax capital of the partnership. This explanation is the same as the definition of tax basis used in the 2018 Form 1065 instructions that required partnerships to disclose a partner’s negative tax basis capital on the 2018 Schedule K-1. Notice 2019-20 provides that partnerships can avoid penalties for failure to file correct partnership returns if they make 2018 negative tax basis disclosures by the unextended due date of their 2019 return (March 15, 2020, for calendar year filers).
- Partner’s share of unrecognized Section 704(c) gain or loss. When a partner contributes property to a partnership with economic value different from its adjusted tax basis, the disparity is tracked under IRC Section 704(c). Prior to the proposed changes, the Schedule K-1 contained an area to disclose whether a partner contributed property with a built-in gain or loss during the year, but no subsequent disclosures were required following that initial year. The draft Schedule K-1 requires the partnership to report a partner’s share of net unrecognized Section 704(c) built-in gain or loss as of the beginning and end of the partnership’s taxable year. Additionally, the Schedule K-1 has specific codes to report the net income or loss effect of all IRC Section 704(c) allocations for each affected partner.
- Guaranteed payments for services or use of capital. The draft Schedule K-1 now has separate lines for guaranteed payments to partners. There is one line for services and one for use of capital. While the IRS has not yet specifically stated the purpose of having separate lines, it is speculated that the lines could be linked to the new IRC Section 163(j) limitation on the business interest deduction. Clarification might come when the final regulations are released, which may be as soon as the end of the year.
- Specific codes. Specific codes have been added to identify whether a partner’s IRC Section 743(b) adjustment is positive or negative and whether gain allocated to a partner is from “hot assets” under IRC Section 751.
- New disclosures. The draft Schedule K-1 has several new disclosures, including:
- Whether the partnership liabilities include liabilities from a lower-tier partnership
- Whether a partner’s decrease in profit, loss, or capital is the result of a sale or exchange
- Whether the activity of the partnership reported on the Schedule K-1 consists of more than one activity for passive activity purposes or at-risk purposes