Tax Planning with Partnership Schedule K-1 Accounts

20 Jun Tax Planning with Partnership Schedule K-1 Accounts

The use of the transactional approach method, which was requested by numerous commentators, reflects significant accommodation by the IRS to taxpayers’ situations. However, even the use of the transactional approach may entail additional work on the part of partnerships to perform calculations not previously done. Partnerships will need to spend time to determining the tax basis capital account to report on each partner’s Schedule K-1s, as well as computing and describing the items that affect the total tax basis capital on the Schedule M-2. In their Real Estate Financing column, Ezra Dyckman and Charles Nelson discuss the new 2020 partnership tax basis capital account reporting requirements which “give the IRS much more visibility into the tax situations of partners in partnerships.” Effective for tax year 2020 and beyond, at the federal level, partnerships must report each partner’s capital account using the transactional approach for the tax basis method.

• Each partner’s share of partnership liabilities under Section 752 and the net tax value of any Section 743(b) basis adjustments are then subtracted from the outside basis to arrive at the partner’s tax capital.
• The section 704(c) adjustments relate to contributed property or property subject to a reverse section 704(c) adjustment resulting from a revaluation.
• Prior to the new rules, a partner, and not the partnership, was responsible for maintaining a calculation of his tax basis in the partnership.
• Note that, as was true for capital contributions, distributions with liabilities in excess of basis may cause this number to properly be negative.
• Under the tax basis method outlined in the instructions, partnerships report partner contributions, the partner’s share of partnership net income or loss, withdrawals and distributions, and other increases or decreases using tax basis principles as opposed to reporting using other methods such as GAAP.
• Section 704(b) data should be available to all partnerships, because partnerships must maintain Section 704(b) capital account schedules for each partner in order to properly make allocations of income and deductions (or to verify that the allocations are proper).

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Partnerships Previously Reporting on a Method Other than Tax Basis for Partners’ Capital

A federal tax specialist for 50 years, Lynn Nichols provides tax consulting services to CPA firms on complex federal income tax issues, professional standards in tax practice and effective tax practice management. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice.

• “Small partnerships,” which are defined as having less than $250,000 in total receipts under $1 million in total assets, are exempt from reporting capital accounts on the tax basis.
• It is required for the ending 2020 (beginning 2021) balance, including restating the balance if necessary, for it to be stated as “Tax Basis Capital.” Wisdom suggests some sort of reconciliation between a partner’s capital account as maintained before 2021 and that partner’s “Tax Basis Capital” on December 31, 2020.
• The IRS requested comments on the new reporting requirement and indicated that it may update the instructions based on the comments it receives.
• Select the appropriate method in Screen 1, Client Information and make the appropriate state only entries to report state capital accounts on an alternative method.
• It is each partner’s responsibility to maintain its record of the adjusted tax basis in its partnership interest.
• The balance at the end of the year should equal the total of the amounts reported as the partners’ ending capital accounts in item L of all the partners’ Schedules K-1.

The IRS defines a partner’s tax basis capital account (or “tax capital”) as a partner’s equity calculated using tax principles, not based on GAAP, Section 704(b), or other principles. For those partnerships that have never used tax basis, since many partnerships would have difficulty reconstructing tax basis, the IRS is allowing them to re-figure beginning basis using one of a number of options including the modified outside basis, modified previously taxed capital, or Section 704(b) methods. If the partnership is not able to determine the tax basis of the capital accounts, there are other alternatives to redetermine the tax basis of partners’ capital accounts. For more information about the 2020 tax basis capital reporting requirement, including assistance with the calculations to comply, please contact us. So must the capital accounts on the Schedule K-1s in total agree with the partners’ capital accounts reported on Schedule L (Balance Sheet)?

Penalty Relief

Of course, if the partnership was previously using the transactional method, they should already have everything they need to accurately report the items of income or deduction to the capital account. Since this approach is based on tax basis principles, each contribution or partnership net income increases a partner’s https://turbo-tax.org/ capital account, and each distribution or shares of loss decrease the capital account. Previously, taxpayers were allowed to use several different methods to calculate their capital accounts, such as GAAP or Section 704(b)—businesses who favored these methods will need to be aware of the differences in tax calculation.

It is clear, the transactional method is the method the IRS wants practitioners to use. The other three methods discussed below are only to be used to arrive at a beginning tax basis capital account for 2020, if necessary. Additionally, https://turbo-tax.org/reporting-partnership-tax-basis/ the following capital account reconciliation’s have been update to reflect the above changes removing the books to tax reconciliation and providing more detail on the partner’s share of taxable income and other increases/decreases.

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Each of the additional methods that the IRS provided for restating beginning tax capital in instances where tax capital wasn’t historically tracked in the books and records of the partnership has limitations on when it will be practical to use. This seems to provide a mechanism for correcting a previously incorrect tax basis capital account and should benefit those clients where the previous year capital account was incorrect. However, the instructions do not address correction of the previous year ending capital account where the capital account was positive. The rules for calculating and maintaining a partner’s “tax basis capital” are unlike those for either basis or capital.

The IRS waived the penalty until March 2020 if the 2018 tax return is filed on time or within the extension period, and the partnership provides a schedule to the IRS detailing the partners who have a negative tax basis. A partnership that is just starting to use tax basis capital accounts can use either of the two methods or may use the §704(b) method to determine the beginning-of-year (BOY) capital account. For 2020, if a partnership is using tax basis capital accounts for the first time, it must attach a statement showing which method was used to compute the BOY capital account. Note that the Modified outside basis method, which requires information about the partners’ outside basis, would require partnerships to maintain records that they never previously had to maintain. The predecessor requirement originally appeared in the Form 1065 instructions for 2018 returns and caused much consternation in the tax preparation community—many practitioners with small to mid-sized partnerships have clients with somewhat dubious accounting methods that are not tax basis.