IRS Adds Requirement for Tax Basis Partner Capital Information Reporting to Form 1065 Instructions

Note: On March 7 , 2019 the IRS provided temporary relief for partnerships unable to timely provide this information. See our article at this link.

An article published in Tax Notes Today on February 15[1] highlighted a change in the 2018 Form 1065 instructions that will impact partnerships reporting partners’ capital accounts on Schedule K-1 using other than tax basis capital account reporting.

The new instructions, found in the instructions for Schedule K-1, Item L in the Form 1065 instructions at page 30 reads as follows:

If a partnership reports other than tax basis capital accounts to its partners on Schedule K-1 in Item L (that is, GAAP, 704(b) book, or other), and tax basis capital, if reported on any partner's Schedule K-1 at the beginning or end of the tax year would be negative, the partnership must report on line 20 of Schedule K-1, using code AH, such partner's beginning and ending shares of tax basis capital. This is in addition to the required reporting in Item L of Schedule K-1.

For these purposes, the term “tax basis capital” means (i) the amount of cash plus the tax basis of property contributed to a partnership by a partner minus the amount of cash plus the tax basis of property distributed to a partner by the partnership net of any liabilities assumed or taken subject to in connection with such contribution or distribution, plus (ii) the partner's cumulative share of partnership taxable income and tax-exempt income, minus (iii) the partner's cumulative share of taxable loss and nondeductible, noncapital expenditures.

The article notes that the IRS is interested in such cases to help identify situations where the partner will likely have to recognize future income or gain.

A failure to provide such information opens up the partnership for a penalty under IRC §6698(a)(2) for filing “a return or a report which fails to show the information required” for a partnership return or report of imputed adjustment.  That penalty is the same penalty as applies for a failure to file a partnership return--$195 per month per partner.

The article points out that the penalty is not subject to abatement under the first-time abatement provisions of IRM, but the IRM does provide that a partnership or S corporation that has such an incomplete filing will be offered the opportunity to provide the information before the penalty is assessed.

The practical impact of this requirement is that all partnerships will be required to maintain some form of tax basis capital accounts for the partners, even if the partnership itself is reporting its balance sheet and Schedule L using another method of accounting for the accounts.  Since partnership also are generally required to maintain §704(b) capital accounts as well, assuming the partnership wishes to avail itself of the substantial economic effect justification for its allocations of income and expense under its partnership agreement, this means virtually all partnerships show now have records for two capital account balances for the partners.

[1] Nathan J. Richman, “IRS Now Asking About Negative Partnership Tax Capital Accounts,” Tax Notes Today, Feburary 15, 2019, 2019 TNT 32-1