Tax Capital Account Reporting – Required for 2020

The latest version of the draft Form 1065 instructions, released January 14, 2021, confirms tax capital reporting will be required for tax year 2020 on the partner’s Schedule K-1 and clarifies some key questions from the industry.

Background

Beginning in the 2020 taxable year, the 2020 Form 1065 Instructions require partnerships to calculate and report their partners’ capital accounts using a tax basis method.

For the partnerships that did not use tax basis method previously, the partnership may refigure a partner’s beginning capital account using the tax basis method, modified outside basis method, modified previously taxed capital method, or section 704(b) method for this year only. Under this circumstance, the beginning capital account on current year Schedules K-1 may not equal to the ending capital account on last year Schedules K-1. If the tax basis method is not used, a statement indicating the method used to determine each partner’s beginning capital account is required to be attached to the partners’ Schedule K-1.

Furthermore, the partner’s ending capital account as reported on Schedules K-1 might not equal the partner’s adjusted tax basis in its partnership interest due to partnership liabilities and other specific adjustments. It is each partner’s responsibility to maintain its record of the adjusted tax basis in its partnership interest.

If the partnership’s balance sheet (Schedule L) is reported on the tax basis and if the aggregate of the partners’ beginning and ending capital accounts differ from the amounts reported on Schedule L, preparers will be required to attach a statement reconciling any differences. Form 1065 instructions released on January 14, 2021 clarified that no such reconciliation is required if Schedule L is not reported on the tax basis.

Penalty Relief

The IRS recently released Notice 2021-13 which provide detailed explanation on relief for partnerships from certain penalties related to the reporting of partners’ beginning capital account balances.

This notice explains that a partnership will not be subject to a penalty under sections 6698, 6721, or 6722 due to the inclusion of incorrect information in reporting its partners’ beginning capital account balances on the 2020 Schedules K-1 if the partnership can show that it took ordinary and prudent business care in following the 2020 Form 1065 Instructions to report its partners’ beginning capital account balances using any one of the following methods

• The tax basis method,
• Modified outside basis method,
• Modified previously taxed capital method, or
• Section 704(b) method.

For purposes of this notice, “ordinary and prudent business care” means the standard of care that a reasonably prudent person would use under the circumstances in the course of its business in handling account information.

This notice also provides relief from accuracy-related penalties for any taxable year for the portion of an imputed underpayment attributable to the inclusion of incorrect information in a partner’s beginning capital account balance reported by a partnership for the 2020 taxable year. The penalty relief provided in this notice is in addition to the reasonable cause exception to penalties for failing to properly report the partners’ beginning capital account balances.

Certain exclusions not eligible for the relief provided by this notice

• A partnership that fails to timely file a 2020 Form 1065, Form 8865, and Schedules K-1.
• A partnership that fails to include a partner’s beginning capital account balance on the Schedule K- 1.
• A partner of its obligation to determine the adjusted basis of its interest in the partnership for purposes of determining its tax liability or that of any other person as prescribed in section 705 of the Code and § 1.705-1(a)(1) of the Income Tax Regulations.

Author: Sally Sun, CPA | [email protected]