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IRS Postpones Reporting Capital Accounts on Tax Basis
(Parker Tax Publishing December 2019)
The IRS has postponed until 2020 the effective date of the requirement to report partners' shares of partnership capital on the tax basis method. For 2019, partnerships and other persons must report partner capital accounts consistent with the reporting requirements in the 2018 forms and instructions, including the requirement to report negative tax basis capital accounts on a partner-by-partner basis. Notice 2019-66 (12/9/19).
Background
Draft forms and instructions for 2019 Form 1065, U.S. Return of Partnership Income, and 2019 Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, have proposed requiring partner tax basis capital reporting by all partnerships and certain other persons, and to prohibit the reporting of partner capital under Code Sec. 704(b), generally accepted accounting principles (GAAP), or any other method.
A partner's tax basis capital account (sometimes referred to as "tax capital") represents the partner's equity as calculated using tax principles. A partner's tax basis capital account is not based on GAAP, Code Sec. 704(b), or other principles. A negative "tax basis capital" generally exists when a partnership allocates tax deductions or losses or makes distributions to a partner in excess of the partner's tax basis equity in the partnership. It can also arise when a partner contributes property subject to debt in excess of the property's adjusted tax basis to a partnership.
In general, a partner's tax basis capital account is equal to money contributed by the partner to the partnership, increased by:
(1) the adjusted tax basis of non-cash property contributed by the partner to the partnership, less the liabilities assumed by the partnership (or to which the property is subject) in connection with the contribution;
(2) the sum of the partner's distributive share for the tax year and prior tax years of partnership income or gain (including tax-exempt income);
(3) the partner's distributive share of the excess of the tax deductions for depletion (other than oil and gas depletion) over the tax basis of the property subject to depletion;
(4) the amount of liabilities of the partnership assumed by the partner, excluding liabilities assumed by the partner (or to which the property is subject) in connection with the distribution; and
(5) the partner's distributive share of any increase to the tax basis of partnership property under Code Sec. 734(b) or with respect to partnership property under Code Sec. 743(b).
In general, a partner's tax basis capital account is decreased by:
(1) distributions of money to the partner;
(2) the adjusted tax basis of property distributed to the partner from the partnership, less the liabilities assumed by the partner (or to which the property is subject) in connection with the distribution;
(3) the sum of the partner's distributive share for the tax year and prior tax years of partnership losses and deductions (including expenditures which are not deductible in computing partnership tax income and which are not capital expenditures);
(4) the partner's distributive share of the tax deductions for depletion of any partnership oil and gas property, not to exceed the partner's share of the adjusted tax basis of that property;
(5) the partner's distributive share of the adjusted tax basis of charitable property contributions and foreign taxes paid or accrued;
(6) the amount of the partner's individual liabilities that are assumed by the partnership, excluding the liabilities assumed by the partnership (or to which the property is subject) in connection with the contribution; and
(7) the partner's distributive share of any decrease to the tax basis of partnership property under Code Sec. 734(b) or with respect to partnership property under Code Sec. 743(b).
In lieu of following the above procedures for calculating tax basis capital, partnerships and other persons may instead use the "partner outside basis safe harbor approach" referenced in the FAQ "Negative Tax Basis Capital Account Reporting Requirements" on the IRS website. Under the safe harbor approach, partnerships may calculate a partner's tax basis capital account by subtracting the partner's share of partnership liabilities under Code Sec. 752 from the partner's outside basis (safe harbor approach). If a partnership elects to use the safe harbor approach, the partnership must report the negative tax basis capital account information as equal to the excess, if any, of the partner's share of partnership liabilities under Code Sec. 752 over the partner's outside basis.
After receiving comments from practitioners, the IRS became aware that certain persons required to file Forms 1065 or Form 8865 might be unable to timely comply with the requirement to report partner capital on the tax basis method for 2019.
At-Risk Activity Reporting
The draft of the instructions for the 2019 Form 1065, Schedule K-1 (to which the draft instructions for the 2019 Form 8865 refer) included a new paragraph "At-Risk Limitations, At-Risk Activity Reporting Requirements" that would expressly require partnerships or other persons that have items of income, loss, or deduction reported on the Schedule K-1 from more than one activity that may be subject to limitation under Code Sec. 465 at the partner level to report certain additional information separately for each activity on an attachment to a partner's Schedule K-1. The new paragraph would require the partnership or other person to identify the at-risk activity, the items of income, loss, or deduction for the activity, other items of income, loss, or deduction, partnership liabilities, and any other information that relates to the activity, such as distributions and partner loans. This requirement in the draft instructions for the 2019 Form 1065 is in addition to longstanding at-risk reporting requirements included in the instructions to the Form 1065.
With respect to this additional at-risk reporting requirement, the IRS said that it has become aware that certain partnerships and other persons may be unable to timely comply with the newly added requirement to report additional information about each at-risk activity separately for 2019.
IRS Provides Relief in Notice 2019-66
In Notice 2019-66, the IRS provides that partnerships and other persons required to furnish and file Form 1065, Schedule K-1 or Form 8865, Schedule K-1, will not be required to report partner capital accounts in Item L of the 2019 Form 1065, Schedule K-1, or in Item F of the 2019 Form 8865, Schedule K-1, using the tax basis method for 2019.
Instead, partnerships and other persons must report partner capital accounts for 2019 consistent with the reporting requirements for the 2018 Forms 1065, Schedule K1, or 8865, Schedule K-1, as applicable. This means that partnerships and other persons may continue to report partner capital accounts on Form 1065, Schedule K-1, Item L, or 8865, Schedule K-1, Item F, using any method available in 2018 (tax basis, Section 704(b), GAAP, or any other method) for 2019. These partnerships and other persons must include a statement with their returns identifying the method upon which a partner's capital account is reported.
According to the IRS, the final instructions for the 2019 Forms 1065, Schedule K-1, Item L and 8865, Schedule K-1, Item F, are expected to include additional details on how such reporting should be done. For 2019 partnership tax years, partner "tax basis capital" must be calculated as provided in the 2018 Form 1065 and Schedule K-1 instructions. Beginning with the 2018 partnership tax year, if a partner's tax basis capital was negative at the beginning or end of a partnership's tax year, a partnership or other person is required to report on Line 20 of a partner's Schedule K-1, using Code AH, such partner's beginning and ending tax basis capital.
Partnerships and other persons who follow Notice 2019-66 and report partner capital accounts for 2019 in Item L of the Form 1065, Schedule K-1, or in Item F of the Form 8865, Schedule K-1, by using a method other than the tax basis method must continue to comply with the requirement in the 2018 forms and instructions with respect to negative tax basis capital accounts.
Additionally, the IRS concluded that partnerships and other persons required to furnish and file Form 1065, Schedule K-1 or Form 8865, Schedule K-1, will not be required to report information for each at-risk activity separately for 2019 that was not previously required to be reported for the 2018 partnership tax year. Partnerships must still indicate in Item K on Form 1065 whether they have aggregated activities for Code Sec. 465 at-risk purposes for 2019.
For a discussion of procedural issues relating to partnership tax returns, see Parker Tax ¶28,850. For a discussion of the partnership at-risk rules, see Parker Tax ¶247,500.
Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.
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