In 2018 you may have secretly admired some additional information items listed on K-1s received from Partnerships. This change was due to the new IRS reporting requirements of the partnership maintaining the partner capital account on a tax basis. The phase in of this reporting requirement began in the 2018 tax year.
For the tax year 2018, the IRS implemented that if the partnership does not report the partner’s capital account on a tax basis in item L, and either the beginning of the year or the end of the year of the partner’s tax basis capital is negative, this information must be reported on line 20 of Schedule K-1 using code AH.
The IRS then changed the Schedule K-1 item L to eliminate the available boxes to check that identified which basis the partner’s capital was being reported as. Rather their intent was to solely have the partner’s tax basis be reported in this area. Since there are some with commitment issues, the IRS issued Notice 2019-66 in late September 2019 which provided a rule update to postpone this reporting requirement until the starting of tax year 2020. For the tax year 2019, a statement to item L on the Schedule K-1 will identify the basis that the partner’s capital account is being reported and then Line 20 will follow that same reporting rules as in the 2018 tax year. For the tax year 2020, item L of the Schedule K-1 must be report the partner’s capital as tax basis.
Why is the IRS trying to woo us with the reporting requirement of the partner’s capital accounting in item L of the Schedule K-1 solely on the tax basis? Some partnerships have a passion to maintain the partner’s capital basis on Section 704(b), GAAP, or any other method. The most common being GAAP basis of accounting as required by their auditors, lenders, or other regulatory bodies (e.g. SEC). The IRS requires the partnership to file Form 1065 on a tax basis. This can cause some significant book-tax adjustments (e.g. depreciation expense and installment sales).
These differences are why the IRS desires the partner’s capital account in item L of the Schedule K-1 to be solely reported on a tax basis. The other forms of reporting the partner’s capital account can charm the partner into thinking they have sufficient basis to take losses, receive distributions, and using this amount when calculating a gain or loss on the sale of the partnership interest on their personal tax return. The partner’s devotion to any other form of their capital basis other than the tax basis can lead substantial tax issues.
The need for the partner to cherish their capital account on a tax basis is due to the limitations that can be caused from the above scenarios. The partner’s losses may be limited if their tax basis is negative. If they receive a distribution in excess of tax basis than the excess may be taxable income to that partner. The gain or loss recognized on the sale of the partnership interest is calculated using tax basis.
Accept and embrace reporting the partner’s capital account on a tax basis. If you have any questions or concerns about your partnership’s capital account, contact our office or speak with your trusted advisor.