The Internal Revenue Service (IRS) made significant changes to the Schedule K-1 for the 2020 tax year to improve the quality of information reported by partnerships. This consists of modified instructions for partnerships required to report capital accounts to partners. All partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital in Box L on the Schedule K-1.
Prior to 2020, a partnership could report partners’ capital using one of the following methods: tax basis, GAAP basis, Section 704(b) basis, or other method. With Notice 2020-43, all partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital on a tax basis starting with the 2020 tax return. Notice 2020-43 outlines two methods of reporting tax basis capital: Modified Outside Basis Method and Modified Previously Taxed Capital Method. The preliminary instructions for the 2020 Form 1065 provide a third option under consideration: Transactional Approach.
Modified outside basis method. The amount to report as a partner’s beginning capital account under the modified outside basis method is equal to the partner’s adjusted tax basis in its partnership interest as determined under the principles and provisions of subchapter K including, for 1) the partner’s share of partnership liabilities under section 752 and (2) the sum of partner’s section 743(b) adjustments. For purposes of establishing a partner’s beginning capital account, you may rely on the adjusted tax basis information provided by your partners.
Modified previously taxed capital method. The amount to report as a partner’s beginning capital account under the modified previously taxed capital method is equal to the following: The amount of cash the partner would receive if you liquidated after selling all of the assets in a fully taxable transaction for cash equal to the fair market value of the assets; increased by the amount of tax loss determined without taking into account any section 743(b) basis adjustments that would be allocated to the partner following such a liquidation; and decreased by the amount of tax gain determined without taking into account any section 743(b) basis that would be allocated to the partner following such a liquidation. Instead of using the assets’ fair market value, you may determine the partnership’s net liquidity value, and gain or loss, by using such assets’ bases as determined under section 704(b), as determined for financial accounting purposes, or on the basis set forth in the partnership agreement for purposes of determining what each partner would receive if the partnership were to liquidate, as determined by partnership management.
Transactional approach. The amount to report as a partner’s beginning capital account under the transactional approach is (1) increased by the amount of cash and the tax basis of property contributed by the partner to the partnership (less liabilities assumed by the partnership or to which property is subject) as well as allocations of income or gain made by the partnership to the partner, and (2) decreased by the amount of cash and the tax basis of property distributed by the partnership to the partner (less any liabilities assumed by the partner or to which the property is subject) as well as allocations of loss or deduction made by the partnership to the partner.
The partnership is required to use one of the methods, and the method selected must be used by all partners for the year. While the capital on the K-1 may look different for 2020, the change to tax basis reporting does not cause an economic consequence to the partner. This is strictly a reporting requirement. However, partnerships that do not comply with the new reporting requirements will be subject to late filing penalties for failure to show all required information. For 2020, the late filing penalty is $210 for each month or part of a month, for a maximum of 12 months, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year.
Check your 2019 K-1 statement to determine the prior method for basis reporting. Many partnerships will opt for the modified previously taxed capital method due to the availability of information. Please contact your Spiegel team with any questions or to discuss your options.
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.