New negative capital account disclosure requirements could complicate compliance for partnerships

A change included in the new Form 1065 US Return of Partnership Income instructions could substantially increase the time to complete partnership tax returns, due to the requirement of disclosing when a partner has a “negative” tax basis capital account.

This alteration has not been widely publicized and could come as a surprise to many partnerships, and it may require additional time to adhere to this rule. This represents additional complexities on top of the changes introduced by the Tax Cuts and Jobs Act (TCJA).

The new instructions read:

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:

1. 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
2. The partner’s cumulative share of partnership taxable income and tax-exempt income, minus
3. The partner’s cumulative share of taxable loss and nondeductible, noncapital expenditures.

We believe the change was enacted to provide the IRS with information required to track various gain calculations. Under Internal Revenue Code (IRC) §731, when a partnership distributes, to a partner, money that exceeds that partner’s adjusted tax basis just before the distribution, a gain must be recognized currently.  A reduction in a partner’s share of liabilities is also considered a distribution of money. Prior to the change in the instructions, the IRS did not have a mechanism in place to track tax basis and determine if a partner is recognizing taxable gains correctly. The change in the disclosure requirements is apparently intended to provide the IRS with the necessary information.

Mazars Insight

It is not clear if tax basis capital, as defined in the instructions, is referring to inside tax basis or outside tax basis.  For instance, if a partner purchases his interest from another partner is it now the partnership’s requirement to account for the purchase price when determining the purchasing partner’s “tax basis capital?”  Also, what happens when a partner receives his interest as an inheritance?  Is it the partnership’s responsibility to obtain the partner’s stepped-up basis?

Please contact your Mazars USA LLP professional for additional information.

Published on: March 1, 2019

Authored by Richard J Bloom and Gregory Kastner

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.