By: Jackie Emert, CPA, MST, and Melissa Ballantine
Partnership tax basis and a taxpayer’s ability to use passed-through deductions has always been a hot issue for the Internal Revenue Service (IRS). However, enforcement has been difficult, due to the multiple basis methods that are reported on partners’ Schedule K-1s.
That was, of course, until now. Effective for tax years beginning after December 31, 2017, the Internal Revenue Service has changed the instructions to the Form 1065 K-1 to include basis reporting requirements.
What are the new basis reporting requirements and who do they affect?
This change directly affects partnerships that are reporting their partners’ capital accounts on an alternative, non-tax basis, such as GAAP, 704(b) or any other acceptable hybrid method.
The change in reporting requires those partnerships not reporting their capital accounts on the income tax method of accounting to additionally report on a partner’s K-1 when their tax basis capital is negative, at either the beginning or the end of the year.
What is tax basis capital and why does the IRS care to have it reported by the partnerships?
Tax basis capital is defined as the amount of cash and the tax basis of property contributed to a partnership by a partner, less the amount of cash, and the tax basis of property distributed to a partner by the partnership, plus the partner’s cumulative share of the partnership’s taxable and non-taxable income and losses.
The believed intent of the IRS is to identify circumstances in which the partners are required to recognize income or gain or to identify losses that the partners are limited in deducting as a result of having a negative tax basis.
Why would a partnership care about reporting these items if they only affect the partners?
The penalty for not complying with this change in reporting is $195 per partner, per month until corrected. This penalty can add up quickly. For example, a partnership that has 10 investors and a negative tax capital account would be penalized $23,400 if not corrected for the year. This is true even if only one of the partners’ tax capital account goes negative.
Fortunately, on March 7, 2019, the IRS provided temporary relief to partnerships who failed to provide their required tax basis capital account information on their 2018 tax returns. The IRS waived the penalty until March 2020 if the 2018 tax return is filed on time or within the extension period, and the partnership provides a schedule to the IRS detailing the partners who have a negative tax basis.
While the temporary relief is welcome, recreating partnership tax basis for each partners’ capital account can be very time consuming. It requires a review of all prior year tax returns, Schedule K-1s, and items which could occur outside of the partnership itself such as changes in ownership. Creating this tax capital schedule means that many partnerships will be required to have at least two sets of capital accounts (tax basis and non-tax basis) for each partner.
Adding these new basis reporting requirements to the already established loss limitation rules (i.e. basis limits, at-risk limits, passive activity loss limits and the new limitation on excess business losses for non-corporate taxpayers enacted by the Tax Cuts and Jobs Acts) creates an increasingly challenging and complex tax environment for partnerships.
If you have any questions or need guidance complying with the new reporting requirements, or the loss limitations rules, please contact a McClintock and Associates tax advisor.