In a continued joint effort to streamline the Tax Capital Reporting Requirement for partnerships, The U.S. Treasury and IRS recently provided additional penalty relief for the transition to reporting requirements effective for taxable years ending on or after December 31, 2020.
The agencies are working to reduce filing complexities and increase transparency and compliance for partnerships reporting partner capital account balances on Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., for Form 1065, Partnership Return of Income, and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
Modified Outside Basis Method & Modified Previously Taxed Capital Method
In June 2020, the agencies released Notice 2020-43. The Notice sought public comment on proposed guidance. The Notice presented two methods – Modified Outside Basis Method and Modified Previously Taxed Capital Method – for consideration. These methods opposed the previous standard, which allowed for any reasonable method, including tax basis, GAAP, or Sec. 704(b) book basis, to be used.
Using the Modified Outside Basis Method, the partnership would report “the partner’s basis in its partnership interest, reduced by the partner’s allocable share of partnership liabilities, as determined under § 752 of the Code.” Using the Modified Previously Taxed Capital Method, the partnership would report “the partner’s share of previously taxed capital, as calculated under a modified version of § 1.743-1(d) of the Income Tax Regulations.”
Penalty Relief for the Transition to 2020 Reporting Requirements
In general, failing to meet specific reporting requirements when completing a Return of Partnership Income can result in penalties. On January 19th, The Treasury and IRS issued Notice 2021-13, providing penalty relief for the transition in tax year 2020. Penalty relief is not available to partnerships that are not timely in filing a 2020 Form 1065, Form 8865, or Schedules K-1 or that do not include a partner’s beginning capital account balance on Schedule K-1.
Notice 2021-13 states, “A partnership will not be subject to a penalty under sections 6698, 6721, or 6722 due to the inclusion of incorrect information in reporting its partners’ beginning capital account balances on the 2020 Schedules K-1 if the partnership can show that it took ordinary and prudent business care in following the 2020 Form 1065 Instructions to report its partners’ beginning capital account balances using any one of the following methods, as outlined in the instructions: the tax basis method, modified outside basis method, modified previously taxed capital method, or section 704(b) method.”
By definition, a section 6698 penalty would result from “failing to file a return or report at the time prescribed therefor, or for filing a return or a report that fails to show the information required under section 6031.” A section 6721 penalty would result from “failure to file an information return on or before the required filing date, and for any failure to include all of the information required to be shown on the return or the inclusion of incorrect information.” A section 6722 penalty would result from “failure to furnish a payee statement on or before the date prescribed therefor to the person to whom such statement is required to be furnished, and for any failure to include all of the information required to be shown on a payee statement or the inclusion of incorrect information.”
The IRS released draft instructions for 2020 Form 1065 (currently watermarked “draft as of February 4, 2021”), which contain the revised reporting requirements the agency refers to for partnership use in reporting capital accounts to partners on Schedule K-1s. The draft instructs partnerships as follows:
If you reported partners’ capital accounts using a method other than the tax basis method last year, but also maintained capital accounts in your books and records using the tax basis method (for example, for purposes of meeting the requirement to report partner negative tax capital accounts), you must report each partner’s beginning capital account using the tax basis method. If you did not report partners’ capital accounts using the tax basis method last year and did not maintain capital accounts under the tax basis method in your books and records, you may refigure a partner’s beginning capital account using the tax basis method, modified outside basis method, modified previously taxed capital method, or section 704(b) method […] for this year only. The same method must be used to determine each partner’s beginning capital account. All other lines in item L must be reported using the tax basis method. You must also attach a statement to the partners’ Schedules K-1 indicating the method used to determine each partner’s beginning capital account. If the modified previously taxed capital method is used, the statement must also include the method used to determine the partnership’s net liquidity value (fair market value, section 704(b) book value, etc.). The method used to determine the partnership’s net liquidity value must be adopted for all partners in the partnership.
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by Daniel Doiron, CPA
Dan has been in public accounting since his college internship with ARB in 1986. He has been a principal since 1996 and works extensively with all types of clients to solve their compliance and tax planning issues. Dan was the May 1987 State of Maine Gold Medalist for earning the highest scores on all four parts of the CPA Examination. He is the Practice Leader of ARB’s Business Tax Services Team and Private Client Advisory Services Team.