Avoiding penalties related to new tax capital basis requirements for partnerships
For tax year 2018 filings, the Internal Revenue Service made a drastic change to the Form 1065, U.S. Return of Partnership Income, that went unnoticed by most practitioners. Specifically, the instructions to Form 1065 added the following requirements:
"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 tax year 2018, any partnerships where GAAP, 704(b) or Other is checked in Item L of the Schedule K-1, or any partnership return where tax capital basis is checked (but the tax capital basis was not properly calculated), practitioners are required to report on a partner’s Schedule K-1 for any partner who has negative tax capital basis at the beginning or end of the year. These reportings should be in box 20 on the Schedule K-1 and coded AH.
Update: Since the writing of this article, the IRS released Notice 2019-66. This notice postpones the tax capital reporting requirement one year to 2020. However, for tax year 2019, the IRS will continue to use the requirements that existed in 2018 to report any partner with negative tax capital basis on Line 20 Code AH of their K-1.
What exactly is tax capital basis? The term “tax basis capital” means:
(i) 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;
(ii) the partner's cumulative share of partnership taxable income and tax-exempt income, minus;
(iii) the partner's cumulative share of taxable loss and nondeductible, noncapital expenditures.
This is a different calculation than an inside or outside basis of the partnership that practitioners are more accustomed to. If this calculation has not been done before for the partnership, it is imperative that practitioners complete the calculation as soon as possible.
Completion of this calculation has become even more important as the IRS has released draft instructions for Form 1065 and the draft Form 1065 Schedule K-1. The 2019 instructions for Form 1065 explicitly state: “Item L — Partner’s capital accounts are now reported only on the tax basis method, and checkboxes to indicate other methods have been removed.” So, every single partnership will now need to comply with the tax capital basis method. This means even if the 2018 rules with negative tax capital basis do not apply, then the calculations will still need to be completed in order to comply with 2019 filing requirements.
For the 2018 tax season filings, the penalty for failure to include this reporting is $195 per partner, per month, in which the filing is not correct. The IRS appears to have noticed many partnerships were not compliant with this filing requirement and therefore released notice 2019-20, Penalty Relief for Missing Negative Tax Basis Capital Account Information.
The IRS allows practitioners to correct these Schedule K-1 filings without needing to amend the tax returns. In order to correct these filings, practitioners need to mail a statement to the IRS disclosing the negative tax capital basis for partners. The statement must be captioned that the statement is “Filed Under Notice 2019-20.”
In addition to the caption, the following is also required on the schedule:
a. the partnership’s name and Employee Identification Number, if any, and Reference ID Number, if any;
b. the partner’s name, address, and taxpayer identification number for any partner with a negative tax capital basis at the beginning or end of the year; and
c. the amount of the partner’s tax basis capital account at the beginning and end of the tax year at issue.
The statement must be mailed to 1973 North Rulon White Blvd. Ogden, UT 84404-7843 MS 4700 Attn: Ogden PTE.
The due date of these statements is March 15, 2020, in order to avoid penalties. Only returns that were timely filed — including extensions — are allowed to file under Notice 2019-20.
Since all partners must report their tax capital basis starting in tax year 2019, the requirement for partners with negative tax capital basis reporting is no longer in effect for the returns filed under the tax year 2019 instructions.