In response to the Tax Cuts and Jobs Acts of 2017, there were a number of changes to the disclosure requirements for partnerships and LLCs filing as partnerships – specifically, on the K-1s of Form 1065 returns, some of which became effective for the 2019 tax year.
For the current (2020) tax year, however, the most significant change relates to the reporting associated with partner capital accounts. Beginning with the 2020 year, partnerships are required to report capital accounts for partners using the tax basis method. The prior rules allowed the capital accounts to be reported in accordance with Generally Accepted Accounting Principles or Section 704(b). This will no longer be permitted.
According to IRS, most partnerships/LLCs taxed as partnerships have already been reporting capital accounts on a tax basis. For those taxpayers, no change is required.
For partnerships that were not using tax basis, the “transactional approach” must be used to switch to tax basis for capital reporting purposes. Under that approach, partnerships use partner contributions, the partner’s share of partnership net income or loss, withdrawals and distributions, and other increases or decreases using tax basis principles, instead of reporting using other methods such as GAAP.
For those partnerships that have never used tax basis, since many partnerships would have difficulty reconstructing tax basis, the IRS is allowing them to re-figure beginning basis using one of a number of options including the modified outside basis, modified previously taxed capital, or Section 704(b) methods. These options are all described on page 32 of the Form 1065 instructions.
The same basis method should be used for each partner. IRS is not assessing penalties as long as the calculation is done with “ordinary and prudent business care.”
“Small partnerships,” which are defined as having less than $250,000 in total receipts under $1 million in total assets, are exempt from reporting capital accounts on the tax basis.
The IRS is hoping this new disclosure will assist in assessing compliance risk and result in fewer audits for compliant taxpayers.