IRS Proposes Two Methods to Report Partner Tax Basis Capital
For tax years ending on or after December 31, 2020, partnerships will be required to report capital accounts, whether positive or negative, on the partners’ Schedules K-1 on an income tax basis and will no longer be permitted to report partner capital accounts using any other method.
To maintain consistency in reporting for all partnerships, the IRS has stated that tax basis partnership accounts that have been maintained by the partnership using the principles of Subchapter K (“the Transactional Approach”) will not satisfy the tax capital reporting requirement. The IRS requests public comments by August 4, 2020, in Notice 2020-43, on a proposed requirement for partnerships to use one of two alternative methods to report partner tax basis capital accounts: the Modified Outside Basis Method, or the Modified Previously Taxed Capital Method; summarized below.
The Modified Outside Basis Method
A partnership may satisfy the reporting requirement by determining (or being provided by the partner) a partner’s adjusted basis in its partnership interest, and subtracting from that basis the partner’s share of partnership tax basis liabilities.
If a partnership uses this method, a partner must notify the partnership of any changes to the partner’s basis in its partnership interest during each partnership taxable year (other than changes attributable to contributions to and distributions from the partnership and the partner’s share of income, gain, deduction, or loss that are otherwise reflected on Schedule K-1 within thirty days or by the taxable year end of the partnership, whichever is later). A partnership may rely on the partner basis information that is provided by its partners unless it has knowledge of facts indicating that such information is clearly erroneous.
The Modified Previously Taxed Capital Method
Alternatively, a partnership that does not satisfy the reporting requirement using the Modified Outside Basis Method would be required to use the Modified Previously Taxed Capital Method. Under this method, the partnership would determine the amount of cash that a partner would receive in a hypothetical partnership liquidation based on the assets’ fair market value (if readily available). Otherwise, a partnership may determine its partnership net liquidity value and gain or loss by using such assets’ bases as determined under section 704(b), GAAP, or the basis set forth in the partnership agreement for purposes of determining what each partner would receive if the partnership were to liquidate. For simplicity, all partnership liabilities would be treated as nonrecourse.
To determine each partner’s share of “previously taxed capital,” the amount of taxable gain that would be recognized by each partner (in the hypothetical transaction described above) would be subtracted from the amount that such partner would receive as a distribution from the hypothetical transaction; conversely, the amount of loss that would be recognized by each partner in such transaction would be added back to the amount that such partner would receive from the hypothetical transaction.
Notice 2020-43 provides guidance with respect to methods that may be used by partnerships to report tax basis capital account information, but is subject to change depending on feedback in the requested public comments. For additional information about how this guidance may impact your partnership, please contact a Cherry Bekaert team member.