Reporting Partnership Schedule K-1 Capital Accounts on the Tax Basis

Background

Partnerships are required to report their partners’ capital accounts on the tax basis method starting with the 2020 tax year unless the partnership qualifies for an exception.

Prior to this compliance reporting requirement, partners’ capital accounts may have alternatively been reported on GAAP, Section 704(b) book or other methods of accounting.

The tax basis method reporting requirement was initiated in part due to the Internal Revenue Service’s inability to calculate partner’s tax basis when a partnership would report the capital accounts on a different method of accounting. For tax year 2021, “small partnerships” do not need to complete the Partner’s Capital Account Analysis on Schedule K-1 if the partnership meets the requirements of 2021 Form 1065, Schedule B, Question 4.

Reporting Schedule K-1 (Form 1065) Partner’s Capital Account on the Tax Basis

Do you have a partnership which no longer meets the exception for this reporting requirement or is currently non-compliant with reporting capital accounts on the tax basis? If so, we recommend calculating and reporting partners’ capital accounts on the tax basis per IRS compliance requirements as soon as possible.

Here is a high-level summary for reporting partners’ capital accounts on the tax basis.

High-Level Summary

The partnership must first determine the tax basis of the capital accounts at the beginning of the tax year. If the partnership already maintained or reported capital accounts under the tax basis method, then that must be the method used to report the capital accounts for the tax basis method.

This may be easier said than done because of all the potential timing differences between the tax basis method and books maintained on another basis of accounting.

Examples of some timing differences include depreciation, revenue recognition, interest expense limitations, cash vs. accrual and syndication costs.

If the partnership is not able to determine the tax basis of the capital accounts, there are other alternatives to redetermine the tax basis of partners’ capital accounts.

The following four methods may be used to redetermine the partner’s beginning capital account under the tax basis method reporting requirements for the partnership:

1. Tax basis method
2. Modified previously taxed capital method
3. Modified outside basis method
4. Section 704(b) method

If the previous partnership tax return did not report the partner’s capital account on the tax basis, a statement is required to be included with the current year partnership tax return. On this statement, the partnership must reconcile the previous year’s ending capital account, which used another basis of accounting, to the current year calculated partner’s beginning capital account, which is now on the tax basis method.

Once the partner’s beginning capital account has been reported on the tax basis, current year activity is required to be reflected on the tax basis in the partner’s capital account analysis. Generally, the partner’s capital account is increased for capital contributed during the year, including their current year income and other increases while the partner’s capital account is decreased for withdrawals or distributions during the year. Current year losses and other decreases are also taken into account.

If you have any questions regarding reporting partners’ capital accounts on the tax basis or redetermining the partner’s beginning capital accounts, please reach out to Kyle Krenske at Mahoney CPAs and Advisors.

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