IRS FAQ offers safe harbor for negative tax basis capital reporting

Cash pileThe IRS has released nine frequently asked questions (FAQ) addressing partnership reporting requirements for negative tax basis capital accounts. The guidance clarifies the information that must be reported, provides details on the relevant calculations, and offers a safe harbor that may ease the compliance burden for some partnerships.

Background The 2018 Form 1065 Instructions require partnerships that report partners’ capital accounts on a basis other than tax basis to provide beginning and ending tax basis capital accounts on Schedule K-1 for any partner with negative “tax basis capital” at either the beginning or end of the tax year. Acknowledging that partnerships were having difficulty complying on a timely basis, the IRS offered penalty relief through Notice 2019-20 on March 7, 2019. The notice applies to partnership tax years beginning after Dec. 31, 2017, but before Jan. 1, 2019, assuming certain conditions are met. See our prior Tax Insights for details on the notice and a summary of the underlying reporting requirement provided in the Form 1065 instructions.    

Definition and calculation The FAQ sheds light on the IRS’s conceptual underpinnings concerning negative tax basis capital. It defines “partner’s tax basis capital account” (sometimes referred to simply as “tax capital”) as a partner’s equity calculated using tax principles, and states the term is not based on generally accepted accounting principles, Section 704(b), or other principles. The FAQ further provides that negative tax basis capital generally exists when a partnership allocates tax deductions or losses or makes distributions to a partner in excess of the partner’s tax basis equity in the partnership. A negative tax basis capital account may also exist when a partner contributes property subject to debt in excess of the property’s adjusted tax basis to the partnership.

The IRS acknowledges a partner’s tax basis capital account may be negative when the tax basis of the partner’s interest in the partnership, commonly referred to as a partner’s outside tax basis, is zero or positive. The guidance confirms that a partner’s tax basis capital account is separate and distinct from outside tax basis because, unlike a partner’s outside tax basis computation, the tax basis capital account should not include a partner’s share of liabilities under IRC Section 752. 

The FAQ expands the items taken into account in calculating a partner’s tax basis capital for purposes of the reporting requirement by including the partner’s share of basis adjustments under Section 734(b) or with respect to partnership property under Section 743(b). It states that revaluations of partnership property pursuant to Section 704 and the regulations thereunder do not affect the tax basis of partnership property or a partner’s tax basis capital account.

The guidance also addresses acquisitions of partnership interests by transfer from another partner (for example, by purchase or in a non-recognition transaction). Under the FAQ, the transferee partner will have a tax capital account immediately after the transfer equal to the transferring partner’s tax capital account immediately before the transfer with respect to the portion of the interest transferred. Where the partnership has a Section 754 election in effect, the partnership further increases (or decreases) the tax capital account of the transferee partner by an amount equal to the positive (or negative) Section 743(b) adjustment as a result of the transfer.  

Grant Thornton Insight: Prior to the release of the FAQ, it was not clear whether Section 734(b) and Section 743(b) adjustments would be taken into account in determining a partner’s tax basis capital account. Now that the IRS has instructed partnerships to include each, to the extent that a basis adjustment is positive, the increase to basis would operate to increase the partner’s tax basis capital account and thus reduce the possibility of a partner having a negative tax basis capital account.
Safe harbor approach The FAQ introduces a safe harbor that allows a partnership to calculate a partner’s tax basis capital account by taking the partner’s outside tax basis in the partnership and subtracting the partner’s share of liabilities under Section 752. If a partnership elects to use this approach, it will be required to report the negative tax basis capital account information as equal to the excess, if any, of the partner’s share of partnership liabilities under Section 752 over the partner’s outside tax basis.

Partnerships exempt from the reporting requirement All partnerships are required to comply with the new reporting requirements except those who meet all of the following conditions, pursuant to Schedule B, Question 4 of Form 1065:

  1. Less than $250,000 in total receipts for the tax year
  2. Less than $1 million in total assets at the end of the tax year
  3. Schedules K-1 are filed with the partnership return and furnished to the partners on or before the due date (including extensions) for the return
  4. No Schedule M-3 is filed or required to be filed

Next steps The additional guidance is certainly welcome and will be helpful for partnerships and their partners as they work toward complying with the reporting requirement. Partnerships now have more details for the computation involved in the reporting requirement, as well as a safe harbor allowing partnerships to look to outside basis. However, each individual partnership must examine and evaluate its particular circumstances to determine the ideal approach for the entity and its partners. For instance, the safe harbor may be a viable option and may ease the compliance burden for partnerships that can easily obtain information on partners’ outside basis.

For more information, contact:
Grace Kim
Washington National Tax Office 
Grant Thornton LLP
T +1 202 521 1590

Jose Carrasco
Senior Manager
Washington National Tax Office 
Grant Thornton LLP
T +1 202 521 1552
Ryan Nodal
Washington National Tax Office
Grant Thornton LLP
T +1 202 861 4111

Whit Cocanower
Senior Associate
Washington National Tax Office
Grant Thornton LLP
T +1 202 521 1541

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