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IRS delays reporting of partner tax basis capital

Notice also stays on course with Section 704(c) reporting

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IRS delays reporting of partner tax basis capital The IRS released Notice 2019-66 on Dec. 9 to provide partnerships a one-year delay of new requirements to report partner capital accounts on the tax basis method.

The notice also delays until 2020 the new requirement for partnerships to report partner at-risk information for each activity separately and provides taxpayers certain penalty relief in accordance with the guidance provided in the notice. However, partnerships must still report partners’ net unrecognized Section 704(c) gain or loss for the 2019 tax year.

While the relief provided in the guidance may appear favorable, partnerships need to gather relevant information, including capital account information, in order to comply with the new Section 704(c) reporting requirements.

Background In September and October 2019, the IRS released draft 2019 forms and instructions for the Form 1065, Schedule K-1, and Form 8865. Together, the drafts impose significant additional reporting requirements, including reporting partners’ “net unrecognized Section 704(c) gains or losses” and tax basis capital accounts on each Schedule K-1. The draft 2019 forms reflected an expansion of a requirement for 2018 returns to report a partner’s capital account on a tax basis method when either the beginning-of-year or end-of-year amount was negative. Practitioners submitted comments requesting a delay in implementing the new 2019 reporting requirements.

For a more detailed discussion of the 2019 draft forms, see our prior coverage. The IRS has also released updated drafts of Form 1065, Schedule K-1 and the form instructions for Form 1065 and Schedule K-1 on Dec. 9 that reflect changes covered in the notice discussed below.

Capital account reporting for 2019 The notice provides that for taxable years beginning in calendar year 2019, partnerships and other persons will not be required to report partner capital accounts using the tax basis method. Rather, partnerships and other persons must report partners’ capital accounts in accordance with the reporting requirements for the 2018 Form 1065, Form 8865, and their respective Schedules K-1, as applicable. This means that for the 2019 tax year, with the exception of required reporting of negative tax basis capital account information (a continuation of the requirements from 2018), partnerships may continue to report partner capital accounts using any method that was previously available, such as tax basis, Section 704(b) or GAAP. For more information on the 2018 negative tax basis capital account reporting requirements, see our prior coverage.

In addition, partnerships will be required to include a statement identifying the method upon which a partner’s capital account is reported. According to the notice, partnerships and other persons will be required to report partners’ shares of partnership capital on the tax basis method (only) for partnership taxable years that begin on or after Jan. 1, 2020.

Grant Thornton Insight: Although the general reporting of capital accounts on the tax basis method is not required until 2020, partnerships must continue to comply with the negative tax basis capital account reporting requirement introduced in 2018 for the 2019 tax year. Partnerships must report on Line 20 Code AH of a partner’s Schedule K-1 the partner’s beginning and ending share of tax basis capital if such partner’s beginning or ending tax basis capital account was negative. The notice provides that taxpayers can rely on the IRS’s FAQ to calculate a partner’s tax basis capital account or may instead use the safe harbor approach.
Net unrecognized Section 704(c) gain or loss The 2019 draft forms and related instructions also proposed to require partnerships to report partners’ shares of net unrecognized Section 704(c) gain or loss as of the beginning and end of the partnership’s 2019 taxable year. However, the definition of the term “net unrecognized Section 704(c) gain or loss” was not included in the draft instructions. The notice provides that solely for purposes of the 2019 forms, “net Section 704(c) unrecognized gain or loss” is defined as “the partner’s share of the net (net means aggregate or sum) of all unrecognized gain or losses under Section 704(c) of the Code (Section 704(c)) in partnership property, including Section 704(c) gains or losses arising from revaluations of partnership property.” The notice also exempts publicly traded partnerships and their partners from having to comply with the requirement for 2019 and thereafter, until further notice.

Grant Thornton Insight: Section 704(c) gain and loss may arise when a partner contributes property to a partnership with a fair market value different from tax basis or upon a revaluation of partnership property where the fair market value of partnership property on the date of adjustment differs from its tax basis. In a situation in which a partnership has multiple layers of Section 704(c) gains or losses resulting from a contribution or revaluation, in accordance with the notice, the partnership should net each partner’s unrecognized Section 704(c) gain or loss and report the aggregate beginning and ending amount on each partner’s 2019 Form 1065, Schedule K-1.
Other reporting items and further guidance The draft 2019 Form 1065 requires partnerships to indicate if they have aggregated activities for purposes of the at-risk limitation rules under Section 465. The draft of the form instructions included a new paragraph that would require partnerships that have items of income, loss, or deduction reported on Schedule K-1 from more than one activity to report certain additional information separately for each activity. The notice provides that partnerships will not be required to report any information for each at-risk activity separately for 2019 that was not previously required to be reported for the 2018 partnership taxable year. Although this requirement is now not effective for 2019, partnerships must still specify in Item K of the 2019 Form 1065 whether they have aggregated activities for at-risk purposes.

Finally, the notice provides certain penalty relief for taxpayers who follow reporting in accordance with the guidance. It also states that in preparation for filing partnership tax returns for the 2020 tax year, further guidance will be published that provides, and requests comments on, the definition of partner tax basis capital.

Next steps The IRS will presumably use this newly requested information to assist in partnership examinations, which are anticipated to increase under the new partnership audit regime under the Bipartisan Budget Act for 2015. Although the notice may be seen as favorable, some of the requirements remain in effect for the 2019 tax year and some are merely deferred until the 2020 tax year, confirming that these new requirements are not going away. In addition, partnerships may need to gather partners’ capital account information in order to comply with the Section 704(c) reporting requirements that remain in effect for the 2019 tax year.

The IRS has also posted updated draft forms and instructions shortly after issuing the notice, and is expected to continue doing so. Partnerships and partners should therefore continue to watch for updates.

For more information contact:
Grace Kim
Principal
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

Tom Connolly
Director
Tax Practice Policy & Quality 
Grant Thornton LLP
T +1 312 754 7336

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

Ryan Nodal
Manager
Washington National Tax Office
Grant Thornton LLP
T +1 803 231 3020

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