Penalty relief available for new negative capital reporting

Business man on steps with briefcaseThe IRS recently released new instructions for the 2018 Form 1065, “U.S. Return of Partnership Income,” which require partnerships to report negative tax basis capital amounts on Schedule K-1. These new instructions had not been widely publicized, and many partnerships were unaware of the new requirements.

The failure to comply could result in penalties, but the IRS has acknowledged that certain partnerships are having difficulty complying on a timely basis. The IRS issued Notice 2019-20 to waive penalties under Section 6722 for furnishing a partner a Schedule K-1 and Section 6698 for filing a Schedule K-1 with a partnership return that fails to report negative tax basis capital account information if certain conditions are met. Affected partnerships should assess the new requirements to understand whether they are affected and what they are required to report and when.

To which partnerships do the new reporting requirements apply?
  • The new reporting requirement potentially applies to any partnership that reports capital accounts in Item L on Schedule K-1 other than tax basis capital accounts.

What is the new reporting requirement in the instructions?
  • The new Form 1065 Instructions require partnerships that report partners’ capital accounts (Item L on Schedule K-1) on a basis other than tax basis capital accounts to provide, on Schedule K-1 on Line 20 using code AH, beginning and ending tax basis capital accounts for any partner who has negative “tax basis capital” either at the beginning or end of the tax year. This is in addition to the required reporting in Item L of Schedule K-1.
  • The instructions define “tax basis capital” as: i) the amount of cash plus the tax basis of property contributed to a partnership by a partner minus the amount of cash plus the tax basis of property distributed to a partner by the partnership net of any liabilities assumed or taken subject to in connection with such contribution or distribution; plus ii) the partner's cumulative share of partnership taxable income and tax-exempt income; minus iii) the partner's cumulative share of taxable loss and nondeductible, noncapital expenditures.
  • This definition is new, and tax basis capital account amounts are not necessarily the same as the partner’s basis in its partnership interest. Further, each partner, and not the partnership, is responsible for computing its basis in its partnership interest.

To which partnerships does the penalty waiver in Notice 2019-20 potentially apply?
The notice will allow additional time for partnerships to provide the negative tax basis capital account information (that is required in the instructions to Form 1065) with respect to the partnership’s taxable years beginning after Dec. 31, 2017, but before Jan. 1, 2019.

Which penalties are being waived?
Notice 2019-20 provides that penalties under both Section 6722 (failure to provide a complete Schedule K-1 to a partner) and Section 6698 (failure to file a complete Schedule K-1 with the partnership return) will be waived.

What are the conditions for a penalty waiver?
Notice 2019-20 specifies two conditions that must be met by the partnership in order for the penalty waiver to apply:

  1. The partnership timely files otherwise complete Schedules K-1 (including extensions) with the IRS and furnishes copies to partners.
  2. The partnership files a schedule (as detailed below) with the IRS by no later than 180 days after the six-month extended due date of the partnership’s Form 1065. For a calendar-year filer, that means the schedule must be filed by no later than March 15, 2020. The schedule must set forth for each partner for whom the partnership is required to provide negative tax basis capital account information: the partner’s name, address, taxpayer identification number, and the amount of the partner’s tax basis capital account at the beginning and end of the tax year at issue.

The notice states that partnerships can use the six-month extension in calculating the due date for filing the required schedule, regardless of whether the partnership files a request to extend the time for filing its return. Additionally, a partnership does not need to furnish an amended Schedule K-1 to each partner as part of the penalty waiver process.

Next steps Form instructions are a relevant authority in interpreting the partnership's reporting requirements. Thus, partnerships filing a 2018 Form 1065, and issuing a Schedule K-1, should include the information required under the new instructions. However, if timely compliance is not possible, partnerships should continue to work toward complying with the negative tax basis capital account reporting requirement and preparing the schedule described in the notice for submission to the IRS within the time frame set forth in the notice.

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
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