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December 19, 2019

IRS Backs Down from Expanded Requirement to Disclose Partnership Tax Capital on 2019 Returns

Partnership Tax Capital

Preparation of 2019 tax returns will be a little easier for partnerships than was initially feared. The IRS recently announced that several information reporting requirements will be delayed for this tax year, which will be a welcome relief for filers.

In Notice 2019-66, the IRS noted that the expanded requirement to report partners’ shares of partnership capital on the tax basis method for all partners will not apply to 2019 returns. Notice 2019-66 delayed the requirement for one year. Partnerships are not wholly exempt from reporting partners’ shares of partnership capital in 2019; the requirement to report partners’ shares of partnership capital on the tax basis method is still in effect for those partners with negative tax basis capital balances.

The IRS is also delaying certain other information reporting requirements that it previously announced for 2019 filings of Form 1065. Taxpayers should note that for now, the draft instructions for both the 2019 Schedule K-1 and the Form 1065 have not been updated for all of the changes made in Notice 2019-66, but here is a summary of what those updates will be.

Tax Basis Capital Disclosure Requirement

The requirement to report partners’ shares of partnership capital on the tax basis method for all partners will be effective for partnership taxable years that begin on or after Jan. 1, 2020.

What the Delay Means for Reporting

For 2019, partnerships should report partner capital accounts consistent with the reporting requirements for the 2018 Forms 1065 and Schedule K-1. This means that partnerships may continue to report partner capital accounts using any method available in 2018 (e.g., tax basis, Section 704(b), GAAP, or any other method) for 2019. This also means that, if a partner’s tax basis capital was negative at the beginning or end of the partnership’s 2019 taxable year, the partnership is required to report such partner’s beginning and ending tax basis capital.

Definition of Tax Basis Capital

The definition of tax basis capital for 2019 reporting purposes remains the same as the 2018 definition, with one potential discrepancy.

The IRS frequently asked questions provide that a Section 743(b) basis adjustment is to be treated as part of a partner’s tax basis capital account (with special rules involving a “step into the shoes” approach for situations involving ownership transfers among partners). However, the current draft current draft Form 1065 instructions continues to provide that “Section 743(b) adjustments don’t affect the transferee’s tax basis capital account.” Perhaps in recognition of these contradictory instructions, the IRS provided in Notice 2019-66 that, “for clarity, the definition of tax basis capital includes (A)(v) and (B)(vii) of FAQ 2,” which provides that such adjustments generally are part of tax basis capital.

Safe Harbor

Notice 2019-66 further provides that the safe harbor approach (which references a partner’s outside tax basis) described under the frequently asked questions can be used to calculate tax basis capital in 2019 in lieu of the detailed approach. Also, Notice 2019-66 clarifies that the penalty relief statements under the frequently asked questions are inapplicable for 2019 filings.

Disclosure of beginning and ending unrecognized section 704(c) balances for partners

In a previously released 2019 draft of the Schedule K-1, the IRS added a requirement to disclose unrecognized Section 704(c) balances for a partner at the beginning and end of the tax year. Notice 2019-66 generally does not change this 2019 disclosure requirement, except that it exempts publicly traded partnerships from the requirement to disclose this information until further notice. For 2019 partnership returns that remain subject to this disclosure requirement, Notice 2019-66 provides the following definition for “a partner’s share of ‘net unrecognized Section 704(c) gain or loss’”: 

[T]he partner’s share of the net (net means aggregate or sum) of all unrecognized gains or losses under section 704(c) of the Code (Section 704(c)) in partnership property, including Section 704(c) gains and losses arising from revaluations of partnership property.

This definition alleviates a prior concern about reporting burdens for multiple section 704(c) layers that may exist.

Section 465 and Section 469 Disclosures

The draft 2019 Schedule K-1 included required disclosures of multiple activities under either (or both) of the Section 465 at-risk loss limitations or the Section 469 passive activity loss limitations. The draft instructions to Form 1065 also imposed a new requirement to provide additional information for each at-risk activity to the partners, including income and loss items for each activity, as well as liability and distribution information for each activity. Further, checkboxes were added to indicate whether the partnership aggregated or grouped activities for each of these purposes.

The IRS announced in Notice 2019-66 that the additional information for each at-risk activity will not be required for 2019.The other disclosure requirements in the draft Schedule K-1, as well as Item K on Form 1065, are not changed by Notice 2019-66.

Taxpayers should take particular note that similar information reporting requirements for each at-risk activity are also scheduled to apply to 2019 filings of Form 1120S. While Notice 2019-66 rolled back the requirement to supply detailed information for each at-risk activity on 2019 filings of Form 1065, the requirement appears to remain for 2019 filings of Form 1120S.

Schedule K-1 Disclosure for the Beneficial Owner of a Partner That is a Disregarded Entity

The draft Schedule K-1 instructions and the draft Form 1065 instructions provide that a beneficial owner’s taxpayer identification number and name must be listed on Schedule K-1 in circumstances where the direct partner is a disregarded entity. If the direct partner is a disregarded entity, the instructions provide that the information for the disregarded entity is indicated only on Schedule K-1, item H2. Despite this requirement, the trustee for certain grantor trusts may instruct the partnership to use the grantor trust’s employer identification number for tax reporting purposes under Reg. Section 1.671-4(b)(5)(ii). The requirement under the regulations to report in accordance with these trustee directives would override any requirements to the contrary in the Schedule K-1 instructions.

Provisions Not Affected

The following changes to required information disclosures that appeared in the 2019 drafts of the Schedule K-1 and 1065 were not affected by Notice 2019-66:

  • Schedule K-1 positive and negative Section 743 adjustments
  • Form 1065 disclosure information for mandatory negative basis adjustments under Sections 743(d) or 734(d)
  • Form 1065 disguised sale transaction checkbox
  • Form 1065 disclosure information to distinguish guaranteed payments for services and for the use of capital

Key Takeaways for Partnerships

Notice 2019-66 provides significant relief from some of the earlier reporting burdens scheduled to affect partnerships filing 2019 Forms 1065, but not all of the enhanced 2019 reporting requirements will be delayed. For more information about the impact of these latest provisions, please contact us.

Related Reading

2019 Individual Tax Planning Supplement

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