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2020 Draft Form 1065 Instruction Indicates Changes in Partners’ Capital Account Reporting

The IRS has released an early draft of instructions for 2020 Form 1065, U.S. Return of Partnership Income. They apply to the 2020 tax year (or 2021 filing season). These revised instructions require partnerships to report partners’ tax basis capital account balances on Schedule K-1.

Facilitating Increased Compliance by Improving Information Quality

The IRS has released these revised instructions as part of a more widespread agency effort to improve compliance. The instructions aim to improve the quality of the information that the partnerships report to both the IRS and their partners. The goal of the change is to facilitate greater compliance.

The altered instructions require partnerships to use the transaction approach when filing this form for the 2020 tax year. Partnerships must use this tax basis method to calculate their partner capital accounts.

This tax basis method requires partnerships to report several elements, including:

  • capital contributions;
  • distributions and withdrawals;
  • each partner’s share of the partnership’s net loss or income for the year; and
  • other decreases or increases using this tax basis principle rather than reporting using different methods, such as Generally Accepted Accounting Principles (GAAP).

Minimal Change for Most Partnerships

Although this may sound like a significant change, according to the IRS’s data, it may not affect most of the partnerships. Most partnerships are already using this method to report partners’ capital accounts.

Partnerships that did not prepare 2019 Schedule K-1 under the tax capital method or otherwise maintain tax basis capital accounts in their books and records may determine each partner’s beginning tax basis capital account balance for 2020 using one of the following methods:

  • The Modified Previously Taxed Capital Method
  • The Modified Outside Basis Method
  • The Section 704(b) Method

Penalty Relief for 2020 Tax Year

Aiming to promote greater compliance with this new reporting method, the IRS and Treasury Department intend to provide a penalty relief. This will cover the transition period for the 2020 tax year. The agencies plan to issue a notice regarding this, stating that there will be no penalty assessed for tax year 2020 if there is an error on the partners’ tax basis capital accounts reporting on Schedule K-1. The relief will only be available for the 2020 tax return and only if the partnership adheres to the new instructions.

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