Starting with the 2021 tax filing season, if you have a business taxed as a partnership, you will have to report the partners’ capital accounts on a tax basis of accounting.
Form 1065 Instructions Early Draft Released
About a week ago, IRS released an early draft of the 2020 form 1065 instructions. This draft provides information about the new reporting requirement.
Under the tax basis method, partnerships report partners’ contributions, distributions, their share of partnership net income or loss, and other increases or decreases using tax basis principles. Until now, other methods were allowed, such as: generally accepted accounting principles, contractual method, regulatory method and others.
If your business already used the tax basis of accounting to report the partners’ capital accounts on schedule K1, you will continue to report them in the same manner as before.
However, businesses taxed as partnerships, that in 2019 did not prepare Schedules K1 under the tax capital method, will need to recalculate the 2019 ending capital account balances. You can use several methods to do this:
- The Modified Outside Basis Method,
- The Modified Previously Taxed Capital Method,
- The Section 704(b) Method.
Because this might be difficult to implement, IRS announced it intends to provide penalty relief, but only for tax year 2020, for any errors in reporting the beginning capital account balances on Schedules K1. The relief applies if the business takes ordinary and prudent business care in following the 1065 form instructions to calculate and report the beginning partners’ capital account balances. IRS will issue a notice soon with details about this penalty relief for the 2020 tax year.
IRS Will Release the Final Version in December
A final version of the 1065 instructions will be released in December. In the mean time IRS is accepting comments to this draft. You have 30 days from the date of the draft release, which was October 22, 2020 to submit your comments.
The rules of tax basis of accounting can be difficult. And transitioning from a different basis of accounting can be confusing. If you need help with the preparation of your business’ tax return, give us a call.
This material is for informational purposes only. It does not constitute tax, legal or accounting advice.