On September 30, 2019 the IRS issued drafts 2019 Form 1065 (partnership income tax return) and Schedule K-1 (partner’s share of income, deductions, credits, and other items). A month later, it issued draft instructions for both forms. The proposed forms and instructions impose significant new tax compliance burdens on many funds organized as partnerships.
The IRS received numerous comments claiming the new reporting requirements would be difficult to meet on a timely basis. In response, the IRS issued Notice 2019-66 on December 9, 2019, which delays certain aspects of the revised Schedule K-1 until 2020. The IRS also issued new draft forms and instructions to clarify 2019 requirements.
Tax Basis Reporting
Prior to 2018, partners’ capital accounts (Item L of Schedule K-1) could have been reported on:
- A tax basis,
- A GAAP basis,
- A 704(b) book basis, or
- Other bases.
In 2018, the IRS introduced a requirement that partnerships use tax basis reporting for partners with negative tax basis capital accounts.
The draft 2019 Schedule K-1 issued on September 30, 2019, however, made tax basis capital reporting compulsory for all partners. (Note that certain smaller partnerships with less than $250,000 in total receipts and less than $1 million in total assets aren’t required to complete Item L of Schedule K-1.) This is a significant departure from previous years’ requirements.
The IRS then issued Notice 2019-66 on December 9, 2019 which postponed the tax basis reporting requirement by one year. The tax basis reporting will be effective for partnership tax years beginning on or after January 1, 2020. For 2019, capital reporting should follow the requirements in the 2018 forms and instructions — including tax basis reporting for partners with negative tax basis capital accounts. You should also submit a statement identifying the method used to report partners’ capital accounts.
More Time and Higher Costs
Even though the tax basis reporting for Item L of Schedule K-1 is not required for 2019 due to the one-year delay, partnerships are still required to provide tax basis reporting for partners with negative tax basis capital accounts for 2019. For many partnerships, tax basis capital reporting will demand a significant amount of extra time and expense. Those who have historically maintained partners’ capital accounts on a GAAP or other nontax basis will have to review all tax returns and Schedule K-1s going back to the partnership’s inception.
They’ll also have to examine sales and other transfers of partnership interests that affect partners’ tax bases. Because tax basis reporting wasn’t mandatory before, many partnerships haven’t maintained the data required to make the necessary calculations. Therefore, they’ll have to gather the information they need from current and former partners before filing their partnership income tax returns and K-1s.
The draft Schedule K-1 adds several other reporting obligations for partnership income tax returns. For example, it requires partnerships to report a partner’s share of “net unrecognized 704(c) gain or loss” at the beginning and end of the tax year. Notice 2019-66 doesn’t delay this requirement. However, it provides a definition of “net unrecognized 704(c) gain or loss” and exempts publicly traded partnerships from the requirement pending further guidance.
Partnerships will also have to indicate whether:
- A partner is a disregarded entity and, if so, to disclose the name and tax identification number of the beneficial owner;
- A decrease in a partner’s share of profit, loss, and capital is due to a sale or exchange of the partnership interest;
- A partner’s share of liabilities includes liability amounts from lower-tier partnerships; and
- The partnership has aggregated activities for purposes of the at-risk limitation rules and, if so, to report certain information separately for each activity.
Regarding this last item, Notice 2019-66 delays the requirement to report information for each at-risk activity separately until 2020. However, partnerships must continue to indicate on their 2019 partnership income tax returns whether they’ve aggregated activities for at-risk purposes.
A one-year reprieve from the most burdensome aspects of the proposed Schedule K-1 is welcome news. Nevertheless, given the amount of legwork required to gather information and make necessary computations, partnerships should begin to prepare soon — particularly those that don’t currently report capital accounts on a tax basis.
As the IRS plans to issue more detailed guidance on the definition of partner tax basis capital, we will communicate additional information on this topic as it becomes available.