The IRS has decided to push back by one year the requirement that all partnerships report partners’ capital on Schedules K-1 on the tax basis of accounting in Notice 2019-66.[1] The IRS had originally only provided the option to report capital on the tax basis of accounting on the draft Form 1065 for 2019.

The IRS received a number of comments on that requirement that indicated both that there was not a clear definition of the tax basis of accounting for these purposes and that many taxpayers would be unable to prepare such returns either at all for 2019 or at least not until much later than their partners expected to receive the K-1s.

Tax Basis Capital Reporting

Reacting to these complaints, the IRS is temporarily delaying the requirement with regard to tax basis capital account reporting for all partners.

The IRS notice provides:

This notice provides that partnerships and other persons required to furnish and file Form 1065, Schedule K-1 or Form 8865, Schedule K-1, will not be required to report partner capital accounts in Item L of the 2019 Form 1065, Schedule K-1, or in Item F of the 2019 Form 8865, Schedule K-1, using the tax basis method for 2019.

Instead, partnerships and other persons must report partner capital accounts for 2019 consistent with the reporting requirements for the 2018 Forms 1065, Schedule K-1, or 8865, Schedule K-1, as applicable. This means that partnerships and other persons may continue to report partner capital accounts on Forms 1065, Schedule K-1, Item L, or 8865, Schedule K-1, Item F, using any method available in 2018 (tax basis, Section 704(b), GAAP, or any other method) for 2019. These partnerships and other persons must include a statement identifying the method upon which a partner's capital account is reported. The final instructions for the 2019 Forms 1065, Schedule K-1, Item L and 8865, Schedule K-1, Item F, are expected to include additional details on how such reporting should be done.[2]

However, the IRS is still retaining the requirement, imposed for 2018 partnership returns, that the partnerships must provide information on partners that had negative tax basis partnership capital accounts at either the beginning or end of the tax year:

For 2019 partnership taxable years, partner “tax basis capital” must be calculated as provided in the 2018 Form 1065 and Schedule K-1 instructions. Beginning with the 2018 partnership taxable year, if a partner’s tax basis capital was negative at the beginning or end of a partnership’s taxable year, a partnership or other person is required to report on line 20 of a partner’s Schedule K-1, using Code AH, such partner’s beginning and ending tax basis capital. Partnerships and other persons who follow this notice and report partner capital accounts for 2019 in Item L of the Form 1065, Schedule K-1, or in Item F of the Form 8865, Schedule K-1, by using a method other than the tax basis method must continue to comply with the requirement in the 2018 forms and instructions with respect to negative tax basis capital accounts.

Thus, unless a partnership is completely sure no partners would have negative tax basis capital, the partnership will still have to calculate such capital accounts. The IRS provides the following information on computing the numbers:

The IRS website for Form 1065 Frequently Asked Questions (FAQs), “Negative Tax Basis Capital Account Reporting Requirements,” provides guidance on the calculation of a partner’s tax basis capital account in FAQ 2, and, for clarity, the definition of tax basis capital includes (A)(v) and (B)(vii) of FAQ 2. Additionally, in lieu of following the definition of tax basis capital in FAQ 2, partnerships and other persons may instead use the partner outside basis safe harbor approach referenced in FAQ 6. If a partnership or other person uses the safe harbor approach, the partnership or other person must attach a statement to the partner’s Schedule K-1 with the information described in (2)(d)(iii) of FAQ 8. Other than the information described in (2)(d)(iii) of FAQ 8, the remainder of FAQ 8 is inapplicable for 2019, including the penalty relief and extension of time to file described therein, which applied only for 2018. The FAQs are found at: https://www.irs.gov/businesses/partnerships/form-1065-frequently-asked-questions.[3]

The safe harbor approach allows for partnerships who know a partner’s basis in his/her partnership interest to back into tax basis capital to determine if there is a negative tax basis capital account for purposes of the negative tax basis capital account reporting. The IRS FAQ provides the following:

Partnerships may calculate a partner’s tax basis capital account by subtracting the partner’s share of partnership liabilities under § 752 from the partner’s outside basis (safe harbor approach). If a partnership elects to use the safe harbor approach, the partnership must report the negative tax basis capital account information as equal to the excess, if any, of the partner’s share of partnership liabilities under § 752 over the partner’s outside basis.[4]

If the safe harbor is used, the following information must be included with the partners’s K-1:

...[I]f the person or partnership required to file the Schedule K-1 or other applicable forms or statements elects to use the safe harbor approach for certain partners, the schedule must set forth for each partner for which negative tax basis capital account information is required:

iii. The amount of the partner’s outside basis, share of partnership liabilities under § 752, and tax basis capital account under the safe harbor approach at the beginning and end of the tax year at issue.[5]

The IRS also is promising to provide additional information on the computation of tax basis capital for 2020 returns, when it will be required to be used, as well as asking for comments on the definition of a partner’s tax basis capital.[6]

Net Unrecognized §704(c) Gain or Loss

However, the IRS is not pushing back all of the new information requests on 2019 returns to 2020. Specifically, for all partnerships except publicly traded partnerships (PTPs), the requirement to disclose net unrecognized §704(c) gain or loss at the beginning and end of the tax year for each partner on the K-1 remains in place.

The IRS provides the following guidance for partnerships other than PTPs:

Solely for purposes of completing the 2019 Forms 1065, Schedule K-1, Item N, and 8865, Schedule K-1, Item G, this notice defines a partner's share of “net unrecognized Section 704(c) gain or loss” as the 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.

Commenters have requested additional guidance with respect to Section 704(c) computations, such as guidance with respect to the issues described in Notice 2009-70, 2009-34 I.R.B. 255. For purposes of reporting for 2019, partnerships and other persons should generally resolve these issues in a reasonable manner, consistent with prior years' practice for purposes of applying Section 704(c) to partners.[7]

PTPs do get relief in this area, and that relief applies until further notice—that is, not just for 2019 returns:

Net unrecognized Section 704(c) gain or loss reporting will not apply to publicly traded partnerships (defined in section 7704 of the Code) and their partners for 2019, and thereafter, until further notice.[8]

At-Risk Activity Reporting

The draft Form 1065 also asked for various information about at-risk activity reporting. As the Notice states:

The draft of the 2019 Form 1065, Item K, released September 30, 2019, requires partnerships to indicate if they have aggregated activities for purposes of the at-risk limitation rules under section 465 of the Code (Section 465). The draft of the instructions for the 2019 Form 1065, Schedule K-1 (to which the draft instructions for the 2019 Form 8865 refer), released October 29, 2019, included a new paragraph at page 12, At-Risk Limitations, At-Risk Activity Reporting Requirements, that would expressly require partnerships or other persons that have items of income, loss, or deduction reported on the Schedule K-1 from more than one activity that may be subject to limitation under Section 465 at the partner level to report certain additional information separately for each activity on an attachment to a partner's Schedule K-1. The new paragraph would require the partnership or other person to identify the at-risk activity, the items of income, loss, or deduction for the activity, other items of income, loss, or deduction, partnership liabilities, and any other information that relates to the activity, such as distributions and partner loans. This requirement in the draft instructions for the 2019 Form 1065 is in addition to longstanding at-risk reporting requirements included in the instructions to the Form 1065. See Part II, Information About the Partner; Item K Partner's Share of Liabilities.[9]

Based on comments, the IRS has decided to remove the requirement to report additional detailed information on each activity for 2019, but kept the requirement to disclose if activities have been aggregated for §465 purposes:

Based on comments received, the Treasury Department and the IRS have become aware that certain partnerships and other persons may be unable to timely comply with the newly added requirement to report additional information about each at-risk activity separately for 2019. Partnerships and other persons required to furnish and file Form 1065, Schedule K-,1 or Form 8865, Schedule K-1, will not be required to report information for each at-risk activity separately for 2019 that was not previously required to be reported for the 2018 partnership taxable year. Partnerships must still indicate in Item K on Form 1065 whether they have aggregated activities for Section 465 at-risk purposes for 2019.[10]

The IRS warns that this does not change the requirements related to the filing of Form 6198 and providing information to partners about such activities:

Nothing in this notice relieves partnerships and partners from complying with the requirements of Form 6198, At-Risk Limitations, for 2019. In particular, partnerships must continue to comply with the instructions to Form 6198 for 2019, which require partnerships to furnish their partners with a separate statement of income, expenses, and deductions for each at-risk and not-at-risk activity.[11]

Penalty Issue

The IRS provides that taxpayers who follow this notice will not face certain penalties:

Taxpayers who follow the provisions of this notice will not be subject to any penalty for reporting in accordance with the guidance provided in this notice, including a penalty under section 6722 for failure to furnish correct payee statements, section 6698 for failure to file a partnership return that shows required information, and section 6038 for failure to furnish information required on a Schedule K-1 (Form 8865).[12]

Since this seems obvious without having to be explicitly noted, presumably this also should be read to mean that advisers need to take care and not read this Notice as excusing the omission of other information from the Form 1065 filing—that could lead to any or all of those penalties being applied.

[1] Notice 2019-66, December 9, 2019, https://www.irs.gov/pub/irs-drop/n-19-66.pdf (retrieved December 10, 2019)

[2] Notice 2019-66, pp. 2-3

[3] Notice 2019-66, pp. 3-4

[4] “Form 1065 Frequently Asked Questions,” IRS Website, Section 6, November 19, 2019 version, https://www.irs.gov/businesses/partnerships/form-1065-frequently-asked-questions (retrieved December 10, 2019)

[5] “Form 1065 Frequently Asked Questions,” IRS Website, Section 8

[6] Notice 2019-66, p. 4

[7] Notice 2019-66, pp. 4-5

[8] Notice 2019-66, p. 5

[9] Notice 2019-66, pp. 5-6

[10] Notice 2019-66, p. 6

[11] Notice 2019-66, p. 6

[12] Notice 2019-66, pp. 6-7