In September of 2019, the IRS released draft versions of 2019 partnership forms and instructions. These proposed forms included several new reporting requirements that would dramatically change the way partnerships (and entities taxed as partnerships, such as LLCs, LLPs, etc.) report capital and other items on their tax returns and Schedules K-1.
In response, the IRS and Treasury received numerous comments from taxpayers and practitioners concerned with the burdens placed on partnerships to comply with these new requirements, including the partnerships’ and practitioners’ abilities to gather, calculate, and compile the required information in time for the 2019 tax return filing season. As a result, the IRS released Notice 2019-66 providing a one-year delay for reporting tax basis capital (often referred to as ‘tax capital’) information and certain details related to at-risk activities.
However, Notice 2019-66 did not provide a delay in required reporting of section 704(c) information. In many cases, the calculation of section 704(c) attributes necessitates the computation of tax capital. Therefore, many partnerships will not benefit from this delay and will be required to compute tax capital as part of their 2019 filings.
Calculating the information for these new reporting requirements may require substantial time and effort. Taxpayers should determine as soon as possible whether additional information or calculations are needed in order to comply with these new rules.
Partnerships must report unrecognized section 704(c) gain and loss in 2019 - which is more common than many expect
Unrecognized section 704(c) gain or loss can arise in many common scenarios, including, but not limited to, the contribution of assets to a partnership, the issuance of profits interests, or the contribution of cash in exchange for equity by a new or existing partner. Each of these common transactions can create what is generally known as either a “forward” 704(c) layer or a “reverse” 704(c) layer. A reverse 704(c) layer is commonly referred to as a “revaluation.”
In the past, partnerships were not required to report section 704(c) attributes and many deferred these calculations until they affected the allocation of taxable income – often in the year of a sale.
Draft 2019 forms and instructions indicate that partnerships will be required to report beginning and ending “net unrecognized section 704(c) gain or loss” on each partner’s Schedule K-1. This requirement was not delayed by Notice 2019-66.
Often, the calculation of section 704(c) attributes involves the computation of tax capital. Therefore, partnerships may have to calculate tax capital for the 2019 tax year even though the IRS has provided for a one-year delay in tax capital reporting.
Due to the volume of information that may need to be gathered, it is important that partnerships act quickly to determine whether additional calculations are needed to establish accurate section 704(c) records, and potentially tax capital account records, for the 2019 tax year.
Negative tax capital must be reported in 2019, tax capital must be reported in 2020
A partner’s tax capital account represents a partner’s share of the partnership’s overall capital calculated using tax principles rather than generally accepted accounting principles (GAAP), section 704(b), or other principles. Tax capital is a separate and distinct concept from a partner’s tax basis (‘outside basis’) as there are several items that would cause a partner’s outside basis and tax capital to differ.
Prior to 2018, partnerships were not required to report capital account information using the tax basis capital method. In 2018, the IRS changed this by requiring partnerships report partner tax capital account information on Schedule K-1, but only if either the beginning or ending amount was negative for a partner.
The draft 2019 forms and instructions broadened this requirement and required that partnerships report tax capital information on each partner’s Schedule K-1, regardless of whether the beginning or ending amounts are negative. However, Notice 2019-66 delayed this requirement for one year. Partnerships relying on Notice 2019-66 for the 2019 tax year must report partner capital account information on Schedule K-1 consistent with the reporting requirements for 2018, including the negative tax capital reporting requirements mentioned above.
Even though the IRS has provided a welcomed relief for reporting tax capital information per partner for the 2019 tax year, many will still need to compute these amounts as part of their compliance with section 704(c) reporting requirements or to confirm that negative tax capital amounts do not exist. Those taxpayers may wish to simplify the transition process by adopting tax capital reporting in 2019, even though it is not a requirement. For others, this requirement will apply to the 2020 tax year.
Partnerships that historically have not tracked partners’ tax capital information should begin compiling the necessary information to establish accurate tax capital account records now to help prepare for this reporting requirement.
Reporting of details related to at-risk activity delayed to 2020
The 2019 draft forms and instructions also required partnerships to report new information for each at-risk activity of the partnership, including separate reporting of each activity’s items of income, loss, or deduction, other items of income, loss or deduction, partnership liabilities, and other related information, such as distributions or partner loans. These new reporting requirements are in addition to existing at-risk reporting requirements for Form 1065.
Commenters expressed their concerns to the IRS and Treasury about their ability to timely comply with the additional at-risk activity reporting requirements for each separate activity. Accordingly, the IRS provided for a one-year delay in Notice 2019-66 for these additional at-risk reporting requirements, however, at-risk activity information that was required to be reported previously will still apply to the 2019 tax year.