Changes would be meaningful for partnerships and S corporations
The IRS has recently released draft Schedule K-1s for both partnerships and S corporations in addition to draft Forms 1065 and 1120S. While the draft Schedule K-1 for S corporations remains relatively similar to prior years, the draft Schedule K-1 for partnerships, if finalized in its current form, would represent a dramatic shift from prior years, and result in the possibility of a significant increase in the compliance burden.
Major changes to partnership Schedule K-1 include:
TAX BASIS CAPITAL REPORTING
Previously, partnerships had the option to report partners’ capital accounts on either tax basis, GAAP basis, section 704(b) book basis, or an ‘other’ basis. The draft 2019 Schedule K-1 requires the partnership to report each partner’s capital account on tax basis. This requirement comes on the heels of the recent update to the Form 1065 instructions (released earlier in the year, relevant for tax year 2018) requiring that partnerships disclose negative tax basis capital balances on the Schedule K-1. This was a significant change, as it required partnerships with negative tax basis capital, either at the beginning or at the end of the tax year, to compute and disclose accordingly. The proposed change on the draft K-1 would require disclosure of tax basis capital in all cases.
BEGINNING AND ENDING SECTION 704(C) AMOUNTS
Built-in gain (or loss) attributable to property contributed to a partnership, or as a result of a revaluation of partnership property, is typically accounted for under the principles of section 704(c) – this generally means specially allocating such gain or loss back to the contributing partner over a period of time. Accounting for built-in gain or loss on property contributed to a partnership pursuant to section 704(c) is nothing new – indeed, prior Schedule K-1 versions contained a box to indicate whether the partner had contributed property with a built-in gain or loss. However, the 2019 draft Schedule K-1 now requires partnerships to disclose each partner’s built-in gain or loss as of both the beginning and end of the year.
SPECIFIC CODE FOR SECTION 743(B) ADJUSTMENTS
Generally, a partnership has the ability (assuming the proper election is in place) to adjust the basis of partnership assets upon the sale or exchange of a partnership interest. The adjustment, if made, can have the effect of increasing or decreasing a partner’s distributive share of partnership items. The draft 2019 Schedule K-1 provides new codes for reporting the effect of special basis adjustments under section 743(b) on a transferee partner’s distributive share of partnership items. Previously, no specific codes existed with respect section 743(b) adjustments. These codes are relevant for both positive and negative adjustments.
SPECIFIC CODES FOR GUARANTEED PAYMENTS FOR SERVICES AND USE OF CAPITAL
In another departure from prior years, the draft 2019 Schedule K-1 requires separate disclosure of guaranteed payments for services and for the use of capital. While the distinction is not new, in prior years guaranteed payments have been disclosed as a single amount – irrespective of which category they may have fallen into.
- Specific code for 751 ‘hot asset’ gain or loss
- Check box disclosing whether partnership liabilities include liabilities from a lower-tier partnership
- Check box disclosing whether a decrease in a partner’s profit, loss or capital is the result of a sale or exchange
- Check box disclosing whether the partnership aggregated or grouped activities for at-risk (section 465) or passive activity loss (section 469) purposes
- Informational check box specific to disregarded entities
The IRS also released the draft Schedule K-1 for Form 1120S (S corporations). While these K-1s remained largely unchanged, they do contain new disclosures regarding whether the S corporation has aggregated or grouped activities for at-risk (section 465) or passive activity (section 469) purposes.
Although the IRS has designated these forms as ‘Draft’, they have signaled their belief that the forms are close to final and were issued in ‘Draft’ form to give tax practitioners time to adjust as necessary. Accordingly, taxpayers and tax practitioners should pay careful attention to the new draft schedules and, if necessary, begin to consider the potential work necessary to comply with the new schedules.