Baker Tilly Virchow Krause, LLP is an IMA Member
The IRS recently released draft 2019 forms and instructions for Form 1065, U.S. Return of Partnership Income, and the corresponding Schedule K-1. In an effort to make audit issues more readily identifiable, partnership returns now require additional information be included. Some of this material is particularly complex and will require taxpayers and their advisors to spend more time and resources to ensure it is reported accurately.
While the forms and instructions are in draft format, all indications from the Treasury Department and commentators lead us to believe the IRS is unlikely to make substantial modifications. The new requirements are the result of an effort to make certain partners are correctly reporting certain partnership transactions. Furthermore, the data is necessary to administer compliance needs under the Tax Cuts and Jobs Act for computing items such as the business interest expense deduction limitation, the qualified business income deduction and the limitation on excess business losses of noncorporate taxpayers.
Despite the additional compliance burden, we view this as an excellent opportunity to review the economics of the partnership and to confirm that the reporting on the tax return accurately reflects the economic deal among the partners. This is the best way to ensure the tax benefits and burdens are shared in accordance with your economic deal and to avoid unexpected allocations of taxable income or loss.
The following summarizes significant changes in the draft 2019 Form 1065 and corresponding Schedule K-1.
- Question L on the K-1 will now require reporting of tax basis capital. Reporting capital on GAAP or other methods on this line is no longer permitted.
For 2018 returns, the IRS mandated disclosure if any partner had negative tax capital at the end of the year. For 2019 returns, all partner K-1s require tax basis capital reporting on line L.
Tracking tax capital generally has been considered the responsibility of the partner, however, the IRS now compels the partnership to track and report tax capital for all partners.
- Any unrealized gain or loss under section 704(c) (built-in gain (BIG) property) must be reported for each partner in every tax year.
Both beginning and ending net unrecognized section 704(c) gain or loss must be disclosed. Previously, if a partner contributed BIG property, a disclosure was required in the year of contribution, but not in subsequent years.
Section 704(c) gain or loss occurs when a partner contributes property to the partnership and the property’s tax basis differs from its fair market value.
The section 704(c) disclosures will also apply to partnerships that have revalued capital accounts under section 704(b).
- Guaranteed payment reporting was expanded to separately report guaranteed payments for services and guaranteed payments for the use of capital, presumably to assist the IRS in tracking whether guaranteed payments for the use of capital are reclassified as interest for computing the business interest expense deduction limitation.
- The K-1 and page one of Form 1065 have boxes to be checked if the partnership has grouped activities for either at-risk or passive loss purposes.
- If a partnership interest is owned by a disregarded entity (DRE), the DRE owner’s name and taxpayer identification number must also be disclosed on the Schedule K-1.
- Form 1065 has a new question about disguised sale transactions.
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