IRS Releases Draft Form 1065 And Schedule K-1 Instructions

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08 November 2019

IRS releases draft Form 1065 and Schedule K-1 instructions

The proposed changes to the Form 1065, Schedule K-1 and associated instructions, if adopted, will likely add significant time and complexity to the partnership tax reporting process.

Before release of the 2018 Form 1065 instructions, partnerships had the option of reporting their partners' capital accounts under any one of several different methods (e.g., tax basis, GAAP or IRC Section 704(b) book). The 2018 Form 1065 instructions, however, required partnerships to report partners' tax basis capital account information for partners with negative tax basis capital accounts at the beginning or end of the tax year (see Tax Alerts 2019-0396 and 2019-0509). The draft 2019 Schedule K-1 goes further and requires the reporting of each partner's tax basis capital account, regardless of whether a partner's tax basis capital account is positive or negative.

[(Amount of cash + tax basis of property contributed to a partnership by a partner) — (amount of cash + (the tax basis of property distributed to a partner by the partnership - any liabilities connected with the contribution or distribution))] + [the partner's cumulative share of partnership taxable income and tax-exempt income - the partner's cumulative share of taxable loss and nondeductible, noncapital expenditures]

The Draft Instruction's approach also raises the possibility that the sum of all partners' tax basis capital accounts reported on the Schedule K-1s would not equal a total tax basis equity amount that would balance on a tax basis balance sheet (e.g., if a partnership had made a prior liquidating distribution to a partner and the basis of the distributed property did not equal the distributee partner's tax basis capital account and the partnership did not have a IRC Section 754 election in effect).

The draft 2019 Schedule K-1 includes a new item (Part II, Item N) for reporting a partner's beginning and ending share of "net unrecognized IRC Section 704(c) gain or (loss)." The Draft Instructions do not provide guidance on how to compute net unrecognized IRC Section 704(c) gain or loss.

The Draft Instructions do not provide an exception to the requirement to report the partners' shares of net unrecognized IRC Section 704(c) gain or loss for publicly-traded partnerships (PTPs).

Furthermore, the Draft Instructions require the reporting of each partner's share of net IRC Section 704(c) adjustments to current year income or loss. This information is reported in Line 20, Code AA (a code previously used for IRC Section 199A information).

IRC Section 751(a)

IRC Section 743(b) adjustments

Insight: Historically, partnerships reported income, deduction, gain or loss resulting from IRC Section 743(b) adjustments in a variety of different manners. This change indicates that IRC Section 743(b) basis adjustments should not be reflected in ordinary business income reported on Line 1 or as a footnote disclosure and will require the consistent reporting of items resulting from IRC Section 743(b) adjustments.

IRC Section 199A items

Implications

In all, partnerships and their advisors should carefully consider the recently released Draft Instructions as they prepare for the 2019 compliance seasons. As significant efforts may be necessary to comply, early consideration of the Draft Instructions is warranted.

Document ID: 2019-2011

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