The IRS today released a draft version of the instructions to Form 1065, “U.S. Return of Partnership Income” for tax year 2020. Specifically, the draft instructions contain much anticipated clarifications to the reporting requirements regarding partners’ capital accounts.
The IRS today also stated that it intends to issue a notice providing additional penalty relief for the transition in tax year 2020. This to-be-issued notice will provide that solely for tax year 2020 (for partnership returns due in 2021), the IRS will not assess a partnership a penalty for any errors in reporting its partners’ beginning capital account balances on Schedules K-1 if the partnership takes “ordinary and prudent business care” in following the Form 1065 instructions to calculate and report the beginning capital account balances. This penalty relief will be in addition to the reasonable cause exception to penalties for any incorrect reporting of a beginning capital account balance.
The draft of instructions to Form 1065 [PDF 1.02 MB] reflects revised instructions for partnerships required to report capital accounts to partners on Schedule K-1 (Form 1065). The draft instructions show a “watermark date” of October 21, 2020.
The draft instructions are intended to provide a preview of the changes and information that software developers would need to update their systems before the final version of the updated instructions is released in December 2020.
Comments are requested during a 30-day comment period.
As noted in a related IRS release—IR-2020-240—the revised instructions are part of an effort to improve the quality of the information reported by partnerships to the IRS and furnished to partners to facilitate increased compliance.
The revised instructions indicate that partnerships filing Form 1065 for tax year 2020 are to calculate partner capital accounts using the transactional approach for the Tax Basis Method.
The IRS in June 2020 released Notice 2020-43 seeking public comment on other possible methods (including the Modified Outside Basis Method and the Modified Previously Tax Capital Method) to report capital accounts to partners. Read TaxNewsFlash
The addition of the transactional approach to determine each partner’s capital account under the Tax Basis Method is viewed by tax professionals as a welcomed addition to the approaches provided in Notice 2020-43, as it will allow many partnerships to more easily comply with the new reporting requirements.
According to today’s IRS release, in response to Notice 2020-43, comments were received from taxpayers on other possible methods to report capital accounts to partners, and these comments requested that the Tax Basis Method approach be retained. The IRS reported that it did not receive practical alternative approaches to partner capital account reporting.
Today’s IRS release states that reporting using only one method assists the IRS in assessing compliance risk, and identifying potential noncompliance, while providing compliant taxpayers’ returns are less likely to be examined.
The reporting of tax basis capital accounts by partnerships is intended to enhance the compliance efforts of the IRS. This has raised concerns regarding whether the partnership could be assessed with an imputed underpayment in the event of a partnership audit to the extent that there was an adjustment with respect to the reporting of tax basis capital accounts. However, the instructions provide that each partner continues to be responsible for maintaining a record of the adjusted tax basis in its partnership interest.
Lastly, the IRS stated that it intends to make similar revisions, as applicable, to Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.