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Are you Tracking your Tax Basis before the IRS Tracks you Down?

Are you Tracking your Tax Basis before the IRS Tracks you Down?

The Internal Revenue Service (IRS) has recently released new instructions for Form 1065, which requires partnerships to report negative tax capital amounts on Schedule K-1.

The instructions require partnerships to report on Line 20 of Schedule K-1, using code AH, a partner's beginning and ending shares of “tax basis capital”. The requirement is for partnerships that do not report capital accounts on a “tax basis capital” account method to their partners on Schedule K-1 in Item L, and the "tax basis capital”, if reported on any partner's Schedule K-1 at the beginning or end of the tax year, would be negative.

Here’s how a taxpayer can determine “tax basis capital” according to the new IRS instructions:

  • The cash amount contributed to the partnership, plus
  • The tax basis of property contributed to a partnership by a partner, minus
  • The amount of cash plus the tax basis of property distributed to a partner by the partnership net of any liabilities assumed or taken subject to in connection with such contribution or distribution, plus
  • The partner's cumulative share of partnership taxable income and tax-exempt income, minus
  • The partner's cumulative share of taxable loss and nondeductible, noncapital expenditures

The practical impact of this requirement is that all partnerships will be required to maintain some form of “tax basis capital” accounts for the partners, even if the partnership reports the capital balance using another method of accounting. If the partnership wishes to protect the substantial economic effect doctrine for its allocations of income and expense under its’ partnership agreement, the partnerships is generally required to maintain 704(b) capital accounts. This basically means that all partnerships must now have records for two capital account balances. One capital account based on Section 704(b), GAAP, or other method and the other capital account determined on a “tax basis capital”. The new requirement will most likely give a partnership tax preparer a headache.

S Corporations
There is also a new reporting requirement for an S corporation shareholder on Form 1040, Schedule E, on a new column (e) that has been added to line 28, which provides, “Check if basis computation is required.” Page E-9 of the Schedule E instructions merely states the following in the context of

S corporation reporting for column (e): If you are claiming a deduction for your share of an aggregate loss, check the box on the appropriate line in Part II, column (e), and attach to your return a computation of the adjusted basis of your corporate stock and of any debt the corporation owes to the shareholder.

While the above appears to focus only on basis computations in the event of a loss, the IRS has indicated that the disclosure requirements extend beyond loss allocations. On February 6, 2019, the IRS issued clarification regarding the reporting.

As stated in Part II of the Schedule E (Form 1040), a taxpayer must check the corresponding box under line 28 column (e) and attach a computation detailing the taxpayer’s S corporation basis if the individual S corporation shareholder has any of the following situations:

  • Owns an interest in an S corporation and reports a loss
  • Receives a distribution
  • Disposes of stock
  • Receives a loan repayment from the S corporation

Penalty Implications
The reporting requirements are subject to penalties. There are regulations that authorize the IRS to impose penalties for filing an incorrect information return (Section 6721) and failing to furnish a correct payee statement (Section 6722). Failure to provide this information opens the partnership for a penalty under Section 6698 (a)(2) for filing a return or a report that fails to show the information required. The penalty is the same penalty that applies for failure to file a partnership return - $195 per month per partner. The penalty is not subject to abatement under the first- time abatement provisions, but the partnership or S corporation that has an incomplete filing will have the opportunity to provide information before the penalty is assessed.

For more information, please contact a member of the Herbein tax team, or email us at info@herbein.com

Article prepared by Maria D. Stromple, click here to read more about Maria.