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IRS Formalizes Penalty Relief RE: Partners’ Beginning Capital Account Balances for 2020

Important Partnerships Update: IRS Formalizes Penalty Relief RE: Partners’ Beginning Capital Account Balances for 2020

Background
In 2018, the Internal Revenue Service introduced new requirements re: how partnerships should report partners’ capital accounts. Then in 2019, in the wake of comments regarding the difficulty of complying with the new 2019 reporting requirement, the IRS delayed until 2020 the requirement to report all partners’ capital accounts using their tax basis capital.

2020 Partnership Reporting Guidance / IRS Intention to Waive Penalties if Some Errors Occur
In October 2020, the IRS released an early draft of the 2020 tax year instructions for Form 1065, U.S. Return of Partnership Income, which included guidance on how partnerships should report partners’ capital accounts on Schedule K-1. In addition, the IRS issued News Release IR-2020-240, indicating that it will not assess penalties for certain errors in the reporting of partners beginning capital accounts if the partnership takes ordinary and prudent business care in following the form instructions.

Both items were addressed in our prior blog post on December 1, 2020: https://www.herbein.com/blog/partnerships-beware-the-irs-wants-you-to-use-tax-basis-method-for-capital-accounts

IRS Notice 2021-13 Further Explaining the Penalty Relief Provisions
On January 20, 2021, the IRS released advanced notice 2021-13 providing partnerships with relief from certain penalties due to the inclusion of incorrect information reporting of their partner’s beginning capital account balances on the 2020 Schedules K-1 (Form 1065) and the 2020 Schedules K-1 (Form 8865) per the instructions for Form 1065 “U.S. Return of Partnership Income.”

Penalty Relief:
Notice 2021-13 provides Partnerships with relief from certain penalties for the inclusion of incorrect information in reporting its partners’ beginning capital account balances on the 2020 Schedules K-1 provided they can show they took ordinary and prudent business care in following the 2020 Form 1065 instructions.

Per these instructions, the permissible methods for reporting partners’ beginning capital account balances for 2020 are the:

  • Tax basis method
  • Modified outside basis method
  • Modified previously taxed capital method
  • Section 704(b) method

“Ordinary and prudent business care” is defined as the standard of care that a reasonably prudent person would use under the circumstance in the course of its business in handling account information. In demonstrating ordinary and prudent business care, taxpayers are reminded that capital account balances are part of a partnership's books and records and must be maintained accordingly.

Penalties relieved per this notice are:

  • Section 6698 Failure to file partnership return
  • Section 6721 Failure to file correct information returns
  • Section 6722 Failure to furnish correct payee statements

Additionally, penalty relief is provided if the inclusion of incorrect information in reporting its partners' ending capital account balances on Schedules K-1 in taxable year 2020, or its partners' beginning or ending capital account balances on Schedules K-1 in taxable years after 2020 to the extent the incorrect information is attributable solely to the incorrect information reported as the beginning capital account balance on the 2020 Schedule K-1 for which relief under notice 2021-13 is available.

Relief is not available if a partnership fails to:

  • Timely file a 2020 Form 1065, Form 8865 and Schedule(s) K-1
  • Include a partner’s beginning capital account balance on Schedule K-1

The IRS will waive any accuracy-related penalty under section 6662 for any taxable year with respect to any portion of an imputed underpayment that is attributable to an adjustment to a partner's beginning capital account balance reported by the partnership for the 2020 taxable year to the extent the adjustment arises from the inclusion of incorrect information for which the partnership qualifies for relief under this notice. This notice does not prevent the IRS from imposing an accuracy-related penalty under section 6662 for any portion of an imputed underpayment related to capital account reporting by the partnership that is not described in the previous sentence.

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

Article Prepared By: Neil Winter