Barring major updates to the draft forms, the proposed changes will be among the most significant in partnership reporting in recent history and will likely require significant additional time to comply.
On September 30, 2019, the IRS released drafts of the 2019 Form 1065, “U.S. Return of Partnership Income” and Schedule K-1, “Partner's Share of Income, Deductions, Credits, etc.”
The drafts provide for significant changes in required reporting, which the IRS states is intended to “improve the quality of the information reported by partnerships both to the IRS and partners of such entities.”
The release (IR-2019-160) further states that the number of partnership returns filed has increased 59% between 2004 and 2017, and that compliance risk detection is one of the primary drivers for the recent changes.
In Notice 2019-66, the IRS has announced that it will delay the requirement to report partners' shares of partnership capital on the tax basis method for one year. These new reporting requirements will not be effective for 2019 years but will be effective in 2020. For 2019, capital accounts must be reported according to the 2018 Form 1065 and its instructions, which allow tax basis, Section 704(b), GAAP, or any other method. Negative tax basis capital accounts must be reported on a partner-by-partner basis on line 20 of Schedule K-1. Partnerships should plan in 2020 for these new requirements, as many partnerships do not track tax basis for its partners.
Summary of proposed changes
Capital account disclosure
Under current rules, partnerships were able to choose whether to report their partner capital on a GAAP, tax, Section 704(b) book, or “other” basis. The only exception to the rule available is when a partner had a negative tax basis at the beginning or ending of the year. In this case, the negative tax basis capital account was required to be disclosed.
Beginning in 20202, partnerships are required to report their capital accounts using the tax basis. Prior to this change, it was common for partnerships to report their capital accounts on the GAAP basis, consistent with their financial statements. It is likely many partnerships will not have tracked their tax basis concurrently over time, and they may require a significant amount of time to recalculate their tax basis to comply with the new requirements.
Reporting net unrecognized Section 704(c) gain or loss
Previously, partnerships were required to disclose the contribution of property with a built-in gain or loss under Section 704(c). Now partnerships are required to report their unrecognized gain or loss on contributed property on an annual basis.
Guaranteed payment disclosure
Previously partners were not required to bifurcate the disclosure of guaranteed payments between those made for services and those for the use of capital. However, this distinction is now required, presumably to assist the IRS with enforcement of the new Section 163(j) interest limitation rules (guaranteed payments for the use of capital are included in the definition of business interest expense subject to limitations).
Section 751 'hot asset' gain or loss disclosure
Previously, the IRS only required limited reporting (filing of Form 8308) with respect to Section 751 gains or losses. However, the new drafts require partnerships to quantify the amount of any gains or losses under Section 751. This additional disclosure will require partnerships to accurately track Section 704(c) layers.
Disregarded entity disclosure
Previously, a partnership was not required to report if a partner was a “disregarded” entity (for example, a single-member LLC not electing other treatment). The new Form K-1 requires that partnerships disclose if a partner is a disregarded entity and report the name of the ultimate beneficial owner.
Disclosure of lower-tier partnership liabilities
Prior to the draft Forms, partnerships were not required to report the share of liabilities attributable to lower-tier partnerships. This disclosure is now required, likely to identify instances where losses or distributions exceed the tax basis when covered with liability allocations.
The additional reporting necessitated by the new Schedule K-1 will likely require a tax professional to spend significantly more time complying with the changed reporting requirements on the U.S. partnership return. Partnerships should determine if they have been tracking the required additional information and discuss the additional effort that may be required with their tax advisors.