Partnerships need to Disclose Significantly More Information to IRS than in Years Past Beginning with 2019 Filings

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On September 30, 2019, the Internal Revenue Service (IRS) posted copies on its website of draft 2019 Form 1065 U.S. Partnership Return of Income, draft 2019 Form 1065 (Schedule K-1) Partner’s Share of Income Deductions, Credits, etc., draft 2019 Form 8865 Return of U.S. Persons With Respect to Certain Foreign Partnerships, and draft 2019 Form 8865 (Schedule K-1) Partner’s Share of Income, Deductions, Credits, etc.
 
Click on the form names below to view the documents on the IRS website: 
 

 
If the 2019 partnership forms remain unchanged after the comment period has lapsed, numerous new disclosures will be required at both the partnership and partner level. Coupled with the new Centralized Partnership Audit Regime that went into effect for tax years beginning after 2017, these new disclosures will be particularly difficult for partnerships that have not previously focused on detailed tracking of this information.
 
As reflected in the draft forms, the new required disclosures include:
 

New Reporting Requirements Prior Reporting Requirements BDO Insights
Item L on Schedule K-1, Partner’s Capital Account Analysis must now be prepared solely on the tax basis. Previously, partnerships could report partner capital on Schedule K-1 on any basis they desired, including GAAP, tax basis, Section 704(b) book and “other.” Note that for tax years beginning in 2018, partnerships were required to report additional information if any partners had beginning or ending negative tax basis capital accounts. The IRS is continuing to attempt to identify situations where partners may owe additional income taxes when there is debt relief or shifts in liability allocations. For example, debt-financed real estate or certain debt-financed distributions may result in negative tax basis capital. It is likely that the partnership will have to provide a reconciliation between tax capital provided on Schedule K-1 and whatever accounting method is used (e.g., GAAP) on the Schedule L balance sheet on Form 1065.
New item N on Schedule K-1 will require the partnership to quantify and report each partner’s share of net unrecognized Section 704(c) gain or loss. Also, line 20, code AA will potentially require additional Section 704(c) information to be specified in forthcoming instructions yet to be released by the IRS. Previously, partnerships had to disclose on Schedule K-1 if a partner contributed built-in gain or loss property. Also, partnerships had to quantify and report Section 704(c) information if there was recognition of pre-contribution gain on certain partnership distributions in Section 737, or there were dispositions of contributed property in Section 704(c)(1)(B). These previous requirements will continue along with the new reporting requirement for item N. The IRS is likely targeting situations where partners that have higher-than-average shares of liabilities allocated to them also have corresponding higher-than-average shares of potential gain. For partnerships that have had numerous revaluations, tracking multiple Section 704(c) layers can be a complex and time-consuming endeavor.
Guaranteed payments to partners will now be broken out between those made for services and those made for the use of capital. In the past, the breakdown between different types of guaranteed payments were not required. In proposed regulations, the IRS included guaranteed payments for the use of capital (GPUC) in its definition of business interest expense subject to the limitations contained in Section 163(j). This additional disclosure may help the IRS identify when GPUCs are paid or accrued.
Line 20, code AB will require reporting of Section 751 gain or loss to be specified in forthcoming instructions yet to be released by the IRS. Previously, the only reporting required in connection with Section 751 gains or losses was the filing of Form 8308, which did not quantify any gain or loss amounts. Form 8308 will likely continue to be a required filing since it is statutorily required under Section 6050K. By quantifying Section 751 gains or losses, the IRS will likely target situations where partners who recognize income from sales or exchanges of partnership interests are neglecting to properly recharacterize a portion of their gain or loss as ordinary income. Disclosure of Section 751 amounts will require accurate tracking of Section 704(c) layers.
Schedule K-1 asks if a partner is a disregarded entity, and if it is, to identify the name of the beneficial owner. Previously, partnerships did not have to disclose the name of the beneficial owner of a disregarded entity. This disclosure may relate to liability allocations to a disregarded entity under the anti-abuse rules contained in Prop. Regs. Sec. 1.752-2 as well as identifying the ultimate taxpayer that will include the income, gain, loss, deduction and credit from Schedule K-1.
Item K on Schedule K-1 now asks whether reported liability amounts include amounts from lower tier partnerships. None. The IRS may be gearing up for future audits by identifying losses or distributions that potentially exceed tax basis when covered with liability allocations.

On October 4, 2019, the U.S. Department of the Treasury released final regulations providing guidance necessary for a partnership to allocate its liabilities among its partners.

 

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