IRS simplifies partnership tax capital reporting rules

Draft instructions authorize use of ‘snapshot’ calculations


Authored by RSM US LLP

For the 2020 tax year (returns filed in 2021) nearly all partnerships will be required to report the ‘tax capital’ of their partners and certain related information. As many are aware, this practice was phased-in for certain partnerships in the 2018 and 2019 tax years (returns filed in 2019 and 2020). Unfortunately, compliance with these new requirements was burdensome for many partnerships. This is mainly because it requires an analysis of historical tax and financial data that may not be readily available or may not even exist. 

Draft instructions for the 2020 tax year -- just released on Oct. 22, 2020 -- provide welcome relief in the form of simplified calculation methods. 

  • In lieu of an in depth analysis of actual historical data, partnerships would be authorized to utilize one of three simplified methods to calculate their partners’ opening tax capital balances for the 2020 tax year. These “snapshot” methods use current year data that nearly all partnerships should have readily at hand.
  • Once that “snapshot” opening tax capital balance is established for each current partner, the partnership may use a “transactional” approach to update and maintain those balances for future years. This is good news for many partnerships since the transactional approach is the method they already use to maintain and report the tax capital of their partners.

These methods generally follow the concepts and methods that the IRS described and sought public comment on earlier this year. See, Notice 2020-43, discussed in more detail here. The draft instructions include an additional optional method that allows a partnership to compute tax capital by utilizing section 704(c) balances.

In addition to the release of the draft instructions for 2020, the IRS noted that it intends to provide penalty relief for partnerships that may not be able to follow the new instructions perfectly, as long as they take “ordinary and prudent business care in following the form instructions to calculate and report the beginning capital account balances”. 

Although these new calculation methods will reduce the reporting burden for many, this process may still be complicated and time consuming in some cases. Partnerships that have not yet addressed these reporting requirements for 2020 are well advised to start the process as soon as practicable.