William Stromsem, CPA, J.D., Assistant Professor, George Washington University School of Business
There is a new and little-noticed requirement for the analysis of partner’s capital accounts that can bring stiff penalties on the partnership for failure to comply and can bring problems for individual partners if the partnership does comply. In the analysis of partner’s capital accounts, if the partnership reports to its partners on other than the tax basis (e.g., GAAP, Section 704(b) book or other), and that report shows a negative beginning or ending balance, then this must be disclosed on the Schedule K-1. Specifically, line 20 of the K-1 must include code AH and report the partner’s beginning and ending capital account on the tax basis.
Failure to comply can result in a large fine for the partnership. The penalty is $195 per partner per month for up to a year (that is up to $2,340 per partner for whom the negative basis is not reported). This seems particularly harsh in that the new requirement is buried on page 30 of the new 2018 Form 1065 instructions that many partnerships may have missed in preparing the K-1s.
Compliance may result in further IRS inquiry into the partner’s tax situation, because the IRS may suspect that the negative basis resulted from an artificial inflating of the basis of property or other contributions to the partnership or may reflect other abusive tax shelter schemes.
The instructions describe the term “tax basis capital” account to distinguish when there is a GAAP or other report that requires the disclosure.
Practitioners should review this requirement with their partnership clients to allow them to file amended K-1s and reduce the partnership’s penalty exposure and to allow them to advise partners of possible increased IRS scrutiny.