The Internal Revenue Service recently issued Notice 2021-13 to provide partnerships with relief from certain penalties due to the inclusion of incorrect information in reporting partners’ tax basis capital accounts on 2020 returns and Schedules K-1. The notice also provides ongoing relief from accuracy-related penalties for subsequent tax years if the source of the error relates back to tax basis capital accounts first reported in 2020.
For tax years beginning in 2020, partnerships are required to report beginning and ending capital accounts for their partners on a tax basis. This applies to all partnerships that are large enough to be required to report capital accounts. The information is reported in item L of a partner’s Schedule K-1 and on Schedule M-2 of Form 1065.
If the tax basis capital account information is left blank, is incorrect, or is not fully reported, the IRS can assert penalties against the partnership for failure to show required information, failure to include all required information, or reporting incorrect information. The penalties can be assessed for misreported amounts on Form 1065 and on each Schedule K-1. As a result, these penalties can quickly add up.
Notice 2021-13 provides relief from these penalties. A partnership will not be subject to a penalty for incorrectly reporting a partner’s beginning tax basis capital account balance when both of the following apply:
- The partnership’s 2020 return is timely filed (including extensions) and all Schedules K-1 are timely delivered to partners, and
- The partnership can show that it took ordinary and prudent business care in following one of the four methods described in the 2020 Form 1065 instructions to report its partners’ beginning tax basis capital accounts
The four methods available to partnerships for determining tax basis capital accounts are (1) the tax basis method; (2) the modified outside basis method; (3) the modified previously taxed capital method; and (4) the section 704(b) method. The same method must be used to determine the beginning tax basis capital accounts for all partners, and a statement must be attached to each partner’s 2020 Schedule K-1 indicating which of the four methods was used to determine the partner’s beginning tax basis capital account.
Once the 2020 beginning amount is determined, the instructions to Form 1065 state that going forward the tax basis method is the only method a partnership can use to maintain partner tax basis capital accounts.
Notice 2021-13 also offers relief from accuracy-related penalties in subsequent tax years. If tax basis capital accounts are incorrect in later years, partnerships will not be subject to penalties to the extent that the incorrect information is attributable to the beginning 2020 tax capital account. This relief requires that ordinary and prudent business care, as discussed above, was taken to establish the 2020 beginning tax basis capital account using one of the four methods.
For more information about partnership filing extensions to reserve flexibility in make corrections to returns, read our article, consider filing an extension for all partnership returns this year. Please consult with your Cherry Bekaert tax advisor if you have questions regarding partner tax basis capital accounts or the relief from penalties provided by Notice 2021-13.
