Tax basis capital account reporting

Effective for tax year 2020 and beyond, at the federal level, partnerships must report each partner's capital account using the transactional approach for the tax basis method. If the partnership reported the partner's capital account last year using any other method (for example, GAAP, Section 704(b), or other), you must use the tax basis method this year.  For more information on the new requirement, see the Form 1065 Instructions.

While tax basis capital account reporting isn’t new, it’s now the only allowed reporting method for federal returns. 

If the partnership previously kept a set of books on the tax basis, and those books were used to complete the Schedules L, M-1, and M-2, and tax basis capital was previously reported, continue to use the program as you always have to complete the tax return. 

If the partnership books and records previously weren’t kept on the tax basis, but you made modifications to accurately report tax basis capital accounts (for example, using the Schedule M-2, Other Increases or Decreases), you may continue to use that approach. 

A new, optional feature has been added to the program to recompute the Schedule M-2, line 3, “Net income (loss) per books” on a tax basis if the partnership’s books and records are NOT kept on a tax basis. 

To activate this feature, go to Screen 28, Schedule M-2 (Capital Account) and check the box labeled  “Recompute Sch. M-2, line 3 if partnership books are NOT on tax basis”.

When you use this feature:

The amount from Schedule M-1, line 1 will no longer flow to Schedule M-2, line 3. Instead, Schedule M-2, line 3 will be recomputed as follows, taking each partner’s share of the given amount:

Income (loss) (Sch. M-1, line 9)

+ Tax exempt interest and income

+ Section 743(b) negative adjustments

- Non-deductible expenses (permanent)

- Guaranteed payments

- Section 743(b) positive adjustments

= Net income (loss) per books (tax basis)

In addition to the Schedule M-2, line 3 calculation, be aware of the following:

• A worksheet of the above computation will appear on Schedule M-2, line 3.
• The partner’s share of the recomputed amount is reported in Schedule K-1, Item L, “Current year net income (loss)”.
• Any additional needed capital account adjustments should be entered on Schedule M-2 as other increases or decreases.
• A different version of the Capital Account Reconciliation will print showing each partner’s computation of the capital account analysis.
• If the Schedule L balance sheet is kept on a book/GAAP basis, you’ll need to override the ending partners’ capital accounts on Screen 24, Balance Sheet to enter the book/GAAP amount. If you don’t override this amount, the program will use the amount from Schedule M-2, line 3, to calculate the ending balance on Schedule L, line 21.

See the Form 1065 Instructions for all the new detailed requirements for tax basis capital account reporting.

Details for state returns:

At this time, several states have continued to allow other methods for reporting capital accounts. Select the appropriate method in Screen 1, Client Information and make the appropriate state only entries to report state capital accounts on an alternative method.

For California returns, the above functionality is only available if you select “Federal and California Schedule M-2 are the same” on Screen 25, Balance Sheet Miscellaneous.