This article will help you balance the 565 or 568 balance sheet and resolve the following diagnostic:
"State ending balance sheet out of balance by $ { amount } ." (ref. #358)
Why is the balance sheet out of balance?
Starting in tax year 2021, California requires all partnerships report partners' capital accounts using the tax basis method on their Schedule K-1. The total amounts for capital accounts columns C, D, and E must match the Schedule M-2.
In practice, this means that the Schedule M-2, line 3, must now report income on tax basis. Although forms 565 and 568 do still mention "book" on the M-2 line 3, we're working with the state for clarification - as the tax basis capital accounts won't normally total to the partnership's book basis income.
This mirrors the new behavior of the federal M-2, since the 1065 instructions (which the state references) lay out more explicitly that the M-2 is on tax basis now.
You'll no longer see M-2 adjustments for items like section 754 depreciation, since they're allowable on tax basis.
How do I fix it?
If the federal and California M-2 should match, and you've already balanced the federal return:
- Go to Input Return ⮕ Balance Sheet, M-1, M-2.
- Select Balance Sheet Miscellaneous.
- Check the box labeled Federal and California Schedule M-2 are the same.
If the California capital accounts differ from the federal amounts:
- Review the Schedule M-1 and Schedule M-2 on the California return to determine which line needs an adjustment.
- Click on the line you want to change to Jump To Input.
- Enter the California amount in the State, if different column.
