This article will help provide answers to frequently asked questions regarding the partnership capital account analysis and Schedule M-2 in Lacerte.
Since tax year 2021, Federal Form 1065 instructions for line 3 have been modified. This line has gone through a few changes in the past years, including;
- 2019 and Prior Schedule M-2, line 3 was the same value as the Schedule M-1, line 1 (net income per books).
- 2020 Schedule M-2, line 3 would default to utilize the Schedule M-1, line 3. However, there were options available on Screen 28, Schedule M-2, to Recompute Sch. M-2, line 3 if partnership books are NOT on tax basis (code 116), which could cause Schedule M-2, line 3 to be different from the Schedule M-1, line 3.
- 2021 Schedule M-2, line 3 changed the instructions to no longer reference Net Income per Books (Schedule M-1, line 1), but instead to be Net Income (Schedule M-1, line 9).
Schedule M-2, line 9 balance at end of year, impacts the Balance Sheet, line 21 Partners’ capital accounts, column (d).
Adjustments may need to be accounted for on:
- Screen 28, Schedule M-2, in other increases (code 103) line 4, and
- Screen 28, Schedule M-2, in other decreases (code 107) line 7.
How to report partners' capital accounts on the tax basis
For 2020 and beyond, tax basis capital account reporting is required on all federal partnership returns. The Recompute Sch. M-2, Line 3 feature can help you ensure compliance; this can be found on Screen 28, Schedule M-2 (Capital Accounts). To learn more, refer to Tax basis capital account reporting.
Why the beginning capital on Schedule K-1, Item L, is zero
Lacerte allocates the beginning capital based on partner percentages by default. If a partner's ending percentage of ownership was zero, you'll need to specially allocate the correct amount of beginning capital. To learn more, refer to Beginning Capital Account Showing Zero on Item L of Schedule K-1 for a 1065 Partnership Return.
How to zero out the partners' ending capital on a final return
Distributions of cash or property, or other decreases, must be entered to reduce the partners' ending capital to zero. To learn more, refer to Adjusting the partners' capital account on Form 1065 in Lacerte.