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Tax basis capital account reporting

SOLVEDby IntuitLacerte Tax124Updated February 23, 2022

For Tax Year 2021:

For 2021, the IRS updated the 1065 Instructions with guidance on Schedule M-2 / Schedule K-1 (Item L) reporting. Schedule M-2, line 3 will flow from Schedule M-1, line 9 “Income (loss) (Analysis of Net Income (Loss), line 1).” To learn more, refer to the Form 1065 Instructions.

The optional feature added in 2020 to recompute Schedule M-2, line 3 “Net income (loss) per books” if the partnership books are NOT on a tax basis has been removed for tax year 2021. Schedule M-1, line 9 “Taxable Income (loss)”, instead of Schedule M-1, line 1 “Net income (loss) per books”, will always flow to Schedule M-2, line 3 and the related partner amounts to Schedule K-1, Item L. Some “other increases / other decreases” will be automatically made to Schedule M-2, lines 4 and 7. Those include:

Other Increases (Schedule M-2, line 4)

  • Tax exempt interest and income
  • Section 743(b) negative adjustments

Other Decreases (Schedule M-2, line 7)

  • Non-deductible expenses (permanent)
  • Guaranteed payments
  • Section 743(b) positive adjustments

All automatically computed amounts have corresponding override inputs in the Schedule M-2 screen and those overrides are also available in the Special Allocations screen.  Any other additional Other Increases/ Decreases may still be entered directly on Schedule M-2 and all amounts are included on the line 4 and line 7 supporting statements and on the Schedule K-1, Item L, “Other increase (decrease)” required attachment.

Additionally, the following capital account reconciliation’s have been update to reflect the above changes removing the books to tax reconciliation and providing more detail on the partner’s share of taxable income and other increases/decreases.

  • Expanded version
  • Per Partner version

If the Schedule L balance sheet is kept on a book or GAAP basis, you’ll need to override the ending partners’ capital accounts on Screen 24, Balance Sheet with the appropriate book/GAAP amount from the partnership’s records. 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. A diagnostic will print if the ending balance sheet is out of balance, Depreciation / Amortization / Depletion is kept on a book basis and the Other Increases/Decreases in Schedule M-2 have not been used.

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, which now require tax basis reporting, similar changes to federal have been made but incorporating several state, if different inputs for Other Increases and Other Decreases.

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.

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