For tax year 2021 and later returns:
Starting with tax year 2021 returns, 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 from tax year 2021 onward. 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. See here for more information.