New Partnership Reporting Regime Effective for 2019

by Prof. Robert Bloink and Prof. William H. Byrnes

Partnership taxation has changed dramatically since the 2017 tax reform legislation became effective—and although Section 199A tends to take the spotlight, those changes are much more far-reaching in reality. Beginning with the 2019 tax filing season, partnership reporting requirements are about to change dramatically as well. The IRS has described the draft forms containing these new requirements as "near final”—and it is widely expected that they will be finalized with these changes as soon as December 2019. This means that many small business clients are about to learn that they will be subject to much more rigorous and time-consuming reporting requirements next year. To avoid unpleasant last-minute surprises, advisors should discuss changes to Form 1065 and Schedule K-1 well in advance so that clients have time to prepare for a new compliance regime.

Background on Tax Reform Changes to Partnership Taxation

Under Section 199A, qualifying partnerships may generally deduct 20 percent of qualified business income. Although the calculation is much more complicated for most partnerships, “service business income” and “specified service businesses”—doctors, lawyers, etc.—are generally excluded.

Similarly, qualified business income does not include certain guaranteed payments or amounts paid or incurred by a partnership to a partner, when the partner is providing services and is not acting in his or her capacity as a partner. The regulations implementing 199A provide further details and permit or prohibit aggregation of business entities and activities in certain circumstances.

Beyond 199A, tax reform made significant changes to the treatment of the business interest deduction (which is now subject to substantial limitations), loss provisions and treatment of built-in gain or loss for partnerships. Post-reform, the business interest limitation does not generally apply to entities that satisfy the gross receipts test—and certain related business entities are required to aggregate their income to determine whether the exemption applies.

Under the new built-in gain rules, , a partnership must adjust the basis of partnership property following a transfer of a partnership interest if the partnership has suffered a substantial built-in loss immediately following the transfer. Under prior law, a substantial built-in loss existed only if the adjusted basis in the partnership’s property exceeded the fair market value of the property by more than $250,000.

Given the substantial changes that have taken place, the IRS has announced that it now requires additional information from partnerships in order to assess compliance risk and noncompliance.

Important Partnership Reporting Changes to Note

To better track compliance with the new tax reform law, partnerships will be subject to expanded reporting requirements beginning with the 2019 tax year. Under these changes, reporting of tax basis capital by the partnership in Question L of the K-1 will be required for capital account reconciliation. Previously, partnerships were permitted to report capital based upon GAAP, IRC Section 704(b) or other reasonable methods. This new rule essentially shifts the responsibility for tracking tax capital to the partnership.

Both beginning and ending unrecognized built-in gain or loss under IRC Section 704(c) must also be reported for all partners in each tax year beginning with 2019. This reporting must take place regardless of the year property was contributed to the partnership and also applies in the case of re-valuations of appreciated or depreciated property.

Under the new rules, partnerships must also separately report guaranteed payments made for services and guaranteed payments made for the use of capital.

Partnerships will be required to report whether any decrease in a partnership’s share of partnership profit, loss or capital is because of a sale or exchange of a partnership interest. If a partnership’s liabilities include liabilities of a lower tier partnership, that fact must also be disclosed, as must any circumstance where transfer between the partnership and partners was subject to the disguised sale rules.

The IRS has also added new boxes that requires the partnership to check a box to disclose whether it has grouped activities for purposes of the at-risk rules or passive activity rules. Partnerships must also disclose whether they have more than one activity for purposes of the at-risk or passive activity rules.

Conclusion

Even though the new reporting forms remain in draft form, all signs indicate that they will be finalized without substantive change. The bottom line? The time to prepare clients for the new partnership reporting regime is now.