On January 19, 2021, the IRS issued Notice 2021-13, which provides partnerships with relief from some penalties for the inclusion of incorrect information in reporting their partners' beginning capital-account balances and relief from accuracy-related penalties under §§ 6698,1 6721,2 and 67223 attributable to incorrect information reported for the 2020 tax year.

Analysis

Pursuant to § 6031 and the accompanying Treasury Regulations, the IRS has, in forms and instructions, long required the reporting of partner capital-account balances.

Beginning with the 2020 tax year, partnerships could report their partners' capital accounts using one of a variety of methods that are based on different principles (for example, tax basis, generally accepted accounting principles (GAAP), § 704(b) book, or any other method).

Starting in the 2018 tax year, partnerships that did not report tax-basis capital accounts to their partners were required to report separately the beginning and ending tax-basis capital-account balance of any partner that would have a negative beginning or ending tax-basis capital-account balance. Beginning in the 2020 tax year, partnerships were required to calculate and report their partners' capital accounts using the transactional approach for the tax-basis method, regardless of whether the beginning or ending balance is negative for a partner.

Under the transactional approach outlined in the 2020 Form 1065 Instructions, partnerships report partner contributions, each partner's share of partnership net income or loss, withdrawals and distributions, and other increases or decreases using tax-basis principles, instead of methods based on other principles such as GAAP. The 2020 Form 1065 Instructions explain that if a partnership did not report its partners' capital accounts using the tax-basis method in the 2019 taxable year and did not maintain its partners' capital accounts under the tax-basis method in its books and records, the partnership may determine its partners' beginning capital accounts for the 2020 taxable year using any one of the following methods: the tax-basis method, modified-outside-basis method, modified-previously-taxed-capital method, or § 704(b) method (each as described in the 2020 Form 1065 Instructions).

Penalty Relief

Notice 2021-13 announced that a partnership will not be subject to a penalty under §§ 6698, 6721, or 6722 for the inclusion of incorrect information in reporting its partners' beginning capital-account balances on the 2020 Schedules K-1 if the partnership can show that it took ordinary and prudent business care in following the 2020 Form 1065 Instructions to report its partners' beginning capital-account balances using any one of the following methods, as outlined in the instructions: the tax-basis method, modified-outside-basis method, modified-previously-taxed-capital method, or § 704(b) method. "Ordinary and prudent business care" means the standard of care that a reasonably prudent person would use under the circumstances in the course of its business in handling account information.

In addition, the Notice provides that a partnership will not be subject to a penalty under §§ 6698, 6721, or 6722 for the inclusion of incorrect information in reporting its partners' ending capital-account balances on Schedules K-1 in the 2020 taxable year or its partners' beginning or ending capital-account balances on Schedules K-1 in taxable years after 2020 to the extent that the incorrect information is attributable solely to the incorrect information reported as the beginning capital-account balance on the 2020 Schedule K-1 for which relief under this Notice is available. The penalty relief provided in the Notice is in addition to the reasonable-cause exception to penalties for failing to properly report the partners' beginning capital-account balances. However, a partnership that fails to timely file a 2020 Form 1065, Form 8865, and Schedules K-1 is not eligible for the relief provided by the Notice. A partnership that fails to include a partner's beginning capital-account balance on the Schedule K-1 is also not eligible for relief.

In addition, the IRS will agree to waive any accuracy-related penalty under § 6662 for any taxable year with respect to any portion of an imputed underpayment that is attributable to an adjustment to a partner's beginning capital-account balance reported by the partnership for the 2020 taxable year to the extent that the adjustment arises from the inclusion of incorrect information for which the partnership qualifies for relief under the Notice.

Footnotes

1. Section 6698 imposes a penalty for failing to file a return or report at the time prescribed, or for filing a return or a report that fails to show the information required under § 6031. A return required under § 6031 includes Form 1065 and each Schedule K-1. A failure to file a partnership return that shows information required under § 6031 would generally subject a partnership to the § 6698 penalty.

2. Section 6721 imposes a penalty for any failure to file an information return on or before the required filing date, and for any failure to include all the information required to be shown on the return or for the inclusion of incorrect information.

3. Section 6722 imposes a penalty for any failure to furnish a payee statement on or before the date prescribed therefor to the person to whom such statement is required to be furnished, and for any failure to include all the information required to be shown on a payee statement or for the inclusion of incorrect information.

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