n-20-43.pdf

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Tax Capital Reporting - Notice Requesting Comments

Notice 2020-43

I. PURPOSE
Partnerships and certain other persons report partner capital accounts in Box L
on the Schedule K-1 (Form 1065) or in Box F on the Schedule K-1 (Form 8865), each
as they currently appear on the 2019 forms (Tax Capital Reporting Requirement). The
final versions of these 2019 forms and their instructions provide that partnerships and
other persons must report partner capital accounts consistent with the reporting
requirements in the 2018 forms and instructions, including the requirement to report
negative tax basis capital accounts on a partner-by-partner basis.
The purpose of this notice is to seek public comment on a proposed requirement
for partnerships to use only one of two alternative methods described in section III of
this notice to satisfy the Tax Capital Reporting Requirement with respect to partnership
taxable years that end on or after December 31, 2020. As a result, partnerships and
certain other persons would no longer be permitted to report partner capital accounts
using any other method, including § 704(b) of the Internal Revenue Code (Code) and
U.S. generally accepted accounting principles (GAAP). Comments received in

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response to this notice will help inform the development of the instructions to be
included in Form 1065, U.S. Return of Partnership Income (to which the instructions for
Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships,
refer), and Partner’s Instructions for Schedule K-1 (Form 1065), for taxable year 2020.
II. BACKGROUND
The 2019 instructions for Form 1065 and Partner’s Instructions for Schedule K-1
(Form 1065), like the 2018 instructions for these forms, require that a partnership
reporting its partners’ capital on a method other than the tax basis method report a
partner’s tax capital account at both the beginning and the end of the partnership’s
taxable year if either amount is negative with respect to the partner. The 2019
instructions for Form 8865, Schedule K-1, incorporate this requirement by reference to
the instructions for Form 1065.
On April 5, 2019, the IRS released Form 1065 Frequently Asked Questions
(FAQs) explaining how a partnership should determine a partner’s tax capital account
and providing a safe harbor approach based on a partner’s outside basis in its
partnership interest. Thereafter, early releases of drafts of the 2019 Form 1065 and the
2019 Form 8865, released September 30, 2019, and related draft instructions for the
2019 Form 1065 (to which the draft instructions for the 2019 Form 8865 refer), and the
2019 Partner’s Instructions for Schedule K-1 (Form 1065), released October 29, 2019,
expanded partner tax capital reporting to require all partnerships and certain other
persons who file Form 8865 to report all partners’ tax capital accounts using the tax
basis method.
In response to the change requiring all partnerships to report their partners’ tax

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capital on a tax basis method, commenters stated that some partnerships might be
unable to comply, either in a timely manner or ever. These commenters explained that
partnerships that have not historically maintained partner tax capital accounts may face
difficulties in calculating their partners’ tax capital by means of a historical transactional
analysis of events. Commenters stated that a partnership would find such a
transactional analysis particularly difficult and burdensome where the partnership has
been operating for many years and either documentation regarding historical
transactional events affecting partner tax capital no longer exists, or the documentation
does exist, but its volume or complexity precludes reconstruction of accurate tax capital
accounts. In addition, commenters asked for guidance on how to calculate tax capital
using a transactional analysis under complicated transactions and structures.
Accordingly, the Department of the Treasury (Treasury Department) and the
Internal Revenue Service (IRS) released Notice 2019-66, 2019-52 I.R.B. 1509 on
December 11, 2019, removing the requirement that partnerships and other persons
required to furnish and file Form 1065, Schedule K-1 or Form 8865, Schedule K-1,
report partner capital accounts in Item L of the 2019 Form 1065, Schedule K-1, or in
Item F of the 2019 Form 8865, Schedule K-1, using the tax basis method for 2019. In
addition, Notice 2019-66 announced that further guidance would be provided regarding
the definition of partner tax capital. In lieu of providing a definition of tax basis capital,
this notice proposes two methods that satisfy the Tax Capital Reporting Requirement.
Section III of this notice describes the two proposed methods for complying with the Tax
Capital Reporting Requirement. Part IV of this notice requests comments on those
proposed methods. The Treasury Department and the IRS anticipate that the two

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proposed methods outlined in section III of this notice will be the only methods that meet
the Tax Capital Reporting Requirement for partnership taxable years ending on or after
December 31, 2020.
III. PROPOSED METHODS FOR COMPLYING WITH THE TAX CAPITAL
REPORTING REQUIREMENT FOR TAXABLE YEARS ENDING ON OR AFTER
DECEMBER 31, 2020

Commenters have indicated that many partnerships that currently possess
partner tax capital information generally develop and maintain partner tax capital by
applying the provisions and principles of subchapter K of chapter 1 of the Code
(subchapter K), including those contained in §§ 705, 722, 733, and 742 of the Code, to
relevant partnership and partner events. In such a situation, commenters have
indicated that partnerships maintaining tax capital (i) increase a partner’s tax capital
account by the amount of money and the tax basis of property contributed by the
partner to the partnership (less any liabilities assumed by the partnership or to which the
property is subject) as well as allocations of income or gain made by the partnership to
the partner, and (ii) decrease a partner’s tax capital account by the amount of money
and the tax basis of property distributed by the partnership to the partner (less any
liabilities assumed by the partner or to which the property is subject) as well as
allocations of loss or deduction made by the partnership to the partner (Transactional
Approach).
The Treasury Department and the IRS understand that many partnerships and
other persons have maintained partner tax capital accounts according to the
Transactional Approach, but due to the array of transactions that might affect partner
tax capital, it is possible that partnerships and other persons that have been using the

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Transactional Approach may not have been adjusting partner tax capital accounts in the
same way under similar fact patterns. Several commenters explained that providing
detailed guidance that would make the Transactional Approach consistent in all
potential transactions would be a major project that would consume significant IRS
resources.
The IRS and Treasury believe that a consistent framework for all partnerships
and other persons to comply with the Tax Capital Reporting Requirement will aid the
IRS in administering the tax law, and consistency will ultimately reduce complexity of
the preparation of partnership returns. Accordingly, this notice proposes two alternative
methods that a partnership would be required to use to comply with the Tax Capital
Reporting Requirement. For such purpose, a partnership may report, for each partner,
either (i) the partner’s basis in its partnership interest, reduced by the partner’s allocable
share of partnership liabilities, as determined under § 752 of the Code (Modified
Outside Basis Method) or (ii) the partner’s share of previously taxed capital, as
calculated under a modified version of § 1.743-1(d) of the Income Tax Regulations
(Modified Previously Taxed Capital Method). Both methods are further described
below. It is intended that a partnership must use one of these two methods for
purposes of satisfying the Tax Capital Reporting Requirement and the method selected
must be used with respect to all of the partnership’s partners. Capital account amounts
based on the Transactional Approach will not satisfy the Tax Capital Reporting
Requirement. For taxable years after 2020, a partnership may change its Tax Capital
Reporting Requirement method from the Modified Outside Basis Method to the Modified
Previously Taxed Capital Method, or vice versa, by attaching a disclosure to each

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Schedule K-1 describing the change, if any, to the amount attributable to each partner’s
beginning and end of year balances, and the reason for the change.
(1) The Modified Outside Basis Method
A partnership may satisfy the Tax Capital Reporting Requirement by determining,
or being provided by its partners, the partner’s adjusted basis in its partnership interest,
determined under the principles and provisions of subchapter K (including those
contained in §§ 705, 722, 733, and 742), and subtracting from that basis the partner’s
share of partnership liabilities under § 752.
If the partnership is satisfying the Tax Capital Reporting Requirement by using
the Modified Outside Basis Method, a partner must notify its partnership, in writing, of
any changes to the partner’s basis in its partnership interest during each partnership
taxable year other than changes attributable to contributions to and distributions from
the partnership and the partner’s share of income, gain, loss, or deduction that are
otherwise reflected on the partnership’s schedule K-1. The partner must provide such
written notification of such changes to the partner’s basis within thirty days or by the
taxable year-end of the partnership, whichever is later. For example, if a person
purchases an interest in a partnership that has chosen to use the Modified Outside
Basis Method, the purchasing partner must notify the partnership of its basis in the
acquired partnership interest, regardless of whether the partnership has an election
under § 754 of the Code in effect or has a substantial built-in loss, as defined in
§ 743(d) of the Code, at the time of such interest purchase. For purposes of the
Modified Outside Basis Method, a partnership is entitled to rely on the partner basis
information that the partnership is provided by its partners unless the partnership has

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knowledge of facts indicating that the provided information is clearly erroneous.
(2) Modified Previously Taxed Capital Method

A partnership that does not satisfy the Tax Capital Reporting Requirement by
using the Modified Outside Basis Method would be required to do so by using the
Modified Previously Taxed Capital Method. Section 1.743-1(d)(1) generally provides
that a partnership interest transferee’s (transferee’s) share of the adjusted basis of
partnership property is equal to the sum of the transferee’s interest as a partner in the
partnership’s previously taxed capital, plus the transferee’s share of partnership
liabilities. The regulation further provides that the transferee’s previously taxed capital
is equal to—
(i) The amount of cash that the partner would receive on a liquidation of the
partnership following a hypothetical transaction; increased by
(ii) The amount of tax loss (including any remedial allocations under § 1.704-3(d) of
the Income Tax Regulations) that would be allocated to the partner from the
hypothetical transaction; and decreased by
(iii) The amount of tax gain (including any remedial allocations under § 1.704-3(d))
that would be allocated to the partner from the hypothetical transaction.
The hypothetical transaction is a disposition by the partnership of all of its assets
in a fully taxable transaction for cash equal to the fair market value of the assets. See
§ 1.743-1(d)(2).
Part (i) of the above calculation is intended to quantify, for each partner, the
partner’s economic right to a share of the distributable proceeds of the partnership
immediately after the hypothetical transaction and the payment by the partnership of all

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of its liabilities (partnership net liquidity value). The Treasury Department and the IRS
understand that although some partnerships may be able to determine the fair market
value of their assets for each taxable period, such information will not be readily
available for all partnerships. I n most instances, a partnership that calculates its
partnership net liquidity value by using a consistent measurement for the value of its
assets (such as GAAP basis or § 704(b) basis) rather than their actual fair market value
will determine the same amount for each of its partners as would be determined if the
partnership had calculated its partnership net liquidity value by hypothesizing a sale of
its assets for actual fair market value. Accordingly, for purposes of the Tax Capital
Reporting Requirement, the Modified Previously Taxed Capital Method modifies the
calculation described in § 1.743-1(d)(2) (for purposes of the Tax Capital Reporting
Requirement only) as follows:
(i) The cash a partner would receive on a partnership liquidation and calculations of
gain and loss in the hypothetical transaction would be based on the assets’ fair
market value, if readily available. Otherwise, a partnership may determine its
partnership net liquidity value and gain or loss by using such assets’ bases as
determined under § 704(b), GAAP, or the basis set forth in the partnership
agreement for purposes of determining what each partner would receive if the
partnership were to liquidate, as determined by partnership management; and
(ii) All liabilities are treated as nonrecourse for purposes of parts (ii) and (iii) of the
calculation referring to gain or loss, respectively. This is to avoid the burden of
having to characterize the underlying debt and to simplify the computation.

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Example – Facts. A and B are equal partners in AB LLC, a calendar-year
partnership. On December 31, 2020, AB LLC’s balance sheet reflects the following
assets and liabilities:
• $500 of cash;
• Inventory with a tax and book basis of $1,000;
• Equipment with a tax and book basis of $500;
• Land with a tax and book basis of $1,000; and
• A long-term loan of $5,000.
AB LLC chooses to comply with the Tax Capital Reporting Requirement by using
the Previously Taxed Capital Method and calculating liquidation values, gains, and
losses, based on the book basis of the assets. Each of A and B’s Previously Taxed
Capital under that method would be $(1,000), an amount equal to (i) the cash each
would receive after the hypothetical liquidation (zero, because the debt of $5,000
exceeds the $3,000 book basis of the assets), less (ii) gain that would be allocated to
each partner on the hypothetical liquidation and sale ($1,000, each partner’s 50% share
of the excess of the $5,000 amount realized on a sale of the property for the debt over
the tax basis of $3,000), plus (iii) loss that would be allocated to each partner (zero).
A partnership that adopts the Modified Previously Taxed Capital Method would
be required, for each taxable year in which the method is used, to attach a statement
indicating that the Modified Previously Taxed Capital Method is used and the method it
used to determine its partnership net liquidity value (for example, fair market value,
§704(b) book basis, etc.).
IV. REQUEST FOR COMMENTS

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The Treasury Department and the IRS request comments on the following topics:
(i) Whether the methods used to satisfy the Tax Capital Reporting
Requirement described in section III of this notice should be modified or
adopted;
(ii) Whether an ordering rule should apply to the basis used in determining
the partnership’s net liquidity value; for example, use of fair market value
is required, but if not readily available, §704(b) book basis is required,
and, if the partnership does not maintain § 704(b) capital, GAAP is
required, etc.;
(iii) How, if at all, the Tax Capital Reporting Requirement should be modified
to apply to partnerships that are treated as publicly traded partnerships
under § 7704 of the Code;
(iv) Whether the Transactional Approach, or similar method, should be
permitted for purposes of meeting the Tax Capital Reporting Requirement
and, if recommended, what additional guidance would be necessary; and
(v) Whether and in what circumstances limitations should be imposed on
partnerships to change from one method to another (for example, whether
there should be a limit on how many times the method can be changed
over a period of years), including compliance with such rules in the case of
the merger of partnerships using different methods.
Written or electronic comments must be received by August 4th, 2020, and
should contain a reference to Notice 2020-43. Commenters are strongly encouraged to
submit comments electronically, as access to mail may be limited. Comments may be

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submitted in one of two ways:
(1) Electronically via the Federal eRulemaking Portal at www.regulations.gov
(type IRS Noti ce 2020-43 in the search field on the regulations.gov homepage to find
the docket for this notice and submit comments).
(2) Alternatively, by mail to Internal Revenue Service, CC:PA: LPD (Notice 2020-
43, Room 5207, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044.
Comments will be available for public inspection and copying.
V. DRAFTING INFORMATION
The principal author of this notice is Kara Altman of the Office of Associate Chief
Counsel (Passthroughs & Special Industries). For further information regarding this
notice contact Kara Altman at (202) 317-5576 (not a toll-free call).