Partner capital account reporting gets transition penalty relief

By Paul Bonner

The IRS provided transition penalty relief Tuesday to partnerships in complying with new rules for reporting partners’ capital account balances.

The relief in Notice 2021-13 follows up on Notice 2020-43, issued in June 2020, in which the IRS sought public comments to help inform its development of the r­ules. Then, in October, the IRS issued tax year 2020 draft instructions for Form 1065, U.S. Return of Partnership Income, containing the rules. The IRS also issued a news release (IR-2020-240) accompanying the draft instructions, in which it said it intended to provide the relief issued Tuesday.

As it explained in the notices and news release, the IRS has sought to impose a more consistent framework for partnerships to comply with the requirement in Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., of both Form 1065 and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, to report partner capital account balances.

Previously, partnerships had been allowed to use any reasonable method, including tax basis, GAAP, or Sec. 704(b) book basis. Notice 2020-43 proposed allowing only either a modified outside basis method or modified previously taxed capital method, as described in the notice. The news release noted that IRS data indicated most partnerships already use the tax-basis method.

To determine partners’ beginning tax-basis capital account balance for 2020, partnerships that did not previously maintain partners’ capital accounts under the tax-basis method in their books and records may use either of the two methods described in Notice 2020-43 or the Sec. 704(b) method, as described in the draft instructions. The news release stated that transition penalty relief for errors in 2020 tax year reporting of partners’ beginning capital accounts on Schedules K-1 would promote compliance with the revised instructions.

In providing that relief, Notice 2021-13 states that partnerships will not be subject to a penalty under Sec. 6698, 6721, or 6722 due to incorrect information in partners’ beginning capital accounts on 2020 Schedules K-1 if the partnership can show it took ordinary and prudent business care in following the 2020 Form 1065 instructions in that regard.

Sec. 6698 imposes a penalty for failing to timely file a correct and complete return or report under Sec. 6031. Sec. 6721 imposes a similar penalty for failing to file an information return, and Sec. 6722 penalizes a failure with respect to furnishing a corresponding payee statement. The notice gives the usual definition of “ordinary and prudent business care” but notes that an element of that care is maintaining capital account balances in partnership books and records.

Partnerships also will not be subject to a penalty under the same Code sections due to errors in reporting partners’ ending 2020 capital account balances that result solely from incorrect beginning capital balances eligible for relief.

The penalty relief in the notice is in addition to the reasonable-cause penalty exception under Sec. 6724 for failing to properly report the partners’ beginning capital account balances.

Partnerships will also be eligible for waiver of accuracy-related penalties under Sec. 6662 for any imputed underpayment attributable to the above errors that qualify for relief under the notice.

The relief is not available to partnerships that fail to timely file a 2020 Form 1065, Form 8865, or Schedules K-1 or that fail to include a partner’s beginning capital account balance on Schedule K-1.

Paul Bonner ( is a JofA senior editor.

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