Benjamin Franklin once said that the only certainties in life are death and taxes. Well he should have added on a third leg – tax compliance requirements! The IRS has been busy preparing for the 2019 tax filing season by updating forms and requiring more reporting items.
For example, let’s look at one small piece of this: the draft 2019 K-1s for a partnership. In the draft K-1 there is now a line “N” for the beginning share of a partner’s “net unrecognized 704(c) gain (or loss).” This would, in the case of a dairy farm for instance, make compliance more burdensome. Let’s look at a simple example where A, B and C are 1/3 members in Northeast Dairy, LLC.
If “A” contributes 60 raised cows into the LLC, the tax rules require that all of the “built in gain” be taxed to the contributor, “A”. This rule is not new, but the ongoing tracking of that built in gain for the tax return is new. If those 60 cows were worth $60,000 and, in the year they are contributed, 20 are sold, then $20,000 is taxed to the contributor regardless of how profits and losses are split.
In other words, just because A, B and C are each 1/3 members and normally split profit and losses in this fashion doesn’t mean that B and C are taxed on any of the cows that A contributed. The entire $20,000 is reported on A’s tax K-1 and ultimately on his or her individual tax return.
Logically this makes sense because if A didn’t contribute the cows, he or she would have sold them and paid tax on the gain. A is not allowed to shift his or her liability by contributing those cows into the LLC.
On the other hand, if those cows appreciated in value above the $60,000, then any gain above that would be permitted to be split under their normal 1/3 profit sharing arrangement. Moving forward, the tax preparer will have to list the remaining $40,000 of built in gains on line “N” of the K-1.
This is one small example in a long list of items that are now required by the IRS. This means taxpayers will likely need to provide more information to their tax preparers this season on a range of items. As a result, the complexity, skill level and time required to complete tax returns will increase along with the cost tax compliance.
Update: The IRS recently issued Notice 2019-66 which has clarified some of the new changes that will apply to partnerships. Relating to the “net unrecognized 704(c) gain (or loss)” provisions, Notice 2019-66 adds clarity on the technical definitions in that area. Some items not discussed in the post above, such as the requirement to report tax basis capital accounts, have been delayed to 2020.