Forbes has published an article, “Is A Major IRS Crackdown On Partnerships Looming?” which discusses the important change in partnership returns in the draft 2020 Instructions for Form 1065. The summary of the article is as follows:
A partnership is considered to be a “taxpayer” even though it will generally not be paying federal income tax. It should have an ID number. It will have its own accounting method and make its own tax elections. The partners can conceivably have transactions with the partnership which will be treated as arms length.
When it gets down to the brass tacks of actually paying taxes, everything the partnership did will be allocated among the partners. How those allocation were done is one of the things that led to lots of shenanigans.
There was a major crackdown on the shenanigans in 1985 with regulations that were issued parsing out Code Section 704(b). Allocations had to have substantial economic effect or if supported by non-recourse debt deemed economic effect. The regulations indicated that the best way to comply with that requirement was to maintain capital accounts that reflected economic reality and have distributions in liquidation be in accordance with those capital accounts.
The effect of the regulations ended up being partnership agreements that most people did not understand. The partnership agreements tended to require the maintenance of those sort of capital accounts.
Posted by Bella Hoang, Managing Associate Editor, Wealth Strategies Journal.