Comment letter on tax capital reporting for partnerships

The Honorable David J. Kautter
Assistant Secretary for Tax Policy
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

Dear Mr. Kautter:

Baker Tilly Virchow Krause, LLP, on behalf of our clients, offers the following comments on IRS Notice 2020-43, Tax Capital Reporting. While we recognize the government’s goal to create a consistent framework for all partnerships to comply with the tax capital reporting requirement, we believe the previously taxed capital method proposed in the Notice as a reporting alternative is flawed, will lead to misinformation and is unduly costly and burdensome. Rather than creating an entirely new framework, we recommend that as an alternative to the proposed Modified Outside Basis Method, partnership capital reporting should be done in accordance with the already-established rules provided under IRC § 704(b).

The Purpose for Tax Capital Reporting

We agree with the need for the IRS to have access to information that provides it the ability to efficiently and accurately administer the tax rules. In this regard, there are really only two broad measures that are pertinent for this purpose. The tax basis for a partner’s interest in the partnership, as governed by the rules outlined in IRC § 705, and the economic structure of the partner’s deal, as memorialized in the Capital Account rules outlined in Reg. § 1.704-1(b)(2)(iv). These two measures of capital are the only ones needed to determine the elements critical to the income tax compliance system: A taxpayer/partner’s economic rights in a partnership and the taxpayer/partner’s tax basis against which the ultimate tax treatment is measured. The former is governed by the principles outlined in the regulations promulgated under IRC § 704(b), and the latter governed by the rules outlined in IRC § 705 and related authority.

Modified Outside Basis Method

We believe this method, as outlined in Notice 2020-43, ultimately provides information necessary for the determination of gain or loss recognized on the sale or exchange of an interest, the proper tax treatment for distributions from the partnership, and the deductibility of allocated losses. Unfortunately, there may be many partnerships that will be unable to utilize this method, for two reasons. First, this method is dependent upon receiving timely information from the partners with respect to transactions that occur outside of the partnership. For large partnerships and, especially, entities organized in tiered structures, it will likely be extremely burdensome, costly and time-consuming to gather this information. Second, and more importantly, use of this method will be dependent upon a partner’s willingness to share outside basis information with the partnership (assuming the partners even have their basis readily available). Other than for small closely held partnerships, the end result is that many partnerships will only be able to report an incomplete picture of partnership tax capital in any given year. For those partnerships unable to properly comply with the Modified Outside Basis Method, the only reasonable alternative method for capital reporting should rely upon the already established rules under IRC § 704(b) — we believe this should be the required method for all partnership capital reporting.