California is Now Requiring Schedules Report California Tax Basis Capital Accounts
February 16, 2022
At a glance
- Main takeaway: The State of California amended their tax laws now requiring Schedules M-2 and K-1 to report California tax basis capital accounts and not federal tax basis capital accounts.
- Impact on your business: California is known for issuing tax laws that differ from federal tax law. Taxpayers should pay close attention to the changing law as tax basis capital is important in determining a partner’s gain or loss from the sale of their partnership interest.
- Next steps: Aprio’s State and Local Tax (SALT) team can navigate you through the changing tax law and help you determine the tax basis capital for each partner.
The full story:
In most cases, California tax law conforms to the Internal Revenue Code (IRC). However, there are many differences between California and federal tax law. Due to these differences, California is now requiring that California Schedules M-2 and K-1 (565/568) report California tax basis capital accounts and not federal tax basis capital accounts. This requirement is effective for tax years beginning on or after January 1, 2021.
Understanding tax basis capital accounts
A tax basis capital account is important in determining a partner’s gain or loss from the sale of their partnership interest and in determining the ability to claim losses. A partner’s tax basis capital account balance is generally:
For tax years prior to 2020, tax basis capital accounts generally did not need to be disclosed on a partnership’s income tax returns. Instead, a partnership was allowed to report its partners’ capital accounts on some other basis, such as Generally Accepted Accounting Principles (GAAP), Section 704(b), Tax, or Other, to report the partners’ capital accounts on a Schedule K-1.
These other methods were often of limited use to the IRS in identifying potentially taxable situations. So, for taxable years ending on or after December 31, 2020, the IRS required partnerships to report each partner’s capital account on a tax basis for federal purposes.
The bottom line
Last year, when the IRS began requiring partnerships to report partners’ partnership capital on the tax basis method, California provided taxpayers the opportunity to follow the federal instructions regarding tax basis capital account reporting but did not make it a requirement. However, California changed their form instructions this year to require the use of California tax basis capital account reporting.
Aprio’s State and Local Tax (SALT) team can navigate you through the changing tax law and help you determine the tax basis capital accounts for each partner.