California FTB Delays Partnership Tax Capital Reporting by a Year

The California Franchise Tax Board (FTB) has granted a one-year extension for partnerships to conform to the state’s required methodology for tax capital reporting. The FTB is requiring partnerships to use the tax basis method as determined under California law—rather than the amounts used for federal reporting—for reporting capital accounts on Schedule K-1 (565) and Schedule K-1 (568). The required method will now become effective beginning with the 2023 tax year.

California and Federal Tax Basis Reporting

The FTB’s requirement to use tax basis capital reporting follows the Internal Revenue Service (IRS), which requires partnerships to use the tax basis method to report partner capital account balances on Schedules K-1 for tax years beginning in 2020. Prior to 2020, partnerships could report capital account balances on their federal Schedules K-1 using tax basis, GAAP, IRC Section 704(b) book, or other reporting methods. The tax basis requirement was originally scheduled to take effect for tax year 2019 but was delayed to allow partnerships more time to adjust to the reporting method.

Since 2006, the FTB has followed the IRS and allowed taxpayers to report their partners’ capital account under one of the four methods allowed under federal reporting. The FTB then followed the IRS by eliminating the reporting options and requiring the use of the tax basis method for reporting capital accounts, but with the method as determined using worldwide amounts under California law rather than using the federal tax basis amounts. Like the IRS, the FTB acknowledged the difficulty in complying with the reporting requirement on the original schedule and delayed the requirement in 2022 and again in 2023.

Partnerships Should Begin Now to Prepare for Additional Complexity

The FTB’s requirement presents additional complexity for partnerships that are already challenged with the new federal tax basis reporting requirements. California partnerships will now have to use the federal method for calculating tax basis for federal purposes and the California method for calculating tax basis for California purposes. This could bring additional burden if taxpayers find significant differences between California and federal tax basis amounts. California last conformed to federal tax law in 2015, when it changed the state’s date of conformity to the federal tax code from January 1, 2009, to January 1, 2015. This conformity date could exclude federal tax provisions passed after 2015 to which the state has not conformed.

While the delay provides some relief, partnerships should begin now in assessing how to implement to these reporting requirements. Complying with the new requirement will likely include compiling and analyzing historical partnership data as well as identifying California tax differences that will modify the federal tax basis amounts.

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