California Tax Basis Capital Accounts Reporting
In early 2022, California Franchise Tax Board (FTB) released 2021 tax form instructions for limited liability companies (Form 568) and partnerships (Form 565) requiring them to report tax basis capital amounts on a California basis rather than using the federal tax basis amounts.
The California tax basis capital reporting requirement followed the IRS’s requirement which went into effect for the 2020 tax year requiring partnerships to report partner capital accounts on a tax basis. Recognizing that taxpayers might have trouble complying to the new reporting obligation, the FTB issued Notice 2022-01 on March 8, 2022, allowing taxpayers to report the capital accounts on either a federal or California tax basis for the 2021 tax year and pushing the requirement to tax year 2022 onwards. California is the first state to require state-specific tax basis reporting for partnerships; however, other states may follow suit.
On January 30, 2023, California Franchise Tax Board (FTB) issue FTB Notice 2023-01 providing much welcomed additional relief to taxpayers and clarifying the reporting requirements for the “Analysis of partner’s tax basis capital account” on Schedule K-1 (565) and Schedule K-1 (568) for taxable years 2021, 2022, and subsequent tax years – permitting extended use of the tax basis method under federal law to taxable year 2022 and requiring tax basis capital account reporting under California law beginning in taxable year 2023, and every year thereafter.
FTB Notice 2023-01 explains that for taxable years 2021 and 2022, the FTB will permit a taxpayer who files Form 565 or Form 568 to report its partners’ or members’ capital accounts on Schedule K-1 (565) or Schedule K-1 (568) using the tax basis method as determined under federal law, as reported on Schedule K-1 (Form 1065), or by using the tax basis method as determined under California law. However, this permission is limited solely to the capital account analysis on Schedule K-1 (565) and Schedule K-1 (568) for the taxable years 2021 and 2022 and does not allow taxpayers to use their federal tax basis in lieu of their California tax basis for any other purpose, including reporting or determining their California tax liability. Beginning for taxable year 2023, and for every taxable year thereafter, Notice 2023-01 explains that the FTB will require a taxpayer who files Form 565 or Form 568 to report its partners’ or members’ capital accounts on the Schedule K-1 (565) and the Schedule K-1 (568) using the tax basis method as determined under California law.
FTB Notice 2023-01 supersedes and replaces FTB Notice 2022-01.
Due to the IRS tax capital reporting requirement effective for 2020, a significant portion of the California tax basis reporting already has been completed, since California generally conforms to the Internal Revenue Code (IRC). However, California’s non-conformity to certain provisions of the IRC and differences that exist due to the timing of California’s adoption of the current IRC will create federal/California differences.
Although the temporary relief provided by FTB Notice 2023-01 was welcome news, partnerships should not delay in determining how they will approach the California tax capital basis calculations for 2023 and beyond. Additional time could be needed to collect information and perform the necessary calculations.
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Article by Zaid Butt, Director