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How to resolve ProConnect Tax Diagnostic ref. 358, California ending balance sheet

by Intuit Updated 8 months ago

This article will help you balance the 565 or 568 balance sheet and resolve the following diagnostic:

"State ending balance sheet out of balance by $ { amount } ." (ref. #358)

Why is the balance sheet out of balance?

Starting in tax year 2021, California requires all partnerships report partners' capital accounts using the tax basis method on their Schedule K-1. The total amounts for capital accounts columns C, D, and E must match the Schedule M-2.

In practice, this means that the Schedule M-2, line 3, must now report income on tax basis. Although forms 565 and 568 do still mention "book" on the M-2 line 3, we're working with the state for clarification - as the tax basis capital accounts won't normally total to the partnership's book basis income.

This mirrors the new behavior of the federal M-2, since the 1065 instructions (which the state references) lay out more explicitly that the M-2 is on tax basis now.

You'll no longer see M-2 adjustments for items like section 754 depreciation, since they're allowable on tax basis.

How do I fix it?

If the federal and California M-2 should match, and you've already balanced the federal return:

  1. Go to Input Return Balance Sheet, M-1, M-2. 
  2. Select Balance Sheet Miscellaneous. 
  3. Check the box labeled Federal and California Schedule M-2 are the same.

If the California capital accounts differ from the federal amounts:

  1. Review the Schedule M-1 and Schedule M-2 on the California return to determine which line needs an adjustment.
  2. Click on the line you want to change to Jump To Input.
  3. Enter the California amount in the State, if different column.

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