Partnership capital account analysis and Schedule M-2 in ProConnect Tax

This article will help provide answers to frequently asked questions regarding the partnership capital account analysis and Schedule M-2 in ProConnect Tax.

Where does the amount on line 3 come from?

• Starting in tax year 2021 Schedule M-2, line 3 changed the instructions to no longer reference Net Income per Books (Schedule M-1, line 1), but instead to be Net Income (Schedule M-1, line 9).
• For tax year 2020 Schedule M-2, line 3 would default to utilize the Schedule M-1, line 3. However, there were options available on the Schedule M-2 screen, to Recompute Sch. M-2, line 3 if partnership books are NOT on tax basis, which could cause Schedule M-2, line 3 to be different from the Schedule M-1, line 3.
• For tax year 2019 and prior Schedule M-2, line 3 was the same value as the Schedule M-1, line 1 (net income per books).

To make adjustments to the M-2:

1. Go to Input Return ⮕ Balance Sheet ⮕M1, M2, Schedule M-2 (Capital Accounts)
2. Enter the adjustments on Other increases or Other decreases.

How to report partners' capital accounts on the tax basis

For 2020 and beyond, tax basis capital account reporting is required on all federal partnership returns. The Recompute Sch. M-2, Line 3 feature can help you ensure compliance; this can be found on the Schedule M-2 (Capital Accounts) screen. To learn more, refer to Tax basis capital account reporting.

Why the beginning capital on Schedule K-1, Item L, is zero

ProConnect Tax allocates the beginning capital based on partner percentages by default. If a partner's ending percentage of ownership was zero, you'll need to specially allocate the correct amount of beginning capital. To learn more, refer to Why is partners' capital account analysis blank for Schedule K-1, Item L (1065)?

How to zero out the partners' ending capital on a final return

Distributions of cash or property, or other decreases, must be entered to reduce the partners' ending capital to zero. To adjust the partners' capital account on Form 1065:

1. Go to the Input Return ⮕ Balance Sheet, M-1, M-2 ⮕ Schedule M-2 (Capital Account).
2. Scroll down to the Other Decreases (-) subsection.
3. Enter the correct amount in Other decreases (Click on button to expand).
   • Or, you may enter the correct amount in the Cash and marketable securities or Property fields, under the Distributions subsection.