Partnership capital account analysis and Schedule M-2 in Lacerte

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

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Changes to Schedule M-2, Line 3 Beginning in 2021

Starting with tax year 2021, the IRS updated the Federal Form 1065 instructions for Schedule M-2, line 3. This line has undergone several changes over recent years:

• 2019 and prior:
  Schedule M-2, line 3 matched Schedule M-1, line 1 (Net income per books).
• 2020:
  Schedule M-2, line 3 defaulted to the value on Schedule M-1, line 3.
  Partnerships could override this by using options on Screen 28, Schedule M-2 to Recompute Sch. M-2, line 3 if partnership books are NOT on a tax basis (code 116).
  If applied, this could cause Schedule M-2, line 3 to differ from Schedule M-1, line 3.
• 2021:
  Instructions for Schedule M-2, line 3 no longer reference Net Income per Books (Schedule M-1, line 1).
  Instead, the required input is Net Income from Schedule M-1, line 9.

Impacts

Changes to Schedule M-2, line 3 affect:

• Schedule M-2, line 9 (year-end balance):
  This flows to the Balance Sheet, line 21, Partners’ capital accounts, column (d).

Adjustments you may need to make

Depending on the situation, updates may be required on Screen 28, Schedule M-2 in:

• Other increases (code 103), line 4
• Other decreases (code 107), line 7

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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. To learn more, refer to Tax basis capital account reporting.

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

Lacerte 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 Beginning Capital Account Showing Zero on Item L of Schedule K-1 for a 1065 Partnership Return.

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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 learn more, refer to Adjusting the partners' capital account on Form 1065 in Lacerte.

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