Partner Capital Accounts

Partner A buys Partners B and C's interest and new partners D and E pay Partner A for share of partnership which has all occurred at about the same time....end of 2017.

This was all done through their S Corps, which are the partners in this partnership, but bookkeeper has not reflected any of this on the partnership books, although she does the S Corp books as well. The partnership equity accounts have not been adjusted.

This is probably a dumb question, but the bookkeeper should adjust their capital accounts, correct? Seems as if Partner D paid Partner A $20,000 that should get added to her equity account so that if and when she leaves the bookkeeper will know how much she paid, correct?

The answer to your question depends on so many many things that aren't given in your explanation of the scenario that I don't even know where to begin in asking for additional facts.

Let's start here: In the simplest case, the transactions among the various partners have no effect on the books of the partnership. The prices paid between partners for interests in a partnership don't affect - not normally, but they can under some conditions - the bookkeeping records of the partnership.

Were B and C the only other partners when A bought their interests in the partnership?

Are you intending to use the partnership's books to keep track of the several partners' tax bases in their partnership interests?

We haven't begun to even take the temperature of the tip of the iceberg that we're confronting...

Sorry, very tired and maybe should stop working tonight.

Yes, there were three partners and then two basically replaced the other two which has caused a technical termination due to the fact that 50% interest was sold. So I have that part down. I am just struggling with reconciling the capital accounts.

I would like to use the partnership books to track the partner's tax bases as I feel their real bases will be overlooked by the bookkeeper. For instance, one of the departing partners got paid out his capital balance which was much lower than I had on his K-1. I don't know if they knew this. His original payment to the two partners many years ago was not reflected in the partnership books. It was on his K-1 capital account but not on the partnership books.

For example, S Corp partner shows "investment in partnership" as $30,000 as other asset on the balance sheet.

K-1 capital account on the Form 1065 should match this correct?

For example, S Corp partner shows "investment in partnership" as $30,000 as other asset on the balance sheet.

K-1 capital account on the Form 1065 should match this correct?

As Harry alludes to, there's more facts we need to know to give you a detailed answer.

As some background as to why we're asking, you could search "704(b) basis", but I'll give a little background here.

Many partnership's must track three different kinds of capital: Tax, Book (or GAAP), and 704(b).

Most of us are familiar with Tax. If the original partners all contributed cash, this basis usually represents the economics of the partners' agreement and works just fine. However...

If the tax return is on a cash basis and they need full accrual GAAP financials, the capital accounts on their financial statements will not be reflective of their tax basis. This requires that you track their tax basis independently of what is probably on their books and reconcile it with each tax return.

Finally, if you have a situation where a partner has contributed property that has a lower tax basis than its FMV, you will likely need to track capital on a 704(b) basis and reconcile this basis to Tax with each tax return. This reconciliation will highlight the existence of any 704(c) items. I'll let you do some reading on 704(c) to let you evaluate if it applies and give you some background on what we need to give you a good answer.

Hope that helps...

If the items mentioned were always buys and sales of "partnership interests" between exiting, new and old partners - why would that change partnership basis on the partnership books? Names change reassign basis on the books and percentages. The partner's tax basis is kept and tracked by the partner. The partnership never received any assets in the buys. Can you have a 754 step up if sale is between partners only? Can you have a mythical goodwill account not having any tax effect?

If the items mentioned were always buys and sales of "partnership interests" between exiting, new and old partners - why would that change partnership basis on the partnership books? Names change reassign basis on the books and percentages. The partner's tax basis is kept and tracked by the partner. The partnership never received any assets in the buys. Can you have a 754 step up if sale is between partners only? Can you have a mythical goodwill account not having any tax effect?

Jon, if we were discussing an s-corporation, your thoughts would be correct. We're not.

- why would that change partnership basis on the partnership books?

Because their economic arrangement may have changed. We don't have enough information to know, but there is likely to be a difference between tax basis and agreed upon FMV between partners. This would be the case, unless the interests were exchanged at exactly tax basis (unlikely).

This is a service business, cash basis and very simple as there aren't any receivables or payables and very minimal computer and office equipment.

Partner capital accounts are on the tax basis. Schedule L on the tax return should match the tax basis capital accounts, which should reflect the partner's activities between themselves, including the buyin and buyouts. So this appears will result in a Section 754 adjustment on the balance sheet. I guess I am just used to the books always matching the Schedule L balance sheet. Makes life simpler that way.

My biggest concern is that her calculation of their capital accounts is what they rely on to see what their capital balances are, but they should be looking at the Schedule K-1's. I feel like I am not able to communicate this with the bookkeeper.

This is a service business, cash basis and very simple as there aren't any receivables or payables and very minimal computer and office equipment.

But the amount they paid for the interest is not equal to the inside tax capital, correct?

Assuming that is the case, you have all the dynamics I described. Although, most preparers ignore this and don't show it properly.
I'm also assuming you didn't bother reading about 704(b) or 704(c).

Partner capital accounts are on the tax basis. Schedule L on the tax return should match the tax basis capital accounts, which should reflect the partner's activities between themselves, including the buyin and buyouts.

Tax basis capital reflects the investment of each individual partner. If there have been transfers of interests, it rarely will reflect the economic arrangement among the group.

I did read 704(b) but will revisit it again in the morning. Thanks for your help. Looks like I need to go back to school on partnership taxation. Really prefer to do Corporate returns, but I got to do this right.

If the items mentioned were always buys and sales of "partnership interests" between exiting, new and old partners - why would that change partnership basis on the partnership books? Names change reassign basis on the books and percentages. The partner's tax basis is kept and tracked by the partner. The partnership never received any assets in the buys. Can you have a 754 step up if sale is between partners only? Can you have a mythical goodwill account not having any tax effect?

Yes, you can have a 754 in a redemption or a purchase of interest, if I'm not mistaken. A bit more complex if you have an installment note as well =D