Dear Sir ,
I like to know Sch K-1 /partner capital accounts , if this transaction should be under under tax basis or section 704(b) book.

Partner A and B each contribute $100 to form AB LLC , member managed .
AB LLC filed form 1065 .Operating agreement stated profit loss shared based on capital ratio but there is also a clause on tax allocation allowed under the Internal revenue Regulations.There is no other capital contribution or asset contribution.

In year one , there is is profit of $200. Because in year 1 ; Partner A contributed more effort and time ,it was agreed that Partner A allocated $150 while Partner B allocate $50 .

Question #1 : In tax return form 1065 , Sch K-1 /Item L /partner capital accounts : Which box to choose ? : Tax Basis/ GAAP/ Section 704(b) /Other .
I prefer to choose Tax basis but not sure if i am correct .

Question #2 : If Tax basis method is selected in year 1 , must Tax basis be used for each and every year ?

Thanks and Regards
JLYS

Question #1 : In tax return form 1065 , Sch K-1 /Item L /partner capital accounts : Which box to choose ? : Tax Basis/ GAAP/ Section 704(b) /Other .
I prefer to choose Tax basis but not sure if i am correct .====> Most companies report on the tax basis If you have a book to tax depreciation ,as shown on Sch L of 1065 ,difference then you cannot be on tax basis reporting. Tax basis means you are using the exact same depreciation for the financial statements as well as for the tax return. An Enrolled agent or a CPA is probably trying to keep his taxpayers/partner's taxable basis so if there are losses or sales the tax accountant will have the information readily available. If you keep the books on the tax basis and the partner is an original partner, therefore no outside basis, then the capital account IS the same as the partner's basis. But if you keep the financial statements on GAAP meaning, straight line depreciation, and you use bonus depreciation or other fast depreciation on the tax return, leading to a diference in book and tax depreciation, the capital account will not correctly reflect taxable partnership basis. Then the tax accountant will need to keep a separate spreadsheet.the box in this section to indicate to the IRS that all the calculations in this section conform to the tax-basis accounting method. When filing the partnership tax return, distribute copies of the completed SCh K-1s to the individual partners so they can use the information to prepare their own personal income tax returns; As you can see,there are two choices when selecting an accounting method for your business: GAAP, generally accepted accounting principles, and tax accounting; each has benefits that may be ideally suited to the needs of your business financial reporting, and each method has drawbacks that may make it an unsuitable choice. GAAP accounting records all financial transactions: cash, accrual, investment, expenses, tax and deductions that may or may not have to be reported on your yearly tax form. This form of accounting is governed by strict standards and rules and may show actual income that is different from taxable income. For example, GAAP accounting is a set of standards provided by policy boards and commonly accepted methods of recording financial information that gives consistency to any type of financial reporting.Tax-based accounting is used by most accountants, and the majority of certified financial statements come from tax-based accounting. The focus of this type of accounting is on tracking your taxable income as it builds throughout the year. Tax accounting is a method of producing financial statements that uses the same methods that will apply to your tax return. GAAP accounting provides a means for a business to have a complete overview of the reality of its operations by tracking all monetary relationships, investments and expenditure. Tax accounting provides a focus on business or personal expenses that pertain to tax records only. GAAP accounting is more involved then tax accounting and provides more details about the monetary reality of daily operations that may or may not pertain to your tax needs; it also provides an accurate statement of your liabilities and assets. Tax based accounting has less rules and makes it easier to see where you stand at any given point of the year with taxable income. It does not, however, reliably report all liabilities and assets. When choosing which form of accounting to use for your personal or business needs there are several points to consider. If your business must issue financial statements to investors, GAAP provides greater consistency in the reporting, as it is guided by industry standards and not subject to the many changes that occur in tax requirements on a yearly basis. If you are established in your business and do not need to issue financial statements or your personal budget is adequate and realistic to your living needs, the simpler tax accounting methods may be better for you; your focus will remain on what is needed to successfully file taxes at the end of each year and you do not need the masses of data associated with tracking every financial transaction that occurs during the year.The IRS requires the reconciliation of the PS’s financial accounting income(book income) and its taxable income on M1 of 1065. So, as said above, book income is calculated according to GAPP including rules promulgated by FASB. On the other hand, taxable income must be calculated using tax rules so, book income and taxable income usually differ.




Question #2 : If Tax basis method is selected in year 1 , must Tax basis be used for each and every year=>>yes or no it depends

Thank you for your advice,appreciated.
I prefer Tax basis /tax accounting since AB LLC does not have complicated transactions.

I was having the understanding that since year end profit ratio is not 50/50 as stated in operating agreement ,though both partner agreed via company resolution to split profit $150 and $50 . Thus, profit split does not follow capital ratio,will it be considered under section 704( b) book instead of Tax basis ?. Hope to get clarification.

Thanks again !

Basically, Sec. 704(b) generally requires allocations to have ?substantial economic effect? or to be in accordance with the ?partner?s interest in the partnership/llc No matter the test met, the regulations require that partnership allocations follow the partners? true economic arrangement. The regulations generally require llc/partnerships to maintain a Sec. 704(b) book capital account for each partner to reflect the partner?s economic interest in the partnership. To pass the substantial economic effect safe harbor, the partnership/llc agreement must require these capital accounts to be maintained in accordance with the subchapter K regulations. If capital accounts are not maintained properly throughout the partnership?s full term, allocations will be deemed to lack substantial economic effect. By and large, capital accounts are determined to be in accordance with the Sec. 704(b) regulations.The flexibility of subchapter K is limited further by rules in the regulations, such as the anti-abuse rule and other rules regarding allocations attributable to nonrecourse liabilities, mixing bowl transactions, and allocations in connection with contributed and distributed property. These rules were included in the regulations with the intent of ensuring that book, and consequently tax, allocations are made in accordance with the partners? economic arrangement.

Thanks again for your advice and updates ,appreciated !.

I prefer to select Tax basis even though the profit split differs from capital ratio.We do not have depreciation and no contribution of asset as capital .
Simple and straight forward ,except the profit split for year 1 differ from capital ratio.
May I know in my LLC situation , In sch k-1 ,Item L on partner capital analysis ;can my LLC select Tax basis among the various selection like GAAP,section 704(b) /other ?

kind regards