The much-anticipated proposed regulations implementing the new centralized partnership audit regime under the Bipartisan Budget Act of 2015 (BBA) have finally been released. The BBA regime replaces the current TEFRA ( Tax Equity and Fiscal Responsibility Act of 1982) procedures beginning for 2018 tax year audits, with an earlier "opt-in" for electing partnerships. Originally issued on January 19, 2017 but delayed by a January 20, 2017 White House regulatory freeze, the re-proposed regs carry with them much of the same criticism leveled against them back in January, as well as several minor modifications
Take away. "The release of these proposed regulations may satiate the relentless clamoring by some for “guidance” (although the regulations are merely proposed)," Michael Grace, Esq., consulting counsel, Wiley Rein LLP, and former IRS pass-throughs attorney, told Wolters Kluwer. "The proposed regulations do not and realistically could not have been expected to answer many practical questions that tax practitioners and clients must answer in preparing for the new rules," he added. Grace identified those issues to include:
- Whether to elect out of the new rules (assuming a partnership’s eligible);
- Selecting a method of satisfying an imputed underpayment;
- Allocating economic responsibility for an imputed underpayment among partners including situations in which partners’ interests change between a reviewed year and the adjustment year; and
- Indemnifications between partnerships and partnership representatives.
Under the proposed regs, to which Congress left many details to be filled in, the new audit regime covers any adjustment to items of income, gain, loss, deduction, or credit of a partnership and any partner’s distributive share of those adjusted items. Further, any income tax resulting from an adjustment to items under the centralized partnership audit regime is assessed and collected at the partnership level. The applicability of any penalty, addition to tax, or additional amount that relates to an adjustment to any such item or share is also determined at the partnership level.
Comment. Aside from the correction of certain typographical errors from the January-released regs, the re-proposed regs had the following "minor changes," as noted by an IRS spokesperson: the parenthetical "domestic or foreign)" was added to emphasize the application of the new regime to all partnerships required to file a return under Code Sec. 6031, the discussion in the preamble on section 6226 relating to push out elections for tiered partnerships has been changed; the "Special Analyses" section has been revised to address Executive Order 13789; and the Example 3 under §301.6225-1(f) involving certain netting rules has been deleted.
The BBA allows certain partnerships after 2017 to elect out of the new audit regime and be audited under the general rules applicable to individual taxpayers. Only an eligible partnership may elect out of the centralized partnership audit regime. A partnership is an eligible partnership if it has 100 or fewer partners during the year and, if at all times during the tax year, all partners are eligible partners, as defined in Proposed Reg. §301.6221(b)-1(b)(3). A special rule applies to partnerships that have S corporation partners.
Proposed Reg. §301.6221(b)-1(c) provides the time, form, and manner for the partnership to make an election out of the centralized partnership audit regime. The election may be made only on a timely filed partnership return. The electing partnership must notify each partner within 30 days of making the election. For partnerships that elect out, the IRS will open deficiency proceedings at the partner level to adjust items associated with the partnership, resolve issues, and assess and collect any tax that may result from the adjustments.
Comment. The IRS intends to carefully review a partnership’s decision to elect out of the centralized partnership audit regime to ensure that the election out is not being used solely to frustrate IRS compliance efforts.
A partner’s treatment of each item of income, gain, loss, deduction, or credit attributable to a partnership must be consistent with the treatment of those items on the partnership return, including treatment with respect to the amount, timing, and characterization of those items. Under the proposed rules, the IRS may assess and collect any underpayment of tax that results from adjusting a partner’s inconsistently reported item to conform that item with the treatment on the partnership return as if the resulting underpayment of tax were on account of a mathematical or clerical error appearing on the partner’s return. A partner may not request an abatement of that assessment.
The proposed regs require a partnership to designate a partnership representative, as well as provide rules describing the eligibility requirements for a partnership representative, the designation of the partnership representative, the representative’s authority, determinations that a designation is not in effect, and IRS designations of a partnership representative. A non-partner is not prohibited from becoming a partnership representative.
The proposed regs coordinate the rules regarding notice of inconsistent treatment with situations where a partner is bound to the treatment of an item under Code Sec. 6223 as a result of actions taken by the partnership though its representative or of any final decision in a proceeding brought under the centralized audit provisions with respect to the partnership.
Imputed Underpayment, Alternatives and "Push Outs"
Generally, if a partnership adjustment results in an imputed underpayment, the partnership must pay the imputed underpayment in the adjustment year. The partnership may request modification with respect to an imputed underpayment set forth in the notice of proposed partnership adjustment (NOPPA) under the procedures described in Proposed Reg. §301.6225-2.
The proposed regs provide that a partnership may elect under Code Sec. 6226 to "push out" adjustments to its reviewed year partners rather than paying the imputed underpayment determined under Code Sec. 6225. If a partnership makes a valid election in accordance with Proposed Reg. §301.6226-1, the partnership is no longer liable for the imputed underpayment. Rather, the reviewed year partners of the partnership are liable for tax, penalties, additions to tax, and additional amounts plus interest, after taking into account their share of the partnership adjustments determined in the final partnership adjustment (FPA). The proposed regulations provide rules for making the election, the requirements for partners to file statements with the IRS and furnish statements to reviewed year partners, and the computation of tax resulting from taking adjustments into account.
Comment. Bipartisan technical corrections (HR 6439, Sen 3506) were introduced in December 2016 to allow a partner that is a partnership or S corporation to elect to either pay an imputed underpayment under rules similar to Code Sec. 6225 or flow the adjustments though the tiers. But according to the IRS, this would result in complexities, challenges, and inefficiencies similar to what occurred under TEFRA. As a result, the IRS has reserved this issue and is asking for comments in considering an approach for tiered partnerships regarding pushing the adjustments beyond the first tier partners.
Administrative Adjustment Requests
Under Proposed Reg. §301.6227-1(a), a partnership may file an administrative adjustment request (AAR) with respect to one or more items of income, gain, loss, deduction, or credit, and any partner’s related distributive share, for any partnership tax year. The partnership must determine whether the adjustments requested in the AAR result in an imputed underpayment for the reviewed year. If so, the partnership must take the adjustments into account and pay the imputed underpayment unless the partnership makes an election under Proposed Reg. §301.6227-2(c), in which case the reviewed year partners take the adjustment into account under rules similar to Code Sec. 6226.
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