Proposed Centralized Partnership Audit Regulations Finally Released After Regulatory Freeze (NPRM REG-136118-15)

CCH Tax Day Report

The 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 in 2018. The proposed regulations were originally issued on January 19 of this year but were covered by a January 20 White House regulatory freeze. The newly released proposed regulations contain several modifications.

The proposed regulations provide rules for partnerships subject to the new regime, including procedures for electing out of the centralized partnership audit regime, filing administrative adjustment requests, and determining amounts owed by the partnership or its partners attributable to adjustments that arise out of an examination of a partnership. The proposed regulations also address the scope of the centralized partnership audit regime and provide definitions and special rules, including the designation of a partnership representative. The proposed regulations affect partnerships for tax years beginning after December 31, 2017, and any partnerships that elect application of the centralized partnership audit regime for tax years beginning after November 2, 2015, and before January 1, 2018. The proposed rules regarding the conversion of partnership items related to listed transaction provided in NPRM REG-138326-07 (February 13, 2009) are withdrawn.

Scope of Centralized Partnership Audit Regime

In general, the centralized partnership audit regime applies to all partnership tax years beginning after December 31, 2017, for any domestic or foreign partnership required to file a return under Code Sec. 6031. Under the proposed regulations, 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.

Election Out of Centralized Partnership Audit Regime

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 partnership has 100 or fewer partners during the year if it is required to furnish 100 or fewer statements under Code Sec. 6031(b) during the tax year for which the partnership makes the election. A special rule applies to partnerships that have S corporation partners. Any statements required to be furnished by the S corporation partner under Code Sec. 6037(b) for the tax year of the S corporation ending with or within the partnership’s tax year are taken into account for purposes of determining whether the partnership is required to furnish 100 or fewer statements for the tax year. Unlike under TEFRA, a husband and wife are not treated as a single partner for these purposes. An eligible partner is any person who is an individual, C corporation, eligible foreign entity, S corporation, or the estate of a deceased partner.

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. An election out is not valid unless all of these requirements are satisfied. An election may be made only on a timely filed partnership return. The partnership must disclose the names, correct TINs, and federal tax classifications of all partners and, if there is an S corporation partner, the names, correct TINs, and federal tax classifications of all persons to whom an S corporation partner is required to furnish statements during the S corporation partner’s tax year ending with or within the partnership’s tax year at issue, and any other information regarding those partners (and shareholders) as required by the IRS in forms and instructions. 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. 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.

Partner’s Return Must Be Consistent with Partnership Return

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. Whether a partner treats an item consistently with the partnership return is determined with reference to the treatment of that item on the partnership return filed with the IRS, and not with reference to any schedule or other information provided or furnished by the partnership to the partner (e.g., a Schedule K-1) unless the election under Proposed Reg. §301.6222-1(d), regarding incorrect statements or information, applies.

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. If the partner is itself a partnership, any adjustment on account of such partnership’s failure to treat an item consistently will be treated as an adjustment on account of a mathematical or clerical error. The rules regarding consistent reporting and treatment of math errors do not apply to items that the partner properly identifies as being treated inconsistently with the partnership return. In order to properly identify such an item, the partner must attach to the partner’s return on which the item is treated inconsistently a statement identifying the inconsistency.

Partnership Representative

Proposed Reg. §301.6223-1 provides rules requiring a partnership to designate a partnership representative and 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. Proposed Reg. §301.6222-1(c)(2) coordinates 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 or of any final decision in a proceeding brought under the centralized audit provisions with respect to the partnership.

Imputed Underpayment and Modification of Imputed Underpayment

Generally, if a partnership adjustment results in an imputed underpayment, the partnership must pay the imputed underpayment in the adjustment year. The partnership adjustments and any imputed underpayment resulting from such adjustments are set forth in a notice of proposed partnership adjustment (NOPPA) mailed to the partnership and partnership representative. The partnership may request modification with respect to an imputed underpayment set forth in the NOPPA under the procedures described in Proposed Reg. §301.6225-2. The proposed regulations address calculation and modifications of an imputed underpayment and treatment of adjustments that do not result in an imputed underpayment.

Election for Alternative to Payment of Imputed Underpayment

Proposed Reg. §301.6226-1(a) provides 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. The proposed regulations coordinate the centralized partnership audit rules with the deficiency dividend procedures under Code Sec. 860 for partners that are RICs or REITs. The proposed regulations reserve on rules that would apply when statements are provided to foreign partners or certain domestic partners. The proposed regulations also coordinate the rules for making the Code Sec. 6226 election, which must be made within 45 days of the mailing of the FPA, with the rules under Code Sec. 6234(a) providing that the partnership may petition for readjustment within 90 days of the date the FPA is mailed. The proposed regulations reserve a place for rules regarding adjustments to a partner’s outside basis or capital account and a partnership’s basis or book value in property when a partnership elects the application of Code Sec. 6226 with respect to an imputed underpayment.

In December 2016, bipartisan technical corrections introduced in both houses of Congress would 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 (H.R. 6439, 114th Cong. (2016); Tax Technical Corrections Act of 2016 (S. 3506, 114th Cong. (2016)). But according to the IRS, this would result in complexities, challenges, and inefficiencies similar to what occurred under TEFRA. As a result, the proposed regulations reserve this issue. The IRS is considering an approach under future proposed regulations for tiered partnerships regarding pushing the adjustments beyond the first tier partners. In this connection, the IRS is seeking comments on how it might administer the requirements of Code Sec. 6226 in tiered structures, including comments on information the IRS needs to monitor whether adjustments are properly flowed through to tiers, and to determine that the proper taxpayers take into account the correct amount of adjustments and report the correct amount of any tax, interest, and penalties.

Administrative Adjustment Requests

The general rules for filing an administrative adjustment request (AAR) are provided in Proposed Reg. §301.6227-1(a). A partnership may file an 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. Only a partnership may file an AAR; a partner may not file an AAR unless the partner is doing so in his or her capacity as the partnership representative. If the partnership pays the imputed underpayment, the payment is treated as a nondeductible expenditure under Code Sec. 705(a)(2)(B). Proposed Reg. §301.6227-2(b)(2) provides the rules for determining penalties and interest with respect to an imputed underpayment resulting from adjustments requested in the AAR. If the adjustments requested in an AAR do not result in an imputed underpayment, the reviewed year partners must take into account their shares of such adjustments. In that situation, the partnership must furnish statements to the reviewed year partners and file a copy of those statements with the IRS. Proposed Reg. §301.6227-3 describes how reviewed year partners take into account adjustments requested in an AAR.

Definitions and Special Rules

Proposed Reg. §301.6241-1(a) contains definitions for purposes of the centralized partnership audit rules. Defined terms include “reviewed year,” “reviewed-year partner,” “adjustment year,” “adjustment-year partner,” “passthrough partner,” “partnership-partner,” “indirect partner,” “partnership adjustment,” “imputed underpayment,” and “tax attribute.” Special rules apply if a partnership is a debtor in a Title 11 bankruptcy case and where the IRS determines that a partnership ceases to exist before a partnership adjustment takes effect. A payment by a partnership of any payment required under the centralized audit rules, including any imputed underpayment, interest, penalties, additions to tax or additional amounts with respect to such amounts are treated as nondeductible expenditures under Code Sec. 705(a)(2)(B). Finally, the proposed regulations extend the centralized audit provisions to a tax year for which any entity files a partnership return, even if it is determined that the filing entity is not a partnership or that no entity existed. If an entity files a partnership return, the centralized audit rules apply to that entity, its items, and any person holding an interest in that entity at any time during the tax year for which the partnership return was filed, unless a valid election out of the centralized audit regime is in effect. The centralized audit rules do not apply to tax years for which a partnership return is filed by certain unincorporated organizations solely to make a Code Sec. 761(a) election out of subchapter K.

Comments Requested

Written or electronic comments must be received by August 14, 2017. Outlines of topics to be discussed at the public hearing scheduled for September 18, 2017, at 10 A.M. must be received by August 14, 2017. Please note that the 60-day period for submitting comments regarding the proposed regulations is truncated from the usual 90-day period.

Submissions may be sent to: CC:PA:LPD:PR (REG-136118-15), Room 5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044, or hand delivered, Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m., to CC:PA:LPD:PR (REG-136118-15), Courier’s Desk, Internal Revenue Service, 1111 Constitution Ave, NW., Washington, D.C. 20224. Alternatively, taxpayers may submit comments electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-136118-15).

AICPA Request for One-Year Delay

On June 13, the American Institute of CPAs submitted a letter to the Treasury Department and the IRS requesting a delay of one year, until December 31, 2018, in the effective date of the partnership audit provisions under the Bipartisan Budget Act. In advocating for the one-year delay, the AICPA identified the following issues and concerns:

(1) Necessary regulations have not been issued by the IRS. —According to the AICPA, the time line for the IRS to consider public comments, prepare responses, and draft a new preamble and temporary regulations is too tight. Issuing temporary procedural regulations even months before their effective date that would, says the AICPA, require significant and immediate decisions by taxpayers, is inefficient, and imposes undue burdens on taxpayers and the IRS.

(2) Withdrawn regulations contained significant gaps. —The question of how to apply adjustments to partners’ outside basis and capital accounts was reserved. Without such guidance, says the AICPA, taxpayers are unable to make informed decisions, especially on needed revisions to their partnership agreements.

(3) Proposed technical corrections would clarify and modify elements of the Regime. —The AICPA states that the first set of proposed regulations mentions the possibility that enactment of the technical corrections provisions in the Technical Corrections Act of 2016 would require the IRS to modify and reissue portions of the regulations.

(4) Impact on financial reporting standards remains unclear. —It remains unclear and there are substantive disagreements, says the AICPA, about whether payment to the IRS as a result of examinations under the new audit regime represent obligations of a partnership or merely payments by a partnership on behalf of partners. The AICPA states that guidance under GAAP (Generally Accepted Accounting Principles) would need to exist in time for entities preparing financial statements covering periods ending as soon as March 31, 2018, and that this is unrealistic.

(5) Partnerships need to amend or draft their partnership agreements for the new Regime. —According to the AICPA, virtually every partnership currently operating in the United States will need to amend its partnership agreements to reflect the new audit regime, including establishing procedures for appointing, replacing and working with the new Partnership Representative, who replaces the Tax Matters Partner. Indemnity provisions, claw-back provisions, notice provisions, mandatory election provisions and other important provisions need to undergo discussion, drafting and approval by every partner. Many of the provision, says the AICPA, should properly take effect prior to the beginning of any tax year covered by the new audit regime—that is, by January 1, 2018. The AICPA states that there is “near unanimous agreement in the tax practitioner community that this timeframe is simply not feasible.”

(6) Impact of state tax law remains uncertain. —Most states, says the AICPA, have no provisions for collecting an audit assessment directly from a partnership operating within their borders. State revenue departments would have to resolve how they will be informed of the results of IRS audits under the new regime, and what new procedures they will need in order to receive the correct additional tax on their share of any adjustment. These matters require substantial time and resources, and, according to the AICPA, trying to address them while there is substantial uncertainty about how the new regime will work at the federal level further complicates and delays the task.

Proposed Regulations, NPRM REG-136118-15, 2017FED ¶49,739

Other References:

Code Sec. 6221

CCH Reference – 2017FED ¶37,952

CCH Reference – 2017FED ¶37,953

Code Sec. 6222

CCH Reference – 2017FED ¶37,958

Code Sec. 6223

CCH Reference – 2017FED ¶37,964

CCH Reference – 2017FED ¶37,965

Code Sec. 6225

CCH Reference – 2017FED ¶37,972

CCH Reference – 2017FED ¶37,973

CCH Reference – 2017FED ¶37,974

CCH Reference – 2017FED ¶37,975

Code Sec. 6226

CCH Reference – 2017FED ¶37,978

CCH Reference – 2017FED ¶37,979

CCH Reference – 2017FED ¶37,980

CCH Reference – 2017FED ¶37,981

Code Sec. 6227

CCH Reference – 2017FED ¶37,984

CCH Reference – 2017FED ¶37,985

CCH Reference – 2017FED ¶37,986

Code Sec. 6241

CCH Reference – 2017FED ¶38,033

CCH Reference – 2017FED ¶38,034

CCH Reference – 2017FED ¶38,035

CCH Reference – 2017FED ¶38,036

CCH Reference – 2017FED ¶38,036C

Tax Research Consultant

CCH Reference – TRC PART: 60,700

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CCHTaxGroup

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