2018 Technical Corrections to the New Partnerships Audit RulesBy Alan M. Blecher | July 27, 2018
In late March, the President signed legislation that includes technical corrections to the new partnership audit rules that were introduced in the Bipartisan Budget Act of 2015. These rules are generally effective for tax years beginning after December 31, 2017 and were discussed in full in our October 2017 newsletter.
The overarching theme of the new rules is that any IRS adjustment due to a partnership-level audit will be assessed - and the resultant balance (the “imputed underpayment”) collected – from the partnership. Under the rules in effect for tax years prior to 2018, these adjustments flowed through to the respective partners, who were responsible for payment. These changes were felt necessary in order to centralize the collection process.
SCOPE OF THE NEW AUDIT REGIME
The 2018 technical corrections clarify that this new regime applies to “partnership-related items,” which are any items or amounts with respect to the partnership that are relevant in determining the income tax liability of any person, including any imputed underpayment. Prior to the technical corrections, the new regime applied to “items of income, gain, loss, deduction or credit.”
It is irrelevant whether the item or amount is reflected on the partnership’s return. A partnership-related item may thus include any item or amount relating to any transaction with, basis in, or liability of, the partnership. It also includes any partner’s distributive share of any item or amount of the partnership. Examples include:
- A partner’s transaction with the partnership other than in his capacity as a partner;
- The determination of the adjusted basis of a partner’s interest in the partnership or involving the basis of the partnership in partnership property; or
- The determination of partnership liabilities or the effect on a partner of a decrease or increase in a partner’s share of partnership liabilities.
These revisions to the scope of the new rules were felt necessary to clarify that the post-2017 audit rules are not narrower than the pre-2018 rules. This clarification extends to judicial review of a partnership adjustment.
The technical corrections also clarify that the new rules do not generally apply to self-employment taxes, the net investment income tax, withholding taxes for nonresident aliens or foreign corporations, or withholding taxes for foreign financial institutions and nonfinancial entities under the Foreign Account Tax Compliance Act. However, to the extent relevant, a partnership adjustment pertaining to income taxes is considered for purposes of determining the tax under these provisions.
The technical corrections also clarify provisions regarding the “push-out” election, pursuant to which a partnership may shift the burden for payment of the resultant tax from the partnership to the partners. The push-out election is a mechanism to correct an incongruity that exists under the new audit regime. The imputed underpayment which is generally collected at the partnership level is paid in the year that the adjustment is made, and thus may affect partners who were not partners for the year that was reviewed.
However, a partnership may elect – not later than 45 days after the date of the notice of the final partnership adjustment – to push out the adjustment to its reviewed-year partners. The technical corrections clarify that no assessment of tax, levy or other proceeding may be made against the partnership if a valid push-out election is made. The technical corrections allow adjustments to be pushed out to the “ultimate partner” in a tiered partnership structure – that is, a partnership in which some (or all) of the partners are themselves partnerships, or “S” corporations.
This technical correction codifies a position that the IRS has already taken in proposed regulations.
However, in so doing, Congress added a requirement that the tiered partnership submit a “partnership adjustment tracking report” to the IRS. The legislative history indicates that a partnership adjustment tracking report may include information such as identification of the partner’s own partners or shareholders, description and qualifying adjustments necessary to determine partnership-related items or the equivalent in the hands of those partners or shareholders, or other information necessary or appropriate to assessment and collection from tiers of partners in a push out. The requirement to file a partnership adjustment tracking report is in addition to the general requirement in a push-out situation that adjusted Schedules K-1 be provided to the partners indicating their share of any partnership adjustment to be used in filing an amended return.
The tiered partnership requirements apply even if the tiered partner has elected out of the new partnership rules itself with respect to the tax year that includes the reviewed year. The technical corrections also authorize the IRS to prescribe rules for trusts to whom an adjustment is pushed out. Proposed regulations treat trusts as partnerships for purposes of the push-out election with respect to tiered partnerships.
The technical corrections also clarify that when a push-out election is made, a reviewed-year partner is allowed to take into account both increases and decreases to its income tax. Previously, such a partner could only consider increases to its tax, but not decreases.
Under the new partnership audit regime, the amount of the imputed underpayment due from the partnership can be reduced if and to the extent that the partners agree to file amended returns and pay their share of the balance due themselves. The technical corrections provide for a “pull-in procedure” that permits partners to pay the tax that would be due under the amended return procedure, but without having to file actual amended returns. The partnership can reduce the imputed underpayment by the amount paid by the partners who follow this procedure. Payment is due by the same filing deadline for filing amended returns – within 270 days after the notice of proposed partnership adjustment is mailed.
Although the partners availing themselves of this procedure are required to provide information necessary for the IRS to substantiate that the tax was correctly paid, the partners do not file amended returns. The legislative history explains that this alternative mechanism provides the benefits of an amendment without the “corollary effects on the partners’ returns,” aside from adjusting the attributes for the effects of the adjustments in other tax years. The partners are left with the results of an amendment without, presumably, opening the statute of limitations. The pull-in procedure does not require the participation of all partners.
While these technical corrections clarify some of the uncertainty surrounding the new partnership audit rules, additional guidance is still needed to implement certain areas. In the meantime, it is important to evaluate the specific facts and circumstances of a partnership on a case-by-case basis to determine the overall impact these new rules will have in the event of an audit.
About Alan M. Blecher
Alan M. Blecher, JD, is a Principal at Marks Paneth LLP. Mr. Blecher has considerable experience serving high-income and high-net-worth individuals and their closely held businesses. He focuses especially on partnerships, limited liability companies and S corporations. He has been in public accounting since 1985 and has been involved in tax planning for numerous transactions. These include transactions involving public debt offerings, sales of family businesses and restructurings of distressed entities, among others. Mr. Blecher... READ MORE +