Fine-Tuning The New Partnership Audit Regime
The omnibus appropriations bill signed into law on March 23, 2018, included several technical corrections to the new partnership audit regime, originally enacted in 2015, effective for partnership taxable years beginning in 2018. Many of the technical corrections were included in a technical corrections bill proposed in 2016 but never enacted. Other changes echo proposed regulations promulgated in 2017, giving legislative authority to those rules. Key among the technical corrections are authorization to use a push-out procedure in tiered partnerships, a new “pull-in” procedure, and rules governing partnerships that do not pay assessments following an audit. Note that the omnibus bill generally did not include technical corrections relating to the tax reform legislation enacted in December 2017 — with one exception to address the so-called “grain glitch,” which had unintentionally provided farmers with a larger Section 199A deduction from selling their crops to cooperatives than if they sold crops to non-cooperative buyers.
Changes to the Push-Out Procedure
The technical corrections provide statutory authorization for a “tiered push-out procedure,” i.e., a mechanism by which an upper-tier partnership receiving a push-out statement under Internal Revenue Code Section 6226 can in turn push out the adjustment to its own partners. The Internal Revenue Service had issued proposed regulations providing for such a tiered push-out procedure in December 2017.
The technical corrections also permit a partner receiving a push-out statement to take into account both increases and decreases in tax — the rules originally permitted only tax increases to be taken into account.
New Pull-In Procedure
The partnership audit rules originally provided that a partnership could reduce an imputed underpayment amount if one or more partners filed amended returns taking into account their share of the underpayment. This approach was unattractive to many partnerships and their partners, who objected to filing amended returns for administrative and other reasons — for example, tax-exempt organizations whose information returns are public records. The technical corrections include a new method for reducing the partnership-level imputed underpayment, nicknamed the “pull-in procedure,” which requires partners to pay their share of the tax and adjust their tax attributes in the same manner as if they had filed amended returns for the reviewed year — and any other year with affected tax attributes — without actually being required to file amended returns.
Failure to Pay the Imputed Underpayment
The technical corrections provide that if a partnership fails to pay an imputed underpayment amount within ten days of the date the IRS provides notice and demand for payment, the interest rate applicable to the underpayment amount increases by two percentage points, and the IRS can assess the partners of the partnership — in the adjusted year — their proportionate share of the partnership’s tax liability. Analogous provisions apply if a partnership receiving a push-out statement fails to either pay its share of an underpayment amount or push-out statements to its own partners.
Other Notable Partnership Audit Technical Corrections:
- Scope of Partnership Audit Regime: Definition of “partnership adjustment” expanded to include adjustments to any “partnership-related item,” which in turn appears to be broader in scope than the concept of “partnership items” under the former law, the Tax Equity and Fiscal Responsibility Act of 1982, or TEFRA. This change appears to have been designed to reduce disagreement and litigation, which proliferated under the TEFRA regime, over whether an adjustment is properly made in a partnership level or partner level proceeding.
- Netting Rules: Streamlining and clarifying changes regarding netting of various types of adjustments, generally consistent with the shift to a regime that applies to all “partnership-related items” rather than specific categories of partnership items. Note that a new provision now prohibits reducing an imputed underpayment by any adjustment if any partner might be subject to any limitation in taking that adjustment into account at the partner level — for example, an adjustment that increases losses that may be passive losses generally is not taken into account in computing the imputed underpayment, because some partners could be limited in their ability to fully use a passive loss.
- Timing of Withholding: Clarification that if a partnership adjustment results in a withholding obligation, that obligation arises in the adjustment year. As a result, partnerships should not face incremental penalties or interest for failure to withhold in the reviewed year.
- Scope of Partnership Audit Regime: Clarification that the partnership audit rules do not apply to taxes imposed — or require withholding — under the self-employment, net investment income, or non-U.S. taxpayer withholding tax provisions, though partnership audit adjustments are taken into account for purposes of determining tax under these other tax provisions.
- CFC and PFIC Partners: Provision that if any controlled foreign corporation, a CFC, or passive foreign investment company, a PFIC, is a partner in a partnership, each U.S. shareholder of a CFC or person making a qualifying electing fund, or QEF, election with respect to an interest in a PFIC will be treated as a partner in the partnership for purposes of the partnership audit rules.
Major aspects of the technical corrections provide rules helpful to partnerships and their partners, including the new pull-in procedure, the statutory authorization for the tiered push-out regime, and certain of the netting and timing rules described above. The pull-in and tiered push-out rules, in particular, should be taken into account in negotiating and drafting partnership agreements. However, another provision of the technical corrections may have the greatest impact on the future of partnership tax controversy matters: the expansion of the partnership audit regime from applying to any item of “income, gain, loss, deduction or credit” to applying to any “partnership-related item.” By defining the scope of the partnership audit regime to include any item or amount with respect to the partnership that is “relevant . . . in determining the [income] tax liability of any person” — even if the item does not appear on the partnership’s return — the technical corrections may prevent taxpayers from arguing in audit or judicial proceedings that the IRS cannot adjust their income in a partnership level proceeding because the adjustment does not pertain to a type of partnership item enumerated in the original version of the rules. Similar litigation has proliferated under the TEFRA regime and its distinction between partnership items and partner level items. The shift to the “partnership-related item” concept in the technical corrections appears designed to prevent the proliferation of such litigation under the new partnership audit regime.