The Treasury Department recently proposed regulations governing tax audits of large partnerships. While the new rules are scheduled to go into effect for tax years beginning in 2018, strategic decisions should be considered that make it important to understand the regulations and their impact on partnerships.
The Trump administration's freeze on new regulations has delayed formal issuance of the rules. However, the potential shifting of economic risks and burdens to a new generation of partnership interest holders must be accounted for and understood.
Section 1101 of the Bipartisan Budget Act of 2015 was enacted into law on Nov. 2, 2015. On Jan. 18, 2017, the Treasury issued proposed regulations regarding its implementation. Section 1101 of the BBA repeals the TEFRA and electing large partnership rules governing partnership audits and replaces them with a new "centralized partnership audit regime." In general, this new regime assesses and collects tax at the partnership level rather than at the partner level.
Here are some notable aspects of the new regulations:
Electing out of the Centralized Partnership Regime
For partnerships that elect out, the IRS will be required to 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 decision to elect out must be made on a timely filed partnership tax return.
There are two conditions that must be met for a partnership to be eligible to elect out of the centralized partnership audit regime. First, a partnership must have 100 or fewer partners. Second, a partnership must only have eligible partners. Under the statute, eligible partners are individuals, C corporations, foreign entities that would be treated as C corporations if they were domestic, S corporations, and estates of deceased 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.
First, a partnership may make the election only on a timely filed partnership return (including extensions) for the partnership taxable year to which the election relates. Therefore, a partnership may not make the election on a return that is filed after the due date for the taxable year. An election out made by a partnership may only be revoked with the consent of the IRS. Second, a partnership that elects out of the centralized partnership audit regime must notify each of its partners that the partnership made the election. This notification must be made within 30 days of making the election. However, the proposed regulations do not mandate the form of the notice that the partnership must provide to its partners. Consequently, the notice may be in writing, electronic, or other form chosen by the partnership.
Further, between now and the effective date of BBA 1101, upon the receipt of a notice of examination/audit of a partnership from the IRS, there is an option to elect in to the provisions of BBA 1101 should such treatment be strategically desired.
Eligibility to Serve as Partnership Representative
Under the centralized partnership audit regime, partnerships will no longer have a "tax matters partner," and will instead have a "partnership representative." Proposed §301.6223-1 provides rules relating to the designation of a partnership representative.
A partnership representative does not need to be a partner of the partnership. It can be any entity with a substantial presence in the United States, including the partnership's management company. If an entity is designated as the partnership representative, the partnership must identify and appoint an individual to act on the entity's behalf, and the individual must also have a substantial presence in the United States.
The designation of a partnership representative is made on the partnership’s return and must be made for each tax year.
Election for the Alternative to Payment of an Imputed Underpayment
Proposed §301.6226-1(a) provides that a partnership may elect under section 6226 to “push out” adjustments to its reviewed year partners rather than paying an imputed underpayment. If a partnership makes a valid election in accordance with proposed §301.6226-1, the partnership is no longer liable for the imputed underpayment.
A partnership may only make an election under section 6226 within 45 days of the date the final partnership adjustment was mailed by the IRS. The time for filing the election may not be extended. The election must be signed by the partnership representative and filed with the IRS in accordance with forms, instructions, and other guidance.
The new centralized partnership audit regime drastically changes the procedural processes associated with partnership audits. Partnerships, including limited liability companies and other business entities treated as partnerships for federal tax purposes, should carefully consider today how they will navigate these new rules in 2018.
Seth Cohen is an experienced tax compliance litigator at Withers Bergman
who represents clients in U.S. federal, state and local controversies.
Joshua Becker's practice at the law firm Withers Bergman
focuses on domestic and international income tax planning and controversy matters.