States beginning to respond to federal partnership changes
TAX BLOG |
On Nov. 2, 2015, President Obama signed into law the Bipartisan Budget Act of 2015, which repealed the so-called TEFRA partnership audit procedures enacted in 1982 and replaced them with a single unified audit, adjustment and collection system for all partnerships for tax years beginning after 2017. The voluntary procedures for electing large partnerships were also repealed.
Under the new rules, any adjustments to tax items of a partnership and any partner's distributive share of such adjustments will be determined at the partnership level on a unified basis with only a single representative of the partnership and all of its direct and indirect partners.
When an adjustment is determined at the entity level, it is anticipated that most partnerships will elect to issue adjusted or amended Schedules K-1 that will trigger an obligation of the historical partner for the audited year to pay additional taxes in the current year, based on the amount the partner would have owed if the original error on the partnership return had not been made. If the partnership fails to elect that approach, the partnership itself must pay a tax on the understated income on behalf of its partners at each partner's top tax rate, which may vary depending on whether the partners are individuals, corporations or tax-exempt entities.
These new procedures create a significant disconnect between the treatment of partnerships and their partners at the federal and state levels.
Even in states that 'automatically' conform to federal changes, the interaction may not be clear, leaving partnerships and their partners with significant federal-to-state reconciliation uncertainties and a possible increase in state income tax compliance costs.
Sensitive to the potential state-level impact of this issue on taxpayers, states have begun to provide guidance regarding the application of the Bipartisan Budget Act of 2015 for state income tax purposes and to pass legislation to close the conformity gap. For example, Arizona's legislature is considering legislation introduced on Jan. 26, 2016, that would revamp procedures and statutes of limitations applicable to state reporting of federal adjustments of partnership income.
Partnerships and their partners should review the state tax implications of the Bipartisan Budget Act of 2015 and keep a close eye on how the states handle the resulting conformity issues.