United States

Arizona conforms to recent federal partnership audit changes

TAX ALERT  | 

On May 11, 2016, Arizona Gov. Doug Ducey signed Senate Bill 1288, which conforms Arizona law to the Internal Revenue Code in effect on Jan. 1, 2016, including federal changes regarding how partnerships are audited as enacted under the Bipartisan Budget Act of 2015.

On Nov. 2, 2015, President Obama signed into law the Bipartisan Budget Act of 2015, which implements a single unified audit, adjustment and collection procedure for all partnerships for tax years beginning after 2017. Under the unified procedure, 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. Under this procedure, an adjustment is determined at the entity level, and the partnership itself must pay 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. Alternatively, partnerships may elect to issue adjusted or amended Schedules K-1, which will trigger an obligation of the historical partners for the audited year to pay additional taxes in the current year, based on the amount the partners would have owed if the original error on the partnership return had not been made.

Pursuant to Senate Bill 1288, a partnership that is issued a final determination by the IRS under the unified procedure and that does not make the election to issue adjusted or amended Schedules K-1 must file an Arizona return for the reviewed year within 90 days after the federal final determination showing the federal adjustments. If the Arizona return reflects a net increase in taxable income, the partnership must pay the additional state tax due in lieu of passing the adjustments through to the partners, and such tax will be imposed on the Arizona sourced portion of any increase at the highest individual rate. For this purpose, underpayment interest is computed for the period beginning on the day after the partnership return due date for the reviewed year.

In the alternative, if the federal final determination results in a net reduction in Arizona taxable income or a net increase where the partnership elects to issue an adjustment through to each partner, the partnership must furnish to each partner and to the Arizona Department of Revenue a statement of the partner’s share of the adjustment. The partners must file amended returns within 150 days after the federal final determination to report the share of the partnership adjustment as reported to them in the statement. A partnership that had a net increase and failed to timely provide the required statements to its partners or the department will be required to pay the tax in lieu of the partners reporting the adjustment.

Arizona is one of the first jurisdictions to specifically address conformity with the Bipartisan Budget Act of 2015. Partnerships and their partners should consider the impact of Senate Bill 1288 in context of the Bipartisan Budget Act of 2015 and watch for similar conforming legislation in other states.  

In addition to conforming to the amended federal partnership audit rules, Senate Bill 1288 provides that, for taxable years beginning after Dec. 31, 2015, the partnership return due date is moved from the fifteenth day of the fourth month to the fifteenth day of the third month after the close of the tax year. Partnerships and their partners with an Arizona filing requirement should adjust their tax calendars accordingly.

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