Proposed regulations provide guidance on tax attribute adjustments
The IRS has recently released new proposed regulations (REG-118067-17) that provide guidance regarding how and when partnerships and their partners adjust tax attributes when the partnership chooses to pay a resulting tax liability at the entity level.
Under the centralized partnership audit regime, a partnership adjustment that is used in the determination of an imputed underpayment is generally taken into account by the partnership in the year in which the payment obligation arises. While items of income, gain, loss, deduction or credit are generally allocated out to the partners based on the principles of partnership taxation, there is no such allocation mechanism for adjustments that are taken into account in determining an imputed underpayment. Instead–barring an election to ‘push-out’–the determination is made at the partnership level, and the partnership then pays the resulting liability, called an imputed underpayment.
However, failing to provide for adjustments to a partner’s outside basis in the partnership for partnership adjustments that ultimately resulted in an imputed underpayment could lead to the possibility of taxation on the same income twice, once via the imputed underpayment, and again upon disposition of the partnership interest or cash distribution to a partner. Accordingly, the new proposed regulations provide guidance that seeks to mitigate this issue.
To do this, the proposed regulations provide for what is called a ‘notional’ item to be created with respect to a partnership adjustment. For increases in income or decreases in expenses, the notational item will be one of income or gain. Conversely, for decreases in income or increases in expenses, the notional item will be one of deduction or loss. These notional items are then allocated out to the partners in accordance with the guidance provided for in the proposed regulations. Once allocated out to the partners, they will increase or decrease their outside basis in the partnership based on the amount and nature of the notional item that has been allocated out to them.
In order to facilitate this, the proposed regulations state that the IRS is considering providing forms, instructions and other guidance requiring partnerships to provide information to their partners regarding the amount and nature of any changes to tax attributes, as well as any other information needed by the partners.
While this new guidance is welcomed by all, it clearly illustrates the complexity involved in what some initially thought was the ‘simpler’ approach of having an entity-level tax paid by the partnership. Among other issues, the task of providing information regarding the appropriate basis adjustment to ultimate affected partners will likely be tedious. If such information must be distributed in any event, as the IRS is considering, partnerships may find the push-out method to be more preferable to that of paying the entity level tax.