Effective for tax years beginning on or after Jan. 1, 2018, the procedures by which the IRS examines partnership tax returns, and collects any resulting liability, has been dramatically overhauled . Handled outside the new regime are so-called, “special enforcement matters,” a broadly defined term, but one that generally includes tax issues requiring special handling, such as criminal investigations or cases where collection might be jeopardized. The IRS has the statutory authority to add to this list through promulgated regulations.
In Notice 2019-6, the IRS announced its intent to do just that, describing two additional special enforcement situations that it feels require special handling. The first identified situation is one in which the IRS discovers an adjustment to a partnership-related item (that is, one normally in scope of the new rules) in connection with an adjustment to a non-partnership item of a partner under examination. If the adjustment to the partnership-related item would be based, in whole or in part, on information provided by, or under control of, the examined partner, then anticipated guidance would provide that this adjustment could be made outside of the new rules, in a proceeding with the partner alone.
The other situation identified in the notice involves a relatively narrow technical issue, regarding who can elect out of the new audit regime. By statute, a partnership with fewer than 100 partners during a year, and having only specified types of persons as partners (generally, individuals, estates, and corporations), can choose not to be subject to the new rules. S corporations are eligible partners, but each shareholder of an S corporation partner counts towards the 100 owner cap. It had become apparent that, because a qualified subchapter S corporation (a disregarded subsidiary of an S corporation, also known as a “QSub”) is technically a type of C corporation for purposes of the tax law, such QSubs could be used to circumvent the 100 owner limit (as the shareholders of their parent S corporations would not count). The notice indicates that future regulations will provide that partnerships with a QSub as a partner are not eligible to elect out of the new rules, unless the partnership would meet the 100 owner limit, even including the QSub’s parent’s shareholders.
Although the proposals set out in this notice may be revised prior to the formal issuance of proposed regulations, and then may be revised further prior to finalization, notices of this sort provide insight on the IRS’s current thinking on matters. As such, they should be considered by taxpayers conducting tax planning, not withstanding their non-binding nature.