IRS proposed exclusions from centralized partnership audit regime
TAX ALERT |
The IRS and Treasury have recently released a new set of proposed rules (see REG-123652-18) to the centralized partnership audit regime that address, among other things, the treatment Qualified Subchapter S Subsidiaries (‘QSubs’) as well as special enforcement matters – those warranting unique treatment outside of the normal regime.
Effective for tax years beginning on or after Jan. 1, 2018, the new centralized partnership audit regime – commonly called the BBA from the Bipartisan Budget Act of 2015 in which it was enacted – allows the IRS to audit partnerships at the entity level. While the bulk of the regulatory guidance regarding the BBA was finalized by the IRS and Treasury in December of 2018, there were some issues in which guidance was still needed – which the IRS identified in Notice 2019-06, as well as stated their intent to propose additional regulations. The IRS and Treasury recently followed through with that promise and issued a new set of proposed rules. In general, these new proposed rules address a myriad of nuanced, highly technical matters of the new audit regime, however, there are two proposed changes that are worth noting.
The first is concerning the treatment of QSubs. Specifically, the proposed regulations state that “…if a QSub is a partner in a partnership and [receives a schedule K-1], that partnership will not be eligible to […] elect out of the centralized partnership audit regime.” While this is not necessary surprising, it is somewhat contrary to the IRS’ position in Notice 2019-06. That is, although IRS stated that the treatment of QSubs were a concern, and as such partnerships with QSub partners would generally not be able to elect out of the regime, the Notice did state that the proposed regulation would treat QSubs in a similar fashion to S corporations – meaning that the ability of a partnership with a QSub partner to elect out of the BBA would be dependent upon their ability to meet certain requirements. The proposed rules eliminate that possibility, and instead apply a much stricter rule.
Second, and perhaps more notably, the proposed regulations set forth rules regarding the period of limitations for adjusting partnership-related items in special assessment cases. Generally, the IRS must adjust partnership-related items within three years from the date the partnership return was filed, the due date of the partnership return or the date an administrative adjustment request was filed. However, according to the IRS, it may not be apparent upon examination of a partner’s return that an adjustment to an item on that partner’s return would require an adjustment to a partnership-related item until that item is traced to a partnership. This delay can lead to issues when a partnership’s period of limitations differs from that of a partner – say, in cases in which the special six-year period of limitations applies, or in cases in which the partner has voluntarily extended their period of limitations.
Accordingly, the proposed regulations provide that, during an audit of a partner, the IRS may look through the partnership period of limitations and instead use the partner’s period of limitations for making adjustments to partnership-related items if the partner has control of the partnership (under section 267(b) and 707(b)), or if the partner has voluntary agreed to extend their period of limitations for making assessments under section 6501. This latter trigger, however, only applies if the statute of limitations extension expressly provides that the partner is agreeing to extend the time to assess partnership-related items.
Although these regulations are still in proposed form, taxpayers should nonetheless be cognizant of these new rules, and keep a close eye on them as they move through the notice and comment period on their way to final regulations.